Luvu Brands, Inc. - Annual Report: 2018 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-K

For the fiscal year ended June 30, 2018

Commission file number:   000-53314

  Luvu Brands, Inc.

(Exact name of Company as specified in its charter)

        or organization)

2745 Bankers Industrial Drive, Atlanta, Georgia 30360

(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code: (770) 246-6400

Securities registered pursuant to Section 12(b) of the Act:  None

Securities registered pursuant to Section 12(g) of the Act:  Common Stock, $.01 par value

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ¨ YES x  NO

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. ¨  YES  x NO

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  x  YES     ¨  NO

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding twelve months (or for such shorter period that the registrant was required to submit such files)    x YES   ¨   NO

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. 

If an emerging growth company, indicate by checkmark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  o

 Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨  YES  x  NO

The aggregate market value of the common stock held by non−affiliates of the registrant computed by reference to the closing price of the common stock on December 29, 2017, the last trading day of the registrant’s most recently completed second fiscal quarter, was $1,459,056.

The number of shares of Common Stock, $.01 par value, outstanding as of the close of business on

October 9, 2018 was 73,452,596. 

Luvu Brands, Inc.

Index to Annual Report on Form 10-K

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 FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K (“Annual Report”) for Luvu Brands, Inc. (“Luvu Brands” the “Company” “we” “our” or “us”) may contain forward-looking statements, which include statements that are predictive in nature, depend upon or refer to future events or conditions, and usually include words such as “expects,” “anticipates,” “intends,” “plan,” “believes,” “predicts”, “estimates” or similar expressions. In addition, any statement concerning future financial performance, ongoing business strategies or prospects and possible future actions are also forward-looking statements. Forward-looking statements are based upon current expectations and projections about future events and are subject to risks, uncertainties and the accuracy of assumptions concerning the Company, the performance of the industry in which they do business and economic and market factors, among other things. These forward-looking statements are not guarantees of future performance.  You should not place undue reliance on forward-looking statements.

Forward-looking statements speak only as of the date of this report, presentation or filing in which they are made. Except to the extent required by federal securities laws, the Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Our forward-looking statements in this report include, but are not limited to:

 These forward-looking statements are subject to risks, uncertainties and assumptions about us and our operations that are subject to change based on various important factors, some of which are beyond our control. The following factors, among others, could cause our financial performance to differ significantly from the goals, plans, objectives, intentions and expectations expressed in our forward-looking statements:

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PART I.

ITEM 1.        Business

General

Luvu Brands, Inc. designs, manufactures and markets a portfolio of consumer lifestyle brands through the Company’s websites, online mass merchants and specialty retail stores worldwide. Brands include: Liberator^®, a brand category of iconic products for enhancing sensuality and intimacy; Avana^®, inclined bed therapy products, assistive in relieving medical conditions associated with acid reflux, surgery recovery and chronic pain; and Jaxx^®, a diverse range of casual fashion daybeds, sofas and beanbags made from virgin and re-purposed polyurethane foam. Many of our products are offered flat-packed and vacuum compressed to save on shipping and reduce our carbon footprint. The Company is headquartered in Atlanta, Georgia in a 140,000 square foot vertically-integrated manufacturing facility that employs over 160 people. Bringing sewn products manufacturing back to the USA and creating innovative consumer brands are core to the Company's operating principles.

 The Company manages, markets, and distributes its products directly to consumers through several websites that include:  liberator.com, theliberator.co.uk, jaxxliving.com, and avanacomfort.com. We reach additional consumers through a retail concept store located within our Atlanta factory.

Unless the context requires otherwise, all references in this report to the “Company,” “Luvu Brands,” “we,” “our,” and “us” refers to Luvu Brands, Inc. and its subsidiaries.

Our executive offices are located at 2745 Bankers Industrial Dr., Atlanta, GA 30360; our telephone number is +1-770-246-6400.  

Corporate History

The Company was incorporated in the State of Florida on February 25, 1999, under the name of WES Consulting, Inc. On October 19, 2009, the Company entered into a Merger and Recapitalization Agreement (the “Merger Agreement”) with Liberator, Inc., a Nevada corporation (“Old Liberator”).  Pursuant to the Merger Agreement, Old Liberator merged with and into the Company, with the Company surviving as the sole remaining entity (the “Merger”). On February 28, 2011, the Company name was changed from WES Consulting, Inc. to Liberator, Inc.

Effective November 5, 2015, the Company changed its corporate name from Liberator, Inc. to Luvu Brands, Inc. to reflect its broader offering of wellness and lifestyle products designed for mass market channels.

Overview of our Facilities and Operations

Since inception we have used a vertically integrated business model, with manufacturing, distribution, product development and marketing performed in-house. We believe this allows us to create new products with reduced lead times at a lower cost while enabling us to quickly respond to market and customer demands for our existing products. For our wholesale accounts, being able to fulfill large orders with shorter turnaround times allows us to capture business during December and February when wholesale customers make just-in-time holiday purchases.

Our 140,000 square foot facility on eight acres is located in a suburb of metro Atlanta, Georgia and includes manufacturing and distribution, sales and marketing, product development, customer service and administrative staff. All of the Liberator, Jaxx and Avana branded products are designed, produced and marketed from our facility in Atlanta, Georgia where we currently employ over 160 people. As of the date of this report, the Company employs 129 people in Production and Distribution, 3 people in Product Development, 13 people in Sales and Marketing, and 18 people in Administration. The Company’s employment levels may change seasonal based on current and anticipated order levels.

Our manufacturing operation has two CAD controlled fabric cutters and one CAD controlled foam contouring machine and two state-of-the-art conveyor unit production sewing systems. We believe that our in-house manufacturing capabilities have enabled us to achieve greater efficiencies and cost savings, as well as strict control over the entire manufacturing cycle including raw material procurement, finished goods production and logistics optimization. In addition to providing us with greater production flexibility, our in-house manufacturing provides us with the opportunity to improve fulfillment response time, reduces the risk of out-of-stock situations, limits finished goods obsolescence and improves overall operating margins.

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Because all cutting, sewing, foam contouring, assembly and vacuum packaging are performed in-house, we believe we can exercise greater control over product quality and respond faster to changing customer demands, which gives us a competitive advantage over companies that utilize out-sourced sewing services. We can source raw materials from multiple domestic and foreign suppliers and we have supply contracts in place to produce our specialty fabrics under specific quality control and performance standards with just-in-time deliveries.

During fiscal 2017, we expanded the conveyor sewing system for our Jaxx and Avana products and, in the second half of fiscal 2017, we installed new roll pack and compression equipment used for the majority of our foam-based products. All of these actions resulted in increased throughput and lower production costs in these operations.

All business activity of the Company is done through our wholly-owned subsidiary, OneUp Innovations, Inc. (“OneUp”). OneUp was organized in 2000 and began operations in 2002.

Business Strategy

Our goals are to achieve long-term growth and profitability and diversify our sales base. We plan to achieve these goals using the following strategies:

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Products, Principal Markets and Methods of Distribution

Liberator Products

We developed a product category which we call “Liberator Bedroom Adventure Gear”^®. Many of the pieces in this product line are designed to elevate, rock and create surfaces and textures that expand the sexual repertoire and make the act of love more exciting. Liberator Bedroom Adventure Gear combines functional design with sensuous textures that transform ordinary bedrooms into supportive landscapes for intimacy. Liberator products present angles, elevations, curves and motion that help people of all sizes, including those with back injuries and other medical conditions, find comfortable ways to connect intimately while assisting their stamina and performance.

 Liberator foam-based products (called “Liberator Shapes”) are manufactured in a variety of heights and widths to accommodate variations in the human body. They consist of differently shaped cushions and props that are available in an assortment of fabric colors to add to the visual excitement. Each of the product profiles of the Liberator Shapes is unique, designed to introduce positions to the sexual experience that were previously difficult to achieve or impossible to achieve with standard pillows or cushions. Liberator Shapes are manufactured from structured polyurethane foam, cut at various angles, platforms and profiles. The foam base is encased in a tight, fluid resistant polyester shell, helping the cushions to maintain their shape.  The original offering of the Liberator Wedge^® and Ramp^®, sold as a set, continue to be our best-selling items. All of the Liberator Shapes are also available in our Black Label Series which includes blindfolds and snap-on Velcro cuffs.

We have also developed larger profile designs that are commonly referred to as “sex furniture”. Most of the sex furniture pieces are made from contoured urethane foam and covered in a variety of fabrics and colors. These items are marketed as the Esse^®, Flip Stage^®, Equus Wave^® and the Equus^®.  Other larger designs include products based on shredded polyurethane foam encased in a wide range of fabric types and colors and sold under our Zeppelin^® product offering. The Liberator larger profile designs can also be used as seating when not being used for relaxed interaction and creative intimacy.

We conduct our wholesale business for Liberator sexual wellness products through four primary channels: (1) adult and female friendly retailers, flash sites and specialty boutiques, (2) e-tailers who sell our products through adult, mass market, drug and other sites offering sexual wellness products, (3) mail order catalogers, and (4) wholesale distributors of adult / sexual wellness products. These wholesale accounts have approximately 950 retail locations and/or websites in the United States and Canada. We have a growing number of retailers who have added a dedicated Liberator exhibition concept to their merchandising space. We also sell our products in Europe through a Netherlands-based third-party fulfillment service.

All products sold under the Liberator brand provided 44% and 45% of our revenues for our fiscal years ended June 30, 2018 and 2017, respectively. 

Products Purchased for Resale

Beginning in 2006, we began importing high-quality pleasure objects from around the world. These resale products provided 15% and 23% of our revenues in each of our fiscal years ended June 30, 2018 and 2017, respectively.

Jaxx Casual Seating

The Company sells a line of contemporary casual indoor and outdoor seating under the Jaxx^® brand. Jaxx is an offshoot from Liberator manufacturing as it provides additional revenue from repurposing our polyurethane foam trim into shredded beanbag fill. The Jaxx product line also includes solid foam indoor furniture collections and outdoor furniture collections that use polystyrene bead filling. The Jaxx product line and accessory products are sold through the following four wholesale channels: (1) beanbag e-tailers, (2) mass marketers, (3) mail order catalogers, and (4) retail furniture stores. The Company also owns and manages a website under the URL www.JaxxLiving.com for direct to consumer sales of Jaxx products. Jaxx products provided 22% and 18% of our revenues in each of our fiscal years ended June 30, 2018 and 2017, respectively. Sales of Jaxx products increased 23% from fiscal 2017 to fiscal year 2018 to $3.7 million.

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The contemporary seating business is highly competitive. We believe we can compete effectively on the basis of product quality, design, customer service and price. We believe that our primary competitive advantages are consumer recognition of the Jaxx brand, as well as distribution through the multiple sales channels where consumers prefer to purchase.

Avana Comfort Products

The Company also sells a unique collection of comfort products that aid in sleep, meditation, and relaxation under the Avana^® brand. The Avana product line is sold through e-merchants, mail order catalogers and through our website under the URL www.AvanaComfort.com. Our Avana products provided 14% and 9% of our revenues in our fiscal years ended June 30, 2018 and 2017, respectively. Sales of Avana products increased 53% to $2.3 million in fiscal 2018 over fiscal 2017.

Sales and Distribution

Our sales personnel are organized by geographic market and by customer type. In North America, we have sales personnel who routinely visit sexual wellness retailers to assist in product training, merchandising and stocking of selling areas. Through our in-house wholesale sales organization, we engage retailers directly and then either ship to them on a wholesale basis or provide fulfillment services by drop-shipping directly to their customers.

 In international markets, the Company has shifted from a licensee model to a direct sales model with the addition of a US-based salesperson. This salesperson is responsible for wholesale sales, marketing operations and customer service in the European Union and other international markets. Customer orders are filled from our third-party warehouse in the Netherlands or directly from our facilities in Atlanta. Total international sales represented approximately 4% of our total net sales in the year ended June 30, 2018 and 2% of total net sales in the year ended June 30, 2017.

As is customary in the sexual wellness and casual furniture industry, sales to customers are generally made pursuant to purchase orders, and we do not have long-term or exclusive contracts with any of our retail customers or wholesale distributors. We believe that our continuing relationships with our customers are based upon our ability to provide a wide selection and reliable source of sexual wellness and casual furniture products, combined with our expertise in marketing and new product introduction.

Internet Websites

Since 2002, our Liberator website located at www.Liberator.com has allowed our customers to purchase our Liberator merchandise over the Internet.  We design and operate our websites using an in-house technical and creative staff.

Our www.Liberator.com website is intended to be an entertainment and educational venue where consumers can watch product demonstration videos, videos on sexual wellness topics and humorous videos on the many facets of human sexuality.

Our www.JaxxLiving.com website offers contemporary indoor and outdoor seating to the young adult and children’s market.

Our www.AvanaComfort.com website blends rest, relaxation and health products in an offering that appeals to a broad range of consumers.

Our corporate website is www.LuvuBrands.com . There we make available copies of Luvu Brands documents, news releases and our filings with the U.S. Securities and Exchange Commission, the “SEC”, including financial statements.

Unless specifically set forth to the contrary, the information that appears on our websites is not part of this annual report.

Research and Development

As a consumer-driven innovation company, we use consumer and market research to better understand consumer needs. This research guides our product development and marketing teams in the design and delivery of our products and customer experience. Our product development expenses were $150,742 in the year ended June 30, 2018, and $166,467 in the year ended June 30, 2017.

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Sources and Availability of Raw Materials

We obtain all of the raw materials and components used to produce our products from outside sources. A number of components, including certain fabrics and zippers, are sourced from suppliers who currently serve as our sole or primary source of supply for these components. We believe we can obtain these raw materials and components from other sources of supply, although we could experience some short-term disruption in our ability to fulfill orders in the event of an unexpected loss of supply from one of the primary suppliers. We utilize dual sourcing on targeted components when effective.

The Trump administration and members of the U.S. Congress have made public statements indicating possible significant changes in U.S. trade policy and have taken certain actions that may impact U.S. trade, including imposing tariffs on certain goods imported into the United States. Any changes in U.S. trade policy could trigger retaliatory actions by affected countries, resulting in “trade wars,” could increase the costs for goods imported into the United States. If these consequences are realized, the cost of certain raw materials, parts or components used in our products may materially increase. Such an increase may materially and adversely affect our sales and our business, as we may increase the price of our products. If any increase in costs of goods cannot be passed on to our customers, our business and profits may be materially and adversely affected.

Major Customers

Our ten largest customers (excluding our own e-commerce sites and retail store) accounted for approximately 48% of net sales for the year ended June 30, 2018 and 38% of net sales for the year ended June 30, 2017. Sales to (and through) Amazon accounted for 33% of our net sales during the year ended June 30, 2018 and 30% of our sales for the year ended June 30, 2017. The loss of, or a significant adverse change in our relationship with, any of our largest customers could have a material adverse effect on our business, prospects, results of operations, financial condition or cash flows.  

Competition

We compete with other manufacturers, distributors and marketers of wellness, lifestyle and casual seating, both within and outside the U.S. The sexual wellness and furniture industries are highly fragmented and competition for the sale of such products comes from many sources. These products are sold primarily through retailers (independent retailers, drug store chains, and mass market retailers), distributors, and direct sales channels (internet marketing and mail order companies).

For Liberator products, we believe that our primary competitive advantage is consumer recognition of our brand. Due to the strength of our brand, we have no direct competition for the majority of our Liberator branded products. In fact, many e-commerce websites refer to Liberator as a product category and not as a discrete product. And since we sell through multiple sales channels, we provide consumers with the ability to shop for Liberator intimacy products in an environment or website that they are most comfortable in. We also believe that we differentiate ourselves from conventional sexual wellness products based on our utility of design and overall customer satisfaction as it relates to enhanced intimacy.

For our Products Purchased for Resale, competition among retailers of adult products and web based marketers is high. Although we compete with retail, catalog, and internet businesses and now mass and drug retailers that sell sexual wellness products including vibrators, pleasure objects, accessories and similar merchandise, we believe that this opens new channels of distribution for our Liberator products and that we are able to compete favorably as our Liberator products are unique, are couple-centric, and are assistive devices for couples with sexual limitations and issues.

For the Liberator e-commerce website, other competitive factors include the effectiveness of our electronic customer mailing lists, maintaining natural search listing, advertising response rates, website design and functionality. The broad range of designs, color choice, fabrics and accessories that we offer helps to differentiate us and allows us to compete favorably against many other adult or sexual wellness websites. Liberator.com also competes against numerous mainstream websites, many of which have a greater volume of web traffic, greater financial strength and marketing resources.

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 We believe competition in our industries is based on, among other things, the ability to deliver the right product at the right time, product quality and safety, innovation, customer service and price. We believe we compete favorably with other companies because of our ability to provide a broad product offering for customers, our vertically-integrated manufacturing operation which allows us to quickly respond to customer demand, our commitment to quality and safety, and our commitment to minimizing our environmental impact.

Our future competitive position will likely depend on, but not be limited to, the following:

Government Regulation

We are subject to customs, truth-in-advertising and other laws, including consumer protection regulations that regulate the promotion and sale of merchandise and the operation of warehouse facilities. We monitor changes in these laws and believe that we are in material compliance with applicable laws.

Intellectual Property

The Liberator trademark is registered with the United States Patent and Trademark office and with the registries of many foreign countries. In addition we were issued approximately 20 other product name trademarks and trade names including: “Bedroom Adventure Gear”^®, Ramp^®, Wedge^®, Stage^®, Esse^®, Zeppelin^®, Hipster^®, Wing^®, Equus^®, Jaxx^®, Avana^®, and Bonbon^®. In August 2005, we were issued utility patent number US 6,925,669 “Support Cushion and System of Cushions.” We believe our trademarks and patent have significant value and we intend to continue to vigorously protect them against infringement.

Employees and Labor Relations

As of September 21, 2018, we had 163 employees (129 in production and warehouse operations, and 34 in sales, marketing and administrative operations).  Additional staffing is typically required to support the peak holiday period through Valentine’s Day.  None of our employees are represented by a union. We have had no labor-related work stoppages, and we believe our relationships with our employees are good.

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 Seasonality

Our business is seasonal and, as a result, revenues will vary from quarter to quarter. During the past three years, we have realized an average of approximately 29% of our annual revenues in our second quarter, which includes Christmas, and an average of approximately 25% of our revenues in the third quarter, which includes Valentine’s Day.

Financial Information about Our Business Segments and Geographic Areas

We conduct our business through two primary sales channels: Direct (consisting of our Internet websites and our Atlanta store) and Wholesale (consisting of our stocking reseller, drop-ship, contract manufacturing and distributor accounts). During our last two years, substantially all of our revenue was generated within North America, and all of our long-lived assets are located within the United States. The following is a summary of our revenues:

Net sales in the Other channel consists primarily of shipping and handling fees derived from our Direct business.

Direct

The following is a summary of our Direct business net sales and the percentage relationship to total revenues:

Wholesale

The following is a summary of our net sales to Wholesale customers and the percentage relationship to total revenues: 

As of June 30, 2018, the Company has over 1,000 active wholesale accounts, most of which are located in the United States.

Sales by Product Type

The following table represents the dollars and percentage of net sales by product type:

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Liberator - Liberator products consist of items that are manufactured by us and are intended for sale in the sexual health and wellness market. Liberator products are sold to retailers and distributors as well as directly through our three e-commerce sites and single retail store. Net sales of Liberator products decreased 5% during the year ended June 30, 2018, from the comparable year earlier period. This decrease is primarily related to lower sales to brick-and-mortar retailers as consumers increasingly purchase through e-merchants.

Jaxx - Jaxx products are contemporary seating products manufactured by us and sold under the Jaxx brand. Jaxx products are sold to e-merchants and retailers as well as directly through our e-commerce site. Net sales of Jaxx products increased 23% during the year ended June 30, 2018, compared to the prior year. This increase is primarily due to greater sales of Jaxx products to (and through) Amazon and other e-merchants and an expanded product offering of outdoor and solid foam furniture products.

Avana - The Avana product line is a unique collection of comfort products that aid in sleep, meditation, and massage. Avana products are sold through e-merchants, mail order catalogers and through our e-commerce site. Net sales of Avana products increased 53% during the year ended June 30, 2018, compared to the prior year.

Products purchased for resale – Product purchased for resale are other branded products that we purchase from others at wholesale or distributor prices and resell through our sales channels to retailers, distributors, or through one of our e-commerce sites and single retail store. Sales of these products decreased 39% during the year ended June 30, 2018 from the prior year. As previously announced, the Company ended its relationship with Tenga Japan. Net sales of these imported products in the current fiscal year were approximately $2 million less than in the prior fiscal year.

Other - Other products include sales from contract manufacturing and fulfillment services. Net sales during the year ended June 30, 2018 were essentially unchanged from the prior year.

ITEM 1A. Risk Factors

Not applicable to a smaller reporting company.

ITEM 2. Properties

We are headquartered in Atlanta, Georgia. Our mailing address is 2745 Bankers Industrial Drive, Atlanta, GA 30360. We lease a 140,000 square feet building on eight acres which we believe allows for expansion when needed. Our facility houses manufacturing, distribution and fulfillment, call center, in-house advertising and creative departments, product design group, administrative offices and a 2,500 square foot factory concept store. On July 23, 2014, the Company entered into an agreement with its landlord to extend the facilities lease by five years. The previous ten year lease was to expire on December 31, 2015. The agreement amended the lease to expire on December 31, 2020. The lease amendment was effective August 1, 2014 and included a four-month rental abatement in the amount of $117,660. In exchange for the rental abatement, the Company agreed to make improvements to the facility totaling $123,505 within six months of August 1, 2014. As of June 30, 2018, the Company has completed $101,408 of the leasehold improvements. Under the lease amendment, the monthly rent on the facility was $29,415 per month, beginning on December 1, 2014. Beginning January 1, 2015, the monthly rent changed to an escalating schedule with the final year of the lease at $35,123 per month. The rent expense under this lease for the 12 months ended June 30, 2018 and 2017 was $352,479 and $352,479, respectively.

Our facilities are currently adequate for their intended purposes and are adequately maintained.

ITEM 3. Legal Proceedings

As of the date of this annual report, there are no material pending legal or governmental proceedings relating to our company or properties to which we are a party, and to our knowledge there are no material proceedings to which any of our directors, executive officers or affiliates are a party adverse to us or which have a material interest adverse to us.

ITEM 4. Mine Safety Disclosures

None.

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PART II.

ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

Our common stock is quoted on the OTC Markets Group on the OTCQB tier (“OTCQB”) under the symbol “LUVU.”  The following table sets forth, for the periods indicated, the reported high and low closing bid quotations for our common stock as reported on the OTCQB.  The bid prices reflect inter-dealer quotations, do not include retail markups, markdowns, or commissions, and do not necessarily reflect actual transactions. The last sale price of our common stock, as reported on the OTCQB on September 28, 2018, was $0.05 per share.

Holders

As of September 28, 2018, we had 82 stockholders of record of our common stock and approximately 450 beneficial holders.

Transfer Agent

The transfer agent and registrar for our common stock is Transfer Online, Inc., 512 SE Salmon Street, Portland, OR 97214. Their telephone number is 503-227-2950.

Dividend Policy

We have not paid dividends and we plan to retain all earnings generated by our operations, if any, for use in our business. We do not anticipate paying any cash dividends to our shareholders in the foreseeable future. The payment of future dividends on the common stock and the rate of such dividends, if any, and when not restricted, will be determined by our board of directors in light of our earnings, financial condition, capital requirements, and other factors. Additionally, under the terms of our credit facility, we are precluded from paying a dividend and we may in the future issue preferred stock and/or other securities that provides for preferences over holders of common stock in the payment of dividends.

Securities Authorized for Issuance under Equity Compensation Plans

The following table sets forth information regarding securities authorized for issuance under our equity compensation plans as of June 30, 2018.

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(1) Includes option awards outstanding under our 2009 Stock Option Plan and our 2015 Equity Incentive Plan.

(2) Includes shares remaining available for future issuance under our 2015 Equity Incentive Plan.

Recent Sales of Unregistered Securities

None.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

None.

ITEM 6. Selected Financial Data.

Not applicable to smaller reporting company.

ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This discussion summarizes the significant factors affecting the results of operations and financial condition of the Company during the fiscal years ended June 30, 2018 and 2017 and should be read in conjunction with our financial statements and accompanying notes thereto included elsewhere herein. Certain information contained in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” are “forward-looking statements.”  Statements that are not historical in nature and which may be identified by the use of words like “expects,” “assumes,” “projects,” “anticipates,” “estimates,” “we believe,” “could be” and other words of similar meaning, are forward-looking statements.  These statements are based on management’s expectations and assumptions and are subject to risks and uncertainties that may cause actual results to differ materially from those expressed. Our actual results may differ materially from the results discussed in this section because of various factors, including those set forth elsewhere herein. See “Forward-Looking Statements” included in this report.

Results of Operations

Overview

The following table sets forth, for the periods indicated, information derived from our Consolidated Financial Statements, expressed as a percentage of net sales.  The discussion that follows the table should be read in conjunction with our Consolidated Financial Statements.

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Fiscal Year ended June 30, 2018 Compared to the Fiscal Year Ended June 30, 2017

Net sales. The net sales decrease of 3% in fiscal 2018 from fiscal 2017 consists of a 39% decrease in sales of products purchased for resale offset, in part, by a 9% increase in sales of manufactured branded consumer products (including Liberator, Jaxx and Avana). Sales of Jaxx products increased 23% from the prior year to $3.7 million during fiscal 2018, and sales of Avana products increased 53% during fiscal 2018 to $2.3 million. Sales through the Wholesale sales channel in fiscal 2018 decreased 1% from the prior year while the Direct sales channel decreased 5% from the prior year. The Wholesale sales channel includes branded products and resale products sold to brick-and-mortar retailers, and e-merchants including, but not limited to, Amazon, Overstock and Wayfair. The Wholesale sales channel also includes contract manufacturing services which consists of specialty items that are manufactured in small quantities for certain customers, and which, to date, has not been a material part of our business. The Direct sales channel consists of consumer sales through our five websites and, to a lesser extent, our single retail store. The decrease in sales through the Wholesale channel was due to lower sales of products purchased for resale, offset in part by greater sales of Liberator, Jaxx and Avana products through and to Amazon and other e-merchants

Gross profit. Gross profit, derived from net sales less the cost of product sales, includes the cost of materials, direct labor, manufacturing overhead and depreciation.  Total gross profit as a percentage of sales for the year ended June 30, 2018 was unchanged from the prior year at 29%. Gross profit dollars decreased to $4,795,000 from $4,937,000 in the prior year and represented a 3% decrease. The production improvements implemented in fiscal 2017 were offset by higher labor and raw material costs in 2018 and the Company has not yet passed on the higher costs to its customers. Current plans call for a 3% to 5% price increase to be in effect at the beginning of calendar 2019.

Operating expenses. Excluding depreciation expense, total operating expenses for the year ended June 30, 2018 were 24% of net sales, or $3,926,000, compared to 24% of net sales, or $3,993,000, for the year ended June 30, 2017.  The 2% decrease in operating expenses from the prior year was primarily due to lower Other selling and marketing costs, primarily personnel related costs.

Other income (expense). Other income (expense) was essentially unchanged from the prior year at $(529,000) compared to $(533,000) in the prior fiscal year. 

Income taxes. No expense or benefit from income taxes was recorded in the twelve months ended June 30, 2018 and 2017. We do not expect any U.S. federal or state income taxes to be recorded for the current fiscal year because of available net operating loss carry-forwards.

We had a net income from operations of $147,000, or $0.00 per diluted share, for the year ended June 30, 2018 compared with net income from operations of $203,000, or $0.00 per diluted share, for the year ended June 30, 2017.

Variability of Results

We have experienced significant quarterly fluctuations in operating results and anticipate that these fluctuations may continue in future periods. As described in previous paragraphs, operating results have fluctuated as a result of changes in sales levels to consumers and wholesalers, competition, costs associated with new product introductions, and increases in raw material costs. In addition, future operating results may fluctuate as a result of factors beyond our control such as foreign exchange fluctuation, changes in government regulations, and economic changes in the regions in which we operate and sell.  A portion of our operating expenses are relatively fixed and the timing of increases in expense levels is based in large part on forecasts of future sales. Therefore, if net sales are below expectations in any given period, the adverse impact on results of operations may be magnified by our inability to meaningfully adjust spending in certain areas, or the inability to adjust spending quickly enough, as in personnel and administrative costs, to compensate for a sales shortfall. We may also choose to reduce prices or increase spending in response to market conditions, and these decisions may have a material adverse effect on financial condition and results of operations.

13

Liquidity and Capital Resources

As of June 30, 2018, our cash and cash equivalents totaled $430,526 compared to $742,193 in cash and cash equivalents as of June 30, 2017.

Operating Activities

Net cash provided by operating activities primarily consists of the net income adjusted for certain non-cash items, including depreciation, stock-based compensation, loss on disposal of fixed assets, and the effect of changes in operating assets and liabilities. Net cash provided by operating activities increased from the prior year due to the net income from operations and an increase in a accounts payable offset, in part, by an increase in inventory and accounts receivable.

Investing Activities

Cash used in investing activities in the years ended June 30, 2018 and 2017 was primarily for the purchase of production equipment, leasehold improvements and computer equipment.

Financing Activities

Cash used in financing activities in the year ended June 30, 2018 was primarily due to the repayment of short-term debt and repayment of the advances secured by our credit card receipts, offset in part by borrowing from the new credit card advance and other credit facilities.

Cash used in financing activities in the year ended June 30, 2017 was primarily due to increased borrowings from secured and unsecured notes payable and issuance of common stock, offset in part by repayment of existing credit obligations.

Sufficiency of Liquidity

The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles, which contemplates continuation of the Company as a going concern. The Company reported net income of approximately $147,000 for the year ended June 30, 2018 and net income of approximately $203,000 for the year ended June 30, 2017 and as of June 30, 2018 the Company has an accumulated deficit of approximately $8.9 million and a working capital deficit of approximately $2.3 million. This raises substantial doubt about its ability to continue as a going concern.

In view of these matters, realization of a major portion of the assets in the accompanying consolidated balance sheet is dependent upon continued operations of the Company, which in turn is dependent upon the Company’s ability to meet its financing requirements, and the success of its future operations.  Management believes that actions presently being taken to revise the Company’s operating and financial requirements provide the opportunity for the Company to continue as a going concern.

These actions include an ongoing initiative to increase sales, gross profits and our gross profit margin. To that end, at the end of fiscal 2016, we evaluated various options for increasing the throughput of our compressed foam products and during the first quarter of fiscal 2017, we purchased new foam compression equipment for installation during the second quarter of fiscal 2017. These actions did yield higher factory throughput at a lower cost of goods sold but were not sufficient to offset rising raw material and labor costs. We also plan to continue to manage discretionary expense levels to be better aligned with current and expected revenue levels. We estimate that the operational and strategic growth plans we have identified over the next twelve months will, at a minimum, require approximately $200,000 of funding, of which we estimate will be provided by debt financing and, to a lesser extent, cash flow from operations as well as cash on hand.

14

Capital Resources

We expect total capital expenditures for fiscal 2019 to be less than $200,000 and to be funded by equipment loans and, to a lesser extent, anticipated operating cash flows and borrowings under the line of credit with Advance Financial Corporation. This includes capital expenditures in support of our normal operations.

If our business plans and cost estimates are inaccurate and our operations require additional cash or if we deviate from our current plans, we could be required to seek additional debt financing for particular projects or for ongoing operational needs.  This indebtedness could harm our business if we are unable to obtain additional financing on reasonable terms.  In addition, any indebtedness we incur in the future could subject us to restrictive covenants limiting our flexibility in planning for, or reacting to changes in, our business.  If we do not comply with such covenants, our lenders could accelerate repayment of our debt or restrict our access to further borrowings, which in turn could restrict our operating flexibility and endanger our ability to continue operations.

 On May 24, 2011, the Company’s wholly owned subsidiary, OneUp and OneUp’s wholly owned subsidiary, Foam Labs entered into a credit facility with a finance company, Advance Financial Corporation, to provide it with an asset based line of credit of up to $750,000 against 85% of eligible accounts receivable (as defined in the agreement) for the purpose of improving working capital.  The term of the agreement was one year, renewable for additional one-year terms unless either party provides written notice of non-renewal at least 90 days prior to the end of the current financing period. The credit facility was secured by our accounts receivable and other rights to payment, general intangibles, inventory and equipment, and are subject to eligibility requirements for current accounts receivable. Advances under the agreement were charged interest at a rate of 2.5% over the lenders Index Rate.  In addition there was a Monthly Service Fee (as defined in the agreement) of up to 1.25% per month.

On September 4, 2013, the credit agreement with Advance Financial Corporation was amended and restated to increase the asset based line of credit to $1,000,000 to include an Inventory Advance (as defined in the amended and restated receivable financing agreement) of up to the lesser of $300,000 or 75% of the eligible accounts receivable loan. In addition, the amended and restated agreement changed the interest calculation to prime rate plus 3% (as of June 30, 2018, the interest rate was 8%) and the Monthly Service Fee was changed to .5% per month.

On December 9, 2015, the credit agreement with Advance Financial Corporation was amended to increase the asset based line of credit to $1,200,000 to include an Inventory Advance (as defined in the amended and restated receivable financing agreement) of up to the lesser of $300,000 or 75% of the eligible accounts receivable loan. All other terms of the credit facility remain the same.

The Company’s CEO, Louis Friedman, has personally guaranteed the repayment of the facility.  In addition, Luvu Brands has provided its corporate guarantee of the credit facility.  On June 30, 2018, the balance owed under this line of credit was $672,171.  As of June 30, 2018, we were current and in compliance with all terms and conditions of this line of credit.

On June 1, 2017, the Company entered into an agreement with Power Up Lending Group, Ltd. (“Power Up”) whereby Power Up agreed to loan OneUp and Foam Labs a total of $150,000. The loan was secured by OneUp’s and Foam Lab’s existing and future credit card collections. The loan called for a repayment of $168,000, which included a one-time finance charge of $18,000, approximately ten months after the funding date. This loan was repaid in full on March 22, 2018. This loan was guaranteed by the Company and was personally guaranteed by the Company’s CEO and controlling shareholder, Louis S. Friedman. Power Up is controlled by Curt Kramer, who also controls HCI.

On June 29, 2017, the Company borrowed an additional amount of $400,000 from Power Up. The loan called for a repayment of $452,000, which included a one-time finance charge of $52,000, approximately ten months after the funding date. The balance of the September 22, 2016 credit card loan was deducted from this loan and the Company received net proceeds of approximately $374,173. This loan was repaid in full on April 6, 2018. This loan was guaranteed by the Company and was personally guaranteed by the Company’s CEO and controlling shareholder, Louis S. Friedman.

15

 On April 6, 2018, the Company borrowed $500,000 from Power Up against its future credit card receivables. Terms for this loan calls for a repayment of $570,000 which includes a one-time finance charge of $70,000, approximately ten months after the funding date. The balance of the June 29, 2017 Power Up loan was deducted from this loan, and a 1% loan origination fee was deducted, and the Company received net proceeds of approximately $478,000. This loan is guaranteed by the Company and is personally guaranteed by the Company’s CEO and controlling shareholder, Louis S. Friedman.

As of June 30, 2018, the principal amount of the credit card advance totaled $360,857, net of a discount of $49,000.

Off-Balance Sheet Arrangements

We do not use off-balance sheet arrangements with unconsolidated entities or related parties, nor do we use other forms of off-balance sheet arrangements. Accordingly, our liquidity and capital resources are not subject to off-balance sheet risks from unconsolidated entities. As of June 30, 2018, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.

We have entered into operating leases primarily for certain equipment and our facilities in the normal course of business. These arrangements are often referred to as a form of off-balance-sheet financing. Future minimum lease payments under our operating leases as of June 30, 2018 are detailed in the section entitled “Commitments and Contingencies” in the Notes to the Consolidated Financial Statements.

Inflation

During fiscal 2017 and 2018, we experienced increases in various raw material costs and increases in labor costs and government mandated employee benefits. We believe these pricing pressures have not stabilized and will continue to increase throughout fiscal 2019, although there is no assurance this will occur. Inflation and import tariffs can harm our margins and profitability if we are unable to increase prices or cut costs enough to offset the effects of inflation in our cost base. Furthermore, if our customers reduce their levels of spending in response to increases in retail prices and/or we are unable to pass such cost increases to our customers, our revenues and our profit margins may decrease. 

Effect of Recently Issued Accounting Standards and Estimates

We do not believe that any recently issued, but not yet effective, accounting standards, if currently adopted, will have a material effect on our consolidated financial position, results of operations, or cash flows.

Application of Critical Accounting Policies and Estimates

Our consolidated financial statements included under Item 8 in this report have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). Our significant accounting policies are described in the notes to our consolidated financial statements. The preparation of financial statements in accordance with GAAP requires that we make estimates and assumptions that affect the amounts reported in our financial statements and their accompanying notes. We have identified certain policies that we believe are important to the portrayal of our financial condition and results of operations. These policies require the application of significant judgment by our management. We base our estimates on our historical experience, industry standards, and various other assumptions that we believe are reasonable under the circumstances. Actual results could differ from these estimates under different assumptions or conditions. An adverse effect on our financial condition, changes in financial condition, and results of operations could occur if circumstances change that alter the various assumptions or conditions used in such estimates or assumptions. Our critical accounting policies include those listed below.  

Revenue Recognition 

To recognize revenue, four basic criteria must be met: 1) there is evidence that an arrangement exists; 2) delivery has occurred; 3) the fee is fixed or determinable; and 4) collectability is reasonably assured. Revenue from sales transactions where the buyer has the right to return the product is recognized at the time of sale only if (1) the seller’s price to the buyer is substantially fixed or determinable at the date of sale; (2) the buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product; (3) the buyer’s obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product; (4) the buyer acquiring the product for resale has economic substance apart from that provided by the seller; (5) the seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer; and (6) the amount of future returns can be reasonably estimated. We recognize revenue upon determination that all criteria for revenue recognition have been met. The criteria are usually met at the time title passes to the customer, which usually occurs upon shipment. Revenue from shipments where title passes upon delivery is deferred until the shipment has been delivered.

16

Net sales are comprised of the total product sales billed during the period plus amounts paid for shipping and handling, less the actual returns, customer allowances, and customer discounts.

Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts to reflect our estimate of current and past due receivable balances that may not be collected. The allowance for doubtful accounts is based upon our assessment of the collectability of specific customer accounts, the aging of accounts receivable and our history of bad debts. We believe that the allowance for doubtful accounts is adequate to cover anticipated losses in the receivable balance under current conditions. However, significant deterioration in the financial condition of our customers, resulting in an impairment of their ability to make payments, could materially change these expectations and an additional allowance may be required.

Inventories

We value inventory at the lower of cost or net realizable value on an item-by-item basis and establish reserves equal to all or a portion of the related inventory to reflect situations in which the cost of the inventory is not expected to be recovered. This requires us to make estimates regarding the net realizable value of our inventory, including an assessment for excess and obsolete inventory. Once we establish an inventory reserve amount in a fiscal period, the reduced inventory value is maintained until the inventory is sold or otherwise disposed of. In evaluating whether inventory is stated at the lower of cost or net realizable value, management considers such factors as the amount of inventory on-hand, the estimated time required to sell such inventory, the foreseeable demand within a specified time horizon and current and expected market conditions. Based on this evaluation, we record adjustments to cost of goods sold to adjust inventory to its net realizable value. These adjustments are estimates, which could vary significantly, either favorably or unfavorably, from actual requirements if future economic conditions, customer demand or other factors differ from expectations.   Finished goods and goods in process include a provision for manufacturing overhead, including depreciation.  

Accounting for Income Taxes

We utilize the asset and liability method of accounting for income taxes. We recognize deferred tax liabilities or assets for the expected future tax consequences of temporary differences between the book and tax basis of assets and liabilities. We regularly assess the likelihood that our deferred tax assets will be recovered from future taxable income. We consider projected future taxable income and ongoing tax planning strategies in assessing the amount of the valuation allowance necessary to offset our deferred tax assets that will not be recoverable. We have recorded and continue to carry a full valuation allowance against our gross deferred tax assets that will not reverse against deferred tax liabilities within the scheduled reversal period. If we determine in the future that it is more likely than not that we will realize all or a portion of our deferred tax assets, we will adjust our valuation allowance in the period we make the determination. We expect to provide a full valuation allowance on our future tax benefits until we can sustain a level of profitability that demonstrates our ability to realize these assets. At June 30, 2018, we carried a valuation allowance of $2.9 million against our net deferred tax assets.

Impairment of Long-Lived Assets

We assess the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An asset or asset group is considered impaired if its carrying amount exceeds the undiscounted future net cash flows the asset or asset group is expected to generate. If an asset or asset group is considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair value. If estimated fair value is less than the book value, the asset is written down to the estimated fair value and an impairment loss is recognized.

In fiscal year 2017 and 2018, we did generate positive cash flows from operations. However, if our long-term future results do not continue to yield positive cash flows in excess of the carrying amount of our long-lived assets, we would anticipate possible future impairments of those assets.

Considerable management judgment is necessary in estimating future cash flows and other factors affecting the valuation of long-lived assets, including the operating and macroeconomic factors that may affect them. We use historical financial information, internal plans and projections and industry information in making such estimates.

17

Non-GAAP Financial Measures

Reconciliation of net income from continuing operations to Adjusted EBITDA income from continuing operations for the years ended June 30, 2018 and 2017: 

As used herein, Adjusted EBITDA represents income from continuing operations before interest income, interest expense, depreciation, amortization, loss on disposal of assets, and stock-based compensation expense. We have excluded the non-cash expenses and stock-based compensation expense as they do not reflect the cash-based operations of the Company. Adjusted EBITDA is a non-GAAP financial measure which is not required by or defined under GAAP. The presentation of this financial measure is not intended to be considered in isolation or as a substitute for the financial measures prepared and presented in accordance with GAAP, including the net income (loss) from continuing operations of the Company or net cash used in operating activities.

Management recognizes that non-GAAP financial measures have limitations in that they do not reflect all of the items associated with the Company’s net income or net loss from continuing operations as determined in accordance with GAAP, and are not a substitute for or a measure of the Company’s profitability or net earnings. Adjusted EBITDA is presented because we believe it is useful to investors as a measure of comparative operating performance and liquidity, and because it is less susceptible to variances in actual performance resulting from depreciation and amortization and non-cash charges for stock-based compensation expense and loss on disposal of assets.

ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk

  Not applicable for a smaller reporting company.

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ITEM 8. Financial Statements and Supplementary Data

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

19

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors of:

Luvu Brands, Inc.

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Luvu Brands, Inc. and Subsidiaries (the “Company”) as of June 30, 2018 and 2017, the related consolidated statements of operations, changes in stockholders’ deficit and cash flows for each of the two years in the period ended June 30, 2018 and 2017, and the related notes (collectively referred to as the “financial statements”).  In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 2018 and 2017, and the results of its operations and its cash flows for the years ended June 30, 2018 and 2017, in conformity with accounting principles generally accepted in the United States of America.

Explanatory Paragraph – Going Concern

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern.  As discussed in Note 2 to the financial statements, the Company has a working capital deficit and an accumulated deficit. The Company has financed its working capital requirements primarily through the issuance of debt. These factors raise substantial doubt about the Company's ability to continue as a going concern.  Management’s plans in regard to these matters are described in Note 2.  The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Basis for Opinion

These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on the Company’s financial statements based on our audits.  We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.  

We conducted our audits in accordance with the standards of the PCAOB.  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal controls over financial reporting.  Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks.  Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements.  Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

/s/ Liggett & Webb, P.A.

LIGGETT & WEBB, P.A.

Certified Public Accountants

We have served as the Company’s auditor since 2012

Boynton Beach, Florida

October 12, 2018

F-1

Luvu Brands, Inc. and Subsidiaries

Consolidated Balance Sheets

As of June 30, 2018 and 2017

The accompanying notes are an integral part of these consolidated financial statements.

F-2

Luvu Brands, Inc. and Subsidiaries

Consolidated Statements of Operations

Years Ended June 30, 2018 and 2017

The accompanying notes are an integral part of these consolidated financial statements.

  F-3

Luvu Brands, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Deficit

For the years ended June 30, 2017 and June 30, 2018

The accompanying notes are an integral part of these consolidated financial statements.

F-4

Luvu Brands, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

Years Ended June 30, 2018 and 2017

The accompanying notes are an integral part of these consolidated financial statements.

F-5

Luvu Brands, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

For the years ended June 30, 2018 and 2017

NOTE 1. ORGANIZATION AND NATURE OF BUSINESS

 Luvu Brands, Inc. (the “Company” or Luvu) was incorporated in the State of Florida on February 25, 1999. References to the “Company” in these notes include the Company and its wholly owned subsidiaries, OneUp Innovations, Inc. (“OneUp”), and Foam Labs, Inc. (“Foam Labs”). All operations of the Company are currently conducted by OneUp Innovations, Inc.

The Company is an Atlanta, Georgia based designer, manufacturer and marketer of a portfolio of consumer lifestyle brands including: Liberator^®, a brand category of iconic products for enhancing sensuality and intimacy; Avana^® inclined bed therapy products, assistive in relieving medical conditions associated with acid reflux, surgery recovery and chronic pain; and Jaxx^®, a diverse range of casual fashion daybeds, sofas and beanbags made from virgin and re-purposed polyurethane foam. These products are sold through the Company’s websites, concept factory store, online mass merchants and retail stores worldwide. Many of our products are offered flat-packed and either roll or vacuum compressed to save on shipping and reduce our carbon footprint.

Sales are generated through internet and print advertisements.  We have a diversified customer base with only one customer accounting for 10% or more of consolidated net sales in the current and prior fiscal year and no particular concentration of credit risk in one economic sector.  Foreign operations and foreign net sales are not material. Our business is seasonal and as a result we typically experience higher sales in our second and third fiscal quarters.

NOTE 2. GOING CONCERN

The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles, which contemplates continuation of the Company as a going concern. The Company reported net income of approximately $147,000 for the year ended June 30, 2018 and net income of approximately $203,000 for the year ended June 30, 2017 and as of June 30, 2018 the Company has an accumulated deficit of approximately $8.9 million and a working capital deficit of approximately $2.3 million. This raises substantial doubt about its ability to continue as a going concern.

In view of these matters, realization of a major portion of the assets in the accompanying consolidated balance sheet is dependent upon continued operations of the Company, which in turn is dependent upon the Company’s ability to meet its financing requirements, and the success of its future operations.  Management believes that actions presently being taken to revise the Company’s operating and financial requirements provide the opportunity for the Company to continue as a going concern.

These actions include an ongoing initiative to increase sales, gross profits and our gross profit margin. To that end, at the end of fiscal 2016, we evaluated various options for increasing the throughput of our compressed foam products and during the first quarter of fiscal 2017, we purchased new foam compression equipment for installation during the second quarter of fiscal 2017. These actions should yield higher factory throughput at a lower cost of goods sold. We also plan to continue to manage discretionary expense levels to be better aligned with current and expected revenue levels. We estimate that the operational and strategic growth plans we have identified over the next twelve months will, at a minimum, require approximately $200,000 of funding, of which we estimate will be provided by debt financing and, to a lesser extent, cash flow from operations as well as cash on hand.

The ability of the Company to continue as a going concern is dependent upon its ability to successfully accomplish the plans described in the preceding paragraph and eventually secure other sources of financing and attain profitable operations.  However, management cannot provide any assurances that the Company will be successful in accomplishing these plans.  The accompanying financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

NOTE 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

These consolidated financial statements include the accounts and operations of our wholly owned operating subsidiaries, OneUp and Foam Labs. Intercompany accounts and transactions have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform to the current year presentation. The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).

F-6

Luvu Brands, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

For the years ended June 30, 2018 and 2017

NOTE 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Use of Estimates

  The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions in determining the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period.  Significant estimates in these consolidated financial statements include estimates of: income taxes; tax valuation reserves; allowances for doubtful accounts; inventory valuation and reserves, share-based compensation; and useful lives for depreciation and amortization.  Actual results could differ materially from these estimates.   

Revenue Recognition

We recognize revenues as goods are shipped to customers and title is transferred. The criteria for recognition of revenue are when persuasive evidence that an arrangement exists and both title and risk of loss have passed to the customer, the price is fixed or determinable, and collectability is reasonably assured. Sales returns and allowances are estimated and recorded as a reduction to sales in the period in which sales are recorded.

The Company records product sales net of estimated product returns and discounts from the list prices for its products. The amounts of product returns and the discount amounts have not been material to date. The Company includes shipping and handling costs in cost of product sales.

Cost of Goods Sold

Cost of goods sold includes raw material, labor, manufacturing overhead, and royalty expense.

Shipping and Handling Costs

We include fees earned on the shipment of our products to customers in sales and include costs incurred on the shipment of product to customers in costs of goods sold.

Cash and Cash Equivalents

For purposes of reporting cash flows, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.

Allowance for Doubtful Accounts

The allowance for doubtful accounts reflects management's best estimate of probable credit losses inherent in the accounts receivable balance. The Company determines the allowance based on historical experience, specifically identified nonpaying accounts and other currently available evidence. The Company reviews its allowance for doubtful accounts monthly with a focus on significant individual past due balances over 90 days. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. The Company does not have any off-balance sheet credit exposure related to its customers.

The following is a summary of Accounts Receivable as of June 30, 2018 and June 30, 2017.

F-7

Luvu Brands, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

For the years ended June 30, 2018 and 2017

NOTE 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Inventories and Inventory Reserves

Inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out (FIFO) method. Market is defined as sales price less cost to dispose and a normal profit margin.  Inventory costs include materials, labor, depreciation and overhead. The company establishes reserves for excess and obsolete inventory, based on prevailing circumstances and judgment for consideration of current events, such as economic conditions, that may affect inventory. The reserve required to record inventory at lower of cost or net realizable value may be adjusted in response to changing conditions.

Concentration of Credit Risk

The Company maintains its cash accounts with banks located in Georgia. The total cash balances are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to $250,000 per bank. The Company had cash balances on deposit at June 30, 2018 and 2017 that exceeded the balance insured by the FDIC by $191,101 and $641,976, respectively. Accounts receivable are typically unsecured and are derived from revenue earned from customers primarily located in North America and Europe.

During 2018, we purchased 17% total inventory purchases from one vendor.

During 2017, we purchased 13% and 10% of total inventory purchases from two vendors.

  As of June 30, 2018 and 2017, one of the Company’s customers (Amazon) represents 54% and 41% of the total accounts receivables, respectively. Sales to (and through) Amazon accounted for 33% of our net sales during the year ended June 30, 2018 and 30% of our sales for the year ended June 30, 2017.

Fair Value of Financial Instruments

At June 30, 2018 and 2017, our financial instruments included cash and cash equivalents, accounts receivable, accounts payable, short-term debt, and other long-term debt.

The fair values of these financial instruments approximated their carrying values based on either their short maturity or current terms for similar instruments.

The Company measures the fair value of its assets and liabilities under the guidance of ASC 820, Fair Value Measurements and Disclosures, which defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements. ASC 820 does not require any new fair value measurements, but its provisions apply to all other accounting pronouncements that require or permit fair value measurement.

ASC 820 clarifies that fair value is an exit price, representing the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants based on the highest and best use of the asset or liability. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. ASC 820 requires the Company to use valuation techniques to measure fair value that maximize the use of observable inputs and minimize the use of unobservable inputs. These inputs are prioritized as follows:

· Level 1: Observable inputs such as quoted prices for identical assets or liabilities in active markets;

· Level 2: Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly such as quoted prices for similar assets or liabilities or market-corroborated inputs; and

· Level 3: Unobservable inputs for which there is little or no market data, which require the reporting entity to develop its own assumptions about how market participants would price the assets or liabilities.

F-8

Luvu Brands, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

For the years ended June 30, 2018 and 2017

NOTE 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Fair Value of Financial Instruments (continued)

The valuation techniques that may be used to measure fair value are as follows:

A. Market approach - Uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.

B. Income approach - Uses valuation techniques to convert future amounts to a single present amount based on current market expectations about those future amounts, including present value techniques, option-pricing models and excess earnings method.

C. Cost approach - Based on the amount that currently would be required to replace the service capacity of an asset (replacement cost).

Advertising Costs

Advertising costs are expensed in the period when the advertisements are first aired or distributed to the public. Prepaid advertising (included in prepaid expenses) was $13,040 at June 30, 2018 and $18,055 at June 30, 2017. Advertising expense for the years ended June 30, 2018 and 2017 was $404,436 and $388,667, respectively.

Research and Development

Research and development expenses for new products are expensed as they are incurred.  Expenses for new product development (included in general and administrative expense) totaled $150,742 for the year ended June 30, 2018 and $166,467 for the year ended June 30, 2017.

Property and Equipment

Property and equipment are stated at cost. Depreciation and amortization are computed using the straight-line method over estimated service lives for financial reporting purposes of 2-10 years.

Expenditures for major renewals and betterments which extend the useful lives of property and equipment are capitalized. Expenditures for maintenance and repairs are charged to expense as incurred. When properties are disposed of, the related costs and accumulated depreciation are removed from the respective accounts, and any gain or loss is recognized currently.

Operating Leases

On July 23, 2014, the Company entered into an agreement with its landlord to extend the facilities lease by five years. The previous ten year lease was to expire on December 31, 2015. The agreement amended the lease to expire on December 31, 2020. The lease amendment was effective August 1, 2014 and included a four-month rental abatement in the amount of $117,660. In exchange for the rental abatement, the Company agreed to make improvements to the facility totaling $123,505 within six months of August 1, 2014. As of June 30, 2018, the Company has completed $101,408 of the leasehold improvements. Under the lease amendment, the monthly rent on the facility was $29,415 per month, beginning on December 1, 2014. Beginning January 1, 2015, the monthly rent increases annually with the final year of the lease at $35,123 per month. The rent expense under this lease for the years ended June 30, 2018 and 2017 was $352,479 in each year.

The Company also leases certain equipment under operating leases, as more fully described in Note 15 - Commitments and Contingencies .

F-9

Luvu Brands, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

For the years ended June 30, 2018 and 2017

NOTE 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Segment Information

We have identified three reportable sales channels:  Direct, Wholesale and Other.   Direct includes product sales through our five e-commerce sites and our single retail store. Wholesale includes Liberator Jaxx and Avana branded products sold to distributors and retailers, purchased products sold to retailers, and private label items sold to other resellers. The Wholesale category also includes contract manufacturing services, which consists of specialty items that are manufactured in small quantities for certain customers, and which, to date, has not been a material part of our business. Other consists principally of shipping and handling fees and costs derived from our Direct business and fulfillment service fees.

The following is a summary of sales results for the Direct, Wholesale, and Other channels. 

Recent accounting pronouncements

From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (“FASB”) or other standard setting bodies that are adopted by the Company as of the specified effective date.

Recently adopted

In March 2016, FASB issued Accounting Standards Update (“ASU”) 2016-09, “Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting,” which reduces complexity in accounting standards related to share-based payment transactions, including, among others, (1) accounting for income taxes, (2) classification of excess tax benefits on the statement of cash flow, (3) forfeitures, and (4) statutory tax withholding requirements. ASU 2016-09 is effective for annual reporting periods beginning on or after December 15, 2016, and interim periods within those annual periods. The Company adopted ASU 2016-09 effective July 1, 2017, which had no material impact on its previously reported financial statements included in the Company’s Annual Report on Form 10-K for fiscal 2017. The Company has elected to continue to recognize estimated forfeitures as stock-based compensation expense.

F-10

NOTE 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Recent accounting pronouncements (continued)

In July 2015, FASB issued ASU 2015-11, “Inventory (Topic 330) Related to Simplifying the Measurement of Inventory,” which applies to all inventory except that which is measured using last-in, first-out (“LIFO”) or the retail inventory method. Inventory measured using first-in, first-out (“FIFO”) or average cost is within the scope of the new guidance and should be measured at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable cost of completion, disposal, and transportation. Subsequent measurement is unchanged for inventory measured using LIFO or the retail inventory method. The amendments are effective for public business entities for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The new guidance is applied prospectively, and earlier application is permitted as of the beginning of an interim or annual reporting period. The Company adopted ASU 2015-11 effective July 1, 2017, which had no material impact on its financial statements or financial statement disclosures.

Not yet adopted

In February 2016, FASB issued ASU 2016-02, “Leases.” This standard requires the recognition of all lease transactions with terms in excess of 12 months on the balance sheet as a lease liability and a right-of-use asset (as defined in the standard). ASU 2016-02 will be effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with earlier application permitted. Upon adoption, the lessee will apply the new standard retrospectively to all periods presented or retrospectively using a cumulative effect adjustment in the year of adoption. ASU 2016-02 is not expected to have a material impact on the Company’s financial statements or financial statement disclosures upon adoption based on current facts and circumstances.

In April 2016, the FASB issued ASU 2016–10, “Revenue from Contract with Customers (Topic 606): identifying Performance Obligations and Licensing”. The amendments in this Update do not change the core principle of the guidance in Topic 606. Rather, the amendments in this Update clarify the following two aspects of Topic 606: identifying performance obligations and the licensing implementation guidance, while retaining the related principles for those areas. Topic 606 includes implementation guidance on (a) contracts with customers to transfer goods and services in exchange for consideration and (b) determining whether an entity’s promise to grant a license provides a customer with either a right to use the entity’s intellectual property (which is satisfied at a point in time) or a right to access the entity’s intellectual property (which is satisfied over time). The amendments in this Update are intended to render more detailed implementation guidance with the expectation to reduce the degree of judgement necessary to comply with Topic 606. We are currently reviewing the provisions of this ASU to determine if there will be any impact on our results of operations, cash flows or financial condition.

In May 2017, the FASB issued ASU 2017-09, “Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting” (“ASU 2017-09”). ASU 2017-09 clarifies when changes to the terms or conditions of a share-based payment award must be accounted for as a modification. The new guidance is expected to reduce diversity in practice and result in fewer changes to the terms of an award being accounted for as a modification. Changes to the terms or conditions of a share-based payment award that do not impact the fair value of the award, vesting conditions, and the classification as an equity or liability instrument will not need to be assessed under modification accounting. ASU 2017-09 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. The amendments in this update should be applied prospectively to an award modified on or after the adoption date. The Company adopted the provisions of ASU 2017-09 effective July 1, 2018. The adoption of ASU 2017-09 did not impact the Company’s accounting for its stock-based compensation.

All other newly issued accounting pronouncements, but not yet effective, have been deemed either immaterial or not applicable.

Net Income Per Share

In accordance with FASB Accounting Standards Codification No. 260 (“FASB ASC 260”), “Earnings Per Share”, basic net income per share is computed by dividing the net income available to common stockholders for the period by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing net income available to common stockholders by the weighted average number of common and common equivalent shares outstanding during the period.  

The total potential dilutive securities as of June 30, 2018 and 2017 are as follows:

F-11

Luvu Brands, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

For the years ended June 30, 2018 and 2017

Income Taxes

We utilize the asset and liability method of accounting for income taxes. We recognize deferred tax liabilities or assets for the expected future tax consequences of temporary differences between the book and tax basis of assets and liabilities. We regularly assess the likelihood that our deferred tax assets will be recovered from future taxable income. We consider projected future taxable income and ongoing tax planning strategies in assessing the amount of the valuation allowance necessary to offset our deferred tax assets that will not be recoverable. We have recorded and continue to carry a full valuation allowance against our gross deferred tax assets that will not reverse against deferred tax liabilities within the scheduled reversal period. If we determine in the future that it is more likely than not that we will realize all or a portion of our deferred tax assets, we will adjust our valuation allowance in the period we make the determination. We expect to provide a full valuation allowance on our future tax benefits until we can sustain a level of profitability that demonstrates our ability to realize these assets. At June 30, 2018, we carried a valuation allowance of $2.9 million against our net deferred tax assets.

Stock Based Compensation

We account for stock-based compensation to employees in accordance with FASB ASC 718, Compensation – Stock Compensation. We measure the cost of each stock option and restricted stock award at its fair value on the grant date. Each award vests over the subsequent period during which the recipient is required to provide service in exchange for the award (the vesting period). The cost of each award is recognized as expense in the financial statements over the respective vesting period.

Stock Issued for Services to other than Employees

Common stock, stock options and common stock warrants issued to other than employees or directors are recorded on the basis of their fair value, as required by FASB ASC 505, which is measured as of the date required by FASB ASC 505, “Equity – Based Payments to Non-Employees”. In accordance with FASB ASC 505, the stock options or common stock warrants are valued using the Black-Scholes option pricing model on the basis of the market price of the underlying common stock on the “valuation date”, which for options and warrants related to contracts that have substantial disincentives to non-performance is the date of the contract, and for all other contracts is the vesting date. Expense related to the options and warrants is recognized on a straight-line basis over the shorter of the period over which services are to be received or the vesting period. Where expense must be recognized prior to a valuation date, the expense is computed under the Black-Scholes option pricing model on the basis of the market price of the underlying common stock at the end of the period, and any subsequent changes in the market price of the underlying common stock up through the valuation date is reflected in the expense recorded in the subsequent period in which that change occurs.

NOTE 4. IMPAIRMENT OF LONG-LIVED ASSETS

We follow Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”) 360, Property, Plant, and Equipment, regarding impairment of our other long-lived assets (property, plant and equipment). Our policy is to assess our long-lived assets for impairment annually in the fourth quarter of each year or more frequently if events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable.

An impairment loss is recognized only if the carrying value of a long-lived asset is not recoverable and is measured as the excess of its carrying value over its fair value. The carrying amount of a long-lived asset is considered not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use of a long-lived asset.

Assets to be disposed of and related liabilities would be separately presented in the consolidated balance sheet. Assets to be disposed of would be reported at the lower of the carrying value or fair value less costs to sell and would not be depreciated.  There was no impairment as of June 30, 2018 or 2017.

F-12

Luvu Brands, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

For the years ended June 30, 2018 and 2017

NOTE 5. INVENTORIES

All inventories are stated at the lower of cost or market using the first-in, first-out method of valuation.  The Company’s inventories consist of the following components at June 30, 2018 and 2017:  

 NOTE 6. EQUIPMENT AND LEASEHOLD IMPROVEMENTS, NET

Property and equipment at June 30, 2018 and 2017 consisted of the following:

Depreciation expense was $192,637 and $208,378 for the years ended June 30, 2018 and 2017, respectively.

NOTE 7. OTHER ACCRUED LIABILITIES

Other accrued liabilities at June 30, 2018 and 2017 consisted of the following:

F-13

Luvu Brands, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

For the years ended June 30, 2018 and 2017

NOTE 8. CURRENT AND LONG-TERM DEBT SUMMARY

Current and long-term debt at June 30, 2018 and 2017 consisted of the following:

NOTE 9. UNSECURED NOTES PAYABLE

 Unsecured notes payable at June 30, 2018 and 2017 consisted of the following:

(1) Unsecured note payable for $300,000 to two individual shareholders with interest at 20%, principal and interest paid bi-weekly, maturing April 20, 2018.  $75,125 of the proceeds from this note was used to retire the balance of the unsecured note issued on June 29, 2016. Personally guaranteed by principal stockholder.

(2) Unsecured note payable for $100,000 to an individual with interest at 20% payable monthly; principal originally due in full on October 31, 2014; extended to October 31, 2015. Subsequent to September 30, 2015, the due date on this note was extended by the holder to October 31, 2017. On October 20, 2017, the due date on this note was extended by the holder to October 31, 2019 with interest payable monthly and principal due on maturity. Personally guaranteed by principal stockholder.

(3) Unsecured note payable for $250,000 to two individual shareholders with interest at 20%, principal and interest paid bi-weekly, maturing September 7, 2018. Personally guaranteed by principal stockholder.

F-14

Luvu Brands, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

For the years ended June 30, 2018 and 2017

NOTE 9. UNSECURED NOTES PAYABLE (continued)

(4) Unsecured note payable for $300,000 to two individual shareholders with interest at 20%, principal and interest paid bi-weekly, maturing February 23, 2018. Personally guaranteed by principal stockholder. $63,016 from the proceeds of this unsecured note payable was used to retire the balance of the unsecured note maturing on April 7, 2017. Personally guaranteed by principal stockholder.

(5) Unsecured note payable for $300,000 to two individual shareholders with interest at 20%, principal and interest paid bi-weekly, maturing October 26, 2018. $98,750 from the proceeds of this unsecured note payable was used to retire the balance of the unsecured note maturing on February 9, 2018. Personally guaranteed by principal stockholder.

(6) Unsecured note payable for $100,000 to an individual, with interest at 20% payable monthly; principal due in full on July 31, 2013. On July 31, 2017, the due date on this note was extended by the holder to July 31, 2019. Personally guaranteed by principal stockholder.

(7) Unsecured note payable for $300,000 to an individual, with interest at 20%, principal and interest originally due in full on  January 3, 2013; extended to January 4, 2016 with interest payable monthly and principal due on maturity. Subsequent to June 30, 2017, the due date on the note was extended by the holder to January 2, 2019. Personally guaranteed by principal stockholder.

(8) Unsecured note payable for $200,000 to an individual, with interest payable monthly at 20%, the principal was due in full on May 1, 2013; extended to May 1, 2015, then further extended by the holder to May 1, 2017. Subsequent to May 1, 2017, the due date on this note was extended by the holder to May 1, 2019. Personally guaranteed by principal stockholder.

(9) Unsecured note payable for $300,000 to two individual shareholders with interest at 20%, principal and interest paid bi-weekly, maturing March 1, 2019. Personally guaranteed by principal stockholder.

NOTE 10. NOTES PAYABLE- RELATED PARTY

Related party notes payable at June 30, 2018 and 2017 consisted of the following:

NOTE 11. TERM NOTES PAYABLE – SHAREHOLDER

On September 5, 2014, the Company amended and restated its outstanding 3% Convertible Note in the original principal amount of $375,000 issued by the Company to Hope Capital, Inc. (“HCI”) on June 24, 2009, as amended (the “June 2009 Note”), and the 3% Convertible Note in the original principal amount of $250,000 issued by the Company to HCI on September 2, 2009, as amended (the “September 2009 Note”), the June 2009 Note and September 2009 Note collectively referred to as the “Original Notes”, to provide for a 3% unsecured promissory note in the principal amount of $700,000 (the “Note”) to HCI. The Note is due on or before August 31, 2019 and bears interest at the rate of 3% per annum. Principal and interest payments under the Note shall be made on a monthly basis, starting on October 1, 2014 and continuing on the first day of each month thereafter for 60 monthly payments. The first 12 payments are $9,406 each and increase 15% each year, with 12 payments of $16,450 during year five. In the event the Company fails to make a monthly payment under the Note or the Company is subject to a bankruptcy event (as defined under the Note), subject to the Company’s ability to cure such default, HCI may convert all or any portion of the outstanding principal, accrued and unpaid interest, and any other sums due and payable under the Note into shares of our common stock at a conversion price equal to $0.10 per share. Conversion is subject to HCI not being able to beneficially own more than 9.99% of our outstanding common stock upon any conversion, subject to waiver by HCI. The Company has the right to prepay the Note, in whole or in part, subject to notice to HCI, without penalty. As of June 30, 2018 the principal balance under this Note was $235,486.

F-15

Luvu Brands, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

For the years ended June 30, 2018 and 2017

NOTE 11. TERM NOTES PAYABLE – SHAREHOLDER (continued)

The principal payments required at maturity under the Company’s outstanding short term notes, secured line of credit, unsecured line of credit, credit cards loans, short term related party notes and term note payable at June 30, 2018 are as follows:

NOTE 12. CREDIT CARD ADVANCES

On June 1, 2017, the Company entered into an agreement with Power Up Lending Group, Ltd. (“Power Up”) whereby Power Up agreed to loan OneUp and Foam Labs a total of $150,000. The loan was secured by OneUp’s and Foam Lab’s existing and future credit card collections. The loan called for a repayment of $168,000, which included a one-time finance charge of $18,000, approximately ten months after the funding date. This loan was repaid in full on March 22, 2018. This loan was guaranteed by the Company and was personally guaranteed by the Company’s CEO and controlling shareholder, Louis S. Friedman (see Note 16). Power Up is controlled by Curt Kramer, who also controls HCI.

On June 29, 2017, the Company borrowed an additional amount of $400,000 from Power Up. The loan called for a repayment of $452,000, which included a one-time finance charge of $52,000, approximately ten months after the funding date. The balance of the September 22, 2016 credit card loan was deducted from this loan and the Company received net proceeds of approximately $374,173. This loan was repaid in full on April 6, 2018. This loan was guaranteed by the Company and was personally guaranteed by the Company’s CEO and controlling shareholder, Louis S. Friedman (see Note 16).

 On April 6, 2018, the Company borrowed $500,000 from Power Up against its future credit card receivables. Terms for this loan calls for a repayment of $570,000 which includes a one-time finance charge of $70,000, approximately ten months after the funding date. The balance of the June 29, 2017 Power Up loan was deducted from this loan, and a 1% loan origination fee was deducted, and the Company received net proceeds of approximately $478,000. This loan is guaranteed by the Company and is personally guaranteed by the Company’s CEO and controlling shareholder, Louis S. Friedman see Note 16).

As of June 30, 2018, the principal amount of the credit card advance totaled $360,857, net of a discount of $49,000.

NOTE 13. LINE OF CREDIT

 On May 24, 2011, the Company’s wholly owned subsidiary, OneUp and OneUp’s wholly owned subsidiary, Foam Labs entered into a credit facility with a finance company, Advance Financial Corporation, to provide it with an asset based line of credit of up to $750,000 against 85% of eligible accounts receivable (as defined in the agreement) for the purpose of improving working capital.  The term of the agreement was one year, renewable for additional one-year terms unless either party provides written notice of non-renewal at least 90 days prior to the end of the current financing period. The credit facility was secured by our accounts receivable and other rights to payment, general intangibles, inventory and equipment, and are subject to eligibility requirements for current accounts receivable. Advances under the agreement were charged interest at a rate of 2.5% over the lenders Index Rate.  In addition there was a Monthly Service Fee (as defined in the agreement) of up to 1.25% per month.

On September 4, 2013, the credit agreement with Advance Financial Corporation was amended and restated to increase the asset based line of credit to $1,000,000 to include an Inventory Advance (as defined in the amended and restated receivable financing agreement) of up to the lesser of $300,000 or 75% of the eligible accounts receivable loan. In addition, the amended and restated agreement changed the interest calculation to prime rate plus 3% (as of June 30, 2018, the interest rate was 8%) and the Monthly Service Fee was changed to .5% per month.

On December 9, 2015, the credit agreement with Advance Financial Corporation was amended to increase the asset based line of credit to $1,200,000 to include an Inventory Advance (as defined in the amended and restated receivable financing agreement) of up to the lesser of $300,000 or 75% of the eligible accounts receivable loan. All other terms of the credit facility remain the same.

F-16

Luvu Brands, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

For the years ended June 30, 2018 and 2017

NOTE 13. LINE OF CREDIT (continued)

The Company’s CEO, Louis Friedman, has personally guaranteed the repayment of the facility.  In addition, Luvu Brands has provided its corporate guarantee of the credit facility (see Note 16).  On June 30, 2018, the balance owed under this line of credit was $672,171.  As of June 30, 2018, we were current and in compliance with all terms and conditions of this line of credit.

Management believes cash flows generated from operations, along with current cash and investments as well as borrowing capacity under the line of credit should be sufficient to finance capital requirements required by operations. If new business opportunities do arise, additional outside funding may be required.

NOTE 14. UNSECURED LINES OF CREDIT

The Company has drawn a cash advance on one unsecured lines of credit that is in the name of the Company and Louis S. Friedman (see Note 16). The terms of this unsecured line of credit calls for monthly payments of principal and interest, with interest at 8%. The aggregate amount owed on the unsecured line of credit was $33,145 at June 30, 2018 and $14,690 at June 30, 2017.

NOTE 15. COMMITMENTS AND CONTINGENCIES

Operating Leases

On July 23, 2014, the Company entered into an agreement with its landlord to extend the facilities lease by five years. The previous ten year lease was to expire on December 31, 2015. The agreement amends the lease to expire on December 31, 2020. The lease amendment was effective August 1, 2014 and included a four month rental abatement in the amount of $117,660. In exchange for the rental abatement, the Company agreed to make improvements to the facility totaling $123,505 within six months of August 1, 2014. As of June 30, 2018, the Company has completed $101,408 of the leasehold improvements. In addition, the monthly rent on the facility decreased from the current rent of $33,139 to $29,415 per month, beginning on December 1, 2014. Beginning January 1, 2015, the monthly rent changed to an escalating schedule with the final year of the lease at $35,123 per month. The rent expense under this lease for the years ended June 30, 2018 and 2017 was $352,479 in each year.

The Company also leases certain postage equipment under an operating lease.  The monthly lease is $102 per month and expires January 2023.

Future minimum lease payments under non-cancelable operating leases at June 30, 2018 are as follows:

Capital Leases

The Company has acquired equipment under the provisions of long-term leases. For financial reporting purposes, minimum lease payments relating to the equipment have been capitalized. The leased properties under these capital leases have a total cost of $145,916. These assets are included in the fixed assets listed in Note 6 and include computers, software, furniture, and equipment. The capital leases have stated or imputed interest rates ranging from 7% to 21%.

The following is an analysis of the minimum future lease payments subsequent to the year ended June 30, 2018:

F-17

Luvu Brands, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

For the years ended June 30, 2018 and 2017

NOTE 15. COMMITMENTS AND CONTINGENCIES (continued)

Equipment Notes Payable

The Company has acquired equipment under the provisions of long-term equipment notes. For financial reporting purposes, minimum note payments relating to the equipment have been capitalized. The equipment acquired with these equipment notes has a total cost of $490,754. These assets are included in the fixed assets listed in Note 6 - Equipment and Leasehold Improvements and include production equipment. The equipment notes have stated or imputed interest rates ranging from 10.5% to 11.3%.

The following is an analysis of the minimum future equipment note payable payments subsequent to June 30, 2018:  

Employment Agreements

The Company has entered into an employment agreement with Louis Friedman, President and Chief Executive Officer. The agreement provides for an annual base salary of $150,000 and eligibility to receive a bonus.  In certain termination situations, the Company is liable to pay severance compensation to Mr. Friedman for up to nine months at his current salary.

Legal Proceedings

As of the date of this Annual Report, there are no material pending legal or governmental proceedings relating to the Company or properties to which the Company is a party, and to the Company’s knowledge there are no material proceedings to which any of its directors, executive officers or affiliates are a party adverse to the Company or which have a material interest adverse to the Company.

NOTE 16. RELATED PARTY TRANSACTIONS

The Company has a subordinated note payable to an officer of the Company who is also the wife of the Company’s CEO (Louis Friedman) and majority shareholder in the amount of $76,000 (see Note 10). Interest on the note during the year ended June 30, 2018 was accrued by the Company at the prevailing prime rate (which is currently 5%) and totaled $3,406. The accrued interest on the note as of June 30, 2018 was $23,801. This note is subordinate to all other credit facilities currently in place.

On October 30, 2010, Mr. Friedman, loaned the Company $40,000 (see Note 10). Interest on the note during the year ended June 30, 2018 was accrued by the Company at the prevailing prime rate (which is currently 5%) and totaled $1,793. The accrued interest on the note as of June 30, 2018 was $6,582. This note is subordinate to all other credit facilities currently in place.

On January 3, 2011, an individual loaned the Company $300,000 with an interest rate of 20%. Interest on the loan is being paid monthly, with the principal due in full on January 3, 2012; extended to January 3, 2013; then extended to January 3, 2015; then extended to January 2, 2017; then extended to January 2, 2018. Subsequent to June 30, 2017, the note was extended to January 2, 2019 with the principal due on maturity (see Note 9). Mr. Friedman personally guaranteed the repayment of the loan obligation.

F-18

Luvu Brands, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

For the years ended June 30, 2018 and 2017

NOTE 16. RELATED PARTY TRANSACTIONS (continued)

The Company’s CEO, Louis Friedman, has personally guaranteed the repayment of the loan obligation to Advance Financial Corporation (see Note 13 – Line of Credit).  In addition, Luvu Brands has provided its corporate guarantees of the credit facility.  On June 30, 2018, the balance owed under this line of credit was $672,171.

On July 20, 2011, the Company issued an unsecured promissory note to an individual for $100,000. Terms of the promissory note call for monthly interest payments of $1,667 (equal to interest at 20% per annum), with the principal amount due in full on July 31, 2012. On July 31, 2012, the note was extended to July 31, 2013 under the same terms. Prior to June 30, 2013, the note was extended to July 31, 2015 under the same terms. Subsequent to June 30, 2015, the note was extended to July 31, 2017. On July 31, 2017, the note was extended to July 31, 2019 under the same terms (see Note 9). Repayment of the promissory note is personally guaranteed by the Company’s CEO and controlling shareholder, Louis S. Friedman.

On October 31, 2013, the Company issued an unsecured promissory note to an individual for $100,000. Terms of the promissory note call for monthly interest payments of $1,667 (equal to interest at 20% per annum) beginning on November 30, 2013, with the principal amount due in full on or before October 31, 2014. Prior to October 31, 2014, the note was extended to October 31, 2015 under the same terms, then extended to October 31, 2017. Prior to October 31, 2017, the note was extended to October 31, 2019 under the same terms (see Note 9). Repayment of the promissory note is personally guaranteed by the Company’s CEO and majority shareholder, Louis S. Friedman.

On May 1, 2012, an individual loaned the Company $200,000 with an interest rate of 20%. Interest on the loan is being paid monthly, with the principal due in full on May 1, 2013; then extended to May 1, 2015; then extended to May 1, 2017; then extended to May 1, 2019 with the principal due on maturity (see Note 9). Mr. Friedman personally guaranteed the repayment of the loan obligation.

The loans from Power Up Lending Group, Ltd. (see Note 12) are guaranteed by the Company (including OneUp and Foam Labs) and are personally guaranteed by the Company’s CEO and majority shareholder, Louis S. Friedman. Power Up Lending Group, Ltd. is controlled by Curt Kramer, who also controls HCI. As last reported to us, HCI owns 7.5% of our common stock.

On February 14, 2017, the Company borrowed $300,000 from two individual shareholders with interest at 20% on an unsecured note payable, principal and interest paid bi-weekly with the final payment due February 23, 2018. The balance due on the $300,000 unsecured note payable due April 7, 2017 was paid in full and the Company received net proceeds of $236,984 after the repayment of the April 11, 2016 loan. This note was repaid in full on October 26, 2017. The loan was personally guaranteed by the Company’s CEO and majority shareholder, Louis S. Friedman.

On April 21, 2017, the Company borrowed $300,000 from two individual shareholders with interest at 20% on an unsecured note payable, principal and interest paid bi-weekly with the final payment due April 20, 2018. A portion of the note proceeds were used to satisfy the balance due on the June 29, 2016 note payable and the remaining proceeds of $224,875 are for working capital purposes. This note was repaid in full on April 20, 2018. This note payable was personally guaranteed by the Company’s CEO and majority shareholder, Louis S. Friedman.

On September 7, 2017, the Company borrowed $250,000 from two individual shareholders with interest at 20% on an unsecured note payment, principal and interest paid bi-weekly with the final payment due September 7, 2018. The balance due on the $150,000 unsecured note payable due December 14, 2017 was paid in full and the Company received net proceeds of $227,049 after the repayment of the December 12, 2016 loan. At June 30, 2018, the principal balance of this note was $52,022. The loan is personally guaranteed by the Company’s CEO and majority shareholder, Louis S. Friedman.

On October 26, 2017, the Company borrowed $300,000 from two individual shareholders with interest at 20% on an unsecured note payable, principal and interest paid bi-weekly with the final payment due October 26, 2018. A portion of the note proceeds were used to satisfy the balance due on the February 14, 2017 note payable and the remaining proceeds of $201,250 are for working capital purposes. At June 30, 2018, the principal balance of this note was $98,750. The loan is personally guaranteed by the Company’s CEO and majority shareholder, Louis S. Friedman.

F-19

NOTE 16. RELATED PARTY TRANSACTIONS (continued)

On March 1, 2018, the Company borrowed $300,000 from two individual shareholders with interest at 20% on an unsecured note payable, principal and interest paid bi-weekly with the final payment due March 1, 2019. At June 30, 2018, the principal balance of this note was $213,973. The loan is personally guaranteed by the Company’s CEO and majority shareholder, Louis S. Friedman.

The Company has drawn a cash advance on one unsecured line of credit that is in the name of the Company and Louis S. Friedman. The terms of this unsecured line of credit calls for monthly payments of principal and interest, with interest at 8%. The aggregate amount owed on the unsecured line of credit was $33,145 at June 30, 2018 and $14,690 at June 30, 2017 (see Note 14). The loan is personally guaranteed by the Company’s CEO and majority shareholder, Louis S. Friedman.

On September 5, 2014, the Company amended and restated its HCI Original Notes, to provide for a 3% unsecured promissory note in the principal amount of $700,000 (the “Note”) to HCI. The Note is due on or before August 31, 2019 and bears interest at the rate of 3% per annum. Principal and interest payments under the Note shall be made on a monthly basis, starting on October 1, 2014 and continuing on the first day of each month thereafter for 60 monthly payments. The first 12 payments are $9,405.60 each and increase 15% every year, with 12 payments of $16,450.45 during year five. In the event the Company fails to make a monthly payment under the Note or the Company is subject to a bankruptcy event (as defined under the Note), subject to the Company’s ability to cure such default, HCI may convert all or any portion of the outstanding principal, accrued and unpaid interest, and any other sums due and payable under the Note into shares of our common stock at a conversion price equal to $0.10 per share. Conversion is subject to HCI not being able to beneficially own more than 9.99% of our outstanding common stock upon any conversion, subject to waiver by HCI. The Company has the right to prepay the Note, in whole or in part, subject to notice to HCI, without penalty. At June 30, 2018, the principal balance under the Note was $235,486.   

NOTE 17. STOCKHOLDERS’ EQUITY

Options  

 At June 30, 2018, the Company had the 2009 and 2015 Stock Option Plans (the “Plans”), which are shareholder-approved and under which 1,115,000 shares are reserved for issuance under the 2009 Plan until that Plan terminates on October 20, 2019 and 5,000,000 shares are reserved for issuance under the 2015 Plan until that Plan terminates on August 31, 2025.

Under the Plans, eligible employees and certain independent consultants may be granted options to purchase shares of the Company’s common stock. The shares issuable under the Plan will either be shares of the Company’s authorized but previously unissued common stock or shares reacquired by the Company, including shares purchased on the open market. As of June 30, 2018, the number of shares available for issuance under the 2015 Plan was 1,050,000. There are no shares available for issuance under the 2009 Plan, other than the 1,115,000 stock options that have already been granted.

 A summary of option activity under the Company’s stock plan for the years ended June 30, 2018 and 2017 is presented below:  

The aggregate intrinsic value in the table above is before applicable income taxes and represents the excess amount over the exercise price optionees would have received if all options had been exercised on the last business day of the period indicated, based on the Company’s closing stock price of $.05, $.05, and $.02 at June 30, 2018, 2017 and 2016, respectively.

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Luvu Brands, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

For the years ended June 30, 2018 and 2017

NOTE 17. STOCKHOLDERS’ EQUITY (continued)

There were 1,100,000 stock options granted during the year ended June 30, 2018 and 1,925,000 stock options granted during the year ended June 30, 2017. 

The range of fair value assumptions related to options granted during the years ended June 30, 2018 and 2017 were as follows: 

The following table summarizes the weighted average characteristics of outstanding stock options as of June 30, 2018:

We account for stock-based compensation to employees in accordance with FASB ASC 718, Compensation – Stock Compensation. We measure the cost of each stock option and at its fair value on the grant date. Each award vests over the subsequent period during which the recipient is required to provide service in exchange for the award (the vesting period). The cost of each award is recognized as expense in the financial statements over the respective vesting period.

All stock option grants made under the Plan were at exercise prices no less than the Company’s closing stock price on the date of grant.  Options under the Plan were determined by the board of directors in accordance with the provisions of the plan.  The terms of each option grant include vesting, exercise, and other conditions are set forth in a Stock Option Agreement evidencing each grant.  No option can have a life in excess of ten (10) years.  The Company records compensation expense for employee stock options based on the estimated fair value of the options on the date of grant using the Black-Scholes option-pricing model.  The model requires various assumptions, including a risk-free interest rate, the expected term of the options, the expected stock price volatility over the expected term of the options, and the expected dividend yield.  Compensation expense for employee stock options is recognized ratably over the vesting term.  The Company has no awards with market or performance conditions.

Stock-based compensation expense recognized in the consolidated statements of operations for each of the fiscal years ended June 30, 2018 and 2017 is based on awards ultimately expected to vest.

 As of June 30, 2018, total unrecognized stock-based compensation expense related to all unvested stock options was $55,599 which is expected to be expensed over a weighted average period of 2.7 years.

In determining the grant date fair value of option awards under the equity incentive plans, the Company applied the Black-Scholes option pricing model. Based upon limited option exercise history, the Company has generally used the “simplified” method outlined in SEC Staff Accounting Bulletin No. 110 to estimate the expected life of stock option grants. Management believes that the historical volatility of the Company’s stock price on OTCQB best represents the expected volatility over the estimated life of the option. The risk-free interest rate is based upon published U.S. Treasury yield curve rates at the date of grant corresponding to the expected life of the stock option. An assumed dividend yield of zero reflects the fact that the Company has never paid cash dividends and has no intentions to pay dividends in the foreseeable future.

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Luvu Brands, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

For the years ended June 30, 2018 and 2017

NOTE 17. STOCKHOLDERS’ EQUITY (continued)

The following table summarizes stock-based compensation expense by line item in the consolidated statements of operations, all relating to employee stock plans:

Share Purchase Warrants

As of June 30, 2018 and 2017, there were no share purchase warrants outstanding.

Common Stock

The Company’s authorized common stock was 175,000,000 shares at June 30, 2018 and 2017.  Common shareholders are entitled to dividends if and when declared by the Company’s Board of Directors, subject to preferred stockholder dividend rights. At June 30, 2018, the Company had reserved the following shares of common stock for issuance:

Preferred Stock

On February 18, 2011, the Company filed an amendment to its Articles of Incorporation, effective February 9, 2011, authorizing the issuance of preferred stock and the Company now has 10,000,000 authorized shares of preferred stock, par value $.0001 per share, of which 4,300,000 shares have been designated and issued as Series A Convertible Preferred Stock. Each share of Series A Convertible Preferred Stock is convertible into one share of common stock and has a liquidation preference of $.2325 ($1,000,000 in the aggregate). Liquidation payments to the preferred holders have priority and are made in preference to any payments to the holders of common stock. In addition, each share of Series A Convertible Preferred Stock is entitled to the number of votes equal to the result of: (i) the number of shares of common stock of the Company issued and outstanding at the time of such vote multiplied by 1.01; divided by (ii) the total number of Series A Convertible Preferred Shares issued and outstanding at the time of such vote. At each meeting of shareholders of the Company with respect to any and all matters presented to the shareholders of the Company for their action or consideration, including the election of directors, holders of Series A Convertible Preferred Shares shall vote together with the holders of common shares as a single class.

NOTE 18. INCOME TAXES

Deferred tax assets and liabilities are computed by applying the effective U.S. federal income tax rate to the gross amounts of temporary differences and other tax attributes. Deferred tax assets and liabilities relating to state income taxes are not material. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. As of June 30, 2018 and 2017, the Company believed it was more likely than not that future tax benefits from net operating loss carryforwards and other deferred tax assets would not be realizable through generation of future taxable income; therefore, they were fully reserved.

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Luvu Brands, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

For the years ended June 30, 2018 and 2017

NOTE 18. INCOME TAXES (continued)

The components of deferred tax assets and liabilities at June 30, 2018 and 2017 are approximately as follows:

The income tax provision differs from the amount of income tax determined by applying the U.S. federal and state income tax rates of 38% to pretax (income) loss from operations for the years ended June 30, 2018 and 2017 due to the following:

At June 30, 2018, the Company had net operating loss (NOL) carryforwards of approximately $2.9 million that may be offset against future taxable income. During 2018 and 2017, the total (decrease) increase in the valuation allowance was $227,411 and $(77,141), respectively. The Company’s ability to use its NOL carryforwards may be substantially limited due to ownership change limitations that may have occurred or that could occur in the future, as required by Section 382 of the Internal Revenue Code of 1986, as amended (the Code), as well as similar state provisions. These ownership changes may limit the amount of NOL that can be utilized annually to offset future taxable income and tax, respectively. In general, an “ownership change” as defined by Section 382 of the Code results from a transaction or series of transactions over a three-year period resulting in an ownership change of more than 50.0% of the outstanding stock of a company by certain stockholders or public groups.

 The Company has not completed a study to assess whether an ownership change has occurred or whether there have been multiple ownership changes since the Company became a “loss corporation” under the definition of Section 382. If the Company has experienced an ownership change, utilization of the NOL carryforwards would be subject to an annual limitation under Section 382 of the Code, which is determined by first multiplying the value of the Company’s stock at the time of the ownership change by the applicable long-term, tax-exempt rate, and then could be subject to additional adjustments, as required. Any limitation may result in expiration of a portion of the NOL carryforwards before utilization. Further, until a study is completed and any limitation known, no positions related to limitations are being considered as an uncertain tax position or disclosed as an unrecognized tax benefit. Any carryforwards that expire prior to utilization as a result of such limitations will be removed from deferred tax assets with a corresponding reduction of the valuation allowance. Due to the existence of the valuation allowance, it is not expected that any possible limitation will have an impact on the results of operations or financial position of the Company.  The NOL carryforwards expire through 2037.

The tax years that remain subject to examination by major taxing jurisdictions are those for the years ended June 30, 2012 through 2018. The Company has not filed its Federal or State tax returns for 2016 and 2017 but expects to file these returns before the end of calendar year 2018.

NOTE 19. – SUBSEQUENT EVENTS

Subsequent to June 30, 2018, the Company borrowed $250,000 from two individual shareholders with interest at 20% on an unsecured note payable, principal and interest paid bi-weekly with the final payment due July 26, 2019. A portion of the note proceeds were used to satisfy the balance due on the September 7, 2017 note payable and the remaining proceeds of $218,548 will be used working capital purposes. This note payable is personally guaranteed by the principal stockholder.

Subsequent to June 30, 2018, the Company borrowed $300,000 from two individual shareholders with interest at 20% on an unsecured note payable, principal and interest paid bi-weekly with the final payment due September 13, 2019. A portion of the note proceeds were used to satisfy the balance due on the October 26, 2017 note payable and the remaining proceeds of $254,757 will be used working capital purposes. This note payable is personally guaranteed by the principal stockholder.

F-23

Luvu Brands, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

For the years ended June 30, 2018 and 2017

NOTE 19. – SUBSEQUENT EVENTS (continued)

Subsequent to June 30, 2018, the Company borrowed an additional $250,000 from Power Up against its future credit card receivables. Terms for this loan calls for a repayment of $290,000 which includes a one-time finance charge of $40,000, approximately ten months after the funding date. A .5% loan origination fee was deducted, and the Company received net proceeds of $248,750. This loan is guaranteed by the Company and is personally guaranteed by the Company’s CEO and controlling shareholder. 

F-24

ITEM 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

There are no events required to be disclosed under this Item.

ITEM 9A.  Controls and Procedures

Disclosure Controls and Procedures

Regulations under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), require public companies to maintain “disclosure controls and procedures,” which are defined to mean a company’s controls and other procedures that are designed to ensure that information required to be disclosed in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported, within the time periods specified in the SEC’s rules and forms.  Our Chief Executive Officer and Chief Financial Officer carried out an evaluation of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report.  Based on those evaluations, as of June 30, 2018, our CEO and CFO believe that:

Internal Control over Financial Reporting

(a)           Management’s annual report on internal control over financial reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting.  Internal control over financial reporting is defined in Rule 13a-15(f) and 15d-15(f) promulgated under the Exchange Act as a process designed by, or under the supervision of, the Company’s principal executive officer and principal financial officer and effected by the Company’s board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:

Because of its inherent limitations, the Company’s internal control over financial reporting may not prevent or detect misstatements.  Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.  Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Our management assessed the effectiveness of our internal control over financial reporting as of June 30, 2018. This assessment was based on the framework in 1992 Internal Control—Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment, using those criteria, management concluded that our internal control over financial reporting was effective as of June 30, 2018.

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This Annual Report on Form 10-K does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to a permanent exemption of the SEC that permits the Company to provide only management’s report in the Annual Report on Form 10-K. Accordingly, our management’s assessment of the effectiveness of our internal control over financial reporting as of June 30, 2018, has not been audited by our auditors or any other independent registered accounting firm.

(b)            Changes in internal control over financial reporting

There were no changes in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) or Rule15d-15(d) promulgated under the Exchange Act that occurred during our fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

ITEM 9B.  Other Information

None.  

PART III.

ITEM 10.      Directors, Executive Officers and Corporate Governance.

The following table sets forth the officers and directors of Luvu Brands, Inc. as of June 30, 2018.

All directors serve for one-year terms until their successors are elected or they are re-elected at the annual shareholders’ meeting.  Officers hold their positions at the pleasure of the board of directors.

There is no arrangement, agreement or understanding between any of the directors or officers and any other person pursuant to which any director or officer was or is to be selected as a director or officer.  Also, there is no arrangement, agreement or understanding between management and non-management shareholders under which non-management shareholders may directly or indirectly participate in or influence the management of our affairs.

Directors are not presently compensated for their service on the board, other than the repayment of actual expenses incurred.  There are no present plans to compensate directors for their service on the board.

Background of Executive Officers and Directors

Louis S. Friedman, President, Chief Executive Officer and Director.   Mr. Friedman has served as President, Chief Executive Officer, and director since our merger with Old Liberator in October 2009.  Prior to that, he served as Old Liberator’s Chief Executive Officer and a director since June 2009, when OneUp Innovations, Inc. merged with Old Liberator in June 2009.  Mr. Friedman founded OneUp in 2000. Before starting OneUp, Mr. Friedman was in business consulting, venture capital and private investing from 1990 to 2000.  Earlier in his career, Mr. Friedman was Executive Vice President of Chemtronics, Inc., until its sale to Morgan Crucible in 1990. Mr. Friedman’s experience as Chief Executive Officer and insight into our operations, our industry, and related risks as well as experience bringing consumer products to market were factors considered by our board of directors in concluding he should serve as a director of our Company.

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Ronald Scott, Chief Financial Officer, Secretary and Director.   Mr. Scott joined the Company in October 2009 in connection with our merger with Old Liberator.  Prior to that, he served as Old Liberator’s Chief Financial Officer, Secretary, and a director since June 2009, when OneUp Innovations, Inc. merged with Old Liberator in June 2009.  Mr. Scott joined OneUp Innovations as a part-time consultant in July, 2006 and as a full-time consultant in October, 2007, serving as its Chief Financial Officer.  From 2004 to 2009, Mr. Scott was president of Impact Business Solutions, LLC, a consulting business that provides financial management services. Prior to Impact Business Solutions, and from 1990 to 2004, Mr. Scott was Executive Vice President - Finance and Administration and a member of the Board of Directors for Cyanotech Corporation, a NASDAQ-listed natural products company. Mr. Scott holds a B.S. degree in Finance and Management from San Jose State University and an M.B.A. degree with a concentration in Accounting from Santa Clara University. Mr. Scott’s relevant operating experience with small, high growth companies and an in-depth understanding of generally accepted accounting principles, financial statements and SEC reporting requirements were factors considered by our board of directors in concluding he should serve as a director of our Company.  

Leslie Vogelman, Treasurer.   Ms. Vogelman joined the Company in October 2009 in connection with our merger with Old Luvu Brands, Inc.  Prior to that, she served as Old Liberator’s Treasurer since June 2009, when OneUp Innovations, Inc. merged with Old Liberator in June 2009.  Ms. Vogelman joined OneUp at its inception in 2000 as Secretary and Treasurer.  Ms. Vogelman holds a B.A. from the State University of New York in Binghamton and an M.B.A. from Adelphi University.

The experience and background of each of the directors, as summarized above, were significant factors in their previously being nominated as directors of the Company.

Family Relationships

Louis Friedman, our President, Chief Executive Officer and Chairman, and Leslie Vogelman, our Treasurer, are husband and wife.

There are no other relationships between the officers or directors of the Company.

Committees

As of June 30, 2018, we have not established an audit committee or any other committee of the board of directors and, therefore, the responsibilities of such committees have been conducted by our board of directors as a whole.

An audit committee’s primary functions are to: (i) serve as an independent and objective party to monitor our financial reporting process and internal control system; (ii) review and appraise the audit efforts of our independent accountants; (iii) evaluate our Annual financial performance as well as our compliance with laws and regulations; (iv) oversee management’s establishment and enforcement of financial policies and business practices; and (v) provide an open avenue of communication among the independent accountants, management and our board of directors.

We may, in the future, establish an audit committee and/or other committees of the board of directors. We currently do not have any independent directors.

Audit Committee Financial Expert

In general, an “audit committee financial expert” is an individual who:

Our board of directors has determined that Ronald Scott, our Chief Financial Officer, is an “audit committee financial expert” within the meaning of the foregoing definition.

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Diversity

While the Company does not have a policy regarding diversity of its board members, diversity is one of a number of factors that is typically taken into account in identifying board nominees.  We only have two members on our board of directors, but we hope to add more members for a diverse board in terms of previous business experience and educational and personal background of the members of our board.

Directors’ Compensation

For the fiscal years ended June 30, 2018 and 2017, our directors did not receive any compensation in their capacity as a director.

Compliance with Section 16(a) of the Exchange Act

Section 16(a) of the Exchange Act requires our executive officers, directors, and persons who beneficially own more than 10% of a registered class of our equity securities to file with the SEC initial statements of beneficial ownership, reports of changes in ownership, and annual reports concerning their ownership of our common shares and other equity securities on Forms 3, 4, and 5 respectively.  Executive officers, directors, and greater than 10% shareholders are required by SEC regulations to furnish us with copies of all Section 16(a) reports they file.  Based on a review of the copies of such forms received by us, and to the best of our knowledge, there were no reports untimely filed during the fiscal year ended June 30, 2018.

Code of Ethics

We have not yet adopted a Code of Business Conduct and Ethics. We are currently working towards developing a formal Code of Business Conduct and Ethics, which will apply to all of our employees, including our board of directors. When available, a copy of our Code of Business Conduct and Ethics may, upon request made to us in writing at the following address, be made available without charge: 2745 Bankers Industrial Drive, Atlanta, Georgia, 30360.

ITEM 11.      Executive Compensation.

Summary Compensation Table

The following summary compensation table indicates the cash and non-cash compensation earned during the fiscal years ended June 30, 2018 and 2017 by our named executive officers as defined in Item 402(a) of Regulation S-K (each an “NEO”).

(1)  The amounts reported in this column represent the full grant date fair value of stock awards in accordance with ASC 718, net of estimated forfeitures.  Refer to Note 17 of the financial statements included in Item 8 of this Annual Report for the assumptions made in the valuation of stock awards.  See Grants of Plan-Based Awards table below.

 Grants of Plan-Based Awards

The following table summarizes information concerning each grant of an award made in our fiscal year ending June 30, 2018 to each of our NEOs:

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Outstanding Equity Awards at Fiscal Year End

The following table shows, for the fiscal year ended June 30, 2018, certain information regarding outstanding equity awards at fiscal year-end for our NEOs.

Employment Agreement

The Company has entered into an employment agreement with Louis Friedman, President and Chief Executive Officer. The agreement provides for an annual base salary of $150,000 and eligibility to receive a bonus, should the Company implement a bonus plan for executives.  Under the agreement, this executive employee may be terminated at any time with or without cause, or by reason of death or disability.  In certain termination situations, the Company is liable to pay severance compensation to this executive for up to 9 months.

   ITEM 12.      Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

The following table sets forth certain information known to us with respect to the beneficial ownership of our common stock by: 

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 Except as otherwise indicated, and subject to applicable community property laws, the persons named in the table below have sole voting and investment power with respect to all shares of common stock held by them.

Applicable percentage ownership in the following table is based on 73,452,596 shares of common stock outstanding as of October 9, 2018.  

Beneficial ownership is determined in accordance with the rules of the SEC. In computing the number of shares beneficially owned by a person and the percentage ownership of that person, shares of common stock subject to options held by that person that are currently exercisable or exercisable within 60 days of October 9, 2018, are deemed outstanding. Such shares, however, are not deemed outstanding for the purpose of computing the percentage ownership of any other person. Unless otherwise disclosed these persons’ address is c/o Luvu Brands, Inc., 2745 Bankers Industrial Drive, Atlanta, GA 30360.

*    Less than 1%