Notes to Condensed Consolidated Financial Statements
(Unaudited)
Note 1. Description of Business
Description of Business
MusclePharm Corporation, or the Company, was incorporated in Nevada
in 2006. Except as otherwise indicated herein, the terms
“Company,” “we,” “our” and
“us” refer to MusclePharm Corporation and its
subsidiaries. The Company is a scientifically driven, performance
lifestyle company that develops, manufactures, markets and
distributes branded nutritional supplements. The Company has
the following wholly-owned operating subsidiaries: MusclePharm
Canada Enterprises Corp. (“MusclePharm Canada”),
MusclePharm Ireland Limited (“MusclePharm Ireland”) and
MusclePharm Australia Pty Limited (“MusclePharm
Australia”). A former subsidiary of the Company, BioZone
Laboratories, Inc. (“BioZone”), was sold on May 9,
2016.
Management’s Plans with Respect to Liquidity and Capital
Resources
Management believes the restructuring plan completed during 2016,
the continued goal in reducing ongoing operating costs and expense
controls, and our recently implemented growth strategy, will enable
the Company to ultimately be profitable. Management believes it has
reduced its operating expenses sufficiently so that its ongoing
source of revenue will be sufficient to cover expenses for the next
twelve months, which management believes will allow the Company to
continue as a going concern. The Company can give no assurances
that this will occur.
As of September 30, 2017, the Company had a stockholders’
deficit of $11.5 million and recurring losses from operations. To
manage cash flow, in January 2016, the Company entered into a
secured borrowing arrangement, pursuant to which it has the ability
to borrow up to $10.0 million subject to sufficient amounts of
accounts receivable to secure the loan. This arrangement was
extended on October 25, 2016, March 22, 2017, and then again on
September 15, 2017 each time for an additional six months with
similar terms. Under this arrangement, during the nine months ended
September 30, 2017, the Company received $22.4 million in cash and
subsequently repaid $22.5 million, including fees and interest, on
or prior to September 30, 2017.
As of September 30, 2017, the Company had approximately $4.9
million in cash and a $3.8 million in working capital.
The accompanying Condensed Consolidated Financial Statements as of
and for the nine months ended September 30, 2017 were prepared on
the basis of a going concern, which contemplates, among other
things, the realization of assets and satisfaction of liabilities
in the ordinary course of business. Accordingly, they do not give
effect to adjustments that would be necessary should the Company be
required to liquidate its assets.
The Company’s ability to meet its total liabilities of $41.6
million as of September 30, 2017, and to continue as a going
concern, is partially dependent on meeting our operating plans, and
partially dependent on our Chairman of the Board, Chief Executive
Officer and President, Ryan Drexler, either converting or extending
the maturity of his note prior to or upon its maturity. As
discussed below, subsequent to the end of the quarter, we entered
into a refinancing transaction with Mr. Drexler to restructure all
of the existing notes, which are now due on December 31,
2019.
Mr. Drexler has verbally both stated his intent and ability to put
more capital into the business if necessary. However, Mr. Drexler
is under no obligation to the Company to do so, and we can give no
assurances that Mr. Drexler will be willing or able to do so at a
future date and/or that he will not demand payment of his
refinanced convertible note on December 31, 2019.
The Company’s ability to continue as a going concern and
raise capital for specific strategic initiatives will also be
dependent on obtaining adequate capital to fund operating losses
until it becomes profitable. The Company can give no assurances
that any additional capital that it is able to obtain, if any, will
be sufficient to meet its needs, or that any such financing will be
obtainable on acceptable terms or at all.
If the Company is unable to obtain adequate capital or Mr. Drexler
does not continue to extend or convert his note, it could be forced
to cease operations or substantially curtail its commercial
activities. These conditions, or significant unforeseen
expenditures including the unfavorable settlement of its legal
disputes, could raise substantial doubt as to the Company’s
ability to continue as a going concern. The accompanying Condensed
Consolidated Financial Statements do not include any adjustments
relating to the recoverability and classification of recorded asset
amounts or the amounts and classification of liabilities that might
result from the outcome of these uncertainties.
Note 2. Summary of Significant Accounting Policies
Basis of Presentation and Principles of Consolidation
The accompanying Condensed Consolidated Financial Statements have
been prepared in accordance with generally accepted accounting
principles in the United States (“GAAP”). The unaudited
Condensed Consolidated Financial Statements include the accounts of
MusclePharm Corporation and its wholly-owned subsidiaries. All
significant intercompany balances and transactions have been
eliminated in consolidation.
Unaudited Interim Financial Information
The accompanying unaudited interim Condensed Consolidated Financial
Statements have been prepared in accordance with GAAP and with the
instructions to Form 10-Q and Article 10 of Regulation S-X for
interim financial information. Accordingly, these statements do not
include all of the information and notes required by GAAP for
complete financial statements. The Company’s management
believes the unaudited interim Condensed Consolidated Financial
Statements include all adjustments of a normal recurring nature
necessary for the fair presentation of the Company’s
financial position as of September 30, 2017, results of
operations for the three and nine months ended September 30,
2017 and 2016, and cash flows for the nine months ended September
30, 2017 and 2016. The results of operations for
the three and nine months ended September 30, 2017 are not
necessarily indicative of the results to be expected for the year
ending December 31, 2017.
These unaudited interim Condensed Consolidated Financial Statements
should be read in conjunction with the consolidated financial
statements and related notes included in the Company’s Annual
Report on Form 10-K for the year ended December 31,
2016.
Use of Estimates
The preparation of consolidated financial statements in conformity
with GAAP requires management to make estimates and assumptions
that affect the amounts reported and disclosed in the consolidated
financial statements and accompanying notes. Such estimates
include, but are not limited to, allowance for doubtful accounts,
revenue discounts and allowances, the valuation of inventory and
tax assets, the assessment of useful lives, recoverability and
valuation of long-lived assets, likelihood and range of possible
losses on contingencies, restructuring liabilities, valuations
of equity securities and intangible assets, fair value of
derivatives, warrants and options, going concern, among others.
Actual results could differ from those estimates.
Revenue Recognition
Revenue is recognized when all of the following criteria are
met:
●
Persuasive evidence of an
arrangement exists.
Evidence of an arrangement consists of an order
from the Company’s distributors, resellers or
customers.
●
Delivery has
occurred.
Delivery is
deemed to have occurred when title and risk of loss has
transferred, typically upon shipment of products to
customers.
●
The fee is fixed or
determinable.
The Company
assesses whether the fee is fixed or determinable based on the
terms associated with the transaction.
●
Collection is reasonably
assured.
The Company
assesses collectability based on credit analysis and payment
history.
The Company’s standard terms and conditions of sale allow for
product returns or replacements in certain cases. Estimates of
expected future product returns are recognized at the time of sale
based on analyses of historical return trends by customer type.
Upon recognition, the Company reduces revenue and cost of revenue
for the estimated return. Return rates can fluctuate over time, but
are sufficiently predictable with established customers to allow
the Company to estimate expected future product returns, and an
accrual is recorded for future expected returns when the related
revenue is recognized. Product returns incurred from established
customers were $0.2 million and $0.1 million for the three months
ended September 30, 2017 and 2016, respectively, and $0.4 million
and $0.6 million for the nine months ended September 30, 2017 and
2016, respectively.
The Company offers sales incentives through various programs,
consisting primarily of advertising related credits, volume
incentive rebates, and sales incentive reserves. The Company
records advertising related credits with customers as a reduction
to revenue as no identifiable benefit is received in exchange for
credits claimed by the customer. Volume incentive rebates are
provided to certain customers based on contractually agreed upon
percentages once certain thresholds have been met. Sales incentive
reserves are computed based on historical trending and budgeted
discount percentages, which are typically based on historical
discount rates with adjustments for any known changes, such as
future promotions or one-time historical promotions that will not
repeat for each customer. The Company records sales incentive
reserves and volume rebate reserves as a reduction to
revenue.
During the three months ended September 30, 2017 and 2016, the
Company recorded discounts and sales returns, totaling $2.1 million
and $10.8 million, respectively, which accounted for 8% and 26% of
gross revenue in each period, respectively. During the nine months
ended September 30, 2017 and 2016, the Company recorded discounts
and sales returns, totaling $13.8 million and $27.9 million,
respectively, which accounted for 16% and 21% of gross revenue in
each period, respectively.
Concentrations
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of cash and
accounts receivable. The Company minimizes its credit risk
associated with cash by periodically evaluating the credit quality
of its primary financial institution. The cash balance at times may
exceed federally insured limits. Management believes the financial
risk associated with these balances is minimal and has not
experienced any losses to date.
Significant customers are those which represent more than 10% of
the Company’s net revenue for each period presented. For each
significant customer, revenue as a percentage of total revenue is
as follows:
|
|
Percentage of Net Revenue
for the Three Months Ended
September 30,
|
Percentage of Net Revenue
for the Nine Months Ended
September 30,
|
|
|
|
|
|
|
|
Customers
|
|
|
|
|
|
Costco
Wholesale Corporation
|
26
%
|
20
%
|
26
%
|
20
%
|
|
Amazon
|
16
%
|
*
|
11
%
|
*
|
*
Represents less than 10% of net revenue.
Share-Based Payments and Stock-Based Compensation
Share-based compensation awards, including stock options and
restricted stock awards, are recorded at estimated fair value on
the applicable award’s grant date, based on estimated number
of awards that are expected to vest. The grant date fair value is
amortized on a straight-line basis over the time in which the
awards are expected to vest, or immediately if no vesting is
required. Share-based compensation awards issued to non-employees
for services are recorded at either the fair value of the services
rendered or the fair value of the share-based payments whichever is
more readily determinable. The fair value of restricted stock
awards is based on the fair value of the stock underlying the
awards on the grant date as there is no exercise
price.
The fair value of stock options is estimated using the
Black-Scholes option-pricing model. The determination of the fair
value of each stock award using this option-pricing model is
affected by the Company’s assumptions regarding a number of
complex and subjective variables. These variables include, but are
not limited to, the expected stock price volatility over the term
of the awards and the expected term of the awards based on an
analysis of the actual and projected employee stock option exercise
behaviors and the contractual term of the awards. Due to the
Company’s limited experience with the expected term of
options, the simplified method was utilized in determining the
expected option term as prescribed in Staff Accounting Bulletin No.
110. The Company recognizes stock-based compensation expense over
the requisite service period, which is generally consistent with
the vesting of the awards, based on the estimated fair value of all
stock-based payments issued to employees and directors that are
expected to vest.
Recent Accounting Pronouncements
During August 2016, the Financial Accounting Standards Board
(“FASB”) issued Accounting Standards Update
(“ASU”)
2016-15,
Statement of Cash Flows -
Classification of Certain Cash Receipts and Cash
Payments
, which addresses eight
specific cash flow issues with the objective of reducing the
existing diversity in practice in how certain cash receipts and
cash payments are presented and classified in the statement of cash
flows. The standard is effective for fiscal years beginning after
December 15, 2017, including interim periods within those fiscal
years. Early adoption is permitted, including adoption in an
interim period. The Company is currently in the process of
evaluating the impact of this new pronouncement on the
Company’s Condensed Consolidated Statements of Cash
Flows.
In May 2014, the FASB issued ASU No. 2014-09,
Revenue from Contracts with
Customers
(“ASU
2014-09”), which provides guidance for revenue recognition.
ASU 2014-09 affects any entity that either enters into contracts
with customers to transfer goods or services or enters into
contracts for the transfer of nonfinancial assets and supersedes
the revenue recognition requirements in Topic 605,
Revenue
Recognition
, and most
industry-specific guidance. This ASU also supersedes some cost
guidance included in Subtopic 605-35,
Revenue Recognition-
Construction-Type and Production-Type Contracts
. ASU 2014-09’s core principle is that a
company will recognize revenue when it transfers promised goods or
services to customers in an amount that reflects the consideration
to which a company expects to be entitled in exchange for those
goods or services. In doing so, companies will need to use more
judgment and make more estimates than under today’s guidance,
including identifying performance obligations in the contract,
estimating the amount of variable consideration to include in the
transaction price and allocating the transaction price to each
separate performance obligation. In August 2015, the FASB issued
ASU No. 2015-14,
Revenue from Contracts with
Customers (Topic 606): Deferral of the Effective
Date
(“ASU
2015-14”), which delays the effective date of ASU 2014-09 by
one year. The FASB also agreed to allow entities to choose to adopt
the standard as of the original effective date. As such, the
updated standard will be effective for the Company in the first
quarter of 2018, with the option to adopt it in the first quarter
of 2017. The Company may adopt the new standard under the full
retrospective approach or the modified retrospective approach. The
Company plans to adopt this guidance under the modified
retrospective approach. The Company is in the process of evaluating
the impact of the pronouncement and has a plan to complete the
evaluation and implement the pronouncement by January 1,
2018.
In March 2016, the FASB issued ASU No. 2016-08,
Revenue from Contracts with
Customers (Topic 606): Principal versus Agent Considerations
(Reporting Revenue Gross versus Net)
(“ASU 2016-08”) which clarified the
revenue recognition implementation guidance on principal versus
agent considerations and is effective during the same period as ASU
2014-09. In April 2016, the FASB issued ASU No.
2016-10,
Revenue from Contracts with
Customers (Topic 606): Identifying Performance Obligations and
Licensing
(“ASU
2016-10”) which clarified the revenue recognition guidance
regarding the identification of performance obligations and the
licensing implementation and is effective during the same period as
ASU 2014-09. In May 2016, the FASB issued ASU No. 2016-12,
Revenue from
Contracts with Customers (Topic 606): Narrow-Scope Improvements and
Practical Expedients
(“ASU 2016-12”) which narrowly amended
the revenue recognition guidance regarding collectability, noncash
consideration, presentation of sales tax and transition. ASU
2016-12 is effective during the same period as ASU 2014-09. Based
on our preliminary assessment, we do not expect the new standard to
have a material impact on the Company’s financial position or
results of operations.
In March 2016, the FASB issued ASU No. 2016-09,
Compensation – Stock
Compensation (Topic 718)
(“ASU 2016-09”). The standard
identifies areas for simplification involving several aspects of
accounting for share-based payment transactions, including the
income tax consequences, classification of awards as either equity
or liabilities, an option to recognize gross stock compensation
expense with actual forfeitures recognized as they occur, as well
as certain classifications on the statement of cash flows. ASU
2016-09 was effective for fiscal years beginning after December 15,
2016, and interim periods within those fiscal years, with early
adoption permitted. The adoption of this guidance did not have a
significant impact on the Condensed Consolidated Financial
Statements.
In February 2016, the FASB issued ASU No. 2016-02,
Leases (Topic
842)
, which supersedes Topic
840,
Leases
(“ASU 2016-02”). The guidance in this
new standard requires lessees to put most leases on their balance
sheets but recognize expenses on their income statements in a
manner similar to the current accounting and eliminates the current
real estate-specific provisions for all entities. The guidance also
modifies the classification criteria and the accounting for
sales-type and direct financing leases for lessors. ASU 2016-02 is
effective for fiscal years beginning after December 15, 2018, and
interim periods within those fiscal years, with early adoption
permitted. The Company is currently evaluating the impact of the
adoption of ASU 2016-02.
In July 2015, the FASB issued ASU No.
2015-11,
Inventory (Topic 330):
Simplifying the Measurement of Inventory
(“ASU 2015-11”), which simplifies the
subsequent measurement of inventory by requiring inventory to be
measured at the lower of cost or net realizable value. Net
realizable value is the estimated selling price of inventory in the
ordinary course of business, less reasonably predictable costs of
completion, disposal and transportation. ASU 2015-11 was effective
for fiscal years beginning after December 15, 2016, and interim
periods within those fiscal years. The adoption of this
guidance did not have a significant impact on our Condensed
Consolidated Financial Statements.
In July 2016, the FASB issued ASU No.
2016-13,
Financial Instruments –
Credit Losses (Topic 326): Measurement of Credit Losses on
Financial Instruments
(“ASU 2016-13”), which among other
things, these amendments require the measurement of all expected
credit losses of financial assets held at the reporting date based
on historical experience, current conditions, and reasonable and
supportable forecasts. Financial institutions and other
organizations will now use forward-looking information to better
inform their credit loss estimates. In addition, the ASU amends the
accounting for credit losses on available-for-sale debt securities
and purchased financial assets with credit deterioration. ASU
2016-13 is effective for periods beginning after December 15, 2019,
and interim periods within those fiscal years. The Company is in
the process of evaluating the impact of the
pronouncement.
Note 3. Fair Value of Financial Instruments
Management believes the fair values of the obligations under the
secured borrowing arrangement and the convertible notes with a
related party approximate carrying value because the debt carries
market rates of interest available to the Company. The
Company’s remaining financial instruments consisted primarily
of accounts receivable, accounts payable, accrued liabilities and
accrued restructuring charges, all of which are short-term in
nature with fair values approximating carrying value. As of
September 30, 2017 and December 31, 2016, the Company held no
assets or liabilities that required re-measurement at fair value on
a recurring basis.
Note 4. Sale of BioZone
In May 2016, the Company completed the sale of its wholly-owned
subsidiary, BioZone, for gross proceeds of $9.8 million, including
cash of $5.9 million, a $2.0 million credit for future inventory
deliveries reflected as a prepaid asset in the Condensed
Consolidated Balance Sheets and $1.5 million which is subject to an
earn-out based on the financial performance of BioZone for the
twelve months following the closing of the transaction. In
addition, the Company agreed to pay down $350,000 of
BioZone’s accounts payables, which was deducted from the
purchase price. As part of the transaction, the Company also agreed
to transfer to the buyer 200,000 shares of its common stock with a
market value on the date of issuance of $640,000, for consideration
of $50,000. The Company recorded a loss of $2.1 million related to
the sale of BioZone for the nine months ended September 30, 2016.
The potential earn-out was not achieved in May 2017.
Purchase Commitment
Upon the completion of the sale of BioZone, the Company entered
into a manufacturing and supply agreement whereby the Company is
required to purchase a minimum of approximately $2.5 million of
products per year from BioZone annually for an initial term of
three years. If the minimum order quantities of specific products
are not met, a $3.0 million minimum purchase of other products must
be met in order to waive the shortfall, which is at 25% of the
realized shortfall. Due to the timing of achieving the minimum
purchase quantities, we are below these targets. As a result, we
have reserved an amount to cover the estimated purchase commitment
shortfall during the three and nine months ended September 30,
2017.
The following table summarizes the components of the loss from the
sale of BioZone (in thousands):
|
Cash
proceeds from sale
|
$
5,942
|
|
Consideration
for common stock transferred
|
50
|
|
Prepaid
inventory
|
2,000
|
|
Fair
market value of the common stock transferred
|
(640
)
|
|
Assets
sold:
|
|
|
Accounts
receivable, net
|
(923
)
|
|
Inventory,
net
|
(1,761
)
|
|
Fixed
assets, net
|
(2,003
)
|
|
Intangible
assets, net
|
(5,657
)
|
|
All
other assets
|
(41
)
|
|
Liabilities
transferred
|
1,197
|
|
Transaction
and other costs
|
(279
)
|
|
Loss
on sale of subsidiary
|
$
(2,115
)
|
Note 5. Restructuring
As part of an effort to better focus and align the Company’s
resources toward profitable growth, on August 24, 2015, the
Board authorized the Company to undertake steps to commence a
restructuring of the business and operations, which concluded
during the third quarter of 2016. The Company closed certain
facilities, reduced headcount, discontinued products and
renegotiated certain contracts. For the three months ended June 30,
2016, the Company recorded a credit in restructuring and other
charges of $4.8 million comprised of the release of restructuring
accrual of $7.0 million, offset by the cash payment of $2.2 million
related to a settlement agreement. For the nine months ended
September 30, 2016, this credit was offset by additional
restructuring expenses resulting in a net credit of $4.2
million.
For the three and nine months ended September 30, 2016, the Company
recorded restructuring charges in “Cost of revenue” of
$0.1 million and $2.3 million, respectively, related to the
write-down of inventory identified for discontinued products in the
restructuring plan.
The following table illustrates the provision of the restructuring
charges and the accrued restructuring charges balance as of
September 30, 2017 (in thousands):
|
|
Contract Termination Costs
|
Purchase Commitment of Discontinued Inventories Not Yet
Received
|
Abandoned Lease Facilities
|
|
|
Balance
as of December 31, 2016
|
$
308
|
$
175
|
$
339
|
$
822
|
|
Expensed
|
—
|
—
|
—
|
—
|
|
Cash
payments
|
—
|
—
|
(102
)
|
(102
)
|
|
Balance
as of September 30, 2017
|
$
308
|
$
175
|
$
237
|
$
720
|
The total future payments under the restructuring plan as of
September 30, 2017 are as follows (in thousands):
|
|
For the Year Ending December 31,
|
|
Outstanding Payments
|
|
|
|
|
|
|
|
Contract
termination costs
|
$
308
|
$
—
|
$
—
|
$
—
|
$
—
|
$
308
|
|
Purchase
commitment of discontinued inventories not yet
received
|
175
|
—
|
—
|
—
|
—
|
175
|
|
Abandoned
leased facilities
|
29
|
92
|
91
|
25
|
—
|
237
|
|
Total
future payments
|
$
512
|
$
92
|
$
91
|
$
25
|
$
—
|
$
720
|
Note 6. Balance Sheet Components
Inventory
Inventory consisted solely of finished goods as of September 30,
2017 and December 31, 2016.
The Company records charges for obsolete and slow moving inventory
based on the age of the product as determined by the expiration
date and when conditions indicate by specific identification.
Products within one year of their expiration dates are considered
for write-off purposes. Historically, the Company has had minimal
returns with established customers. Other than write-off of
inventory during restructuring activities, the Company incurred
insignificant inventory write-offs during the three and nine months
ended September 30, 2017 and 2016. Inventory write-downs, once
established, are not reversed as they establish a new cost basis
for the inventory.
As disclosed further in Note 5, the Company executed a
restructuring plan starting in August 2015 and wrote off
inventory related to discontinued products. For the three and nine
months ended September 30, 2016, discontinued inventory of $0.1
million and $2.3 million, respectively, was written off and
included as a component of “Cost of revenue” in the
accompanying Condensed Consolidated Statements of Operations.
Additionally, $0.4 million of inventory related to the Arnold
Schwarzenegger product line was considered impaired, and included
as a component of “Impairment of assets” in the
accompanying Condensed Consolidated Statements of Operations for
the nine months ended September 30, 2016.
Property and Equipment
Property and equipment consisted of the following as of September
30, 2017 and December 31, 2016 (in thousands):
|
|
|
|
|
Furniture,
fixtures and equipment
|
$
3,605
|
$
3,521
|
|
Leasehold
improvements
|
2,505
|
2,504
|
|
Manufacturing
and lab equipment
|
3
|
3
|
|
Vehicles
|
86
|
334
|
|
Displays
|
485
|
483
|
|
Website
|
462
|
462
|
|
Construction
in process
|
—
|
55
|
|
Property
and equipment, gross
|
7,146
|
7,362
|
|
Less:
accumulated depreciation and amortization
|
(4,920
)
|
(4,119
)
|
|
Property
and equipment, net
|
$
2,226
|
$
3,243
|
Depreciation and amortization expense related to property and
equipment was $0.3 million for each of the three months ended
September 30, 2017 and 2016 and $0.8 million and $1.2 million for
the nine months ended September 30, 2017 and 2016, respectively,
which is included in “Selling, general and
administrative” expense in the accompanying Condensed
Consolidated Statements of Operations.
Intangible Assets
Intangible assets consisted of the following (in
thousands):
|
|
|
|
|
|
|
|
Remaining Weighted-AverageUseful Lives(years)
|
|
Amortized Intangible Assets
|
|
|
|
|
|
Brand
|
$
2,244
|
$
(847
)
|
$
1,397
|
4.6
|
|
Total
intangible assets
|
$
2,244
|
$
(847
)
|
$
1,397
|
|
|
|
|
|
|
|
|
|
Remaining Weighted-AverageUseful Lives(years)
|
|
Amortized Intangible Assets
|
|
|
|
|
|
Brand
|
$
2,244
|
$
(606
)
|
$
1,638
|
5.1
|
|
Total
intangible assets
|
$
2,244
|
$
(606
)
|
$
1,638
|
|
For the three months ended September 30, 2017 and 2016, intangible
asset amortization expense was $0.1 million and $0.1 million,
respectively, and for the nine months ended September 30, 2017 and
2016 intangible asset amortization was $0.2 million and $0.5
million, respectively, which is included in the “Selling,
general and administrative” expense in the accompanying
Condensed Consolidated Statements of Operations. Additionally, $1.2
million of trademarks with a net carrying value of $0.8 million
related to the Arnold Schwarzenegger product line were considered
impaired, and included as a component of “Impairment of
assets” in the accompanying Condensed Consolidated Statements
of Operations for the nine months ended September 30,
2016.
As of September 30, 2017, the estimated future amortization expense
of intangible assets is as follows (in thousands):
|
For the Year Ending December 31,
|
|
|
Remainder
of 2017
|
$
80
|
|
2018
|
321
|
|
2019
|
321
|
|
2020
|
321
|
|
2021
|
321
|
|
Thereafter
|
33
|
|
Total
amortization expense
|
$
1,397
|
Note 7. Other Expense, net
For the three and nine months ended September 30, 2017 and 2016,
“Other expense, net” consisted of the following (in
thousands):
|
|
For the
Three Months
Ended September 30,
|
For the
Nine Months
Ended September 30,
|
|
|
|
|
|
|
|
Other
expense, net:
|
|
|
|
|
|
Interest
expense, related party
|
$
(676
)
|
$
(134
)
|
$
(1,839
)
|
$
(376
)
|
|
Interest
expense, other
|
(6
)
|
(32
)
|
(14
)
|
(160
)
|
|
Interest
expense, secured borrowing arrangement
|
(172
)
|
(9
)
|
(397
)
|
(636
)
|
|
Foreign
currency transaction gain
|
16
|
19
|
49
|
213
|
|
Other
|
(20
)
|
34
|
(325
)
|
(467
)
|
|
Total
other expense, net
|
$
(858
)
|
$
(122
)
|
$
(2,526
)
|
$
(1,426
)
|
Note 8. Debt
As of September 30, 2017 and December 31, 2016, the Company’s
debt consisted of the following (in thousands):
|
|
|
|
|
2015
Convertible Note due November 8, 2017 with a related
party
|
$
—
|
$
6,000
|
|
2016
Convertible Note due November 8, 2017 with a related
party
|
—
|
11,000
|
|
2017
Refinanced Convertible Note due December 31, 2019 with a related
party
|
18,000
|
—
|
|
Obligations
under secured borrowing arrangement
|
3,927
|
2,681
|
|
Unamortized
debt discount
|
(75
)
|
(535
)
|
|
Total
debt
|
21,852
|
19,146
|
|
Less:
current portion
|
(3,927
)
|
(19,146
)
|
|
Long
term debt
|
$
17,925
|
$
—
|
Related-Party Notes Payable
On July
24, 2017, the Company entered into a secured demand promissory note
(the “2017 Note”), pursuant to which Mr. Ryan
Drexler
, the Company’s Chairman
of the Board, Chief Executive Officer and President,
loaned
the Company $1.0 million, which was payable upon demand. Proceeds
from the 2017 Note were used to partially fund a settlement
agreement. The 2017 Note carried interest at a rate of 15% per
annum. Any interest not paid when due would be capitalized and
added to the principal amount of the 2017 Note and bears interest
on the applicable interest payment date along with all other unpaid
principal, capitalized interest, and other capitalized obligations.
The Company could prepay the 2017 Note without penalty any time
prior to a demand request from Mr. Drexler.
In November 2016, the Company entered into a convertible secured
promissory note agreement (the “2016 Convertible Note”)
with Mr. Drexler pursuant to which Mr. Drexler loaned the
Company $11.0 million. Proceeds from the 2016 Convertible Note
were used to fund the settlement of litigation. The 2016
Convertible Note was secured by all assets and properties of the
Company and its subsidiaries, whether tangible or intangible. The
2016 Convertible Note carried interest at a rate of 10% per annum,
or 12% if there is an event of default. Both the principal and the
interest under the 2016 Convertible Note were due on November 8,
2017, unless converted earlier. Mr. Drexler could convert the
outstanding principal and accrued interest into 6,010,929 shares of
the Company’s common stock for $1.83 per share at any time.
The Company could prepay the 2016 Convertible Note at the aggregate
principal amount therein, plus accrued interest, by giving Mr.
Drexler between 15 and 60 day-notice depending upon the specific
circumstances, provided that Mr. Drexler could convert the 2016
Convertible Note during the applicable notice period. The Company
recorded the 2016 Convertible Note as a liability in the balance
sheet and also recorded a beneficial conversion feature of $601,000
as a debt discount upon issuance of the convertible note, which was
amortized over the term of the debt using the effective interest
method. The beneficial conversion feature was calculated based on
the difference between the fair value of common stock on the
transaction date and the effective conversion price of the
convertible note. As of September 30, 2017 and December 31, 2016,
the 2016 Convertible Note had an outstanding principal balance of
$11.0 million and a carrying value of $10.9 million and $10.5
million, respectively.
In December 2015, the Company entered into a convertible secured
promissory note agreement (the “2015 Convertible Note”)
with Mr. Drexler, pursuant to which he loaned the Company
$6.0 million. Proceeds from the 2015 Convertible Note were
used to fund working capital requirements. The 2015 Convertible
Note was secured by all assets and properties of the Company and
its subsidiaries, whether tangible or intangible. The 2015
Convertible Note originally carried an interest at a rate of 8% per
annum, or 10% in the event of default. Both the principal and the
interest under the 2015 Convertible Note were originally due in
January 2017, unless converted earlier. The due date of the
2015 Convertible Note was extended to November 8, 2017 and the
interest rate raised to 10% per annum, or 12% in the event of
default. Mr. Drexler could convert the outstanding principal and
accrued interest into 2,608,695 shares of common stock for $2.30
per share at any time. The Company could prepay the convertible
note at the aggregate principal amount therein plus accrued
interest by giving the holder between 15 and 60 day-notice,
depending upon the specific circumstances, provided that Mr.
Drexler could convert the 2015 Convertible Note during the
applicable notice period. The Company recorded the 2015 Convertible
Note as a liability in the balance sheet and also recorded a
beneficial conversion feature of $52,000 as a debt discount upon
issuance of the 2015 Convertible Note, which was amortized over the
original term of the debt using the effective interest method. The
beneficial conversion feature was calculated based on the
difference between the fair value of common stock on the
transaction date and the effective conversion price of the
convertible note. As of September 30, 2017 and December 31,
2016, the convertible note had an outstanding principal balance and
carrying value of $6.0 million. In connection with the Company
entering into the 2015 Convertible Note with Mr. Drexler, the
Company granted Mr. Drexler the right to designate two
directors to the Board.
On
November 3, 2017, subsequent to the end of the quarter, the Company
entered into a refinancing transaction (the
“Refinancing”) with Mr. Drexler. As part of the
Refinancing, the Company issued to Mr. Drexler an amended and
restated convertible secured promissory note (the “Refinanced
Convertible Note”) in the original principal amount of
$18,000,000, which amends and restates (i) 2015 Convertible Note,
(ii) the 2016 Convertible Note, and (iii) the 2017 Note, and
together with the 2015 Convertible Note and the 2016 Convertible
Note, collectively, the “Prior Notes”).
The
Refinanced Convertible Note bears interest at the rate of 12% per
annum. Interest payments are due on the last day of each quarter.
At the Company’s option (as determined by its independent
directors), the Company may repay up to one sixth of any interest
payment by either adding such amount to the principal amount of the
note or by converting such interest amount into an equivalent
amount of the Company’s common stock. Any interest not paid
when due shall be capitalized and added to the principal amount of
the Refinanced Convertible Note and bear interest on the applicable
interest payment date along with all other unpaid principal,
capitalized interest, and other capitalized
obligations.
Both
the principal and any capitalized and unpaid interest under the
Refinanced Convertible Note are due on December 31, 2019, unless
converted earlier. Mr. Drexler may convert the outstanding
principal and accrued interest into shares of the Company’s
common stock at a conversion price of $1.11 per share, which was
the 5 day average price of the Company’s common stock prior
to the refinance closing date, at any time.
The
Company may prepay the Refinanced Convertible Note by giving Mr.
Drexler between 15 and 60 days’ notice depending upon the
specific circumstances, subject to Mr. Drexler’s conversion
right. The Refinanced Convertible Note contains customary events of
default, including, among others, the failure by the Company to
make a payment of principal or interest when due. Following an
event of default, interest will accrue at the rate of 14% per
annum. In addition, following an event of default, any conversion,
redemption, payment or prepayment of the Refinanced Convertible
Note will be at a premium of 105%.
The
Refinanced Convertible Note also contains customary restrictions on
the ability of the Company to, among other things, grant liens or
incur indebtedness other than certain obligations incurred in the
ordinary course of business. The restrictions are also subject to
certain additional qualifications and carveouts, as set forth in
the Refinanced Convertible Note. The Refinanced Convertible Note is
subordinated to certain other indebtedness of the
Company.
As part
of the Refinancing, the Company and Mr. Drexler entered into a
restructuring agreement (the “Restructuring Agreement”)
pursuant to which the parties agreed to enter into the Refinanced
Convertible Note and to amend and restate the security agreement
pursuant to which the Prior Notes were secured by all of the assets
and properties of the Company and its subsidiaries whether tangible
or intangible, by entering into the Third Amended and Restated
Security Agreement (the “Amended Security Agreement”).
Pursuant to the Restructuring Agreement, the Company agreed to pay,
on the effective date of the Refinancing, all outstanding interest
on the Prior Notes through November 8, 2017 and certain fees and
expenses incurred by Mr. Drexler in connection with the
Restructuring.
In connection with the Company’s entry into of a Loan and
Security Agreement with Crossroads Financial Group, LLC
(“Crossroads”) (the “Crossroads Loan
Agreement”), Mr. Drexler agreed to enter into a subordination
agreement with Crossroads (the “Subordination
Agreement”), pursuant to which the payment of the
Company’s obligations under the Prior Notes were subordinated
to the Company’s obligations to Crossroads. As part of the
Refinancing, Crossroads waived certain provisions of the Crossroads
Loan Agreement that would have been triggered by the
Company’s entry into of the Refinanced Convertible Note. In
addition, Mr. Drexler and Crossroads entered into an amendment to
the Subordination Agreement that replaced the obligations under the
Prior Notes with the obligations under the Refinanced Convertible
Note (see Note 16).
For the three months ended September 30, 2017 and 2016, interest
expense related to the related party convertible secured promissory
notes was $0.7 million and $0.1 million, respectively. For the nine
months ended September 30, 2017 and 2016, interest expense related
to the related party convertible secured promissory notes was $1.8
million and $0.4 million, respectively. During the nine months
ended September 30, 2017 and 2016, $1.8 million and $0.4 million,
respectively, in interest was paid in cash to Mr.
Drexler.
Secured Borrowing Arrangement
In January 2016, the Company entered into a Purchase and Sale
Agreement (the “Agreement”) with Prestige Capital
Corporation (“Prestige”) pursuant to which the Company
agreed to sell and assign and Prestige agreed to buy and accept,
certain accounts receivable owed to the Company
(“Accounts”). Under the terms of the Agreement, upon
the receipt and acceptance of each assignment of Accounts, Prestige
will pay the Company 80% of the net face amount of the
assigned Accounts, up to a maximum total borrowings of $12.5
million subject to sufficient amounts of accounts receivable to
secure the loan. The remaining 20% will be paid to the Company upon
collection of the assigned Accounts, less any chargeback, disputes,
or other amounts due to Prestige. Prestige’s purchase of the
assigned Accounts from the Company will be at a discount fee which
varies based on the number of days outstanding from the assignment
of Accounts to collection of the assigned Accounts. In addition,
the Company granted Prestige a continuing security interest in and
lien upon all accounts receivable, inventory, fixed assets, general
intangibles and other assets. The Agreement’s term has been
extended to March 29, 2018. Prestige may cancel the Agreement with
30-day notice (see Note 16).
During the three months ended September 30, 2017, the Company sold
to Prestige accounts with an aggregate face amount of approximately
$13.3 million, for which Prestige paid to the Company approximately
$10.6 million in cash. During the three months ended September 30,
2017, $9.8 million was subsequently repaid to Prestige,
including fees and interest. During the nine months ended September
30, 2017, the Company sold to Prestige accounts with an aggregate
face amount of approximately $27.9 million, for which Prestige paid
to the Company approximately $22.3 million in cash. During the nine
months ended September 30, 2017, $21.4 million was
subsequently repaid to Prestige, including fees and
interest.
During
the three months ended September 30, 2016, the Company had no new
transactions with Prestige. During the nine months ended September
30, 2016, the Company sold to Prestige accounts with an aggregate
face amount of approximately $49.3 million, for which Prestige paid
to the Company approximately $39.5 million in cash. During the
three and nine months ended September 30, 2016, $8.7 million
and $40.0 million was subsequently repaid to Prestige,
including fees and interest. The proceeds from the initial
assignment to Prestige under this secured borrowing arrangement
were primarily utilized to pay off the balance of the existing line
of credit and term loan with ANB Bank.
Note 9. Commitments and Contingencies
Operating Leases
The Company leases office and warehouse facilities under operating
leases, which expire at various dates through 2022. The amounts
reflected in the table below are for the aggregate future minimum
lease payments under non-cancelable facility operating leases for
properties that have not been abandoned as part of the
restructuring plan. See Note 5 for additional details regarding the
restructured leases. Under lease agreements that contain escalating
rent provisions, lease expense is recorded on a straight-line basis
over the lease term. During the three months ended September 30,
2017 and 2016, rent expense was $0.1 million and $0.2 million,
respectively. During the nine months ended September 30, 2017 and
2016, rent expense was $0.3 million and $0.8 million,
respectively.
As of September 30, 2017, future minimum lease payments are as
follows (in thousands):
|
For the Year Ending December 31,
|
|
|
Remainder
of 2017
|
$
219
|
|
2018
|
860
|
|
2019
|
846
|
|
2020
|
735
|
|
2021
|
481
|
|
2022
|
369
|
|
Total
minimum lease payments
|
$
3,510
|
Capital Leases
In December 2014, the Company entered into a capital lease
agreement providing for approximately $1.8 million in credit to
lease up to 50 vehicles as part of a fleet lease program. As of
September 30, 2017, the Company was leasing two vehicles under the
capital lease which were included in “Property and equipment,
net” in the Condensed Consolidated Balance Sheets. The
original cost of leased assets was $86,000 and the associated
accumulated depreciation was $41,000. The Company also leases
manufacturing and warehouse equipment under capital leases, which
expire at various dates through February 2020. Several of such
leases were reclassified to the restructuring liability during
2016, and related assets were written off to restructuring expense
for the year ended December 31, 2016.
As of September 30, 2017 and December 31, 2016, short-term
capital lease liabilities of $135,000 and $173,000, respectively,
are included as a component of current accrued liabilities, and the
long-term capital lease liabilities of $171,000 and $332,000,
respectively, are included as a component of long-term liabilities
in the Condensed Consolidated Balance Sheets.
As of September 30, 2017, the Company’s future minimum lease
payments under capital lease agreements, are as follows (in
thousands):
|
For the Year Ending December 31,
|
|
|
Remainder
of 2017
|
$
37
|
|
2018
|
136
|
|
2019
|
101
|
|
2020
|
50
|
|
Total
minimum lease payments
|
324
|
|
Less
amounts representing interest
|
(19
)
|
|
Present
value of minimum lease payments
|
$
305
|
Purchase Commitment
Upon the completion of the sale of BioZone on May 9, 2016, the
Company entered into a manufacturing and supply agreement whereby
the Company is required to purchase a minimum of approximately $2.5
million of products per year from BioZone annually for an initial
term of three years. If the minimum order quantities of specific
products are not met, a $3.0 million minimum purchase of other
products must be met in order to waive the shortfall, which is at
25% of the realized shortfall. Due to the timing of achieving the
minimum purchase quantities, we are below these targets. As a
result, we have reserved an amount to cover the estimated purchase
commitment shortfall during the three and nine months ended
September 30, 2017.
Settlements
Bakery Barn
In May 2017, Bakery Barn, a supplier of our protein bars, filed a
lawsuit in the Western District of Pennsylvania alleging that the
Company had failed to pay $1,406,078.59 owing for finished product
manufactured by Bakery Barn, as well as packaging materials
purchased by Bakery Barn to manufacture the Company’s protein
bars. The Company filed an answer and counterclaims against Bakery
Barn, alleging that Bakery Barn had breached the Manufacturing
Agreement and the Quality Agreement by supplying the Company with
stale, hardened, moldy or otherwise unsaleable protein bars, and
that Bakery Barn’s breaches have caused the Company, at a
minimum, several hundred thousand dollars in damages. On October
27, 2017, the parties settled their dispute and entered into a
settlement agreement, pursuant to which the Company agreed to pay
Bakery Barn $350,000 on October 28, 2017, and an additional
$352,416 by November 26, 2017. The parties also agreed that Bakery
Barn would resume producing products for the Company under
substantially the same terms embodied in the oral Manufacturing
Agreement, until such time that the Manufacturing Agreement can be
reduced to writing.
The Company recorded a credit in its Statement of Operations for
the three and nine months ended September 30, 2017 for
approximately $391,000.
Manchester City Football Group
The Company was engaged in a dispute with City Football Group
Limited (“CFG”), the owner of Manchester City Football
Group, concerning amounts allegedly owed by the Company under a
Sponsorship Agreement with CFG. In August 2016, CFG commenced
arbitration in the United Kingdom against the Company, seeking
approximately $8.3 million for the Company’s purported breach
of the Agreement.
On July 28, 2017, the Company approved a Settlement Agreement (the
“Settlement Agreement”) with CFG effective July 7,
2017. The Settlement Agreement represents a full and final
settlement of all litigation between the parties. Under the terms
of the agreement, the Company has agreed to pay CFG a sum of $3
million, consisting of a $1 million payment that was advanced by a
related party on July 7, 2017, and subsequent $1 million
installments to be paid by July 7, 2018 and July 7, 2019,
respectively.
The Company recorded a charge in its Statement of Operations for
the nine months ended September 30, 2017 for approximately $1.5
million, representing the discounted value of the unrecorded
settlement amount and an additional $0.1 million, representing
imputed interest. The Company has now concluded the finalization of
all its major legacy endorsement deals.
Arnold Schwarzenegger
The Company was engaged in a dispute with Marine MP, LLC
(“Marine MP”), Arnold Schwarzenegger
(“Schwarzenegger”), and Fitness Publications, Inc.
(“Fitness,” and together with Marine MP and
Schwarzenegger, the “AS Parties”) concerning amounts
allegedly owed under the parties’ Endorsement Licensing and
Co-Branding Agreement (the “Endorsement Agreement”). In
May 2016, the Company received written notice that the AS Parties
were terminating the Endorsement Licensing and Co-Branding
Agreement by and among the Company and the AS Parties, then the
Company provided written notice to the AS Parties that it was
terminating the Endorsement Agreement, and the AS Parties then
commenced arbitration, which alleged that the Company breached the
parties’ agreement and misappropriated Schwarzenegger’s
likeness. The Company filed its response and counterclaimed for
breach of contract and breach of the implied covenant of good faith
and fair dealing.
On December 17, 2016, the Company entered into a Settlement
Agreement (the “Settlement Agreement”) with the AS
Parties, effective January 4, 2017. Pursuant to the Settlement
Agreement, and to resolve and settle all disputes between the
parties and release all claims between them, the Company agreed to
pay the AS Parties (a) $1.0 million, which payment was released to
the AS Parties on January 5, 2017, and (b) $2.0 million within six
months of the effective date of the Settlement Agreement. The
Company paid the settlement in full as of September 30, 2017. The
Company also has agreed that it will not sell any products from its
Arnold Schwarzenegger product line, will donate to a charity chosen
by Arnold Schwarzenegger any remaining usable product, and
otherwise destroy any products currently in inventory. This
inventory was written off to “Impairment of assets” in
the Consolidated Statement of Operations during the year ended
December 31, 2016. In addition, in connection with the transaction,
the 780,000 shares of Company common stock held by Marine MP were
sold to a third party on January 4, 2017 in exchange for an
aggregate payment by such third party of $1,677,000 to the AS
Parties.
Contingencies
In the normal course of business or otherwise, the Company may
become involved in legal proceedings. The Company will accrue a
liability for such matters when it is probable that a liability has
been incurred and the amount can be reasonably estimated. When only
a range of possible loss can be established, the most probable
amount in the range is accrued. If no amount within this range is a
better estimate than any other amount within the range, the minimum
amount in the range is accrued. The accrual for a litigation loss
contingency might include, for example, estimates of potential
damages, outside legal fees and other directly related costs
expected to be incurred. As of September 30, 2017, the Company was
involved in the following material legal proceedings described
below.
Supplier Complaint
In January 2016, ThermoLife International LLC
(“ThermoLife”), a supplier of nitrates to MusclePharm,
filed a complaint against the Company in Arizona state court. In
its complaint, ThermoLife alleges that the Company failed to meet
minimum purchase requirements contained in the parties’
supply agreement and seeks monetary damages for the deficiency in
purchase amounts. In March 2016, the Company filed an answer
to ThermoLife’s complaint, denying the allegations contained
in the complaint, and filed a counterclaim alleging that ThermoLife
breached its express warranty to MusclePharm because
ThermoLife’s products were defective and could not be
incorporated into the Company’s products. Therefore, the
Company believes that ThermoLife’s complaint is without
merit. The lawsuit continues to be in the discovery
phase.
Former Executive Lawsuit
In December 2015, the Company accepted notice by Mr. Richard
Estalella (“Estalella”) to terminate his employment as
the Company’s President. Although Estalella sought to
terminate his employment with the Company for “Good
Reason,” as defined in Estalella’s employment agreement
with the Company (the “Employment Agreement”), the
Company advised Estalella that it deemed his resignation to be
without Good Reason.
In February 2016, Estalella filed a complaint in Colorado state
court against the Company and Ryan Drexler, Chairman of the Board,
Chief Executive Officer and President, alleging, among other
things, that the Company breached the Employment Agreement, and
seeking certain equitable relief and unspecified damages. The
Company believes Estalella’s claims are without merit. As of
the date of this report, the Company has evaluated the potential
outcome of this lawsuit and recorded the liability consistent with
its policy for accruing for contingencies. The lawsuit continues to
be in the discovery phase with a revised trial date expected to
commence in May 2018.
Insurance Carrier Lawsuit
The Company is engaged in litigation with an insurance carrier,
Liberty Insurance Underwriters, Inc. (“Liberty”),
arising out of Liberty’s denial of coverage. In 2014, the
Company sought coverage under an insurance policy with Liberty
for claims against directors and officers of the Company arising
out of an investigation by the Securities and Exchange Commission.
Liberty denied coverage, and, on February 12, 2015, the Company
filed a complaint in the District Court, City and County of Denver,
Colorado against Liberty claiming wrongful and unreasonable denial
of coverage for the cost and expenses incurred in connection with
the SEC investigation and related matters. Liberty removed the
complaint to the United States District Court for the District of
Colorado, which in August 2016 granted Liberty’s motion for
summary judgment, denying coverage and dismissing the
Company’s claims with prejudice, and denied the
Company’s motion for summary judgment. The Company filed an
appeal in November 2016. The Company filed its opening brief on
February 1, 2017 and Liberty filed its response brief on April 7,
2017. the 10th Circuit affirmed the lower court's grant of summary
judgment in favor of Liberty. The Company intends to seek a
rehearing of the appellate court's decision.
IRS Audit
On April 6, 2016, the Internal Revenue Service (“IRS”)
selected the Company’s 2014 Federal Income Tax Return for
audit. As a result of the audit, the IRS proposed certain
adjustments with respect to the tax reporting of the
Company’s former executives’ 2014 restricted stock
grants. Due to the Company’s current and historical loss
position, the proposed adjustments would have no material impact on
its Federal income tax. On October 5, 2016, the IRS commenced an
audit of the Company’s employment and withholding tax
liability for 2014. The IRS is contending that the Company
inaccurately reported the value of the restricted stock grants and
improperly failed to provide for employment taxes and federal tax
withholding on these grants. In addition, the IRS is proposing
certain penalties associated with the Company’s filings. On
April 4, 2017, the Company received a “30-day letter”
from the IRS asserting back taxes and penalties of approximately
$5.3 million, of which $0.4 million related to employment taxes and
$4.9 million related to federal tax withholding and penalties.
Additionally, the IRS is asserting that the Company owes
information reporting penalties of approximately $2.0 million. The
Company’s counsel has submitted a formal protest to the IRS
disputing on several grounds all of the proposed adjustments and
penalties on the Company’s behalf, and the Company intends to
pursue this matter vigorously through the IRS appeal process.
Due to the uncertainty associated with determining the
Company’s liability for the asserted taxes and penalties, if
any, and to the Company’s inability to ascertain with any
reasonable degree of likelihood, as of the date of this report, the
outcome of the IRS appeals process, the Company is unable to
provide an estimate for its potential liability, if any, associated
with these taxes.
IRS Notice
On
September 11, 2017, the
IRS sent a notice of assessment to
MusclePharm, LLC indicating payroll taxes, penalties and interest
in the amount of approximately $344,000. The Company believes this
notice to be a clerical error as this this entity was dissolved
prior to the period the IRS is claiming this assessments relates
to. The Company is in the process of resolving this matter with the
IRS.
Sponsorship and Endorsement Contract Liabilities
The Company has various non-cancelable endorsement and sponsorship
agreements with terms expiring through 2019. The total value of
future contractual payments as of September 30, 2017 are as follows
(in thousands):
|
|
For the Year Ending December 31,
|
|
|
|
|
|
|
|
Outstanding Payments
|
|
|
|
|
|
Endorsement
|
$
32
|
$
11
|
$
—
|
$
43
|
|
Sponsorship
|
52
|
144
|
55
|
251
|
|
Total
future payments
|
$
84
|
$
155
|
$
55
|
$
294
|
Note 10. Stockholders’ Deficit
Common Stock
During the nine months ended September 30, 2017, the Company had
the following transactions related to its common stock including
restricted stock awards (in thousands, except share and per share
data):
|
Transaction Type
|
|
|
|
|
Stock
issued to employees, executives and directors
|
538,945
|
$
1,045
|
$
1.87-2.17
|
|
Total
|
538,945
|
$
1,045
|
$
1.87-2.17
|
During the nine months ended September 30, 2016, the Company issued
common stock including restricted stock awards, as follows (in
thousands, except share and per share data):
|
Transaction Type
|
|
|
|
|
Stock
issued to employees, executives and directors
|
372,154
|
$
914
|
$
1.89-2.95
|
|
Stock
issued related to sale of subsidiary
|
200,000
|
640
|
3.20
|
|
Cancellation
of executive restricted stock
|
(433,000
)
|
(456
)
|
13.00
|
|
Total
|
139,154
|
$
1,098
|
$
1.89-13.00
|
The fair value of all stock issuances above is based upon the
quoted closing trading price on the date of issuance.
Common stock outstanding as of September 30, 2017 and December 31,
2016 includes shares legally outstanding even if subject to future
vesting.
Warrants
In November 2016, the Company issued a warrant to purchase
1,289,378 shares, equal to approximately 7.5% of the
Company’s fully diluted equity of its common stock to the
parent company of Capstone Nutrition, the Company’s former
product manufacturer, pursuant to a settlement agreement, which
under certain circumstances is subject to adjustment. The exercise
price of this warrant was $1.83 per share, with a contractual term
of four years. The Company has valued this warrant by utilizing the
Black Scholes model at approximately $1.8 million with the
following assumptions: contractual life of four years, risk
free interest rate of 1.27%, dividend yield of 0%, and expected
volatility of 118.4%.
In July 2014, the Company issued a warrant to purchase 100,000
shares of its common stock related to an endorsement agreement. The
exercise price of this warrant was $11.90 per share, with a
contractual term of five years. This warrant fully vested during
2016. The Company used the Black-Scholes model to determine the
estimated fair value of the warrants, with the following
assumptions: contractual life of five years, risk free
interest rate of 1.7%, dividend yield of 0%, and expected
volatility of 55%.
Treasury Stock
During the nine months ended September 30, 2017 and the year ended
December 31, 2016, the Company did not repurchase any shares of its
common stock and held 875,621 shares in treasury as of September
30, 2017 and December 31, 2016.
Note 11. Stock-Based Compensation
Restricted Stock
The Company’s stock-based compensation for the three and nine
months ended September 30, 2017 and 2016 consist primarily of
restricted stock awards. The activity of restricted stock awards
granted to employees, executives and Board members was as
follows:
|
|
Unvested Restricted Stock Awards
|
|
|
|
Weighted Average
Grant
Date
Fair
Value
|
|
Unvested
balance – December 31, 2016
|
378,425
|
$
3.45
|
|
Granted
|
538,945
|
1.94
|
|
Vested
|
(179,680
)
|
2.67
|
|
Cancelled
|
—
|
—
|
|
Unvested
balance – September 30, 2017
|
737,690
|
2.53
|
The Company issued 168,783 and 538,945 shares of restricted stock
to its Board members for the three and nine months ended September
30, 2017, respectively. The total fair value of restricted stock
awards granted to employees and the Board was $0.3 million and $0.5
million for the three months ended September 30, 2016,
respectively, and $1.0 million and $0.9 million for the nine months
ended September 30, 2017 and 2016, respectively. As of September
30, 2017, the total unrecognized expense for unvested restricted
stock awards, net of expected forfeitures, was $0.8 million, which
is expected to be amortized over a weighted average period of 0.8
years.
Restricted Stock Awards Issued to Ryan Drexler, Chairman of the
Board, Chief Executive Officer and President
In January 2017, the Company issued Mr. Ryan Drexler 350,000 shares
of restricted stock pursuant to an Amended and Restated Executive
Employment Agreement dated November 18, 2016 (“Employment
Agreement”) with a grant date value of $0.7 million based
upon the closing price of the Company’s common stock on the
date of issuance. These shares of restricted stock vest in full
upon the first anniversary of the grant date.
Accelerated Vesting of Restricted Stock Awards Related to
Termination of Employment Agreement with Brad Pyatt, Former Chief
Executive Officer
In March 2016, Brad Pyatt, the Company’s former Chief
Executive Officer, terminated his employment with the Company.
Pursuant to the terms of the separation agreement with the Company,
in exchange for a release of claims, the Company agreed to pay
severance in the amount of $1.1 million, payable over a 12-month
period, a lump sum of $250,000 paid during March 2017 and
reimbursement of COBRA premiums, which the Company recorded in the
six months ended September 30, 2016. In addition, the remaining
unvested restricted stock awards held by Brad Pyatt of 500,000
shares vested in full upon his termination in accordance with the
original grant terms. In connection with the accelerated vesting of
these restricted stock awards, the Company recognized stock
compensation expense of $3.9 million, which is included in
“Salaries and benefits” in the accompanying Condensed
Consolidated Statements of Operations for the nine months ended
September 30, 2016. All amounts due Mr. Pyatt were paid as of March
31, 2017.
Stock Options
The Company may grant options to purchase shares of the
Company’s common stock to certain employees and directors
pursuant to the 2015 Plan. Under the 2015 Plan, all stock options
are granted with an exercise price equal to or greater than the
fair market value of a share of the Company’s common stock on
the date of grant. Vesting is generally determined by the
Compensation Committee of the Board within limits set forth in the
2015 Plan. No stock option will be exercisable more than ten years
after the date it is granted.
In February 2016, the Company issued options to purchase 137,362
shares of its common stock to Mr. Drexler, the Company’s
Chairman of the Board, Chief Executive Officer, and President, and
54,945 to Michael Doron, the former Lead Director of the Board.
Upon resignation from the Board of Directors, Mr. Doron forfeited
20,604 of the options issued. These stock options have an exercise
price of $1.89 per share, a contractual term of 10 years and a
grant date fair value of $1.72 per share, or $0.3 million, which is
amortized on a straight-line basis over the vesting period of two
years. The Company determined the fair value of the stock options
using the Black-Scholes model. The table below sets forth the
assumptions used in valuing such options.
|
|
For the Six Months Ended
June 30, 2016
|
|
|
Expected term of options
|
6.5 years
|
|
|
Expected volatility
|
131.0%
|
|
|
Risk-free interest rate
|
1.71%
|
|
|
Expected dividend yield
|
0.0%
|
|
For the three months ended September 30, 2017 and 2016, the Company
recorded stock compensation expense related to options of $29,000
and $42,000, respectively. For the nine months ended September 30,
2017 and 2016, the Company recorded stock compensation expense
related to options of $112,000 and $97,000,
respectively.
Note 12. Net Loss per Share
Basic net loss per share is computed by dividing net loss for the
period by the weighted average number of shares of common stock
outstanding during each period, excluding any unvested restricted
stock shares which are included in common stock outstanding. There
was no dilutive effect for the outstanding potentially dilutive
securities for the three and nine months ended September 30, 2017
and 2016, respectively, as the Company reported a net loss for all
periods.
The following table sets forth the computation of the
Company’s basic and diluted net loss per share for the
periods presented (in thousands, except share and per share
data):
|
|
For the Three Months
Ended September 30,
|
For the Nine Months
Ended September 30,
|
|
|
|
|
|
|
|
Net
loss
|
$
(2,128
)
|
$
(1,447
)
|
$
(8,426
)
|
$
(12,248
)
|
|
Weighted
average common shares used in computing net loss per share, basic
and diluted
|
13,875,119
|
13,978,833
|
13,819,939
|
13,886,496
|
|
Net
loss per share, basic and diluted
|
$
(0.15
)
|
$
(0.10
)
|
$
(0.61
)
|
$
(0.88
)
|
Diluted net income per share is computed by dividing net income for
the period by the weighted average number of shares of common
stock, common stock equivalents and potentially dilutive securities
outstanding during each period. The Company uses the treasury stock
method to determine whether there is a dilutive effect of
outstanding potentially dilutive securities, and the if-converted
method to assess the dilutive effect of the convertible
notes.
There was no dilutive effect for the outstanding awards for the
three and nine months ended September 30, 2017 and 2016,
respectively, as the Company reported a net loss for all periods.
However, if the Company had net income for the three and nine
months ended September 30, 2017, the potentially dilutive
securities included in the earnings per share computation would
have been 8,852,627 and 9,048,072, respectively. If the Company had
net income for the three and nine months ended September 30, 2016,
the potentially dilutive securities included in the earnings per
share computation would have been 2,608,695 for both
periods.
Total outstanding potentially dilutive securities were comprised of
the following:
|
|
|
|
|
|
|
|
Stock
options
|
171,703
|
192,307
|
|
Warrants
|
1,389,378
|
100,000
|
|
Unvested
restricted stock
|
737,690
|
336,014
|
|
Convertible
notes
|
8,619,624
|
2,608,695
|
|
Total
common stock equivalents
|
10,918,395
|
3,237,016
|
Note 13. Income Taxes
Income taxes are provided for the tax effects of transactions
reported in the Condensed Consolidated Financial Statements and
consist of taxes currently due. Deferred taxes relate to
differences between the basis of assets and liabilities for
financial and income tax reporting which will be either taxable or
deductible when the assets or liabilities are recovered or settled.
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 income tax assets will not be realized. The
ultimate realization of deferred income 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 income tax
liabilities, projected future taxable income, and tax planning
strategies in making this assessment. Based on consideration of
these items, management has established a full valuation allowance
as it is more likely than not that the tax benefits will not be
realized as of September 30, 2017.
Note 14. Segments, Geographical Information
The Company’s chief operating decision maker reviews
financial information presented on a consolidated basis for
purposes of allocating resources and evaluating financial
performance. As such, the Company currently has a single reporting
segment and operating unit structure. In addition, substantially
all long-lived assets are attributable to operations in the U.S.
for both periods presented.
Revenue, net by geography is based on the company addresses of the
customers. The following table sets forth revenue, net by
geographic area (in thousands):
|
|
For the Three Months
Ended September 30,
|
For the Nine Months
Ended September 30,
|
|
|
|
|
|
|
|
Revenue,
net:
|
|
|
|
|
|
United
States
|
$
14,502
|
$
18,744
|
$
46,769
|
$
71,955
|
|
International
|
9,894
|
11,950
|
29,828
|
34,518
|
|
Total
revenue, net
|
$
24,396
|
$
30,694
|
$
76,597
|
$
106,473
|
Note 15. Key Executive Life Insurance
The Company had purchased split dollar life insurance policies on
certain key executives. These policies provide a split of 50% of
the death benefit proceeds to the Company and 50% to the
officer’s designated beneficiaries. None of these key
executives are currently employed by the Company, and all policies
were terminated or transferred to the former employees as of
December 31, 2016.
Note 16. Subsequent Events
GAAP requires an entity to disclose events that occur after the
balance sheet date but before financial statements are issued or
are available to be issued (“subsequent events”) as
well as the date through which an entity has evaluated subsequent
events. There are two types of subsequent events. The first type
consists of events or transactions that provide additional evidence
about conditions that existed at the date of the balance sheet,
including the estimates inherent in the process of preparing
financial statements, (“recognized subsequent events”).
The second type consists of events that provide evidence about
conditions that did not exist at the date of the balance sheet but
arose subsequent to that date (“non-recognized subsequent
events”).
Recognized Subsequent Events
Refinancing Transaction with Ryan Drexler
As
described in Note 8, the related party Prior Notes were refinanced
on November 3, 2017 whereby, among other things, the maturity date
was extended to December 31, 2019 and accordingly such debt has
been classified as a long-term liability in the accompanying
condensed consolidated Balance Sheet as of September 30,
2017.
Unrecognized Subsequent Events
Inventory Financing
On
October 6, 2017, the Company and its affiliate (together with the
Company, “Borrower”) entered into a Loan and Security
Agreement (“Security Agreement”) with Crossroads
Financial Group, LLC (“Lender”). Pursuant to the
Security Agreement, Borrower may borrow up to 70% of its Inventory
Cost
or up to 75% of Net
Orderly Liquidation Value (each as defined in the Security
Agreement), up to a maximum amount of $3.0 million at an interest
rate of 1.5% per month, subject to a minimum monthly fee of
$22,500. The initial term of the Security Agreement is six months
from the date of execution, and such initial term is extended
automatically in six month increments, unless earlier terminated
pursuant to the terms of the Security Agreement. The Security
Agreement contains customary events of default, including, among
others, the failure to make payments on amounts owed when due,
default under any other material agreement or the departure of Mr.
Drexler. The Security Agreement also contains customary
restrictions on the ability of Borrower to, among other things,
grant liens, incur debt and transfer assets. Under the Security
Agreement, Borrower has agreed to grant Lender a security interest
in all Borrower’s present and future accounts, chattel paper,
goods (including inventory and equipment), instruments, investment
property, documents, general intangibles, intangibles, letter of
credit rights, commercial tort claims, deposit accounts, supporting
obligations, documents, records and the proceeds
thereof.