PART I
MusclePharm
Corporation was incorporated in Nevada in 2006. Except as otherwise
indicated herein or the context requires otherwise, the terms
“MusclePharm,” the “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 sports nutrition products and nutritional
supplements. Our portfolio of
recognized brands, including MusclePharm®
and FitMiss®,
is marketed and sold in more than 100 countries
globally. The Company is headquartered in Burbank,
California and, as of December 31, 2019, had the following
wholly-owned operating subsidiaries: MusclePharm Canada Enterprises
Corp., MusclePharm Ireland Limited and MusclePharm Australia Pty
Limited.
Products
The MusclePharm brand product portfolio is designed for athletes of
all levels and anyone who pursues an active lifestyle. We offer a
broad range of performance powders, capsules, tablets and gels that
satisfy the needs of enthusiasts and professionals alike. Our
products are marketed in multiple performance and active lifestyle
distribution channels that reach athletes of all types and
demographics. Our goal is to serve the needs of our customers,
while fueling the engine of sport for all ages and genders. Our
portfolio of products targets every type of fitness enthusiast and
professional, from combat sport, weight training, bodybuilding,
running, and all team and individual sports, as well as individuals
who lead an active lifestyle.
We place considerable emphasis on transparency, high-quality
ingredients, innovation and science. Products are placed
through rigorous third-party independent testing to ensure safe,
quality ingredients to support all levels of athletic
ability. Tests performed on products include banned substance
testing and protein verification, among others.
Sport Series - Scientifically-advanced, performance-driven sports
nutrition items that cover the needs of athletes. This line of
award-winning, independently-tested products helps to fuel athletes
safely by increasing strength, energy, endurance, recovery and
overall athletic performance. Sport Series’ lineup includes
products like Combat Protein Powder, a top selling five-protein
blend on the market, and the award winning Combat Crunch Protein
Bars.
Essentials Series - To meet the
day-in and day-out demands of fitness and sport, the Essentials
Series (formerly known as the Core Series) line of supplements
exists for athletes to take daily. These products include daily
staples for a healthy body, such as BCAA, creatine, glutamine,
carnitine, CLA, fish oil, a multi-vitamin and
more.
Natural Series - A natural, non-genetically modified
organism (“non-GMO”) sports performance line, made for
a growing consumer base that seeks organic, vegan and plant-based
nutritional product and supplement options. We created the Natural
Series with USDA-certified organic ingredients, plant-based protein
and natural caffeine sources, in clean and delicious formats, to
power all stages of the workout.
FitMiss® - Designed and formulated specifically for the
female body, FitMiss sports nutrition products are complementary to
any active female’s diet. In seeking a stronger, more
balanced foundation, FitMiss ingredients support women in areas of
weight management, lean muscle mass, body composition, and general
health and wellness.
On-the-Go – As more and
more consumers are seeking healthier and convenient snacking
options, retailers across multiple channels are capitalizing on
this emerging trend by aggressively expanding their assortments to
accommodate this demand. The On-the-Go portfolio of ready to eat
products includes the award winning Combat Crunch, Protein Crisp,
Organic Protein and Protein Cookie.
Sales and Marketing
Our
goal is to position MusclePharm as the “must have”
brand for elite athletes and fitness enthusiasts, alike, who are on
a journey to holistically better themselves and achieve their
maximum potential. Our marketing is focused on our most prominent
products and includes brand partnerships, focusing on grass-roots
marketing and advertising efforts with athletes and retail outlets
close to our core audience. Our marketing includes digital
marketing, sampling, public relations, athlete/influencer
marketing, event marketing, trade activity, paid media,
advertising, SEO/SEM, and affiliate marketing. Our roster of elite
athletes, influencers and brand ambassadors play a role in our
marketing. New product innovation is also a key component of
driving incremental sales.
Distribution Channels
MusclePharm brands are marketed across major global retail
distribution channels – Specialty, International and Food,
Drug, and Mass (“FDM”). Our largest customers,
Costco Wholesale Corporation (“Costco”), Amazon.com,
Inc. (“Amazon”), and iHerb, LLC (“iHerb”)
accounted for approximately 33%, 13% and 17% of our 2019 net
revenue, respectively. Costco, Amazon and iHerb accounted for
approximately 29%, 13% and 13% of our 2018 net revenue,
respectively. For further information concerning our customer
concentration, see Note 2 to the accompanying Consolidated
Financial Statements.
Specialty: This channel is
comprised of brick-and-mortar sales and e-commerce. Due to
high competition within this market, we continually seek to respond
to customer trends and shifts by adjusting the mix of existing
product offerings, developing new innovative products and
influencing preferences through our marketing. We experienced
significant growth in online sales in 2019, primarily through
our Amazon and iHerb distribution channels.
International: Our
international reach touches every relevant market in the world. We
seek to further grow our international sales by continuing to offer
new products in key markets as well as opening new distribution
channels in select regions of the world. We also are evaluating the
benefits of developing expanded manufacturing partnerships outside
of North America to take advantage of local
opportunities.
FDM: This channel is primarily
served by our direct sales force, as well as our network of
brokers. We believe direct relationships with retail partners
provide us an opportunity to expand our distribution into
additional discount warehouses and national
retailers.
Below is a table of net revenue by our major distribution
channel:
|
For the Years Ended December 31,
|
|
|
|
|
|
Distribution
Channel
|
|
|
|
|
Specialty
|
$35,812
|
45%
|
$35,690
|
41%
|
International
|
22,691
|
28%
|
32,143
|
36%
|
FDM
|
21,164
|
27%
|
20,280
|
23%
|
Total
|
$79,667
|
100%
|
$88,113
|
100%
|
Product Research, Development and Quality Control
Customers’ belief in the safety and efficacy of our products
is critical. Continued innovation in delivery techniques and
ingredients, new product line extensions, and new product offerings
are important in order to sustain existing and create new market
opportunities, meet consumer demand, and strengthen consumer
relationships. To support our research and development
efforts, we invest in formulation, processing and packaging
development, perform product quality and stability studies, and
conduct consumer market research to sample consumer opinions on
product concepts, design, packaging, advertising, and marketing
campaigns.
We are committed to science and sport being equal in our product
development. We believe real-world applications are essential. Our
state-of-the-art, 20,000 square-foot professional training and
performance facility in Burbank, California is dedicated to
optimizing the performance of our products for all ranges of
athletes. Collecting feedback from athletes in our facility helps
our team strive to improve our products and to continue to be
innovative. Our product lines have been developed through a
stringent protocol to ensure that all formulations promote quality
and safety for our customers. Our quality control team follows
detailed supplier selection and certification processes, validation
of raw material verification processes, analytical testing, process
audits, and other quality control procedures. Our products are also
subject to extensive shelf life stability testing. We also engage
third-party laboratories to routinely evaluate and validate our
internal testing processes on every MusclePharm
product.
We qualify ingredients, suppliers, and facilities by performing
site assessments and conducting on-going performance and process
reviews. Dedicated quality teams regularly audit and assess
manufacturing facilities for compliance with Good
Manufacturing Practices (“GMPs”), as regulated by
the United States Food and Drug Administration (“FDA”),
to ensure our compliance with all MusclePharm, regulatory, and
certification standards and requirements. To ensure overall
consistency, our quality assurance team adheres to strict written
procedures. From the raw ingredient stage to the finished product
stage, we monitor and perform quality control checks. Before
distributing our products, we place our products under
quarantine to test for environmental contaminants and verify
that the finished product meets label claims. Once a
product has successfully passed quality assurance testing and
conforms to specifications for identity, purity, strength, and
composition, we then conduct testing with third-party
laboratories for added label claim verification. Multi-level
practices are part of our product development process to ensure
athletes and our consumers receive what we believe to be the
most scientifically innovative and safest products on the
market. Post-distribution, we have standard operating procedures in
place for investigating and documenting any adverse events or
product quality complaints. We are committed to the process of
having all of our products certified to be banned-substance-free
before they are available to consumers. Informed Choice, a globally
recognized leader in sports testing, conducts all of our
third-party banned substance testing, ensuring that all MusclePharm
products are free of banned substances.
Manufacturing and Distribution
We have relationships with multiple third-party manufacturers.
Certain of our vendors supply in excess of 10% of our products.
Once a product is manufactured, it is sent to our distribution
center in Spring Hill, Tennessee, or shipped directly to the
customer. All of the third-party manufacturing facilities that we
source from and distribution facilities are designed and operated
to meet current GMP standards as promulgated by the
FDA.
The manufacturing process performed by our third-party
manufacturers generally consists of the following operations:
(i) qualifying ingredients for products; (ii) testing of
all raw ingredients; (iii) measuring ingredients for inclusion
in production; (iv) granulating, blending and grinding
ingredients into a mixture with a homogeneous consistency;
(v) encapsulating or filling the blended mixture into the
appropriate dosage form using either automatic or semiautomatic
equipment; and (vi) testing finished products prior to
distribution.
We maintain and operate a system that integrates distribution,
warehousing, and quality control. This provides real-time lot and
quality tracking of raw materials, work in progress and finished
goods. We employ a supply chain staff that works with sales,
marketing, product development, and quality control personnel to
ensure that only products that meet all specifications are produced
and released to customers.
Our Competitors
The sports nutrition market is very competitive, and the range of
products is diverse and subject to rapid and frequent changes in
consumer demand. Competitors use price, shelf space and store
placement, brand and product recognition, new product
introductions, and raw materials to capture market share. We
believe that retailers look to partner with suppliers who
demonstrate brand development, market intelligence, customer
service, and produce high quality products with proven science. We
believe we are competitive in all of these areas.
Our competitors include numerous nutritional companies that are
highly fragmented in terms of geographic market coverage,
distribution channels, and product categories. In addition, we
compete with large pharmaceutical companies and packaged food and
beverage companies. Many of these competitors have greater
financial and distribution resources available to them than us and
some compete through vertical integration. Private label entities
have gained a foothold in many nutrition categories and also are
direct competitors. Our principal competitors are: Glanbia
Performance Nutrition (Optimum Nutrition), Nutrabolt, (Cellucor
C4), Dymatize Enterprises LLC, and Iovate Health Sciences
International Inc. As many of our competitors are either privately
held or divisions within larger organizations, it is difficult to
fully gauge their size and relative ranking.
Government Regulation
The formulation, manufacturing, packaging, labeling, advertising,
distribution, storage, and sale of each of our product groups are
subject to regulation by one or more governmental agencies. The
most active of these is the FDA, which regulates our products under
the Federal Food, Drug and Cosmetic Act (“FDCA”) and
regulations promulgated thereunder. The FDCA defines the terms
“food” and “dietary supplement” and sets
forth various requirements that, unless complied with, may
constitute adulteration or misbranding of such products. The FDCA
has been amended several times with respect to dietary supplements,
most recently by the Nutrition Labeling and Education Act of 1990
(the “NLEA”) and the Dietary Supplement Health and
Education Act of 1994.
FDA regulations relating specifically to foods and dietary
supplements for human use are set forth in Title 21 of the Code of
Federal Regulations. These regulations include basic labeling
requirements for both foods and dietary supplements. Additionally,
FDA regulations require us and our third-party manufacturers to
meet relevant good manufacturing practice regulations for the
preparation, packaging and storage of our food and dietary
supplements.
Our business practices and products are also regulated by the
Federal Trade Commission (“FTC”), the Consumer Product
Safety Commission, the United States Department of Agriculture
(“USDA”) and the Environmental Protection Agency. Our
activities, including our direct selling distribution activities,
are also regulated by various agencies of the states, localities
and foreign countries in which our products are sold.
In foreign markets, prior to commencing operations and initiating
or permitting sales of our products in the market, we may be
required to obtain an approval, license or certification from the
country’s ministry of health or comparable agency. Prior to
entering a new market in which a formal approval, license or
certificate is required, we work extensively with local consultants
and authorities in order to obtain the requisite approvals. We
must also comply with product labeling and packaging regulations
that vary from country to country. Our failure to comply with
these regulations can result in a product being removed from sale
in a particular market, either temporarily or
permanently.
Intellectual Property
We regard our trademarks and other proprietary rights as valuable
assets and believe that protecting our intellectual property is
crucial to the continued successful implementation of our business
strategy. Since we regard our intellectual property as a crucial
element of our business with significant value in the marketing of
our products, our policy is to rigorously pursue registrations for
all trademarks associated with our products.
We have over 55 trademark applications in the United States, 53 of
which are currently registered with the United States Patent and
Trademark Office. Our registered trademarks include
registrations of our house marks, as well as marks associated with
our core product lines.
We also have filed for protection of various marks throughout the
world and are committed to a significant long-term strategy to
build and protect the MusclePharm brand globally. We have
applied for the “MusclePharm” mark effective in 37
countries, including the United States. The mark has been granted
final trademark registration effective in all 37 of those
countries.
Seasonality
Our business does not typically experience seasonal variations, but
revenue may fluctuate based upon promotions.
Employees
As of December 31, 2019, we had 45 total employees, all of whom were full time. None
of the employees are represented by a union. Management considers
its relations with our employees to be good and to have been
maintained in a normal and customary manner.
Corporate Information
Our principal executive offices are located at 4400 Vanowen St.,
Burbank, CA 91505 and our telephone number is (800) 292-3909.
We were incorporated in the State of Nevada in 2006. Our Internet
addresses are www.musclepharm.com
and www.musclepharmcorp.com.
The information contained on our
websites is not incorporated herein.
Available Information
Our corporate website is www.musclepharmcorp.com. We post the following filings as soon as
reasonably practicable after they are electronically filed with or
furnished to the SEC: our Annual Report on Form 10-K, our
quarterly reports on Form 10-Q, our current reports on
Form 8-K and any amendments to those reports filed or
furnished pursuant to Section 13(a) or 15(d) of the Exchange
Act, as amended. All such filings are available free of charge on
the Investor Relations section of our website, or from the
SEC’s website at www.sec.gov. Information on our website does
not constitute part of this report. Also available on the Investor
Relations section of our website are the charters of the committees
of our Board, as well as our corporate governance guidelines and
code of ethics.
Certain factors may have a material adverse effect on our business,
financial condition and results of operations. You should consider
carefully the risks and uncertainties described below, in addition
to other information contained in this Annual Report on Form 10-K,
including our consolidated financial statements and related notes.
The risks and uncertainties described below are not the only ones
we face. Additional risks and uncertainties that we are unaware of,
or that we currently believe are not material, may also become
important factors that adversely affect our business. If any of the
following risks actually occurs, our business, financial condition,
results of operations and future prospects could be materially and
adversely affected. In that event, the trading price of our common
stock could decline, and you could lose part or all of your
investment.
Risks Related to Our Business and Industry
We have a history of losses from operations, there is uncertainty
as to when we may become profitable, and our current indebtedness
may limit our operating flexibility, which raise substantial doubt
about the Company’s ability to continue as a going
concern.
The
Company has incurred significant losses and experienced negative
cash flows since inception. As of December 31, 2019, we had a
working capital deficit of $29.4 million, a stockholders’
deficit of $28.0 million and recurring losses from operations
including an accumulated deficit of $195.9 million resulting from
losses from operations. During 2019, we incurred an additional
substantial loss. As a result of our history of losses and
financial condition, there is substantial doubt about our ability
to continue as a going concern.
As of
December 31, 2019, we had outstanding indebtedness of $10.2
million. For a description of our indebtedness, see “Item 7.
Management’s Discussion and Analysis of Financial Condition
and Results of Operations – Liquidity and Capital
Resources.”
The
ability to continue as a going concern is dependent upon us
achieving profitable operations in the future and/or obtaining the
necessary financing to meet our obligations and repay our
liabilities when they come due. Management is on an ongoing basis
evaluating strategies to obtain financing to fund our expenses and
achieve a level of revenue adequate to support our current cost
structure. There is no assurance that we will be able to obtain
additional financing on acceptable terms or at all or to generate
an adequate level of revenues.
Our
indebtedness, and history of losses, could have important
consequences to us. For example, it could:
●
make us more
vulnerable to general adverse economic and industry conditions,
including effects of the ongoing COVID-19 pandemic;
●
limit our ability
to obtain additional financing for working capital, capital
expenditures, acquisitions and other general corporate
requirements; and
●
limit our
flexibility in planning for, or reacting to, changes in our
business and the industry in which we operate.
In
addition, our ability to pay or refinance our debt depends on our
successful financial and operating performance, cash flows and
capital resources, which in turn depend upon prevailing economic
conditions and certain financial, business and other factors, many
of which are beyond our control. These factors include, among
others:
●
economic and demand
factors affecting our industry;
●
increased operating
costs;
●
competitive
conditions; and
●
other operating
difficulties.
If our
cash flows and capital resources are insufficient to fund our debt
service obligations, we may be forced to reduce or delay operating
or capital expenditures, sell material assets or operations, seek
to obtain additional capital, or restructure our debt.
We may
incur additional indebtedness in the future. Our incurrence of
additional indebtedness would intensify the risks described
above.
Our operating results may fluctuate, which makes them difficult to
predict and they may fall short of expectations.
Our
operating results may fluctuate due to a number of factors, many of
which are outside of our control. As a result, comparing our
operating results on a period-to-period basis may not be
meaningful, and you should not rely on our past results as an
indication of our future performance. Our quarterly, year-to-date,
and annual expenses as a percentage of our revenues may differ
significantly from our historical or projected rates. Our operating
results in future quarters may not meet expectations.
Each of
the following factors, as well as others, may affect our operating
results:
●
our loss of one or
more significant customers;
●
the introduction of
successful new products by our competitors;
●
the effects of the
ongoing COVID-19 pandemic; and
●
adverse media
reports on the use or efficacy of nutritional
supplements.
Because
our business is changing and evolving, our historical operating
results may not be useful to you in predicting our future operating
results.
We will likely be required to raise additional financing to fund
our operations.
We will
likely be faced with the need to raise additional funds in the
future. There can be no assurance that we will be able to obtain
debt or equity financing on acceptable terms, or at
all.
Mr. Drexler’s stock ownership gives him the ability to
substantially influence the strategic direction of the Company and
to direct the outcome of matters requiring stockholder
approval.
Mr.
Ryan Drexler, our Chairman of the Board, Chief Executive Officer
and President, owns approximately 55.7% of our outstanding shares
of common stock. As a result, Mr. Drexler is able to substantially
influence the strategic direction of the Company and the outcome of
matters requiring approval by our stockholders. Mr. Drexler’s
interests may not be, at all times, the same as those of our other
stockholders, and his control may delay, deter or prevent acts that
may be favored by our other stockholders.
We rely on a limited number of customers for a substantial portion
of our sales, and the loss of or material reduction in purchase
volume by any of these customers would adversely affect our sales
and operating results.
During
2019, our largest customers, Costco, Amazon, and iHerb individually
accounted for approximately 33%, 13% and 17%, respectively, of our
net revenue. Net revenue is equal to our gross revenue less product
discounts, customer rebates and incentives. The loss of any of our
major customers, a significant reduction in purchases by any major
customer, price pressure from any of our major customers or any
serious financial difficulty of a major customer may have a
material adverse effect on our sales and operating
results.
The Company’s retail
customers have been and may continue to be affected by outbreaks of
disease, such as epidemics or pandemics, including the ongoing
COVID-19 pandemic.
The
Company’s retail customers have been and continue to be
affected by the ongoing global COVID-19 pandemic and the resulting
volatility and uncertainty it has caused in the U.S. and
international markets. Store closures and social distancing have
adversely impacted the Company’s sales to retailers. The
COVID-19 pandemic also has the potential to significantly impact
our supply chain if the facilities of our third- party
manufacturers, the distribution centers where our inventory is
managed or the operations of our logistics and other service
providers are disrupted, temporarily closed or experience worker
shortages. We may also see disruptions or delays in shipments of
certain materials or products.
As a
result of the ongoing COVID-19 outbreak, the Company has
transitioned the majority of its workforce to a temporary remote
working model, which may result in the Company experiencing lower
work efficiency and productivity, which in turn may adversely
affect the Company’s business. As Company employees work from
home and access the Company’s system remotely, the Company
may be subject to heightened security risks, including the risks of
cyberattacks. Additionally, if any of the Company’s key
management or other employees are unable to perform his or her
duties for a period of time, including as the result of illness,
the Company’s results of operations or financial condition
could be adversely affected.
The
Company cannot reasonably estimate the length or severity of the
COVID-19 pandemic or the related responses, or the extent to which
the disruption may materially impact the Company’s business,
consolidated financial position, consolidated results of operations
or consolidated cash flows.
Our failure to respond appropriately to competitive challenges,
changing consumer preferences and demand for new products could
significantly harm our customer relationships and product
sales.
The
sports nutrition market is very competitive, and the range of
products is diverse and subject to rapid and frequent changes in
consumer demand. Our failure to accurately predict product trends
could negatively impact our results and cause our revenues to
decline. Our success with any product offering (whether new or
existing) depends upon a number of factors, including our ability
to:
●
deliver quality
products in a timely manner in sufficient volumes;
●
accurately
anticipate customer needs and forecast accurately to our
manufacturers;
●
differentiate our
product offerings from those of our competitors;
●
competitively price
our products; and
Furthermore,
products often have to be promoted heavily in stores or in the
media to obtain visibility and consumer acceptance. Acquiring
distribution for products is difficult and often expensive due to
slotting and other promotional charges mandated by retailers.
Products can take substantial periods of time to develop consumer
awareness, consumer acceptance and sales volume. Accordingly, some
products may fail to gain or maintain sufficient sales volume and
as a result may have to be discontinued. In a highly competitive
marketplace, it may be difficult to have retailer’s open
SKU’s for new products.
Our industry is highly competitive, and our failure to compete
effectively could adversely affect our market share, financial
condition, and future growth.
The
sports nutrition market is highly competitive with respect
to:
●
shelf space and
store placement;
●
brand and product
recognition;
●
new product
introductions; and
Many of
our competitors are larger, more established companies and possess
greater financial strength and other resources than we have. We
face competition in the supplement market from a number of large
nationally known manufacturers, private label brands and many
smaller manufacturers.
Our industry is highly regulated. We may in the future incur
increased compliance costs and/or incur substantial judgments,
fines, legal fees, and other costs.
The
manufacturing, packaging, labeling, advertising, distribution,
storage and sale of our products are regulated by various federal,
state, and local agencies as well as those of each foreign country
to which we distribute. Our compliance costs may increase in the
future, and those increases could be material. In addition,
governmental authorities may commence regulatory or legal
proceedings, which could restrict the permissible scope of our
product claims or the ability to manufacture and sell our products
in the future. For example, the FDA regulates our products to
ensure that the products are not adulterated or misbranded. Failure
to comply with FDA requirements may result in, among other things,
warning or untitled letters, injunctions, product withdrawals,
recalls, product seizures, fines, and criminal
proceedings.
Our
advertising is subject to regulation by the FTC under the Federal
Trade Commission Act. In recent years, the FTC has initiated
numerous investigations of dietary supplement and weight loss
products and companies. Additionally, some states also permit
advertising and labeling laws to be enforced by private attorney
generals, who may seek relief for consumers, seek class action
certifications, seek class wide damages, and product recalls. Any
of these types of actions could have a material adverse effect on
our business, financial condition, and results of
operations.
Adverse publicity or consumer perception of our products and any
similar products distributed by others could harm our reputation
and adversely affect our sales.
We are
highly dependent upon positive consumer perceptions of the safety
and quality of our products as well as similar products distributed
by other sports nutrition supplement companies. Consumer perception
of sports nutrition supplements and our products in particular can
be substantially influenced by scientific research or findings,
national media attention and other publicity about product
use.
Adverse
publicity from these sources regarding the safety, quality, or
efficacy of our products or nutritional supplements could seriously
harm our reputation and results of operations. The mere publication
of news articles or reports asserting that such products may be
harmful or questioning their efficacy could have a material adverse
effect on our business, financial condition, and results of
operations, regardless of whether such news articles or reports are
scientifically supported or whether the claimed harmful effects
would be present at the dosages recommended for such
products.
We may be exposed to material product liability claims, which could
increase our costs and adversely affect our reputation and
business.
As a
marketer and distributor of products designed for human
consumption, we could be subject to product liability claims if the
use of our products is alleged to have resulted in injury or
undesired results. Our products consist of vitamins, minerals,
herbs, and other ingredients that are classified as dietary
supplements and in most cases are not subject to pre-market
regulatory approval in the United States or internationally.
Previously unknown adverse reactions resulting from human
consumption of these ingredients could occur.
We have
not had any significant product liability claims filed against us
but, in the future, we may be subject to various product liability
claims, including due to tampering by unauthorized third parties,
product contamination, and claims that our products had inadequate
instructions for use, or inadequate warnings concerning possible
side effects and interactions with other substances. The cost of
defense can be substantially higher than the cost of settlement
even when claims are without merit. The high cost to defend or
settle product liability claims could have a material adverse
effect on our business, financial condition and results of
operations, and our insurance, if any, may not be
adequate.
In
addition, the perception of our products resulting from a product
liability claim also could have a material adverse effect on our
business, financial condition and results of
operations.
Our insurance coverage or third-party indemnification rights may
not be sufficient to cover our legal claims or other losses that we
may incur in the future.
We
maintain insurance at what we believe are adequate levels for
property, general product liability, product recall,
director’s and officer’s liability, and workers’
compensation to protect ourselves against potential loss exposures.
In the future, insurance coverage may not be available at adequate
levels or on adequate terms to cover potential losses, including on
terms that meet our customer’s or manufacturer’s
requirements. If insurance coverage is inadequate or unavailable,
we may face claims that exceed coverage limits or that are not
covered, which could increase our costs and adversely affect our
operating results.
If we are unable to retain key management personnel or hire
qualified personnel, our ability to manage our business effectively
and grow could be negatively impacted.
Over
the last few years, the Company has had significant management
turnover. Our future success depends in part on our ability to
identify, hire, develop, motivate and retain key skilled management
personnel and employees for all areas of our organization,
particularly sales and marketing. Competition in our industry for
qualified employees has been intense. The loss or limitation of the
services of any of our key management employees, including as a
result of illness, or our inability to hire qualified employees
could have a material adverse effect on our business, financial
condition and results of operations.
Changes in the economies of the markets in which we do business may
affect consumer demand for our products.
Consumer
spending habits, including spending for our products, are affected
by, among other things, prevailing economic conditions, levels of
employment, fuel prices, changes in exchange rates, salaries and
wages, the availability of consumer credit, consumer confidence and
consumer perception of economic conditions. Economic slowdowns in
the markets in which we do business and an uncertain economic
outlook may adversely affect consumer spending habits, which may
result in lower sales of our products in future
periods.
Beginning
in April 2020, we began experiencing a slowdown in sales to our
retail customers, including our largest customer. However, we are
experiencing growth in our largest online customer, which has
offset this decline, although there can be no assurances that such
growth will continue, or that we will have the financial resources
to produce the additional quantities required by this customer. A
prolonged global or regional economic downturn could have a
material negative impact on our business, financial condition,
results of operations and cash flows.
If we fail to effectively manage our growth, our business and
operating results could be harmed.
Growth
in our business will place significant demands on our management,
and our operational and financial infrastructure. To effectively
manage growth, we expect that we will need to continue to improve
our operational, financial and management controls and our
reporting systems and procedures. To accomplish these objectives,
we may need to hire additional employees, make certain enhancements
to our technology systems, make capital expenditures, and utilize
management resources. Failure to implement these measures could
have a material adverse effect on our business, financial condition
and results of operations.
Our intellectual property rights are valuable, and any inability to
protect them could reduce the value of our products and
brand.
We have
invested significant resources to protect our brands and
trademarks. However, we may be unable or unwilling to strictly
enforce our intellectual property rights, including our brands and
trademarks, from infringement. Our failure to enforce our
intellectual property rights could diminish the value of our brands
and product offerings and harm our business and future growth
prospects.
We may be subject to intellectual property rights claims, which are
costly to defend, could require us to pay damages and could limit
our ability to sell some of our products.
Our
industry is characterized by vigorous pursuit and protection of
intellectual property rights, which has resulted in protracted and
expensive litigation for several companies. Third parties may
assert claims of misappropriation of trade secrets or infringement
of intellectual property rights against us or against our end
customers or partners for which we may be liable. Intellectual
property lawsuits are subject to inherent uncertainties due to the
complexity of the technical issues involved, and we cannot be
certain that we would be successful in defending ourselves against
intellectual property claims.
Further,
many potential litigants have the capability to dedicate
substantially greater resources than we can to enforce their
intellectual property rights and to defend claims that may be
brought against them. Furthermore, a successful claimant could
secure a judgment that requires us to pay substantial damages or
prevents us from distributing products or performing certain
services.
Product returns could negatively impact our operating results and
profitability.
We
permit the return of damaged or defective products and accept
limited amounts of product returns in certain instances. While such
returns from established customers have historically been nominal
and within management’s expectations and the provisions
established, future return rates may differ from those experienced
in the past. Any significant increase in damaged or defective
products or accepted returns could have a material adverse effect
on our operating results for the period or periods in which such
returns materialize.
We rely on third-party manufacturers for the production of our
products.
We rely
on third-party manufacturers to produce products required to meet
our quality and market needs, and plan to continue to do so. If our
contract manufacturers fail to maintain high manufacturing
standards and processes, it could harm our business. In the event
of a natural disaster or business failure, including due to
bankruptcy of a contract manufacturer, we may not be able to secure
a replacement of our products on a timely or cost-effective basis,
which could result in delays, additional costs and reduced
revenues. Additionally, our third-party manufacturers have been and
may continue to be negatively affected by the ongoing COVID-19
pandemic.
A shortage in the supply of key raw materials or price increases
could increase our costs or adversely affect our
sales.
All of
our raw materials for our products are obtained from third-party
suppliers. Since all of the ingredients in our products are
commonly used, we have not experienced shortages or delays in
obtaining raw materials. If circumstances change, shortages could
result in materially higher raw material prices or adversely affect
our ability to have a product manufactured. Prices for our raw
materials can and do fluctuate. Price increases from a supplier
would directly affect our profitability if we are not able to pass
price increases on to customers. Our inability to obtain adequate
supplies of raw materials in a timely manner or a material increase
in the price of our raw materials could have a material adverse
effect on our business, financial condition and results of
operations. Additionally, our third-party suppliers have been and
may continue to be negatively affected by the ongoing COVID-19
pandemic.
Our share price has been and may continue to be
volatile.
The
market price of our common shares is subject to significant
fluctuations in response to a multitude of factors, including
variations in our quarterly operating results and financial
condition. Factors other than our financial results that may affect
our share price include, but are not limited to, market
expectations of our performance, market perception or our industry,
the activities of our managers, customers, and investors, and the
level of perceived growth in the industry in which we participate,
general trends in the markets for our products, general economic
business and political conditions in the countries and regions in
which we conduct our business, and changes in government regulation
affecting our business, many of which are not within our control.
In addition, like many companies of our size with low trading
volume, our stock price may fluctuate significantly for reasons
unrelated to our business.
We may, in the future, issue additional shares of common stock
and/or preferred stock, which would reduce investors’ percent
of ownership and may dilute our share value.
Our
articles of incorporation, as amended, authorize the issuance of
100,000,000 shares of common stock and 10,000,000 shares of
preferred stock. As of December 31, 2019, 33,000,412 shares of our
common stock were outstanding, and we did not have any outstanding
shares of preferred stock. As of August 18, 2020, 33,101,866 shares
of our common stock were outstanding. The future issuance of common
stock and preferred stock may result in substantial dilution in the
percentage of our common stock held by our then existing
stockholders. The issuance of common stock for future services or
acquisitions or other corporate actions may have the effect of
diluting the value of the shares held by our investors and might
have an adverse effect on any trading market for our common
stock.
We may issue shares of preferred stock in the future that may
adversely impact your rights as holders of our common
stock.
Our
Board has the authority to fix and determine the relative rights
and preferences of our authorized but undesignated preferred stock,
as well as the authority to issue shares of such preferred stock,
without further stockholder approval. As a result, our Board could
authorize the issuance of a series of preferred stock that would
grant to holders preferred rights to our assets upon liquidation,
the right to receive dividends before dividends are declared to
holders of our common stock, and the right to the redemption of
such preferred stock, together with a premium, prior to the
redemption of the common stock.
To the
extent that we do issue such additional shares of preferred stock,
your rights as holders of common stock could be impaired thereby,
including, without limitation, dilution of your ownership interests
in us. In addition, shares of preferred stock could be issued with
terms calculated to delay or prevent a change in control or make
removal of management more difficult, which may not be in your
interest as a holder of common stock.
Our inventory financing and convertible promissory note agreements
contain covenants that limit our ability to incur additional debt
and grant liens on assets.
Our
convertible promissory note agreement that we have entered into
with Mr. Drexler and our inventory financing contain restrictive
covenants that limit our ability to, among other things, incur
additional debt and grant liens on assets. If we fail to comply
with the restrictions in this debt instruments, a default may allow
the debtor to accelerate the related debt and to exercise his
remedies under the agreement, which includes the right to declare
the principal amount of that debt, together with accrued and unpaid
interest and other related amounts, immediately due and payable,
and to exercise any remedies he may have to foreclose on assets
that are subject to liens securing that debt.
For
additional details regarding our indebtedness, see Note 8 to the
accompanying Consolidated Financial Statements.
Our common stock is quoted on the OTCQB, which may have an
unfavorable impact on our stock price and liquidity.
Our
common stock is quoted on the OTCQB Marketplace
(“OTCQB”). The OTCQB is an automated quotation service
operated by OTC Markets, LLC. The quotation of our shares on the
OTCQB may result in a less liquid market available for existing and
potential stockholders to trade shares of our common stock, in part
because of the inability or unwillingness of certain investors to
acquire shares of common stock not traded on a national securities
exchange, and could depress the trading price of our common stock
and have a long-term adverse impact on our ability to raise capital
in the future.
Nevada corporation laws limit the personal liability of corporate
directors and officers and require indemnification under certain
circumstances.
Section
78.138(7) of the Nevada Revised Statutes provides that, subject to
certain very limited statutory exceptions or unless the articles of
incorporation provide for greater individual liability, a director
or officer of a Nevada corporation is not individually liable to
the corporation or its stockholders for any damages as a result of
any act or failure to act in his or her capacity as a director or
officer, unless it is proven that the act or failure to act
constituted a breach of his or her fiduciary duties as a director
or officer and such breach involved intentional misconduct, fraud
or a knowing violation of law. We have not included in our articles
of incorporation any provision intended to provide for greater
liability as contemplated by this statutory provision.
In
addition, Section 78.7502(3) of the Nevada Revised Statutes
provides that to the extent a director or officer of a Nevada
corporation has been successful on the merits or otherwise in the
defense of certain actions, suits or proceedings (which may include
certain stockholder derivative actions), the corporation shall
indemnify such director or officer against expenses (including
attorneys’ fees) actually and reasonably incurred by such
director or officer in connection therewith.
We have ongoing material weaknesses and may in the future fail to
maintain effective systems of internal control over financial
reporting and disclosure controls and procedures, any of which
could, among other things, result in significant additional costs
being incurred, cause a loss of confidence in our financial
reporting, and adversely affect the trading price of our common
stock.
We have
concluded that our internal controls over financial reporting were
not effective as of December 31, 2018 due to the existence of
material weaknesses in such controls, and we have also concluded
that our disclosure controls and procedures were not effective as
of December 31, 2019, all as described in Item 9A, “Controls
and Procedures,” of this Annual Report on Form 10-K.
Remediation efforts to address the identified weaknesses are just
beginning. Continuing costs to remedy these material weaknesses and
to address inquiries from regulators may be significant and may
require significant time from our management and other personnel,
and we cannot assure you that we will be able to remedy the
material weaknesses.
The
incurrence of significant additional expense, or the requirement
that management and other personnel devote significant time to
these matters could reduce the time available to execute on our
business strategies and could have a material adverse effect on our
business, financial condition and results of operations. We also
cannot assure you that additional material weaknesses in our
internal control over financial reporting will not arise or be
identified in the future. If our remediation measures are
insufficient to address the identified deficiencies, or if
additional deficiencies in our internal control over financial
reporting are discovered or occur in the future, our consolidated
financial statements may contain material misstatements and we
could be required to restate our financial results and may be
unable to make our filings with the SEC on a timely basis.
Moreover, because of the inherent limitations of any control
system, material misstatements due to error or fraud may not be
prevented or detected on a timely basis, or at all.
If we
are unable to provide reliable and timely financial reports in the
future, our business and reputation may be further harmed. Failures
in internal controls may negatively affect investor confidence in
our management and the accuracy of our financial statements and
disclosures, or result in adverse publicity and concerns from
investors and commercial customers, any of which could have a
negative effect on the price of our shares, subject us to
regulatory investigations and penalties and/or shareholder
litigation, and materially adversely impact our business and
financial condition.
Item 1B. Unresolved Staff
comments
None.
As of
December 31, 2019, we operated in leased office and warehouse
facilities across the United States totaling approximately 53,000
square feet, including approximately 27,000 square feet for
our corporate headquarters and MP Sports Science Center in Burbank,
California. We do not own any real property.
Our
current office space and locations can be seen in the below
table.
Location
|
|
Function
|
|
|
|
|
Burbank,
CA
|
|
Company
Headquarters, MP Sports Science Center
|
|
27,226
|
September 30,
2022
|
$38,620
|
Spring Hill,
TN
|
|
Warehouse and
distribution
|
|
52,740
|
June 30,
2020*
|
$24,176
|
Denver,
CO
|
|
Former Company
Headquarters
|
|
30,302
|
December
31,2020
|
$11,616
|
Centennial,
CO
|
|
Denver
Administrative Office
|
|
10,289
|
July 30,
2020
|
$8,318
|
The
Company subleased the properties in Denver, CO and Centennial, CO
(through July 30, 2020). The Company does not intend to extend the
lease terms expiring in 2020.
*MusclePharm
made additional month-to-month lease payments on the Tennessee
warehouse for the months of July and August, 2020.
Item 3. Legal Proceedings
In the
normal course of business or otherwise, we may become involved in
legal proceedings. We 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.
The
Company provides disclosures for material contingencies when there
is a reasonable possibility that a loss or an additional loss may
be incurred. In assessing whether a loss is a reasonable
possibility, the Company may consider the following factors, among
others: the nature of the litigation, claim or assessment,
available information, opinions or views of legal counsel and other
advisors, and the experience gained from similar
cases.
As of
December 31, 2019, we were involved in the following material legal
proceedings described below. These are not the only legal
proceedings in which we are involved. We are involved in additional
legal proceedings in the ordinary course of our business and
otherwise.
ThermoLife International
In
January 2016, ThermoLife International LLC
(“ThermoLife”), a supplier of nitrates to MusclePharm,
filed a complaint against us in Arizona state court. ThermoLife
alleged that we failed to meet minimum purchase requirements
contained in the parties’ supply agreement. In March 2016, we
filed counterclaims alleging that ThermoLife’s products were
defective. Through orders issued in September and
November 2018, the court dismissed MusclePharm’s
counterclaims and found that the Company was liable to ThermoLife
for failing to meet its minimum purchase requirements.
The court held a bench trial on the issue of damages in
October 2019, and on December 4, 2019, the court entered
judgment in favor of ThermoLife and against the Company in the
amount of $1.6 million, comprised of $0.9 million in damages,
interest in the amount of $0.3 million and attorneys’ fees
and costs in the amount of $0.4 million. The Company recorded $1.6
million in accrued expenses as of December 31, 2018. In the
interim, the Company filed an appeal, which is in the process of
being briefed, and has posted bonds in the total amount of
$0.6 million in order to stay execution on the judgment
pending appeal. Of the $0.6 million,
$0.25 million (including fees) was paid by Mr. Drexler on behalf of
the Company. See “Note 8. Debt” for additional
information. The balance of $0.35 million was secured by a personal
guaranty from Mr. Drexler, while the associated fees of $12,500 was
paid by the Company.
The
Company intends to continue to vigorously pursue its defenses on
appeal.
White Winston Select Asset Fund Series MP-18, LLC et al., v
MusclePharm Corp., et al., (Nev. Dist. Ct.; Cal. Superior Court;
Colorado Dist. Ct.; Mass. Super. Ct.)
On
August 21, 2018, White Winston Select Asset Fund Series MP-18, LLC
and White Winston Select Asset Fund, LLC (together “White
Winston”) initiated a derivative action against MusclePharm
and its directors (collectively the “director
defendants”). White Winston alleges that the director
defendants breached their fiduciary duties by improperly approving
the refinancing of three promissory notes issued by MusclePharm to
Drexler (the “Amended Note”) in exchange for
$18.0 million in loans. White Winston alleges that this
refinancing improperly diluted their economic and voting power and
constituted an improper distribution in violation of Nevada law. In
its complaint, White Winston sought the appointment of a receiver
over MusclePharm, a permanent injunction against the exercise of
Drexler’s conversion right under the Amended Note, and other
unspecified monetary damages. On September 13, 2018, White Winston
filed an amended complaint, which added a former MusclePharm
executive, as a plaintiff (together with White Winston, the
“White Winston Plaintiffs”). On December 9, 2019, the
White Winston Plaintiffs filed a Second Amended Complaint, in which
they added allegations relating to the resignation of
MusclePharm’s auditor, Plante & Moran PLLC (“Plante
Moran”). MusclePharm has moved to dismiss the Second Amended
Complaint. That motion has not yet been fully briefed.
Along
with its complaint, the White Winston Plaintiffs also filed a
motion for a temporary restraining order (“TRO”) and
preliminary injunction enjoining the exercise of Drexler’s
conversion right under the Amended Note. On August 23, 2018,
the Nevada district court issued an ex parte TRO. On September 14, 2018,
the court let the TRO expire and denied the White Winston
Plaintiffs’ request for a preliminary injunction, finding,
among other things, that the White Winston Plaintiffs did not show
a likelihood of success on the merits of the underlying action and
failed to establish irreparable harm. Following the court’s
decision, MusclePharm filed a motion seeking to recoup the legal
fees and costs it incurred in responding to the preliminary
injunction motion. On October 31, 2019, the court awarded
MusclePharm $56,000 in fees and costs. The White Winston Plaintiffs
have appealed that award.
On June
17, 2019, the White Winston Plaintiffs moved for the appointment of
a temporary receiver over MusclePharm, citing Plante Moran’s
resignation. The court granted the White Winston Plaintiffs’
request to hold an evidentiary hearing on the motion, but the date
for that hearing was not set as of the date hereof.
On July
30, 2019, the White Winston Plaintiffs filed an action in the
Superior Court of the State of California in and for the County of
Los Angeles, seeking access to MusclePharm’s books and
records. MusclePharm has answered the petition, asserting as a
defense that the request does not have a proper
purpose. A trial on the
petition has been set for February 25, 2021.
The Company intends to vigorously defend these
actions.
IRS Audit
On April 6, 2016, the Internal Revenue Service (“IRS”)
selected our 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 our former executives’ 2014 restricted
stock grants. Due to our current and historical loss position, the
proposed adjustments would have no material impact on our Federal
income tax. On October 5, 2016, the IRS commenced an audit of our
employment and withholding tax liability for 2014. The IRS contends
that we 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 our filings. On April
4, 2017, we received a “30-day letter” from the IRS
asserting back taxes and penalties of approximately $5.3 million,
of which $4.4 million related to withholding taxes, specifically,
income withholding and Social Security taxes, and $0.9 million
related to penalties. Additionally, the IRS asserts that we owe
information reporting penalties of approximately $2.0
million.
Our counsel has submitted a formal protest to the IRS disputing on
several grounds all of the proposed adjustments and penalties on
our behalf, and we have been pursuing this matter vigorously
through the IRS appeal process. An Appeals Conference was held with
the IRS in Denver, Colorado on July 31, 2019. At the Conference,
the Company made substantial arguments challenging the IRS’s
claims for employment taxes and penalties. On December 16, 2019, a
further Appeals Conference was held with the IRS by telephone. At
the telephone conference, the Appeals Officer confirmed that he
agreed with the Company’s argument that the failure to
deposit penalties should be conceded by the IRS. The failure to
deposit penalties total about $2.0 million. Thus, with this
concession, the IRS’s claims have been reduced from
approximately $7.3 million to about $5.3 million.
The remaining issue in dispute in this matter involves the fair
market value of restricted stock units in the Company granted to
certain of its former officers (the “Former Officers”)
under Internal Revenue Code § 83. The Company and the IRS
disagree as to the value of the restricted stock on the date of the
grants, i.e., October 1, 2014. The Company and the IRS have
exchanged expert valuation reports on the fair market value of the
stock and have had extensive negotiations on this issue. The
parties, however, have not been able to reach an agreement with
respect to the value of the stock. The IRS has also made parallel
claims regarding the restricted stock units against the Former
Officers of the Company. The IRS has asserted that the Former
Officers received ordinary income from the stock grants, and that
they owe additional personal income taxes based on the fair market
value of the stock. The Former Officers’ cases, unlike the
Company’s case, are pending before the United States Tax
Court. In the Tax Court litigation, the Former Officers are
challenging the IRS’s determinations regarding the fair
market value of the restricted stock grants on October 1, 2014. The
Former Officers have separate counsel from the Company. The same
IRS Appeals Officer and Revenue Agents assigned to the
Company’s case are also involved in the cases for the Former
Officers. Throughout the proceedings, the Company has argued to the
IRS that it is the Former Officers who are directly and principally
liable for the amount of any tax due, and not the Company. The
Former Officers cases were scheduled for trial in Tax Court on
March 9, 2020. The trial of the cases was continued by the Court on
February 4, 2020. The basis for the continuance was that the IRS
and the Former Officers had made progress toward a settlement of
the valuation issue involving the grants of the restricted stock.
The outcome of these settlement negotiations will be relevant to
the Company’s case. The Company is closely monitoring the
settlement discussions between the IRS and the Former Officers. The
Tax Court has ordered the Former Officers to file status reports
regarding progress of their settlement negotiations with the IRS on
or before October 22, 2020.
Due to the uncertainty associated with determining our liability
for the asserted taxes and penalties, if any, and to our inability
to ascertain with any reasonable degree of likelihood, as of the
date of this report, the outcome of the IRS appeals process, we
have not recorded an estimate for its potential liability, if any,
associated with these taxes.
On August 22, 2018, Richard Estalella filed an action against
us and two other defendants in the Colorado District Court for the
County of Denver, seeking damages arising out of the IRS’s
assertion of tax liability and penalties relating to the 2014
restricted stock grants. We have answered Estalella’s
complaint, asserted counterclaims against Estalella for his failure
to ensure that all withholding taxes were paid in connection with
the 2014 restricted stock grants, and filed cross-claims against a
valuation firm named in the action for failing to properly value
the 2014 restricted stock grants for tax purposes. The Company is
waiting on next steps from the court and will continue to
vigorously litigate the matter.
4Excelsior Matter
On March 18, 2019, 4Excelsior, a manufacturer of MusclePharm
products, filed an action against MusclePharm in the Superior Court
of the State of California for the County of Los Angeles, claiming
approximately $6.2 million in damages relating to allegedly
unpaid invoices, as well as approximately $7.8 million in
consequential damages. On January 27, 2020, MusclePharm
filed a counterclaim against 4Excelsior seeking unidentified
damages relating to, among other things, 4Excelsior’s failure
to fulfill a purchase order. MusclePharm also moved to strike
4Excelsior’s consequential damages on the grounds that they
are unrecoverable under the Uniform Commercial Code. The
court denied that motion, and the action has proceeded to
discovery. The Company recognized a liability of $5.3 million (past
due invoices plus interest) as of December 31, 2019. Trial has not
yet been set, although a Trial Setting Conference has been set for
September 21, 2020.
The Company intends to vigorously defend this action.
Nutrablend Matter
On February 27, 2020, Nutrablend, a manufacturer of
MusclePharm products, filed an action against MusclePharm in the
United States District Court for the Eastern District of
California, claiming approximately $3.1 million in allegedly
unpaid invoices. The amount is currently recorded as a
liability as of December 31, 2019. Trial has been set for
November 17, 2020. The Company intends to vigorously defend
this action.
Item 4. Mine Safety Disclosures
None.
Notes to Consolidated Financial Statements
Note 1. Description of Business
Description of Business
MusclePharm
Corporation was incorporated in Nevada in 2006. Except as otherwise
indicated herein, or the context requires otherwise, the terms
“MusclePharm,” “the 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 sports nutrition products and nutritional
supplements. Our portfolio of
recognized brands, including MusclePharm®
and FitMiss®,
is marketed and sold in more than 100 countries
globally. The Company is headquartered in Burbank,
California and, as of December 31, 2019 had the following
wholly-owned operating subsidiaries: MusclePharm Canada Enterprises
Corp., MusclePharm Ireland Limited and MusclePharm Australia Pty
Limited.
The Company has incurred significant losses and experienced
negative cash flows since inception. As of December 31,
2019, the Company had cash of $1.5 million, a decline of $0.8
million from the December 31, 2018 balance of $2.3 million. This
decline is due to a net loss of $18.9 million, offset by non-cash
adjustments of $2.0 million, cash provided by a change in operating
assets and liabilities of $10.4 million and cash provided by
financing activities of $5.7 million.
Our working capital was a deficit of $229.4 million as of December
31, 2019, and we had a stockholders’ deficit of $28.0 million
and recurring losses from operations resulting in an accumulated
deficit of $195.9 million. As a result of our history of losses and
financial condition, there is substantial doubt about our ability
to continue as a going concern. For financial information
concerning more recent periods, see our reports for such periods
filed with the SEC.
The ability to continue as a going concern is dependent upon us
generating profits in the future and/or obtaining the necessary
financing to meet our obligations and repay our liabilities arising
from normal business operations when they come due. Management is
evaluating different strategies to obtain financing to fund our
expenses and achieve a level of revenue adequate to support our
current cost structure. Financing strategies may include, but are
not limited to, private placements of capital stock, debt
borrowings, partnerships and/or collaborations.
In response to the Company’s continued losses in 2018,
management implemented the following plans to improve the
Company’s operating costs:
1)
reduced
our workforce;
2)
renegotiated
or terminated a number of contracts with endorsers in a strategic
shift away from such arrangements and toward more cost-effective
marketing and advertising efforts; and
3)
discontinued
a number of stock keeping units (“SKUs”) and wrote down
inventory to net realizable value, or to zero in cases where the
product was discontinued.
Despite these measures, during 2019, the Company continued to incur
substantial losses. In order to improve the Company’s
operating results, management has continued to focus on its 2018
initiatives. In addition, during the fourth quarter of 2019,
management implemented the following measures to improve gross
margin:
1)
reduced
or eliminated sales to low or negative margin
customers;
2)
reduced
product discounts and promotional activity;
3)
implemented
a more aggressive SKU reduction; and
4)
formed
a pricing committee to review all orders to better align gross
margin expectations with product availability.
As a
result of these measures, as well as a reduction in protein prices,
the Company realized increased gross margins in the fourth quarter
of 2019, a trend which continued through the first and second
quarters of 2020. Beginning in April 2020, the Company began to
experience a slowdown in sales from its retail customers, including
its largest customer. This decline has been offset by a growth in
sales to our online customers, including our largest online
customer, although there can be no assurances that such growth will
continue, or that the Company will have the financial resources to
produce the additional quantities required by this customer.
Management believes reductions in operating costs, and continued
focus on gross margin, primarily pricing controls and a reduction
in product discounts and promotional activity with the
Company’s customers, will allow us to ultimately achieve
profitability, however, the Company can give no assurances that
this will occur. To manage cash flow,
the Company has entered into multiple financing arrangements. See
additional information in “Note 8.
Debt.”
Our results of operations are affected by economic conditions,
including macroeconomic conditions and levels of business
confidence. There continues to be significant volatility and
economic uncertainty in many markets and the ongoing COVID-19
pandemic has increased that level of volatility and uncertainty and
has created economic disruption. We are actively managing our
business to respond to the impact.
Note 2. Summary of Significant Accounting Policies
Basis of Presentation and Principles of Consolidation
The
accompanying Consolidated Financial Statements are prepared using
the accrual method of accounting in accordance with GAAP
and have been prepared on a going
concern basis, which contemplates the realization of assets and the
settlement of liabilities in the normal course of business.
The 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.
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
deferred 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, present value of lease
liabilities, among others. Actual results could differ from those
estimates.
Cash
The Company considers all highly liquid investments purchased with
an original maturity of three months or less at the date of
purchase and money market accounts to be cash equivalents. As of
December 31, 2019 and 2018, the Company had no cash equivalents and
all cash amounts consisted of cash on deposit.
Accounts Receivable and Allowance for Doubtful
Accounts
Accounts receivable represents trade obligations from customers
that are subject to normal trade collection terms and are recorded
at the invoiced amount, net of any sales discounts and allowance
for doubtful accounts, and do not typically bear interest. The
Company assesses the collectability of the accounts by taking into
consideration the aging of accounts receivable, changes in customer
credit worthiness, general market and economic conditions, and
historical experience. Bad debt expenses are recorded as part of
“Selling, general and administrative” expenses in the
consolidated statements of operations. The Company writes off the
receivable balance against the allowance when management determines
a balance is uncollectible. The Company also reviews its customer
discounts and an accrual is made for discounts earned but not yet
utilized at each period end.
The Company performs ongoing evaluations of its customers’
financial condition and generally does not require collateral. Some
international customers are required to pay for their orders in
advance of shipment. Accounts receivable consisted of the
following as of December 31, 2019 and 2018 (in thousands):
|
|
|
|
|
Accounts
receivable
|
$8,419
|
$14,647
|
Less: allowance for
discounts and returns
|
(2,901)
|
(5,574)
|
Less: allowance for
doubtful accounts
|
(711)
|
(2,800)
|
Accounts
receivable, net
|
$4,807
|
$6,273
|
The
allowance for discounts and returns consisted of the following
activity for the years ended December 31, 2019 and 2018 (in
thousands):
|
For the Years
Ended December 31,
|
|
|
|
Allowance for
discounts and returns, beginning balance
|
$5,574
|
$2,387
|
Charges against
revenues
|
26,941
|
33,500
|
Utilization of
reserve
|
(29,614)
|
(30,313)
|
Allowance for
discounts and returns, ending balance
|
$2,901
|
$5,574
|
Revenue Recognition
The
Company adopted ASC 606, “Revenue from Contracts with
Customers,” effective January 1, 2018. With the
adoption of the new standard, revenue is recognized when control of
the promised goods or services is transferred to the
Company’s customers in an amount that reflects the
consideration the Company expects to be entitled to in exchange for
those goods or services.
|
a.
|
Nature of Goods and Services
|
The Company sells a variety of protein products through a broad
distribution platform that includes supermarkets, mass
merchandisers, wholesale clubs, drugstores, convenience stores,
home stores, specialty stores and websites and other e-commerce
channels, all of which sell our products to consumers.
|
b.
|
When Performance Obligations are Satisfied
|
For performance obligations related to the shipping and invoicing
of products, control transfers at the point in time upon which
finished goods are delivered to the Company’s customers or
when finished goods are picked up by a customer or a
customer’s carrier, depending on shipping terms. Once a
product has been delivered or picked up by the customer, the
customer is able to direct the use of, and obtain substantially all
of the remaining benefits from, the asset. The Company considers
control to have transferred upon delivery or customer receipt
because the Company has an enforceable right to payment at
that time, the customer has legal title to the asset,
the Company has transferred physical possession of the asset,
and the customer has significant risk and rewards of ownership of
the asset.
|
c.
|
Variable Consideration
|
The Company conducts extensive promotional activities, primarily
through the use of off-list discounts, slotting, coupons,
cooperative advertising, periodic price reduction arrangements, and
end-aisle and other in-store displays. The costs of such
activities are netted against sales and are recorded when the
related sale takes place. The reserves for sales returns
and consumer and trade promotion liabilities are established based
on the Company’s best estimate of the amounts necessary to
settle future and existing obligations for products sold as of the
balance sheet date. To
determine the appropriate timing of recognition of consideration
payable to a customer, all consideration payable to our customers
is reflected in the transaction price at inception and reassessed
routinely.
The Company expenses incremental direct costs of obtaining a
contract (broker commissions) when the related sale takes
place, since the amortization period of the commissions paid
for the sale of products is less than a year. These costs are recorded in “Selling, general and administrative”
expenses in the accompanying consolidated statements of
operations. The Company
accounts for shipping and handling costs as fulfillment activities
which are therefore recognized upon shipment of the
goods.
Shipping and handling costs related to inbound purchases of raw
material and finished goods are included in cost of revenues
in our consolidated statements of operations. For the years ended
December 31, 2019 and 2018, the Company incurred $1.2 million and
$1.8 million, respectively, of inbound shipping and handling costs.
Shipping and handling costs related to shipments to our customers
is included in “Selling, general and administrative”
expense in our consolidated statements of operations. For the years
ended December 31, 2019 and 2018, the Company incurred $3.8 million
and $4.2 million, respectively, of shipping and handling costs
related to shipments to our customers.
The
Company excludes from its revenue any amounts collected from
customers for sales (and similar) taxes. During the years ended
December 31, 2019 and 2018, the Company recorded discounts, and to
a lesser degree, sales returns, totaling $26.9 million and $33.5
million, respectively, which accounted for 25% and 28% of gross
revenue in each period, respectively.
The Company adopted ASC 606 using the modified retrospective method
and the cumulative effect of this change in accounting method for
the expected value of customer credits related to certain contracts
in place, as defined by ASC 606, is presented below:
|
Balance at December 31, 2017
|
|
Balance at January 1, 2018
|
Accounts
receivable, net
|
$11,105
|
$(1,053)
|
$10,052
|
Accumulated
deficit
|
$(165,069)
|
$(1,053)
|
$(166,122)
|
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 that represent more than 10%
of the Company’s net revenue or accounts receivable for each
period presented. For each significant customer, percentage of net
revenue and accounts receivable are as follows:
|
Percentage
of Net Revenue for the
Years Ended
December 31,
|
Percentage of Net Accounts Receivable as of December
31,
|
|
|
|
|
|
Customers
|
|
|
|
|
Costco
|
33%
|
29%
|
*
|
16%
|
Amazon
|
13%
|
13%
|
*
|
22%
|
iHerb
|
17%
|
13%
|
35%
|
*
|
*
Represents less than 10% of net revenue or net accounts
receivable.
The
Company uses a limited number of non-affiliated suppliers for
contract manufacturing its products. The Company has quality
control and manufacturing agreements in place with its primary
manufacturers to ensure consistency in production and quality. The
agreements ensure products are manufactured to the Company’s
specifications and the contract manufacturers will bear the costs
of recalled product due to defective manufacturing.
The
Company had the following concentration of purchases with contract
manufacturers for years ended December 31, 2019 and
2018:
|
For the
Years
Ended December 31,
|
Vendor
|
|
|
Nutra
Blend
|
22%
|
16%
|
S.K.
Laboratories
|
34%
|
26%
|
4Excelsior
|
*
|
14%
|
Bakery
Barn
|
*
|
14%
|
Prinova
|
*
|
23%
|
*
Represents less than 10% of purchases.
Inventory
Inventory
consisted solely of finished goods and raw materials, used to
manufacture our products by one of our co-manufacturers as of
December 31, 2019 and 2018. The
Company records charges for obsolete and slow-moving inventory
based on the age of the product as determined by the expiration
date or otherwise determined to be obsolete. Products within one
year of their expiration dates are considered for write-off
purposes. Inventory write-downs, once established, are not reversed
as they establish a new cost basis for the inventory. Historically,
the Company has had minimal returns with established customers. The
Company incurred insignificant inventory write-offs during the
years ended December 31, 2019 and 2018.
Prepaid Expenses and Other Current Assets
Prepaid
expenses and other current assets consist of various payments the
Company has made in advance for goods or services to be received in
the future. These prepaid expenses include legal retainers,
giveaways, print advertising, insurance and service contracts
requiring up-front payments.
Property and Equipment
Property
and equipment are stated at cost less accumulated depreciation and
amortization. Depreciation and amortization is computed on a
straight-line basis over the estimated useful lives of the
respective assets or, in the case of leasehold improvements, the
remaining lease term, if shorter. When assets are retired or
otherwise disposed of, the assets and related accumulated
depreciation are removed, and the resulting gains or losses are
recorded in the statements of operations. Repairs and maintenance
costs are expensed as incurred.
The
estimated useful lives of the property and equipment are as
follows:
Property and
Equipment
|
|
Estimated Useful Life
|
Furniture,
fixtures and equipment
|
|
3 - 7
years
|
Leasehold
improvements
|
|
Lesser of estimated useful
life or remaining lease term
|
Manufacturing and
lab equipment
|
|
3 - 5
years
|
Vehicles
|
|
3 - 5
years
|
Displays
|
|
5
years
|
Website
|
|
3
years
|
Intangible Assets
Acquired
intangible assets are recorded at estimated fair value, net of
accumulated amortization, and costs incurred in obtaining certain
trademarks are capitalized, and are amortized over their related
useful lives, using a straight-line basis consistent with the
underlying expected future cash flows related to the specific
intangible asset.
Costs
to renew or extend the life of intangible assets are capitalized
and amortized over the remaining useful life of the asset.
Amortization expenses are included as a component of
“Selling, general and administrative” expenses in the
consolidated statements of operations. The estimated useful life of
the intangible assets is 7 years.
Impairment of Long-Lived Assets
Long-lived assets are reviewed for impairment whenever events or
changes in circumstances exist that indicate the carrying amount of
an asset may not be recoverable. When indicators of impairment
exist, an estimate of undiscounted future cash flows is used in
measuring whether the carrying amount of the asset or related asset
group is recoverable. Measurement of the amount of impairment, if
any, is based upon the difference between the asset’s
carrying value and estimated fair value. There were no impairments
for the years ended December 31, 2019 and 2018.
Fair Value
GAAP
defines fair value as the exchange price that would be received
from selling an asset or paid to transfer a liability in the
principal or most advantageous market for the asset or liability in
an orderly transaction between market participants on the
measurement date. The Company measures its financial assets and
liabilities at fair value at each reporting period using an
estimated fair value hierarchy which requires the Company to use
observable inputs and minimize the use of unobservable inputs when
measuring fair value.
A
financial instrument’s classification within the fair value
hierarchy is based upon the lowest level of input that is
significant to the fair value measurement. Three levels of inputs
may be used to measure fair value:
●
Level 1 —
Observable inputs are unadjusted quoted prices in active markets
for identical assets or liabilities;
●
Level 2 —
Observable inputs are quoted prices for similar assets and
liabilities in active markets or inputs other than quoted prices
which are observable for the assets or liabilities, either directly
or indirectly through market corroboration, for substantially the
full term of the financial instruments; and
●
Level 3 —
Unobservable inputs which are supported by little or no market
activity and which are significant to the fair value of the assets
or liabilities. These inputs are based on our own assumptions used
to measure assets and liabilities at fair value and require
significant management judgment or estimation
The
determination of where assets and liabilities fall within this
hierarchy is based upon the lowest level of input that is
significant to the fair value measurement.
Cost of Revenue
Cost of revenue for MusclePharm and its subsidiaries represents
costs directly related to the production, manufacturing and
freight-in of the Company’s products purchased from
third-party manufacturers.
Advertising and Promotion
Our
advertising and promotion expenses consist primarily of digital,
print and media advertising, athletic endorsements and
sponsorships, promotional giveaways, trade show events and various
partnering activities with our retail partners, and are expensed as
incurred.
Some of
the contracts provide for contingent payments to endorsers or
athletes based upon specific achievement in their sports, such as
winning a championship. The Company records expense for these
payments if and when the endorser achieves the specific
achievement.
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
awards’ grant date, based on the 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 also recorded at fair value on the grant date. 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.
Foreign Currency
The
functional currency of the Company’s foreign subsidiaries,
MusclePharm Canada, MusclePharm Australia, and MusclePharm Ireland,
is the local currency. The assets and liabilities of the foreign
subsidiaries are translated into U.S. dollars at exchange rates in
effect at each balance sheet date. Revenue and expenses are
translated at average exchange rates in effect during the year.
Equity transactions are translated using historical exchange rates.
The resulting translation adjustments are recorded to a separate
component of “Accumulated other comprehensive loss” in
the consolidated balance sheets.
Foreign
currency gains and losses resulting from transactions denominated
in a currency other than the functional currency are included in
“Interest and other expense, net” in the consolidated
statements of operations.
Comprehensive Loss
Comprehensive
loss is composed of two components: net loss and other
comprehensive loss. Other comprehensive loss refers to revenue,
expenses, gains and losses that under GAAP are recorded as an
element of stockholders’ deficit, and are excluded from the
Company’s net loss. The Company’s other comprehensive
loss is made up of foreign currency translation adjustments for
both periods presented.
Segments
Management
has determined that it currently operates in one segment. The
Company’s chief operating decision maker reviews financial
information on a consolidated basis, together with certain
operating and performance measures principally to make decisions
about how to allocate resources and to measure the Company’s
performance.
Income Taxes
Income
taxes are accounted for using the asset and liability method.
Income tax expense includes the current tax liability from
operations and the change in deferred income taxes during the year.
Interest income, interest
expense
and penalties associated with income taxes are reflected in "Income
tax expense" on the consolidated statements
of income. Deferred tax assets and liabilities are recognized for
the future tax consequences attributable to differences between the
consolidated financial statement carrying amounts of existing
assets and liabilities and their respective tax bases, operating
loss and tax credit carry-forwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply
to taxable income in the years in which those temporary differences
are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date.
A valuation allowance is required to be established unless
management determines that it is more likely than not that we will
ultimately realize the tax benefit associated with a deferred tax
asset. We recognize the effect of income tax positions only
if those positions are more likely than not to be sustained.
Recognized income tax positions are measured at the largest amount
that is greater than 50% likely to be realized. Changes in
recognition or measurement are reflected in the period in which the
change in judgment occurs.
Recent Accounting Pronouncements
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. The new lease standards also provide
practical expedients for an entity's ongoing accounting. In July
2018, the FASB issued ASU No. 2018-11, Leases (842), Targeted Improvements
(“ASU 2018-11”), which provides an additional
transition election to not restate comparative periods for the
effects of applying the new standard. This transition election
permits entities to apply ASU 2016-02 on the adoption date and
recognize a cumulative-effect adjustment to the opening balance of
accumulated deficit. These ASU's are effective for fiscal years,
and interim periods within those years, beginning after December
15, 2018.
The
Company adopted the ASUs, as of January 1, 2019, using the modified
retrospective transition method prescribed by ASU 2018-11. Under
this transition method, financial results reported in periods prior
to the first quarter of 2019 are unchanged. As a result of the
adoption of the ASUs, the Company recorded a ROU asset and
liability of $2.1 million. Also as a result of the adoption, the
Company reclassified $0.2 million of liabilities on its
consolidated balance sheets as of January 1, 2019 against the
operating lease ROU asset. The adoption of these ASUs did not
result in a cumulative-effect adjustment to the opening balance of
accumulated deficit.
In
addition, the Company elected the package of practical expedients
permitted by the transition guidance. The adoption of these
ASU’s did not have an impact on the Company’s
consolidated statements of operations or cash flows.
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.
On September 20, 2018, FASB issued Accounting Standards Update No.
2018-07, “Compensation - Stock Compensation” (Topic
718): Improvements to Nonemployee Share-Based Payment Accounting
(“ASU 2018-07”). ASU 2018-07 is intended to
reduce cost and complexity and to improve financial reporting for
share-based payments issued to non-employees. This ASU expands the
scope of ASC Topic 718, “Compensation - Stock
Compensation”, which currently only includes share-based
payments issued to employees, to also include share-based payments
issued to non-employees for goods and services. Consequently, the
accounting for share-based payments to non-employees and employees
will be substantially aligned. ASU 2018-07 supersedes ASC
Subtopic 505-50, “Equity - Equity-Based Payments to
Non-Employees”. The amendments in this ASU are effective for
public companies for fiscal years beginning after December 15,
2018, including interim periods within that fiscal year. The new
standard has been adopted by the Company. The Company has evaluated
the impact of ASU 2018-07 on its consolidated financial
statements and it did not have a material impact.
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic
740): Simplifying the
Accounting for Income Taxes, expected to reduce cost and complexity
related to the accounting for income taxes. The ASU
removes specific exceptions to the general principles in Topic 740
in GAAP. It eliminates the need for an organization to analyze
whether the following apply in a given period: exception to the
incremental approach for intra-period tax allocation; exceptions to
accounting for basis differences when there are ownership changes
in foreign investments; and exception in interim period income tax
accounting for year-to-date losses that exceed anticipated
losses. The ASU also improves financial statement
preparers’ application of income tax-related guidance and
simplifies GAAP for: franchise taxes that are partially based on
income; transactions with a government that result in a step up in
the tax basis of goodwill; separate financial statements of legal
entities that are not subject to tax; and enacted changes in tax
laws in interim periods. The Company is evaluating the
impact of the pronouncement.
Note 3. Fair Value of Financial Instruments
Management
believes the fair values of the Company’s debt obligations
approximate carrying value because the debts carry market rates of
interest available to the Company. As of December 31, 2019 and
2018, the Company held no assets or liabilities that required
re-measurement at fair value on a recurring basis.
Purchase Commitment
Upon
the completion of the sale of a former subsidiary, BioZone Laboratories, Inc.
(“BioZone”), on May 9, 2016, the Company entered
into a manufacturing and supply agreement whereby the Company
agreed to minimum purchase
requirements of products from BioZone over a three-year period. The
Company fell below the requirements, and as a result, the
Company reserved an amount to cover the estimated purchase
commitment shortfall during the year ended December 31,
2018.
In July
2019, the Company settled this matter
through the payment of $0.6 million and the issuance of 150,000
shares of the Company’s common stock, which was valued at
$60,000 on the settlement date.
Note 4. 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. As of December 31, 2018, the
Company had a balance of $0.4 million, representing contract
termination costs and $0.1 million representing abandoned lease
facilities. As of December 31, 2019, the Company had made payments
to settle all the outstanding contract termination
costs.
As a
result of the adoption of the new lease standards, the
restructuring liability for the company’s abandoned lease
facilities was used to reduce the ROU asset, in accordance with the
new standards. See additional information in “Note 6.
Leases.”
Note 5. Balance Sheet Components
Inventory
Inventory
consisted solely of finished goods and raw materials, used to
manufacture our products at one of our co-manufacturers as of
December 31, 2019 and 2018. The
Company records charges for obsolete and slow-moving inventory
based on the age of the product as determined by the expiration
date or otherwise determined to be obsolete. 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 years ended December 31, 2019 and 2018. Inventory
write-downs, once established, are not reversed as they establish a
new cost basis for the inventory.
Property and Equipment
Property
and equipment consisted of the following as of December 31, 2019
and 2018 (in thousands):
|
|
|
|
|
Furniture, fixtures
and equipment
|
$2,592
|
$3,511
|
Leasehold
improvements
|
236
|
236
|
Vehicles
|
39
|
39
|
Displays
|
453
|
453
|
Website
|
497
|
497
|
Property and
equipment, gross
|
3,817
|
4,736
|
Less: accumulated
depreciation and amortization
|
(3,601)
|
(4,223)
|
Property and
equipment, net
|
$216
|
$513
|
Depreciation
and amortization expense related to property and equipment was $0.3
million and $0.5 million for the years ended December 31, 2019 and
2018, respectively, which is included in “Selling, general,
and administrative” expense in the accompanying consolidated
statements of operations.
Intangible Assets
Intangible
assets consisted of the following (in thousands):
|
|
|
|
|
|
Remaining
Weighted-Average Useful Lives (years)
|
Amortized
Intangible Assets
|
|
|
|
|
Brand (apparel
rights)
|
$2,244
|
$(1,568)
|
$676
|
2.1
|
Total intangible
assets
|
$2,244
|
$(1,568)
|
$676
|
|
|
|
|
|
|
|
Remaining
Weighted-Average Useful Lives (years)
|
Amortized
Intangible Assets
|
|
|
|
|
Brand (apparel
rights)
|
$2,244
|
$(1,247)
|
$997
|
3.1
|
Total intangible
assets
|
$2,244
|
$(1,247)
|
$997
|
|
Intangible
assets amortization expense was $0.3 million for each of the years
ended December 31, 2019 and 2018, which is included in
“Selling, general, and administrative” expense in the
accompanying consolidated statements of operations. As of December
31, 2019, the estimated future amortization expense of intangible
assets is as follows (in thousands):
For the Year Ending December 31,
|
|
2020
|
$320
|
2021
|
320
|
2022
|
36
|
Total amortization
expense
|
$676
|
Note 6. Leases
The Company has operating leases for warehouse facilities and
office spaces across the U.S. The remaining lease terms for these
leases range from 1 to 4 years. The Company also leases
manufacturing and warehouse equipment under finance lease
arrangements, which expire at various dates through July 2020. The
Company does not intend to extend the lease terms expiring in
2020.
In
adopting the new lease standards (“ASC 842”), the
Company has elected the “package of practical
expedients,” which permit it not to reassess under the new
standard its prior conclusions about lease identification, lease
classification and initial direct costs. The Company did not elect
the use-of-hindsight or the practical expedient pertaining to land
easements, as the latter is not applicable to the Company. In
addition, the Company elected not to apply ASC 842 to arrangements
with lease terms of 12 month or less.
The
Company determines if a contract contains a lease when the contract
conveys the right to control the use of identified property, plant,
or equipment for a period of time in exchange for consideration.
Upon identification and commencement of a lease, we establish a ROU
asset and a lease liability.
ROU
assets and lease liabilities are measured and recognized based on
the present value of the future minimum lease payments over the
lease term at the commencement date. At adoption, the Company
reduced the ROU asset through a derecognition of the restructuring
liability for its abandoned lease facilities. Subsequent to
adoption, the Company no longer recognized lease expense on a
straight-line basis, as the impact of the derecognition resulted in
a front-loading of the lease expenses.
Supplemental
balance sheet information related to leases was as follows (in
thousands):
|
Balance Sheet
Classification
|
|
Assets
|
|
|
Operating
|
ROU assets,
net
|
$1,175
|
Finance
|
Property and
equipment, net
|
57
|
Total
Assets
|
|
1,232
|
|
|
Liabilities
|
|
|
Current
liabilities:
|
|
|
Operating
|
Operating lease
liability - current
|
$624
|
Finance
|
Current accrued
liability
|
54
|
Total current
liabilities
|
|
678
|
|
|
Non-current
liabilities:
|
|
|
Operating
|
Operating lease
liability - long term
|
723
|
Finance
|
Other long term
liabilities
|
—
|
Total non-current
liabilities
|
|
723
|
The
Company has elected the practical expedient to combine lease and
non-lease components into a single component for all of its leases.
Fixed lease costs represent the explicitly quantified lease
payments prescribed by the lease agreement and are included in the
measurement of the ROU asset and corresponding lease
liability.
Some
leasing arrangements require variable payments that are dependent
on usage, output, or may vary for other reasons, such as insurance
and tax payments. The variable lease payments are not presented as
part of the initial ROU asset or lease liability. The Company's
lease agreements do not contain any material restrictive
covenants.
The
components of lease cost for operating and finance leases for the
year ended December 31, 2019 were as follows (in
thousands):
|
Income Statement
Classification
|
Year Ended
December 31, 2019
|
|
|
|
Operating lease
cost
|
Selling, general
and administrative
|
$1,041
|
|
|
Finance lease
cost:
|
|
|
Amortization of ROU
asset
|
Selling, general
and administrative
|
119
|
Interest on lease
liabilities
|
Selling, general
and administrative
|
6
|
Total finance lease
cost
|
|
125
|
|
|
Variable lease
payments
|
Selling, general
and administrative
|
219
|
Sublease
income
|
Other
income
|
(380)
|
|
|
Total lease
cost
|
|
$1,005
|
The
Company had no short-term leases as of December 31, 2019. The
Company's leases do not provide an implicit rate; therefore, the
Company uses its incremental borrowing rate based on the
information available at the effective date in determining the
present value of future payments for those leases.
Supplemental
cash flow information related to leases was as
follows:
|
Year Ended December
31, 2019
|
Cash paid for
amounts included in the measurement of lease liabilities (in
thousands):
|
|
Operating cash
flows from operating leases
|
$770
|
Operating cash
flows from finance leases
|
6
|
Financing cash
flows from finance leases
|
120
|
|
|
The weighted
average remaining lease term was as follows:
|
|
Operating leases
(in years)
|
2.3
|
Finance leases (in
years)
|
0.5
|
The weighted
average discount rate was as follows:
|
|
Operating
leases
|
18%
|
Finance
leases
|
5%
|
The
maturities of lease liabilities at December 31, 2019 were as
follows (in thousands):
|
|
|
|
|
|
2020
|
$808
|
$55
|
2021
|
481
|
—
|
2022
|
369
|
—
|
Thereafter
|
—
|
—
|
Total future
undiscounted lease payments
|
1,658
|
55
|
Less amounts
representing interest
|
(311)
|
(1)
|
Present value of
lease liabilities
|
$1,347
|
$54
|
Note 7. Interest and other expense, net
For the
years ended December 31, 2019 and 2018, “Interest and other
expense, net” consisted of the following (in
thousands):
|
For the Year
Ended December 31,
|
|
|
|
|
|
|
Interest expense,
related party
|
$(1,597)
|
$(2,160)
|
Interest expense,
related party debt discount
|
(60)
|
(60)
|
Interest expense,
other
|
(894)
|
(486)
|
Interest expense,
secured borrowing arrangement
|
(1,205)
|
(1,094)
|
Foreign currency
transaction loss
|
(236)
|
(115)
|
Other
|
383
|
18
|
Total
interest and other expense, net
|
$(3,609)
|
$(3,897)
|
“Other”
for 2019 includes sublease income and interest income.
Note 8. Debt
As of
December 31, 2019 and 2018, the Company’s debt consisted of
the following (in thousands):
|
|
|
|
|
Refinanced
convertible note, related party
|
$1,287
|
$18,000
|
Revolving line of
credit, related party
|
1,239
|
—
|
Obligations under
secured borrowing arrangement
|
4,443
|
1,285
|
Line of credit
– inventory financing
|
2,965
|
1,500
|
Notes
payable
|
247
|
—
|
Unamortized debt
discount, related party
|
—
|
(60)
|
Total
debt
|
10,181
|
20,725
|
Less: current
portion
|
(10,130)
|
(20,725)
|
Long term
debt
|
$51
|
$—
|
Related-Party Refinanced Convertible Note
On November 3, 2017, the Company entered into the refinancing with
Mr. Ryan Drexler, the Company’s Chairman of the Board of
Directors, Chief Executive Officer and President (the
“Refinancing”). 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 amended and restated (i) a convertible secured
promissory note dated as of December 7, 2015, amended as of January
14, 2017, in the original principal amount of $6,000,000 with an
interest rate of 8% prior to the amendment and 10% following the
amendment (the “2015 Convertible Note”), (ii) a
convertible secured promissory note dated as of November 8, 2016,
in the original principal amount of $11,000,000 with an interest
rate of 10% (the “2016 Convertible Note”) , and (iii) a
secured demand promissory note dated as of July 27, 2017, in the
original principal amount of $1,000,000 with an interest rate of
15% (the “2017 Note”, and together with the 2015
Convertible Note and the 2016 Convertible Note, collectively, the
“Prior Notes”). The due date of the 2015 Convertible
Note and the 2016 Convertible Note was November 8, 2017. The 2017
Note was due on demand.
The $18.0 million 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 the interest under the Refinanced
Convertible Note were 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 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 amend and
restate the security agreement, resulting in a Third Amended and
Restated Security Agreement (the “Amended Security
Agreement”) in which the Prior Notes were secured by all of
the assets and properties of the Company and its subsidiaries
whether tangible or intangible. 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.
On September 16, 2019, Mr. Ryan Drexler, the Chief Executive
Officer, President and Chairman of the Board of Directors of
MusclePharm Corporation, a Nevada corporation (the
“Company”), delivered a notice to the Company and its
independent directors of his election to convert, effective as of
September 16, 2019 (the “Notice Date”), $18,000,000 of
the amount outstanding under that certain Amended and Restated
Convertible Secured Promissory Note, dated as of November 8, 2017
(the “Note”), issued by the Company to Mr. Drexler,
into shares of the Company’s common stock, par value $0.001
per share (the “Common Stock”), at a conversion price
of $1.11 per share, pursuant to the terms and conditions of the
Note (the “Partial Conversion”). As of the Notice Date,
the total amount outstanding under the Note (including principal
and accrued and unpaid interest) was equal to $19,262,910. Pursuant
to the terms of the Note, the Company instructed the transfer agent
for its shares to issue to Mr. Drexler 16,216,216 shares (the
“Shares”) of its Common Stock in respect of the Partial
Conversion.
The
outstanding principal and the interest, due on December 31, 2019,
were refinanced under a new agreement on July 1, 2020. See
additional information in “Note 17. Subsequent
Events.”
For the years ended December 31, 2019 and 2018, interest expense,
including the amortization of debt discount, related to the related
party convertible secured promissory notes was $1.7 million and
$2.2 million, respectively. During the years ended December 31,
2019 and 2018, $0.8 million and $1.9 million, respectively, in
interest was paid in cash to Mr. Drexler.
Related-Party Revolving Note
On October 4, 2019, the Company entered into a secured revolving
promissory note (the “Revolving Note”) with Mr.
Drexler. Under the terms of the Revolving Note, the Company can
borrow up to $3.0 million. The Revolving Note bears interest at the
rate of 12% annually. The use of funds will be solely for the
purchase of whey protein to be used in the manufacturing of
MusclePharm products. The Company may prepay the Revolving Note by
giving Mr. Drexler one days’ written notice.
The Revolving 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, Mr.
Drexler is entitled to accelerate the entire indebtedness under the
Revolving Note. The Revolving 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.
The Revolving Note is subordinated to certain other indebtedness of
the Company held by Crossroads.
In connection with the Revolving Note, the Company and Mr. Drexler
entered into a security agreement dated October 4, 2019 pursuant to
which the Revolving Note is secured by all of the assets and
properties of the Company and its subsidiaries whether tangible or
intangible. As of December 31, 2019, the outstanding balance on the
revolving note was $1.2 million. Both the outstanding
principal and all accrued interest, which became due on March 31,
2020, were refinanced under a new agreement on July 1, 2020. The
revolving note is included in “Line of credit” in the
consolidated balance sheets. See additional information in
“Note 17. Subsequent Events.”
Related-Party Note Payable
The
Company entered into a collateral
receipt and security agreement with Mr. Drexler, dated December 27,
2019 pursuant to which Mr. Drexler agreed to post bond relating to
the judgment ruled on the ThermoLife case, pending the appeal. The
amount paid by Mr. Drexler on behalf of the Company, including
fees, was $0.25 million. The amount, which was outstanding as of
December 31, 2019, was refinanced under a new agreement on
July 1, 2020. The note payable is included in “Convertible
note with a related party, net of discount” in the
consolidated balance sheets. See additional information in
“Note 17. Subsequent Events.”
Line of Credit - Inventory Financing
On
October 6, 2017, the Company entered into a Loan and Security
Agreement (“Security Agreement”) with Crossroads
Financial Group, LLC (“Crossroads”). Pursuant to the
Security Agreement, the Company 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. Subsequent to the end of 2017 the
maximum amount was increased to $4.0 million. The term of the
Security Agreement automatically extends in one-year 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 the Company to,
among other things, grant liens, incur debt, and transfer assets.
Under the Security Agreement, the Company agreed to grant
Crossroads a security interest in all of the Company’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.
As of December 31, 2019 and December 31, 2018, we owed Crossroads
$3.0 million and $1.5 million, respectively, and the amount
is included in “Line of credit” in the consolidated
balance sheets.
On April 1, 2019, the Company and Crossroads amended the terms of
the agreement. The agreement was extended until March 31, 2020, the
rate was modified to 1.33% per month, and increased the amount the
Company can borrow from $3.0 million to $4.0 million.
On February 26, 2020, the Company and Crossroads amended the terms
of the agreement. The agreement was extended until April 1, 2021
and the amount the Company can borrow was decreased from $4.0
million to $3.0 million.
Secured Borrowing Arrangement
In
January 2016, the Company entered into a Purchase and Sale
Agreement (the “Purchase and Sale 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 Purchase and Sale
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 borrowing 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 chargebacks
(including chargebacks for any customer amounts that remain
outstanding for over 90 days), 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 from 0.7% to 4%,
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. Prestige will have no
recourse against the Company if payments are not made due to the
insolvency of an account debtor within 90 days of invoice date,
with the exception of international and certain domestic
customers. The Purchase and Sale Agreement’s term was
extended to April 1, 2020 at which point the term now renews
automatically for successive one-year periods unless either party
receives written notice of cancellation from the other, at minimum,
thirty days prior to the expiration date. At December 31, 2019 and
2018, the Company had outstanding
borrowings of approximately $4.4 million and $1.3 million,
respectively.
On
April 10, 2019, the Company and Prestige amended the terms of the
agreement. The agreement was extended until April 1, 2020.
Thereafter the agreement shall renew itself automatically for one
(1) year periods unless either party receives written notice of
cancellation from the other, at minimum, thirty (30 days prior to
the expiration date. The new agreement also modified certain rates
and allows for increased borrowing on foreign
borrowings.
For the
years ended December 31, 2019 and 2018, the Company assigned to
Prestige, accounts with an aggregate face amount of approximately
$55.1 million and $46.2 million, respectively, for which Prestige
paid to the Company approximately $44.1 million and $36.9 million,
respectively, in cash. During years ended December 31, 2019 and
2018, $40.9 million and $41.0 million, respectively, was
repaid to Prestige, including fees and interest.
Note 9. Commitments and Contingencies
Leases
The
Company leases office and warehouse facilities under operating
leases, which expire at various dates through 2022. The Company
also leases manufacturing and warehouse equipment under finance
leases, which expire at various dates through July 2020. The
Company does not intend to extend the lease terms expiring in
2020. See
additional information in “Note 6.
Leases.”
Purchase Commitment
Upon
the completion of the sale of a former subsidiary, BioZone Laboratories, Inc.
(“BioZone”), on May 9, 2016, the Company entered
into a manufacturing and supply agreement whereby the Company
agreed to minimum purchase
requirements of products from BioZone over a three-year period. The
Company fell below the requirements, and as a result, the
Company reserved an amount to cover the estimated purchase
commitment shortfall during the year ended December 31, 2018. In
July 2019, the Company settled this
matter through the payment of $0.6 million and the issuance of
150,000 shares of the Company’s common stock, which was
valued at $60,000 on the settlement date.
Settlements
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 (the “Sponsorship
Agreement”). 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 Sponsorship
Agreement.
On July 28, 2017, the Company approved a Settlement Agreement (the
“CFG Settlement Agreement”) with CFG effective July 7,
2017. The CFG Settlement Agreement represents a full and final
settlement of all litigation between the parties. Under the terms
of the agreement, the Company agreed to pay CFG a sum of $3
million, which was recorded as accrued expenses in 2017. The
settlement consists of a $1 million payment that was advanced by a
related party on July 7, 2017, a $1 million installment paid on
July 7, 2018 and a subsequent $1 million installment payment to be
paid by July 7, 2019. Of this amount, the Company
has remitted $0.3
million.
During the years ended December 31, 2019 and 2018, the Company
recorded a charge of $38,000 and $0.2 million, respectively,
included in “Interest and other expense, net” in the
Company’s consolidated statements of operations, representing
imputed interest.
Former Executive Lawsuit
The Company was engaged in a dispute with Mr. Richard Estalella
(“Estalella”) concerning amounts allegedly owed by the
Company under an employment agreement with Estalella. Estalella was
seeking certain equitable relief and unspecified damages. On May 7,
2018, the Court vacated the trial in contemplation of the
parties’ settlement of this matter.
On June 19, 2018, the Company approved a settlement agreement (the
“Estalella Settlement Agreement”) with Estalella,
concerning amounts allegedly owed by the Company under an
employment agreement with Estalella (the “Employment
Litigation”). The Estalella Settlement Agreement represents a
full and final settlement of the Employment Litigation. Under the
terms of the agreement, the Company agreed to pay Estalella a sum
of $0.93 million consisting of a $0.33 million initial payment that
was made in July 2018, and subsequent payments of $0.15 million
installments to be paid within 90, 180, 270 and 360 days of the
initial payment, respectively. As of December 31, 2019, all
outstanding payments had been fully paid.
Manziel Matter
On July 15, 2014, JMAN2 General LP (“JMAN2”), Jonathan
Manziel and MusclePharm entered into an endorsement agreement,
pursuant to which the Endorser would provide certain endorsements
of MusclePharm’s businesses, products and services in
exchange for payments to JMAN2 by MusclePharm. On April 17, 2018,
JMAN2 commenced an action against MusclePharm in the District
Court, City and County of Denver, Colorado and on July 19, 2018
filed an amended complaint against MusclePharm, in which JMAN2
asserted various claims against MusclePharm concerning their rights
and obligations under the Endorsement Agreement.
On April 10, 2019, a settlement agreement was reached for an amount
of $0.1 million, which had been recorded as an accrued expense as
of December 31, 2018. Of this amount, $70,000 was paid in 2019,
while the balance was paid in the first quarter of
2020.
United World Wrestling Arbitration
In
November 2017, United World Wrestling (“UWW”), an
amateur wrestling governing body, initiated arbitration against the
Company before the Court of Arbitration for Sport in Lausanne,
Switzerland (“CAS”), alleging that the Company owed it
$0.6 million, comprised of a $0.4 million sponsorship fee plus
accrued interest, under the terms of a 2015 sponsorship agreement.
In September 2018, the CAS issued an order and decision in
UWW’s favor for $0.4 million, plus interest at 12% per annum,
as well as attorney’s fees in the amount of 5,000 Swiss
Francs. On January 25, 2019, the two parties reached a settlement
agreement for $0.4 million, which had been recorded as an accrued
expense as of December 31, 2018. As of June 30, 2019, all amounts
owed to UWW had been paid.
Durnford Matter
On July
28, 2015, Plaintiff, Tucker Durnford, filed a First Amended Class
Action Complaint which alleged that the Company’s (now
discontinued) Arnold Iron Mass product violates consumer protection
laws by misleading consumers about the amount and sources of
protein in the product. On February 10, 2016, the court granted our
motion to dismiss the complaint on federal preemption grounds. On
October 12, 2018, the Ninth Circuit reversed the dismissal. On
October 8, 2019, the parties successfully mediated the case to a
settlement of $0.15 million, which had been recorded as an accrued
expense as of December 31, 2018. Of
the settlement amount, $0.1 million was paid during the
fourth quarter of 2019 and the balance was paid during the first
quarter of 2020.
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. The Company provides disclosures
for material contingencies when there is a reasonable possibility
that a loss or an additional loss may be incurred. In assessing
whether a loss is a reasonable possibility, the Company may
consider the following factors, among others: the nature of the
litigation, claim or assessment, available information, opinions or
views of legal counsel and other advisors, and the experience
gained from similar cases. As of
December 31, 2019, the Company was involved in the following
material legal proceedings described below.
ThermoLife International
In January 2016, ThermoLife International LLC
(“ThermoLife”), a supplier of nitrates to MusclePharm,
filed a complaint against the Company in Arizona state court.
ThermoLife alleged that the Company failed to meet minimum purchase
requirements contained in the parties’ supply agreement. In
March 2016, the Company filed counterclaims alleging that
ThermoLife’s products were defective. Through orders issued
in September and November 2018, the court dismissed
MusclePharm’s counterclaims and found that the Company was
liable to ThermoLife for failing to meet its minimum purchase
requirements.
The court held a bench trial on the issue of damages in
October 2019, and on December 4, 2019, the court entered
judgment in favor of ThermoLife and against the Company in the
amount of $1.6 million, comprised of $0.9 million in damages,
interest in the amount of $0.3 million and attorneys’ fees
and costs in the amount of $0.4 million. The Company recorded $1.6
million in accrued expenses as of December 31, 2018. In the
interim, the Company filed an appeal, which is in the process of
being briefed, and has posted bonds in the total amount of
$0.6 million in order to stay execution on the judgment
pending appeal. Of the $0.6 million,
$0.25 million (including fees) was paid by Mr. Drexler on behalf of
the Company. See “Note 8. Debt” for additional
information. The balance of $0.35 million was secured by a personal
guaranty from Mr. Drexler, while the associated fees of $12,500 was
paid by the Company.
The Company intends to vigorously pursuing its defenses, including
on appeal.
White Winston Select Asset Fund Series MP-18, LLC et al., v
MusclePharm Corp., et al., (Nev. Dist. Ct.; Cal. Superior Court;
Colorado Dist. Ct.; Mass. Super.
Ct.)
On
August 21, 2018, White Winston Select Asset Fund Series MP-18, LLC
and White Winston Select Asset Fund, LLC (together “White
Winston”) initiated a derivative action against MusclePharm
and its directors (collectively the “director
defendants”). White Winston alleges that the director
defendants breached their fiduciary duties by improperly approving
the refinancing of three promissory notes issued by MusclePharm to
Drexler (the “Amended Note”) in exchange for
$18.0 million in loans. White Winston alleges that this
refinancing improperly diluted their economic and voting power and
constituted an improper distribution in violation of Nevada law. In
its complaint, White Winston sought the appointment of a receiver
over MusclePharm, a permanent injunction against the exercise of
Drexler’s conversion right under the Amended Note, and other
unspecified monetary damages. On September 13, 2018, White Winston
filed an amended complaint, which added a former MusclePharm
executive, as a plaintiff (together with White Winston, the
“White Winston Plaintiffs”). On December 9, 2019, the
White Winston Plaintiffs filed a Second Amended Complaint, in which
they added allegations relating to the resignation of
MusclePharm’s auditor, Plante & Moran PLLC (“Plante
Moran”). MusclePharm has moved to dismiss the Second Amended
Complaint. That motion has not yet been fully briefed.
Along
with its complaint, the White Winston Plaintiffs also filed a
motion for a temporary restraining order (“TRO”) and
preliminary injunction enjoining the exercise of Drexler’s
conversion right under the Amended Note. On August 23, 2018,
the Nevada district court issued an ex parte TRO. On September 14, 2018,
the court let the TRO expire and denied the White Winston
Plaintiffs’ request for a preliminary injunction, finding,
among other things, that the White Winston Plaintiffs did not show
a likelihood of success on the merits of the underlying action and
failed to establish irreparable harm. Following the court’s
decision, MusclePharm filed a motion seeking to recoup the legal fees and costs it
incurred in responding to the preliminary injunction motion. On
October 31, 2019, the court awarded MusclePharm $56,000 in fees and
costs. The White Winston Plaintiffs have appealed that
award.
On June
17, 2019, the White Winston Plaintiffs moved for the appointment of
a temporary receiver over MusclePharm, citing Plante Moran’s
resignation. The court granted the White Winston Plaintiffs’
request to hold an evidentiary hearing on the motion, but the date
for that hearing was not set as of the date hereof. On July 30,
2019, the White Winston Plaintiffs filed an action in the Superior
Court of the State of California in and for the County of Los
Angeles, seeking access to MusclePharm’s books and records.
MusclePharm has answered the petition, asserting as a defense that
the request does not have a proper purpose. A trial on the petition has been set
for February 25, 2021.
The Company intends to vigorously defend these
actions.
IRS Audit
On April 6, 2016, the Internal Revenue Service (“IRS”)
selected our 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 our 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 the Company’s Federal income tax. On October 5,
2016, the IRS commenced an audit of our employment and withholding
tax liability for 2014. The IRS contends 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 $4.4 million related to withholding taxes,
specifically, income withholding and Social Security taxes, and
$0.9 million related to penalties. Additionally, the IRS asserts
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 has
been pursuing this matter vigorously through the IRS appeal
process. An Appeals Conference was held with the IRS in Denver,
Colorado on July 31, 2019. At the conference, the Company made
substantial arguments challenging the IRS’s claims for
employment taxes and penalties. On December 16, 2019, a further
Appeals Conference was held with the IRS by telephone. At the
telephone conference, the Appeals Officer confirmed that he agreed
with the Company’s argument that the failure to deposit
penalties should be conceded by the IRS. The failure to deposit
penalties total about $2 million. Thus, with this concession, the
IRS’s claims have been reduced from approximately $7.3
million to about $5.3 million.
The remaining issue in dispute in this matter involves the fair
market value of restricted stock units in the Company granted to
certain former officers (the “Former Officers”) of the
Company under Internal Revenue Code § 83. The Company and the
IRS disagree as to the value of the restricted stock on the date of
the grants, i.e., October 1, 2014. The Company and the IRS have
exchanged expert valuation reports on the fair market value of the
stock and have had extensive negotiations on this issue. The
parties, however, have not been able to reach an agreement with
respect to the value of the stock. The IRS has also made parallel
claims regarding the restricted stock units against the Former
Officers of the Company. The IRS has asserted that the Former
Officers received ordinary income from the stock grants, and that
they owe additional personal income taxes based on the fair market
value of the stock. The Former Officers’ cases, unlike the
Company’s case, are pending before the United States Tax
Court. In the Tax Court litigation, the Former Officers are
challenging the IRS’s determinations regarding the fair
market value of the restricted stock grants on October 1, 2014. The
Former Officers have separate counsel from the Company. The same
IRS Appeals Officer and Revenue Agents assigned to the
Company’s case are also involved in the cases for the Former
Officers. Throughout the proceedings, the Company has argued to the
IRS that it is the Former Officers who are directly and principally
liable for the amount of any tax due, and not the
Company.
The Former Officers cases were scheduled for trial in Tax Court on
March 9, 2020. The trial of the cases was continued by the Court on
February 4, 2020. The basis for the continuance was that the IRS
and the Former Officers had made progress toward a settlement of
the valuation issue involving the grants of the restricted stock.
The outcome of these settlement negotiations will be relevant to
the Company’s case. The Company is closely monitoring the
settlement discussions between the IRS and the Former Officers. The
Tax Court has ordered the Former Officers to file status reports
regarding progress of their settlement negotiations with the IRS on
or before October 22, 2020.
Due to the uncertainty associated with determining our liability
for the asserted taxes and penalties, if any, and to our 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 has not recorded an estimate for its potential liability,
if any, associated with these taxes.
On August 22, 2018, Richard Estalella filed an action against
the Company and two other defendants in the Colorado District Court
for the County of Denver, seeking damages arising out of the
IRS’s assertion of tax liability and penalties relating to
the 2014 restricted stock grants. The Company has answered
Estalella’s complaint, asserted counterclaims against
Estalella for his failure to ensure that all withholding taxes were
paid in connection with the 2014 restricted stock grants, and filed
cross-claims against a valuation firm named in the action for
failing to properly value the 2014 restricted stock grants for tax
purposes. The Company is waiting on the next steps from the court
and will continue to vigorously litigate the matter.
4Excelsior Matter
On March 18, 2019, 4Excelsior, a manufacturer of MusclePharm
products, filed an action against MusclePharm in the Superior Court
of the State of California for the County of Los Angeles, claiming
approximately $6.2 million in damages relating to allegedly
unpaid invoices, as well as approximately $7.8 million in
consequential damages. On January 27, 2020, MusclePharm
filed a counterclaim against 4Excelsior seeking unidentified
damages relating to, among other things, 4Excelsior’s failure
to fulfill a purchase order. MusclePharm also moved to strike
4Excelsior’s consequential damages on the grounds that they
are unrecoverable under the Uniform Commercial Code. The
court denied that motion, and the action has proceeded to
discovery. The Company recognized a liability of $5.3 million (past
due invoices plus interest) as of December 31, 2019. Trial has not
yet been set, although a Trial Setting Conference has been set for
September 21, 2020.
The Company intends to vigorously defend this action.
Nutrablend Matter
On February 27, 2020, Nutrablend, a manufacturer of
MusclePharm products, filed an action against MusclePharm in the
United States District Court for the Eastern District of
California, claiming approximately $3.1 million in allegedly
unpaid invoices. The amount is currently recorded as a liability as
of December 31, 2019. Trial has been set for
November 17, 2020. The Company intends to vigorously defend
this action.
Note 10. Stockholders’ Deficit
Common Stock
The
fair value of all stock issuances is based upon the quoted closing
trading price on the date of issuance. Common stock outstanding as of December 31, 2019
and 2018 includes shares legally outstanding even if subject to
future vesting. For the year ended December 31, 2019, 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 for note conversion
|
16,216,216
|
$18,000
|
$1.11
|
Stock
issued for consulting services
|
22,222
|
10
|
0.45
|
Stock
issued in relation to Biozone settlement
|
150,000
|
60
|
0.40
|
Restricted
stock issued to directors
|
595,238
|
250
|
0.42
|
Stock
issued for advertising services
|
702,069
|
632
|
0.90
|
Total
|
17,685,745
|
$18,952
|
$0.40 to 1.11
|
For the year ended December 31, 2018, 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 related party for interest
|
81,113
|
$53
|
0.65
|
Stock
issued to directors
|
250,000
|
250
|
1.00
|
Total
|
331,113
|
$303
|
$0.65 to 1.00
|
Warrants
For the
years ended December 31, 2019 and 2018, the Company did not issue
any warrants. Outstanding warrants as of December 31, 2019 and
2018, were 1,289,378 shares and 1,389,378 shares,
respectively.
Treasury Stock
During the years ended December 31, 2019 and 2018, the Company did
not repurchase any shares of its common stock and held 875,621
shares in treasury as of both December 31, 2019 and
2018.
Note 11. Stock-Based Compensation
Stock Incentive Plans
In
2015, the Board adopted the MusclePharm Corporation 2015 Incentive
Compensation Plan (the “2015 Plan”). The 2015 Plan
provides for the issuance of incentive stock options, non-qualified
stock options, restricted stock, stock appreciation rights,
restricted stock units, dividend equivalent rights, and other cash-
and stock-based awards to employees, consultants and directors of
the Company or its subsidiaries.
The
2015 Plan is administered by the Board, unless the Board elects to
delegate administration responsibilities to a committee (either of
the foregoing, or their authorized delegates, the “plan
administrator”), and will continue in effect until
terminated. The 2015 Plan may be amended, modified or terminated,
subject to stockholder approval to the extent necessary to comply
with applicable law or to the extent an amendment increases the
number of shares available under the 2015 Plan or permits the
extension of the exercise period for an stock option or stock
appreciation right beyond ten years from the date of grant, and,
with respect to outstanding awards, subject to the consent of the
holder thereof if the amendment, modification or termination
materially and adversely affects such holder. The total number of
shares that may be issued under the 2015 Plan cannot exceed
2,000,000, subject to adjustment in the event of certain changes in
the capital structure of the Company. As of December 31, 2019,
there were 576,494 remaining shares available for issuance under
the 2015 Plan.
The
plan administrator determines the individuals who are issued awards
and the terms and conditions of the awards, including vesting terms
and conditions. The plan administrator also determines the methods
by which the exercise price of stock options may be paid, which may
include a combination of cash or check, shares, a promissory note
or other property, and the methods by which shares are
delivered.
Under
the 2015 Plan, in any calendar year, the maximum number of shares
with respect to which awards may be granted to any one participant
during the year is 350,000 shares, subject to adjustment in the
event of specified changes in the capital structure of the Company,
and the maximum amount that may be paid in cash during any calendar
year with respect to any award is $1.5 million.
Restricted Stock
The
Company’s stock-based compensation for the years ended
December 31, 2019 and 2018 consisted primarily of restricted stock
awards. The restricted stock awards granted to employees,
executives and Board members during the years ended December 31,
2019 and 2018 were as follows:
|
Unvested
Restricted Stock Awards
|
|
|
Weighted
Average
Grant Date Fair
Value
|
Unvested
balance – December 31, 2017
|
487,267
|
$2.32
|
Granted
|
250,000
|
1.00
|
Vested
|
(539,767)
|
2.18
|
Unvested
balance – December 31, 2018
|
197,500
|
1.05
|
Granted
|
838,942
|
0.42
|
Vested
|
(346,310)
|
0.78
|
Unvested
balance – December 31, 2019
|
690,132
|
$0.42
|
The
total fair value of restricted stock awards granted to employees,
executives and Board members was $0.4 million and $0.3 million for
the years ended December 31, 2019 and 2018, respectively. As of
December 31, 2019, the total unrecognized expense for unvested
restricted stock awards, net of expected forfeitures, was $0.2
million, which is expected to be amortized over a weighted average
period of 0.5 years.
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 plan administrator under the
2015 Plan. No stock option may 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.
These stock options were granted with 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 in the aggregate, which
was 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 Year
Ended
December 31, 2016
|
Expected
term of options
|
6.5
years
|
Expected
volatility-range used
|
118.4%
-131.0%
|
Expected
volatility-weighted average
|
125.7%
|
Risk-free
interest rate-range used
|
1.27%
-1.71%
|
For the
year ended December 31, 2019, the Company recorded no stock
compensation expense related to stock options. For the year ended
December 31, 2018, the Company recorded stock compensation expense
of $16,000 related to stock options.
Stock Options Summary Table
The
following table describes the total options outstanding, granted,
exercised, expired and forfeited as of and during the years ended
December 31, 2019 and 2018, as well as the total options
exercisable as of December 31, 2019. Shares obtained from the
exercise of our options are subject to various trading
restrictions.
|
Options Pursuant to the 2015 Plan
|
Weighted Average Exercise Price Per Share
|
Weighted Average Fair Value of Options
|
Weighted Average Remaining Contractual Life (Years)
|
Aggregate Intrinsic Value
|
Issued
and outstanding as of December 31, 2017
|
171,703
|
$1.89
|
$1.72
|
8.15
|
$—
|
Granted
|
—
|
—
|
—
|
—
|
—
|
Exercised
|
—
|
—
|
—
|
—
|
—
|
Forfeited
|
—
|
—
|
—
|
—
|
—
|
Issued
and outstanding as of December 31, 2018
|
171,703
|
$1.89
|
$1.72
|
7.17
|
$—
|
Granted
|
—
|
—
|
—
|
—
|
—
|
Exercised
|
—
|
—
|
—
|
—
|
—
|
Forfeited
|
—
|
—
|
—
|
—
|
—
|
Issued
and outstanding as of December 31, 2019
|
171,703
|
$1.89
|
$1.72
|
6.17
|
$—
|
Exercisable
as of December 31, 2019
|
171,703
|
$1.89
|
$1.72
|
6.17
|
$—
|
Note 12. Defined Contribution Plan
The
Company established a 401(k) Plan (the “401(k) Plan”)
for eligible employees of the Company. Generally, all employees of
the Company who are at least twenty-one years of age and who have
completed six months of service are eligible to participate in the
401(k) Plan. The 401(k) Plan is a defined contribution plan that
provides that participants may make voluntary salary deferral
contributions, on a pretax basis, in the form of voluntary payroll
deductions. The Company may make discretionary matching
contributions.
For
each of the years ended December 31, 2019 and 2018, the
Company’s matching contribution were $80,000 and $0.1
million, respectively.
Note 13. 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. There was no dilutive effect for
the outstanding potentially dilutive securities for either the
years ended December 31, 2019 or 2018, 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 years presented (in
thousands, except share and per share data):
|
For the Years
Ended
December
31,
|
|
|
|
Net
loss
|
$(18,927)
|
$(10,755)
|
Weighted average
common shares used in computing net loss per share, basic and
diluted
|
20,475,313
|
15,023,872
|
Net loss per share,
basic and diluted
|
$(0.92)
|
$(0.72)
|
Diluted
net loss per share is computed by dividing net loss 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 years
ended December 31, 2019 and 2018 as the Company reported a net loss
for both periods. However, if the Company had net income for the
year ended December 31, 2019, the potentially dilutive securities
included in the earnings per share computation would have been
3,083,187. If the Company had net income for the year ended
December 31, 2018, the potentially dilutive securities included in
the earnings per share computation would have been
17,956,797.
Total
outstanding potentially dilutive securities were comprised of the
following:
|
|
|
|
|
Stock
options
|
171,703
|
171,703
|
Warrants
|
1,289,378
|
1,389,378
|
Unvested restricted
stock
|
690,132
|
179,500
|
Convertible
notes
|
931,974
|
16,216,216
|
Total common stock
equivalents
|
3,083,187
|
17,956,797
|
Note 14. Income Taxes
The
components of loss before provision for income taxes for the years
ended December 31, 2019 and 2018 are as follows (in
thousands):
|
For the
Years Ended December 31,
|
|
|
|
Domestic
|
$(18,831)
|
$(10,396)
|
Foreign
|
(10)
|
(259)
|
Loss before
provision for income taxes
|
$(18,841)
|
$(10,655)
|
Income
taxes are provided for the tax effects of transactions reported in
the 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.
As of
December 31, 2019, the Company has a Federal net operating loss
carry-forward of $114.2 million available to offset future taxable
income. The Company has estimated state loss carry-forwards of
$83.1 million. The Company also has federal and state research and
development credit carryforwards of $0.5 million as of December 31,
2019.
Utilization
of net operating losses and R&D credits may be limited due to
potential ownership changes under Section 382 of the IRS Code. The
Company is currently undergoing a review of its net operating
losses in connection with the conversion of Mr. Drexler’s
convertible note in September 2019. It is anticipated that the
utilization of the net operating losses carry-forwards may be
limited as a result of the conversion. These pre-2018 net operating
loss carry-forwards of $91.2 million for federal and $73.4 million
for states and federal R&D credits have expiration dates
starting in 2025 through 2037.
The
valuation allowance as of December 31, 2019 was $32.3 million. The
net change in valuation allowance for the year ended December 31,
2019 was an increase of $5.4 million. 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 determined that enough uncertainty
exists relative to the realization of the deferred income tax asset
balances to warrant the application of a full valuation allowance
as of December 31, 2019.
The
effects of temporary differences that gave rise to significant
portions of deferred tax assets as of December 31, 2019 and 2018,
are as follows (in thousands):
|
|
|
|
|
Deferred
tax assets:
|
|
|
Net
operating loss carryforwards
|
$28,505
|
$23,625
|
Other
|
3,784
|
3,235
|
Gross
deferred tax assets
|
32,289
|
26,860
|
Valuation
allowance
|
(32,289)
|
(26,860)
|
Net
deferred tax assets
|
$—
|
$—
|
The
Company incurred income tax expense of $0.1 million for both years
ended December 31, 2019 and 2018. Of the total tax provision for
the years ended December 31, 2019 and 2018, $32,000 and $39,000 was
attributed to taxes for foreign operations,
respectively.
The
income tax provision for the years ended December 31, 2019 and 2018
included the following (in thousands):
|
For the Years
Ended December 31,
|
|
|
|
Current income tax
expense:
|
|
|
Federal
|
$—
|
$—
|
State
|
54
|
61
|
Foreign
|
32
|
39
|
|
86
|
100
|
Deferred income tax
provision:
|
|
|
Federal
|
—
|
—
|
State
|
—
|
—
|
Foreign
|
—
|
—
|
|
—
|
—
|
Provision for
income taxes, net
|
$86
|
$100
|
The
income tax provision differs from those computed using the
statutory federal tax rate of 34% due to the following (in
thousands):
|
For the Years
Ended December 31,
|
|
|
|
Expected provision
at statutory federal rate
|
$(3,957)
|
$(2,249)
|
State tax —
net of federal benefit
|
48
|
35
|
Foreign
income/losses taxed at different rates
|
34
|
94
|
Other
|
11
|
38
|
Change in valuation
allowance
|
3,950
|
2,182
|
Income tax
expense
|
$86
|
$100
|
A
reconciliation of the beginning and ending amount of unrecognized
tax benefits (“UTB’s”) is as follows (in
thousands):
Gross UTB’s
as of December 31, 2018
|
$39
|
Additions for tax
positions taken in the current year
|
89
|
Deductions for tax
positions taken in a prior year
|
—
|
Gross UTB’s
as of December 31, 2019
|
$128
|
If
recognized, none of the Company’s unrecognized tax benefits
as of December 31, 2019 would reduce its annual effective tax rate
but would result in a corresponding adjustment to its deferred tax
valuation allowance. As of December 31, 2019, the Company has not
recorded a liability for potential interest or penalties. The
Company also does not expect its unrecognized tax benefits to
change significantly over the next 12 months. By statute, all
tax years are open to examination by the major taxing jurisdictions
to which the Company is subject.
The Tax
Cuts and Jobs Act of 2017 (Tax Act), as signed by the President of
the United States on December 22, 2017, significantly revised U.S.
tax law. The tax reform legislation reduced the corporate tax rate,
limits or eliminated certain tax deductions and changed the
taxation of foreign earnings of U.S. multinational companies. The
Deemed Repatriation Transition Tax (Transition Tax) is a tax on
previously untaxed accumulated and current earnings and profits
(E&P) of our foreign subsidiary at reduced tax rates. To
determine the amount of the Transition Tax, we must determine, in
addition to other factors, the amount of post-1986 E&P of the
relevant subsidiaries, as well as the amount of non-U.S. income
taxes paid on such earnings. The Tax Act reduced the corporate tax
rate to 21 percent, effective January 1, 2018. Consequently, we
recorded a provisional decrease to deferred tax assets, which was
fully offset by a corresponding change in the valuation allowance
recorded against our deferred tax assets.
On
March 27, 2020, President Trump signed into law the CARES Act.
Among the changes to the U.S. federal income tax, the CARES Act
restored net operating loss carryback rules that were eliminated by
2017 Tax Cuts and Jobs Act, modified the limit on the deduction for
net interest expense and accelerated the timeframe for refunds of
AMT credits. Based on an analysis of the impact of the CARES Act,
the Company has not identified any overall material effect on the
2018 and 2019 tax liabilities.
Note 15. 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 Years
Ended
December
31,
|
|
|
|
Revenue,
net:
|
|
|
United
States
|
$56,976
|
$55,970
|
International
|
22,691
|
32,143
|
Total revenue,
net
|
$79,667
|
$88,113
|
Note 16. Changes and Correction
of Errors in Previously Reported Consolidated Financial
Statements
Background on the Restatement
In February 2019, the Company was made aware, as part of the
year-end sales cut-off testing procedures performed during the
Company’s 2018 annual audit, by its then independent
auditors, Plante & Moran, PLLC, that sales transactions may
have been recognized as revenue prematurely which could have a
material impact on revenue recognition for the year ended December
31, 2018. Upon such notification, the Company reviewed its revenue
recognition reporting system, practices and underlying documents
supporting the appropriateness of revenue under the Company’s
previously established accounting policies for each quarterly
period in the year ended December 31, 2018. In addition to the 2018
year-end period, the Company initially concluded that a potential
material misstatement in revenue recognition was isolated to the
previously issued quarterly financial statements for the three and
nine months ended September 30, 2018.
Audit Committee Investigation
In March 2019, following management’s presentation of their
initial assessment of the revenue recognition issue, the Audit
Committee of the Board of Directors engaged independent legal
counsel and a forensic accountant to conduct an investigation and
to work with the Company to determine the potential impact on
accounting for revenues. The investigation included the review of
the Company’s initial assessment, interviews with key
personnel, correspondence and document review, among other
procedures. In April 2019, as a result of the findings of the Audit
Committee's investigation to date, the Company determined that
certain of its employees had engaged in deliberate inappropriate
conduct, which resulted in revenue being intentionally recorded in
periods prior to the criteria for revenue recognition under GAAP
being satisfied. Further, the investigation discovered that revenue
had been prematurely recorded in prior periods as well as the
periods initially identified by management.
The investigation revealed that certain customer orders had been
invoiced, triggering revenue recognition, prior to the actual
shipment leaving the Company’s control. Such orders from
customers had been marked as fulfilled in the Company’s
enterprise reporting platform (“ERP”), thereby
triggering the generation of an invoice and the recognition of
revenue, in advance of shipments from both the Company’s
distribution center in Tennessee and for orders that were
drop-shipped directly to key customers from certain contract
manufacturers. In addition, it was discovered during the
investigation that certain orders had been moved to third-party
locations at the respective cut-off periods and not actually
shipped to the end customer until after the cut-off period
resulting in the premature issuance of invoices to customers and
recognition of revenue.
As a result of the Audit Committee's investigation, certain
employees were terminated, and others received written reprimands
related to their conduct as it relates to their behavior. In
connection with the improprieties identified during the
investigation resulting in the restatement of previously reported
financial statements, the Company identified control deficiencies
in its internal control over financial reporting that constitute
material weaknesses.
Other Adjustments Resulting from Reconsidering Previously Issued
Financial Statements
As a result of issues identified during the Audit Committee
investigation, management reconsidered the Company’s
previously issued consolidated financial statements and as a result
additional corrections to the Company’s previously issued
consolidated financial statements for each of the quarterly
reporting periods ended September 30, 2018 and for the year ended
December 31, 2017 were identified. These errors, for each period
presented below, were primarily due to the following:
●
Improper
classification of trade promotions, payable to the Company’s
customers, as operating expenses instead of a reduction in
revenues;
●
Improper
cut-off related to sales transactions recorded prior to transfer of
control to customers in 2018 and risk of loss transferred to the
customer in 2017;
●
Corrections
of estimates of the expected value of customer payments, in the
form of credits, issued to customers;
●
Untimely
recording of the change in the estimated useful life of leasehold
improvements and an asset retirement obligation related to a
modification to the lease of the Company’s former
headquarters;
●
Incorrect
treatment of debt discounts related to the related-party
convertible note; and
●
Other period-end
expense cutoff.
Other adjustments include, but are not limited to the following;
purchase price variances, accrual for legal fees, payroll tax
adjustment on restricted stock, rebate receivable and recognizing
revenue on a net versus gross basis.
Accumulated deficit has been adjusted to reflect changes to net
loss, for each period restated.
Restatement Adjustments
Several restatement adjustments were made to the Company's
previously filed consolidated financial statements in order to
reflect revenue recognition in the appropriate periods as discussed
above. Accordingly, for the subject sales transactions, revenue and
accounts receivable balances were reduced by an equivalent amount
in the period that the sale was originally recorded as revenue, and
revenue was increased in the subsequent period in which the
criteria for revenue recognition were met. Further, for the subject
sales transactions, cost of revenue was reduced, and inventory was
increased, in the period that the sale was originally recorded as
revenue, and cost of revenue was increased, and inventory was
reduced, in the period the sale was ultimately recorded as
revenue.
In addition, (i) revenue and operating expenses were reduced by an
equivalent amount relating to the reclassification of customer
payments, which were originally recorded on a gross versus net
basis; (ii) revenue was increased or decreased each period, as
appropriate, relating to revised estimates of the expected value of
credits issued to customers, (iii) untimely recording of the change
in the estimated useful life of leasehold improvements and an asset
retirement obligation related to a modification to the lease of the
Company’s former headquarters and (iv) other adjustments as
referred to above.
December 31, 2017 Restatements (Unaudited)
As of and for the year ended December 31, 2017, the Company
recorded the following restatement adjustments and charges (in
thousands):
Impact on consolidated statements of operations - increase
(decrease):
Accrual
for customer credits – ($1,281)
Sales
cutoff – ($4,111)
Reclassification
of payments to customers – ($6,177)
Restatement
adjustment applicable to prior year error - $3,000
Sales
cutoff – ($2,831)
Restatement
adjustment applicable to prior year error - $1,435
Purchase
Price Variance - ($154)
Reclassification
of advertising expenses directly related to product sales -
$482
●
Advertising
and promotion:
Accrual
for customer credits – $90
Reclassification
of payments to customers – ($6,111)
Sales
cutoff – ($3)
Reclassification of
advertising expenses directly related to product sales and
commissions – ($893)
●
Selling,
general and administrative:
Accrual
for customer credits – $72
Reclass
of payments to customers – ($65)
Depreciation
adjustment for facility relocation – $1,093
Reclassification of
advertising expenses representing commissions - $411
●
Professional fees:
legal over accrual – ($148)
●
Impairment of
assets: reclassification of impairment of assets –
($180)
●
Interest and other
expense, net: payroll tax adjustment on restricted stock –
($231)
Impact on consolidated balance sheets - increase
(decrease):
●
Accounts
receivable, net of allowance for doubtful accounts:
Accrual
for customer credits – ($1,443)
Sales
cutoff – ($4,120)
Sales
cutoff – $2,837
Purchase
Price Variance - $154
●
Property
and equipment, net: depreciation adjustment for facility relocation
– ($912)
●
Accounts
payable: Sales cutoff – ($4)
Legal
over accrual – ($148)
Payroll
tax adjustment on restricted stock – ($230)
●
Convertible note with a related party, net of
discount: debt discount adjustment - $1,212
●
Additional
paid-in capital: debt discount adjustment –
($1,212)
●
Accumulated
Deficit – $3,102
The unaudited restated consolidated balance sheets as of December
31, 2017 is presented below (in thousands, except per share
data):
|
|
|
|
|
|
ASSETS
|
|
|
|
Current
assets:
|
|
|
|
Cash
|
$6,228
|
$—
|
$6,228
|
Accounts
receivable, net of allowance for doubtful accounts of $1,363 as of
December 31, 2017
|
16,668
|
(5,563)
|
11,105
|
Inventory
|
6,572
|
2,991
|
9,563
|
Prepaid
expenses and other current assets
|
994
|
—
|
994
|
Total
current assets
|
30,462
|
(2,572)
|
27,890
|
Property
and equipment, net
|
1,822
|
(912)
|
910
|
Intangible
assets, net
|
1,317
|
—
|
1,317
|
Other
assets
|
225
|
—
|
225
|
TOTAL
ASSETS
|
$33,826
|
$(3,484)
|
$30,342
|
LIABILITIES AND STOCKHOLDERS’ DEFICIT
|
|
|
|
Current
liabilities:
|
|
|
|
Obligation
under secured borrowing arrangement
|
$5,385
|
$—
|
$5,385
|
Line
of credit
|
3,000
|
—
|
3,000
|
Accounts
payable
|
11,742
|
(4)
|
11,738
|
Accrued
liabilities
|
7,761
|
(378)
|
7,383
|
Accrued
restructuring charges, current
|
595
|
—
|
595
|
Total
current liabilities
|
28,483
|
(382)
|
28,101
|
Convertible
note with a related party, net of discount
|
16,669
|
1,212
|
17,881
|
Accrued
restructuring charges, long-term
|
120
|
—
|
120
|
Other
long-term liabilities
|
1,088
|
—
|
1,088
|
TOTAL
LIABILITIES
|
46,360
|
830
|
47,190
|
Commitments
and contingencies (Note 9)
|
|
|
|
Stockholders'
deficit:
|
|
|
|
Common
stock, par value of $0.001 per share; 100,000,000 shares
authorized; 15,859,175 shares issued as of December 31, 2017,
respectively; 14,983,554 shares outstanding as of December 31,
2017
|
14
|
—
|
14
|
Additional
paid-in capital
|
159,608
|
(1,212)
|
158,396
|
Treasury
stock, at cost; 875,621 shares
|
(10,039)
|
—
|
(10,039)
|
Accumulated
other comprehensive loss
|
(150)
|
—
|
(150)
|
Accumulated
deficit
|
(161,967)
|
(3,102)
|
(165,069)
|
TOTAL
STOCKHOLDERS’ DEFICIT
|
(12,534)
|
(4,314)
|
(16,848)
|
TOTAL
LIABILITIES AND STOCKHOLDERS’ DEFICIT
|
$33,826
|
$(3,484)
|
$30,342
|
The unaudited restated consolidated statements of operations for
the year ended December 31, 2017 is presented below (in thousands,
except per share data):
|
Year Ended December 31, 2017
|
|
|
|
|
Revenue,
net
|
$102,155
|
$(8,569)
|
$93,586
|
Cost
of revenue
|
71,710
|
(1,068)
|
70,642
|
Gross
profit
|
30,445
|
(7,501)
|
22,944
|
Operating
expenses:
|
|
|
|
Advertising
and promotion
|
9,352
|
(6,917)
|
2,435
|
Salaries
and benefits
|
10,134
|
—
|
10,134
|
Selling,
general and administrative
|
12,071
|
1,511
|
13,582
|
Research
and development
|
642
|
—
|
642
|
Professional
fees
|
3,378
|
(148)
|
3,230
|
Gain
on settlement of accounts payable
|
(430)
|
—
|
(430)
|
Impairment
of assets
|
180
|
(180)
|
—
|
Total
operating expenses
|
35,327
|
(5,734)
|
29,593
|
Loss
from operations
|
(4,882)
|
(1,767)
|
(6,649)
|
Other
(expense) income:
|
|
|
|
Loss
on settlement of obligations
|
(1,877)
|
—
|
(1,877)
|
Interest
and other expense, net
|
(4,072)
|
231
|
(3,841)
|
Loss
before provision for income taxes
|
(10,831)
|
(1,536)
|
(12,367)
|
Provision
for income taxes
|
142
|
—
|
142
|
Net
loss
|
$(10,973)
|
$(1,536)
|
$(12,509)
|
|
|
|
|
Net
loss per share, basic and diluted
|
$(0.79)
|
$(0.09)
|
$(0.88)
|
|
|
|
|
Weighted
average shares used to compute net loss per share, basic and
diluted
|
13,877,686
|
337,713
|
14,215,399
|
The unaudited restated consolidated statements of
stockholders’ deficit for the year ended December 31, 2017 is
presented below (in thousands):
|
Year Ended December 31, 2017
|
|
|
|
|
Accumulated
Deficit at January 1, 2017
|
$(150,994)
|
$(1,566)
|
$(152,560)
|
Net
loss
|
(10,973)
|
(1,536)
|
(12,509)
|
Accumulated
deficit at December 31, 2017
|
$(161,967)
|
$(3,102)
|
$(165,069)
|
The
unaudited restated consolidated statements of cash flows for the
year ended December 31, 2017 is presented below (in
thousands):
|
|
|
Year
Ended December 31, 2017
|
|
|
|
|
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
Net
loss
|
$(10,973)
|
$(1,536)
|
$(12,509)
|
Adjustments
to reconcile net loss to net cash used in operating
activities:
|
|
|
|
Depreciation
and amortization of property and equipment
|
1,320
|
912
|
2,232
|
Amortization
of intangible assets
|
320
|
—
|
320
|
Bad
debt expense
|
1,524
|
—
|
1,524
|
Gain
on settlement of accounts payable
|
(430)
|
—
|
(430)
|
Loss
on disposal of property and equipment
|
31
|
—
|
31
|
Amortization
of debt discount and issuance costs
|
545
|
—
|
545
|
Stock-based
compensation
|
2,096
|
—
|
2,096
|
Write
off of prepaid financing costs
|
275
|
—
|
275
|
Changes
in operating assets and liabilities:
|
|
|
|
Accounts
receivable
|
(4,619)
|
2,564
|
(2,055)
|
Inventory
|
2,124
|
(1,558)
|
566
|
Prepaid
expenses and other current assets
|
849
|
—
|
849
|
Other
assets
|
(77)
|
—
|
(77)
|
Accounts
payable and accrued liabilities
|
1,991
|
(382)
|
1,609
|
Accrued
restructuring charges
|
(107)
|
—
|
(107)
|
Net
cash provided by operating activities
|
(5,131)
|
—
|
(5,131)
|
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
Purchase
of property and equipment
|
(37)
|
—
|
(37)
|
Net
used in provided by investing activities
|
(37)
|
—
|
(37)
|
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
Proceeds
from line of credit
|
3,000
|
—
|
3,000
|
Net
proceeds from convertible notes with a related party
|
871
|
—
|
871
|
Proceeds
from secured borrowing arrangement, net of reserves
|
33,692
|
—
|
33,692
|
Payments
on secured borrowing arrangement, net of fees
|
(30,988)
|
—
|
(30,988
|
Repayment
of capital lease obligations
|
(139)
|
—
|
(139
|
Net
cash provided by financing activities
|
6,436
|
—
|
6,436
|
Effect
of exchange rate changes on cash
|
17
|
—
|
17
|
NET
CHANGE IN CASH
|
1,285
|
—
|
1,285
|
CASH
— BEGINNING OF PERIOD
|
4,943
|
—
|
4,943
|
CASH
— END OF PERIOD
|
$6,228
|
$—
|
$6,228
|
SUPPLEMENTAL
DISCLOSURE OF CASH FLOW INFORMATION:
|
|
|
|
Cash
paid for interest
|
$2,445
|
$—
|
$2,445
|
Cash
paid for taxes
|
$106
|
$—
|
$106
|
SUPPLEMENTAL
DISCLOSURE OF NON-CASH INVESTING AND FINANCING
ACTIVITIES:
|
|
|
|
Conversion
feature related to Refinanced Convertible Note
|
$1,212
|
$(1,212)
|
$—
|
March 31, 2018 Restatements (Unaudited)
Impact on consolidated statements of operations for the three
months ended March 31, 2018 (in thousands) - increase
(decrease):
Reversal
of December 31, 2017 accrual for credits –
$1,281
Sales
cutoff – $545
Correction
of estimate of expected value of customer credits –
($1,572)
Reclassification
of payments to customers – ($2,584)
Recognizing
revenue on a net versus gross basis– ($30)
Sales
cutoff – $776
Reversal
of December 31, 2017 purchase price variance - $154
Recognizing
revenue on a net versus gross basis– ($30)
Accrual
for rebate receivable – ($170)
Reclassification
of advertising expenses directly related to product sales -
$107
●
Advertising
and promotion:
Reversal
of December 31, 2017 accrual for credits - ($90)
Reclassification
of payments to customers – ($2,582)
Sales
cutoff - $3
Reclassification of
advertising expenses directly related to product sales and
commissions – ($178)
●
Selling,
general and administrative:
Reversal
of December 31, 2017 accrual for credits – ($72)
Depreciation
adjustment for facility relocation – ($56)
Reclassification
of payments to customers – ($2)
Reclassification of
advertising expenses representing commissions - $71
●
Professional fees: reversal of December
2017 legal over accrual – $148
●
Interest and other
expense, net: adjusted debt discount amortization –
($233)
Impact on consolidated balance sheets - increase
(decrease):
●
Accounts
receivable, net of allowance for doubtful accounts:
Sales
cutoff – ($3,556)
Correction
of estimate of expected value of customer credits –
($1,573)
ASC
606 modified retrospective transition – ($1,053)
●
Inventory:
Sales cutoff – $2,364
●
Property
and equipment, net: depreciation adjustment for facility
relocation: ($856)
●
Prepaid
expenses and other current assets: accrual for rebate receivable
– $170
●
Accounts
payable: sales cutoff - $320
●
Accrued
liabilities: Payroll tax adjustment on restricted stock –
($230)
●
Convertible
note with a related party, net of discount: debt discount
adjustment net of amortization – $979
●
Additional
paid-in capital: debt discount adjustment –
($1,212)
●
Accumulated
Deficit – $4,361
The unaudited restated consolidated balance sheets as of March 31,
2018 is presented below (in thousands, except per share
data):
|
|
|
|
|
|
ASSETS
|
|
|
|
Current
assets:
|
|
|
|
Cash
|
$5,114
|
$—
|
$5,114
|
Accounts
receivable, net of allowance for doubtful accounts of $1,518 as of
March 31, 2018
|
16,925
|
(6,182)
|
10,743
|
Inventory
|
7,738
|
2,364
|
10,102
|
Prepaid
giveaways
|
111
|
—
|
111
|
Prepaid
expenses and other current assets
|
895
|
170
|
1,065
|
Total
current assets
|
30,783
|
(3,648)
|
27,135
|
Property
and equipment, net
|
1,632
|
(856)
|
776
|
Intangible
assets, net
|
1,237
|
—
|
1,237
|
Other
assets
|
239
|
—
|
239
|
TOTAL
ASSETS
|
$33,891
|
$(4,504)
|
$29,387
|
LIABILITIES AND STOCKHOLDERS’ DEFICIT
|
|
|
|
Current
liabilities:
|
|
|
|
Obligation
under secured borrowing arrangement
|
$5,547
|
$—
|
$5,547
|
Line
of credit
|
2,000
|
—
|
2,000
|
Accounts
payable
|
14,897
|
320
|
15,217
|
Accrued
liabilities
|
7,441
|
(230)
|
7,211
|
Accrued
restructuring charges, current
|
560
|
—
|
560
|
Total
current liabilities
|
30,445
|
90
|
30,535
|
Convertible
note with a related party, net of discount
|
16,917
|
979
|
17,896
|
Accrued
restructuring charges, long-term
|
110
|
—
|
110
|
Other
long-term liabilities
|
1,060
|
—
|
1,060
|
Total
liabilities
|
48,532
|
1,069
|
49,601
|
Commitments
and contingencies (Note 9)
|
|
|
|
Stockholders'
deficit:
|
|
|
|
Common
stock, par value of $0.001 per share, 100,000,000 shares
authorized; 15,940,288 shares issued as of March 31, 2018;
15,064,667 shares outstanding as of March 31, 2018
|
14
|
—
|
14
|
Additional
paid-in capital
|
159,798
|
(1,212)
|
158,586
|
Treasury
stock, at cost; 875,621 shares
|
(10,039)
|
—
|
(10,039)
|
Accumulated
other comprehensive loss
|
(142)
|
—
|
(142)
|
Accumulated
deficit
|
(164,272)
|
(4,361)
|
(168,633)
|
TOTAL
STOCKHOLDERS’ DEFICIT
|
(14,641)
|
(5,573)
|
(20,214)
|
TOTAL
LIABILITIES AND STOCKHOLDERS’ DEFICIT
|
$33,891
|
$(4,504)
|
$29,387
|
The unaudited restated quarterly consolidated statements of
operations for the three months ended March 31, 2018 is presented
below (in thousands, except per share data):
|
Three Months Ended March 31, 2018
|
|
|
|
|
Revenue,
net
|
$26,547
|
$(2,360)
|
$24,187
|
Cost
of revenue
|
18,328
|
837
|
19,165
|
Gross
profit
|
8,219
|
(3,197)
|
5,022
|
Operating
expenses:
|
|
|
|
Advertising
and promotion
|
3,661
|
(2,847)
|
814
|
Salaries
and benefits
|
2,154
|
—
|
2,154
|
Selling,
general and administrative
|
2,546
|
(59)
|
2,487
|
Research
and development
|
212
|
—
|
212
|
Professional
fees
|
572
|
148
|
720
|
Total
operating expenses
|
9,145
|
(2,758)
|
6,387
|
Loss
from operations
|
(926)
|
(439)
|
(1,365)
|
Other
(expense) income:
|
|
|
|
Interest
and other expense, net
|
(1,310)
|
233
|
(1,077)
|
Loss
before provision for income taxes
|
(2,236)
|
(206)
|
(2,442)
|
Provision
for income taxes
|
69
|
—
|
69
|
Net
loss
|
$(2,305)
|
$(206)
|
$(2,511)
|
|
|
|
|
Net
loss per share, basic and diluted
|
$(0.16)
|
$(0.01)
|
$(0.17)
|
|
|
|
|
Weighted
average shares used to compute net loss per share, basic and
diluted
|
14,615,677
|
341,540
|
14,957,217
|
The unaudited restated consolidated statements of cash flows for
the three months ended March 31, 2018 is presented below (in
thousands):
|
Three Months Ended March 31, 2018
|
|
|
|
|
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
Net
loss
|
$(2,305)
|
$(206)
|
$(2,511)
|
Adjustments
to reconcile net loss to net cash used in operating
activities:
|
|
|
|
Depreciation
and amortization
|
287
|
(56)
|
231
|
Bad
debt expense
|
164
|
—
|
164
|
Amortization
of debt discount
|
248
|
(233)
|
15
|
Inventory
provision
|
—
|
35
|
35
|
Stock-based
compensation
|
137
|
—
|
137
|
Changes
in operating assets and liabilities:
|
|
|
|
Accounts
receivable
|
(443)
|
(434)
|
(877)
|
Inventory
|
(1,255)
|
592
|
(663)
|
Prepaid
giveaways
|
(23)
|
—
|
(23)
|
Prepaid
expenses and other current assets
|
100
|
(170)
|
(70)
|
Other
assets
|
(14)
|
—
|
(14)
|
Accounts
payable and accrued liabilities
|
2,917
|
472
|
3,389
|
Accrued
restructuring charges
|
(45)
|
—
|
(45)
|
Net
cash used in operating activities
|
(232)
|
—
|
(232)
|
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
Purchase
of property and equipment
|
(14)
|
—
|
(14)
|
Net
cash used in investing activities
|
(14)
|
—
|
(14)
|
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
Payments
on line of credit
|
(1,000)
|
—
|
(1,000)
|
Proceeds
from secured borrowing arrangement, net of reserves
|
13,494
|
—
|
13,494
|
Payments
on secured borrowing arrangement, net of fees
|
(13,332)
|
—
|
(13,332)
|
Repayment
of capital lease obligations
|
(34)
|
—
|
(34)
|
Net
cash used in financing activities
|
(872)
|
—
|
(872)
|
Effect
of exchange rate changes on cash
|
4
|
—
|
4
|
NET
CHANGE IN CASH
|
(1,114)
|
—
|
(1,114)
|
CASH
— BEGINNING OF PERIOD
|
6,228
|
—
|
6,228
|
CASH
— END OF PERIOD
|
$5,114
|
$—
|
$5,114
|
SUPPLEMENTAL
DISCLOSURE OF CASH FLOW INFORMATION:
|
|
|
|
Cash
paid for interest
|
$614
|
$—
|
$614
|
Cash
paid for taxes
|
$68
|
$—
|
$68
|
SUPPLEMENTAL
DISCLOSURE OF NON-CASH ACTIVITIES:
|
|
|
|
Property
and equipment acquired in conjunction with capital
leases
|
$—
|
$—
|
$—
|
Purchase
of property and equipment included in current
liabilities
|
$13
|
$—
|
$13
|
Interest
paid through issuance of shares of common stock
|
$53
|
$—
|
$53
|
June 30, 2018 Restatements (Unaudited)
Impact on consolidated statements of operations for the three
months ended June 30, 2018 - increase (decrease):
Sales
cutoff – ($2,283)
Correction
of estimate of expected value of customer credits –
$818
Reclassification
of payments to customers – ($3,799)
Recognizing
revenue on a net versus gross basis– ($13)
Sales
cutoff – ($1,884)
Accrual
for rebate receivable – ($180)
Recognizing
revenue on a net versus gross basis– ($13)
Reclassification of
advertising expenses directly related to product sales -
$242
●
Advertising
and promotion:
Reclassification
of payments to customers – ($3,794)
Reclassification of
advertising expenses directly related to product sales and
commissions – ($318)
●
Selling,
general and administrative:
Depreciation
expense for facility relocation – ($56)
Reclassification
of payments to customers – ($5)
Reclassification of
advertising expenses representing commissions - $77
●
Interest and other expense, net: adjusted
debt discount amortization – ($140)
Impact on consolidated statements of operations for the six months
ended June 30, 2018 - increase (decrease):
Reversal
of December 31, 2017 accrual for credits –
$1,281
Sales
cutoff – ($1,738)
Correction
of estimate of expected value of customer credits –
($754)
Reclassification
of payments to customers – ($6,383)
Recognizing
revenue on a net versus gross basis– ($43)
Reversal
of December 31, 2017 purchase price variance - $154
Sales
cutoff – ($1,108)
Accrual
for rebate receivable – ($350)
Recognizing
revenue on a net versus gross basis– ($43)
Reclassification of
advertising expenses directly related to product sales -
$349
●
Advertising
and promotion:
Reversal
of December 31, 2017 accrual for credits - ($90)
Reclassification
of payments to customers – ($6,376)
Sales
cutoff – $3
Reclassification of
advertising expenses directly related to product sales and
commissions – ($496)
●
Selling,
general and administrative:
Reversal
of December 31, 2017 accrual for credits – ($72)
Depreciation
adjustment for facility relocation – ($112)
Reclassification
of payments to customers – ($7)
Reclassification of
advertising expenses representing commissions - $148
●
Professional fees: reversal of December
2017 legal over accrual – $148
●
Interest and other
expense, net: adjusted debt discount amortization –
($371)
Impact on consolidated balance sheets - increase
(decrease):
●
Accounts
receivable, net of allowance for doubtful accounts:
Sales
cutoff – ($5,853)
Correction
of estimate of expected value of customer credits –
($760)
ASC
606 modified retrospective transition – ($1,053)
●
Inventory:
Sales cutoff – $3,942
●
Property
and equipment, net: depreciation adjustment for facility
relocation: ($800)
●
Prepaid
expenses and other current assets: accrual for rebate receivable
– $346
●
Accounts
payable: sales cutoff – ($5)
●
Accrued
liabilities: Payroll tax adjustment on restricted stock –
($231)
●
Convertible
note with a related party, net of discount: debt discount
adjustment net of amortization – $839
●
Additional
paid-in capital: debt discount adjustment –
($1,212)
●
Accumulated
Deficit – $3,569
The unaudited restated consolidated balance sheets as of June 30,
2018 is presented below (in thousands, except per share
data):
|
|
|
|
Restatement
Adjustments
|
|
ASSETS
|
|
|
|
Current
assets:
|
|
|
|
Cash
|
$2,442
|
$—
|
$2,442
|
Accounts
receivable, net of allowance for doubtful accounts of $1,556 as of
June 30, 2018
|
16,278
|
(7,666)
|
8,612
|
Inventory
|
7,651
|
3,942
|
11,593
|
Prepaid
expenses and other current assets
|
1,140
|
346
|
1,486
|
Total
current assets
|
27,511
|
(3,378)
|
24,133
|
Property
and equipment, net
|
1,491
|
(800)
|
691
|
Intangible
assets, net
|
1,157
|
—
|
1,157
|
Other
assets
|
238
|
—
|
238
|
TOTAL
ASSETS
|
$30,397
|
$(4,178)
|
$26,219
|
LIABILITIES AND STOCKHOLDERS’ DEFICIT
|
|
|
|
Current
liabilities:
|
|
|
|
Obligation
under secured borrowing arrangement
|
$2,787
|
$—
|
$2,787
|
Line
of credit
|
2,000
|
—
|
2,000
|
Accounts
payable
|
16,562
|
(5)
|
16,557
|
Accrued
liabilities
|
5,700
|
(231)
|
5,469
|
Accrued
restructuring charges, current
|
564
|
—
|
564
|
Total
current liabilities
|
27,613
|
(236)
|
27,377
|
Convertible
note with a related party, net of discount
|
17,071
|
839
|
17,910
|
Accrued
restructuring charges, long-term
|
80
|
—
|
80
|
Other
long-term liabilities
|
1,248
|
—
|
1,248
|
Total
liabilities
|
46,012
|
603
|
46,615
|
Commitments
and contingencies (Note 9)
|
|
|
|
Stockholders'
deficit:
|
|
|
|
Common
stock, par value of $0.001 per share; 100,000,000 shares authorized
15,940,288; shares issued as of June 30, 2018; 15,064,667 shares
outstanding as of June 30, 2018
|
15
|
—
|
15
|
Additional
paid-in capital
|
159,918
|
(1,212)
|
158,706
|
Treasury
stock, at cost; 875,621 shares
|
(10,039)
|
—
|
(10,039)
|
Accumulated
other comprehensive loss
|
(165)
|
—
|
(165)
|
Accumulated
deficit
|
(165,344)
|
(3,569)
|
(168,913)
|
TOTAL
STOCKHOLDERS’ DEFICIT
|
(15,615)
|
(4,781)
|
(20,396)
|
TOTAL
LIABILITIES AND STOCKHOLDERS’ DEFICIT
|
$30,397
|
$(4,178)
|
$26,219
|
The unaudited restated quarterly consolidated statements of
operations for the three months ended June 30, 2018 is presented
below (in thousands, except per share data):
|
Three Months Ended June 30, 2018
|
|
|
|
|
Revenue,
net
|
$27,104
|
$(5,277)
|
$21,827
|
Cost
of revenue
|
18,952
|
(1,835)
|
17,117
|
Gross
profit
|
8,152
|
(3,442)
|
4,710
|
Operating
expenses:
|
|
|
|
Advertising
and promotion
|
4,991
|
(4,112)
|
879
|
Salaries
and benefits
|
2,295
|
—
|
2,295
|
Selling,
general and administrative
|
2,654
|
16
|
2,670
|
Research
and development
|
208
|
—
|
208
|
Professional
fees
|
626
|
—
|
626
|
Total
operating expenses
|
10,774
|
(4,096)
|
6,678
|
Loss
from operations
|
(2,622)
|
654
|
(1,968)
|
Other
(expense) income:
|
|
|
|
Gain
on settlement of obligation
|
2,747
|
—
|
2,747
|
Interest
and other expense, net
|
(1,165)
|
140
|
(1,025)
|
Loss
before income taxes
|
(1,040)
|
794
|
(246)
|
Income
taxes
|
34
|
—
|
34
|
Net
loss
|
$(1,074)
|
$794
|
$(280)
|
|
|
|
|
Net
loss per share, basic and diluted
|
$(0.07)
|
$0.05
|
$(0.02)
|
|
|
|
|
Weighted
average shares used to compute net loss per share, basic and
diluted
|
14,701,473
|
297,058
|
14,998,531
|
The unaudited restated consolidated statements of operations for
the six months ended June 30, 2018 is presented below (in
thousands, except per share data):
|
Six Months Ended June 30, 2018
|
|
|
|
|
Revenue,
net
|
$53,651
|
$(7,637)
|
$46,014
|
Cost
of revenue
|
37,280
|
(998)
|
36,282
|
Gross
profit
|
16,371
|
(6,639)
|
9,732
|
Operating
expenses:
|
|
|
|
Advertising
and promotion
|
8,652
|
(6,959)
|
1,693
|
Salaries
and benefits
|
4,449
|
—
|
4,449
|
Selling,
general and administrative
|
5,200
|
(43)
|
5,157
|
Research
and development
|
420
|
—
|
420
|
Professional
fees
|
1,198
|
148
|
1,346
|
Total
operating expenses
|
19,919
|
(6,854)
|
13,065
|
Loss
from operations
|
(3,548)
|
215
|
(3,333)
|
Other
(expense) income:
|
|
|
|
Gain
on settlement of obligation
|
2,747
|
—
|
2,747
|
Interest
and other expense, net
|
(2,473)
|
371
|
(2,102)
|
Loss
before income taxes
|
(3,274)
|
586
|
(2,688)
|
Income
taxes
|
103
|
—
|
103
|
Net
loss
|
$(3,377)
|
$586
|
$(2,791)
|
|
|
|
|
Net
loss per share, basic and diluted
|
$(0.23)
|
$0.04
|
$(0.19)
|
|
|
|
|
Weighted
average shares used to compute net loss per share, basic and
diluted
|
14,658,812
|
319,176
|
14,977,988
|
The unaudited restated consolidated statements of cash flows for
the six months ended June 30, 2018 is presented below (in
thousands):
|
Six Months Ended June 30, 2018
|
|
|
|
|
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
Net
loss
|
$(3,377)
|
$586
|
$(2,791)
|
Adjustments
to reconcile net loss to net cash used in operating
activities:
|
|
|
|
Depreciation
and amortization
|
558
|
(112)
|
446
|
Gain
on settlement of accounts payable
|
—
|
—
|
—
|
Settlement
of obligation
|
(2,747)
|
2,747
|
—
|
Bad
debt expense
|
414
|
—
|
414
|
Amortization
of debt discount
|
403
|
(373)
|
30
|
Inventory
provision
|
—
|
36
|
36
|
Stock-based
compensation
|
257
|
—
|
257
|
Changes
in operating assets and liabilities:
|
|
|
|
Accounts
receivable
|
(71)
|
1,050
|
979
|
Inventory
|
(1,169)
|
(987)
|
(2,156)
|
Prepaid
expenses and other current assets
|
(56)
|
(346)
|
(402)
|
Other
assets
|
(15)
|
—
|
(15)
|
Accounts
payable and accrued liabilities
|
5,835
|
(2,601)
|
3,234
|
Accrued
restructuring charges
|
(71)
|
—
|
(71)
|
Net
cash used in operating activities
|
(39)
|
—
|
(39)
|
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
Purchase
of property and equipment
|
(73)
|
—
|
(73)
|
Net
cash used in investing activities
|
(73)
|
—
|
(73)
|
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
Payments
on line of credit
|
(1,000)
|
—
|
(1,000)
|
Proceeds
from secured borrowing arrangement, net of reserves
|
23,785
|
—
|
23,785
|
Payments
on secured borrowing arrangement, net of fees
|
(26,383)
|
—
|
(26,383)
|
Repayment
of capital lease obligations
|
(69)
|
—
|
(69)
|
Net
cash (used) provided by financing activities
|
(3,667)
|
—
|
(3,667)
|
Effect
of exchange rate changes on cash
|
(7)
|
—
|
(7)
|
NET
CHANGE IN CASH
|
(3,786)
|
—
|
(3,786)
|
CASH
— BEGINNING OF PERIOD
|
6,228
|
—
|
6,228
|
CASH
— END OF PERIOD
|
$2,442
|
$—
|
$2,442
|
SUPPLEMENTAL
DISCLOSURE OF CASH FLOW INFORMATION:
|
|
|
|
Cash
paid for interest
|
$1,936
|
$—
|
$1,936
|
Cash
paid for taxes
|
$69
|
$—
|
$69
|
SUPPLEMENTAL
DISCLOSURE OF NON-CASH ACTIVITIES:
|
|
|
|
Property
and equipment acquired in conjunction with capital
leases
|
$—
|
$—
|
$—
|
Purchase
of property and equipment included in current
liabilities
|
$4
|
$—
|
$4
|
Interest
paid through issuance of shares of common stock
|
$53
|
$—
|
$53
|
September 30, 2018 Restatement (Unaudited)
Impact on consolidated statements of operations for the three
months ended September 30, 2018 (in thousands) - increase
(decrease):
Sales
cutoff – ($3,445)
Correction
of estimate of expected value of customer credits –
$897
Reclassification
of payments to customers – ($2,905)
Sales
cutoff – ($2,170)
Accrual
for rebate receivable – ($144)
Reclassification of
advertising expenses directly related to product sales -
$103
●
Advertising
and promotion:
Reclassification
of payments to customers – ($2,871)
Reclassification of
advertising expenses directly related to product sales and
commissions – ($201)
●
Selling,
general and administrative:
Depreciation
adjustment for facility relocation – ($56)
Retirement
of asset obligation – $151
Reclassification
of payments to customers – ($36)
Reclassification of
advertising expenses representing commissions - $99
●
Impairment
of assets: Recorded in wrong period – ($743)
●
Interest and other expense, net: adjusted
debt discount amortization – ($140)
Impact on consolidated statements of operations for the nine months
ended September 30, 2018 - increase (decrease):
Reversal
of December 31, 2017 accrual for credits –
$1,281
Sales
cutoff – ($5,183)
Correction
of estimate of expected value of customer credits –
$142
Reclassification
of payments to customers – ($9,288)
Recognizing
revenue on a net versus gross basis– ($43)
Reversal
of December 31, 2017 purchase price variance - $154
Sales
cutoff – ($3,279)
Accrual
for rebate receivable – ($494)
Recognizing
revenue on a net versus gross basis– ($43)
Reclassification of
advertising expenses directly related to product sales -
$452
●
Advertising
and promotion:
Reversal
of December 31, 2017 accrual for credits - ($90)
Reclassification
of payments to customers – ($9,247)
Sales
cutoff – $3
Reclassification of
advertising expenses directly related to product sales and
commissions – ($697)
●
Selling,
general and administrative:
Reversal
of December 31, 2017 accrual for credits – ($72)
Depreciation
adjustment for facility relocation – ($168)
Asset
retirement obligation - $151
Reclassification
of payments to customers – ($43)
Reclassification of
advertising expenses representing commissions - $246
●
Professional fees: reversal of December
2017 legal over accrual – $148
●
Impairment
of assets: Recorded in wrong period – ($743)
●
Interest and other
expense, net: adjusted debt discount amortization –
($511)
Impact on consolidated balance sheets - increase
(decrease):
●
Accounts
receivable, net of allowance for doubtful accounts:
Sales
cutoff – ($9,330)
Correction
of estimate of expected value of customer credits –
($138)
ASC
606 modified retrospective transition – ($1,053)
●
Inventory:
Sales cutoff – $3,054
●
Prepaid
expenses and other current assets: accrual for rebate receivable
– $491
●
Accounts
payable: sales cutoff – ($3,066)
Payroll
tax adjustment on restricted stock – ($231)
Sales
cut off – ($29)
●
Convertible
note with a related party, net of discount: debt discount
adjustment net of amortization – $699
●
Other
long term liabilities: Asset retirement obligation -
$152
●
Additional
paid-in capital: debt discount adjustment –
($1,212)
●
Accumulated
deficit: $3,013
The unaudited restated consolidated balance sheets as of September
30, 2018 is presented below (in thousands, except per share
data):
|
|
|
|
|
|
ASSETS
|
|
|
|
Current
assets:
|
|
|
|
Cash
|
$1,749
|
$—
|
$1,749
|
Accounts
receivable, net of allowance for doubtful accounts of
$1,985
|
16,235
|
(10,245)
|
5,990
|
Inventory
|
7,324
|
3,054
|
10,378
|
Prepaid
expenses and other current assets
|
1,120
|
491
|
1,611
|
Total
current assets
|
26,428
|
(6,700)
|
19,728
|
Property
and equipment, net
|
576
|
—
|
576
|
Intangible
assets, net
|
1,077
|
—
|
1,077
|
Other
assets
|
267
|
—
|
267
|
TOTAL
ASSETS
|
$28,348
|
$(6,700)
|
$21,648
|
LIABILITIES AND STOCKHOLDERS’ DEFICIT
|
|
|
|
Current
liabilities:
|
|
|
|
Obligation
under secured borrowing arrangement
|
$594
|
$—
|
$594
|
Line
of credit
|
1,500
|
—
|
1,500
|
Accounts
payable
|
20,672
|
(3,066)
|
17,606
|
Accrued
liabilities
|
5,238
|
(260)
|
4,978
|
Accrued
restructuring charges, current
|
463
|
—
|
463
|
Total
current liabilities
|
28,467
|
(3,326)
|
25,141
|
Convertible
note with a related party, net of discount
|
17,226
|
699
|
17,925
|
Accrued
restructuring charges, long-term
|
58
|
—
|
58
|
Other
long-term liabilities
|
74
|
152
|
226
|
Total
liabilities
|
45,825
|
(2,475)
|
43,350
|
Commitments
and contingencies (Note 9)
|
|
|
|
Stockholders'
deficit:
|
|
|
|
Common
stock, par value of $0.001 per share; 100,000,000 shares authorized
16,190,288 shares issued as of September 30, 2018; 15,314,667
shares outstanding as of September 30, 2018
|
15
|
—
|
15
|
Additional
paid-in capital
|
160,038
|
(1,212)
|
158,826
|
Treasury
stock, at cost; 875,621 shares
|
(10,039)
|
—
|
(10,039)
|
Accumulated
other comprehensive loss
|
(169)
|
—
|
(169)
|
Accumulated
deficit
|
(167,322)
|
(3,013)
|
(170,335)
|
TOTAL
STOCKHOLDERS’ DEFICIT
|
(17,477)
|
(4,225)
|
(21,702)
|
TOTAL
LIABILITIES AND STOCKHOLDERS’ DEFICIT
|
$28,348
|
$(6,700)
|
$21,648
|
The unaudited restated quarterly consolidated statements of
operations for the three months ended September 30, 2018 is
presented below (in thousands, except per share data):
|
Three Months Ended September 30, 2018
|
|
|
|
|
Revenue,
net
|
$27,388
|
$(5,453)
|
$21,935
|
Cost
of revenue
|
18,595
|
(2,211)
|
16,384
|
Gross
profit
|
8,793
|
(3,242)
|
5,551
|
Operating
expenses:
|
|
|
|
Advertising
and promotion
|
3,589
|
(3,072)
|
517
|
Salaries
and benefits
|
1,856
|
—
|
1,856
|
Selling,
general and administrative
|
2,974
|
158
|
3,132
|
Research
and development
|
185
|
—
|
185
|
Professional
fees
|
436
|
—
|
436
|
Impairment
of assets
|
743
|
(743)
|
—
|
Total
operating expenses
|
9,783
|
(3,657)
|
6,126
|
Loss
from operations
|
(990)
|
415
|
(575)
|
Other
(expense) income:
|
|
|
|
Interest
and other expense, net
|
(990)
|
140
|
(850)
|
Loss
before income taxes
|
(1,980)
|
555
|
(1,425)
|
Income
taxes (benefit)
|
(3)
|
—
|
(3
|
Net
loss
|
$(1,977)
|
$555
|
(1,422)
|
|
|
|
|
Net
loss per share, basic and diluted
|
$(0.13)
|
$0.04
|
(0.09)
|
|
|
|
|
Weighted
average shares used to compute net loss per share, basic and
diluted
|
15,029,312
|
8,354
|
15,037,666
|
The unaudited restated consolidated statements of operations for
the nine months ended September 30, 2018 is presented below (in
thousands, except per share data):
|
Nine Months Ended September 30, 2018
|
|
|
|
|
Revenue,
net
|
$81,039
|
$(13,091)
|
$67,948
|
Cost
of revenue
|
55,875
|
(3,210)
|
52,665
|
Gross
profit
|
25,164
|
(9,881)
|
15,283
|
Operating
expenses:
|
|
|
|
Advertising
and promotion
|
12,241
|
(10,031)
|
2,210
|
Salaries
and benefits
|
6,305
|
—
|
6,305
|
Selling,
general and administrative
|
8,175
|
114
|
8,289
|
Research
and development
|
605
|
—
|
605
|
Professional
fees
|
1,634
|
148
|
1,782
|
Impairment
of assets
|
743
|
(743)
|
—
|
Total
operating expenses
|
29,703
|
(10,512)
|
19,191
|
Loss
from operations
|
(4,539)
|
631
|
(3,908)
|
Other
(expense) income:
|
|
|
|
Gain
on settlement of obligation
|
2,747
|
—
|
2,747
|
Interest
and other expense, net
|
(3,463)
|
511
|
(2,952)
|
Loss
before income taxes
|
(5,255)
|
1,142
|
(4,113)
|
Income
taxes
|
100
|
—
|
100
|
Net
loss
|
$(5,355)
|
$1,142
|
(4,213)
|
|
|
|
|
Net
loss per share, basic and diluted
|
$(0.36)
|
$0.08
|
(0.28)
|
|
|
|
|
Weighted
average shares used to compute net loss per share, basic and
diluted
|
14,783,669
|
214,430
|
14,998,099
|
The unaudited restated consolidated statements of cash flows for
the nine months ended September 30, 2018 is presented below (in
thousands):
|
Nine
Months Ended September 30, 2018
|
|
|
|
|
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
Net
loss
|
$(5,355)
|
$1,142
|
$(4,213)
|
Adjustments
to reconcile net loss to net cash provided by (used in) operating
activities:
|
|
|
|
Depreciation
and amortization
|
822
|
(169)
|
653
|
Settlement
of obligation
|
(2,747)
|
2,747
|
—
|
Bad
debt expense
|
822
|
—
|
822
|
Impairment
of assets
|
743
|
(743)
|
—
|
Amortization
of debt discount
|
557
|
(513)
|
44
|
Inventory
provision
|
—
|
130
|
130
|
Stock-based
compensation
|
377
|
—
|
377
|
Changes
in operating assets and liabilities:
|
|
|
|
Accounts
receivable
|
(454)
|
3,629
|
3,175
|
Inventory
|
(755)
|
(193)
|
(948)
|
Prepaid
expenses and other current assets
|
(114)
|
(491)
|
(605)
|
Other
assets
|
(44)
|
—
|
(44)
|
Accounts
payable and accrued liabilities
|
8,365
|
(5,539)
|
2,826
|
Accrued
restructuring charges
|
(194)
|
—
|
(194)
|
Net
cash provided by operating activities
|
2,023
|
—
|
2,023
|
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
Purchase
of property and equipment
|
(86)
|
—
|
(86)
|
Net
cash used in investing activities
|
(86)
|
—
|
(86)
|
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
Payments
on line of credit
|
(1,500)
|
—
|
(1,500)
|
Proceeds
from secured borrowing arrangement, net of reserves
|
31,677
|
—
|
31,677
|
Payments
on secured borrowing arrangement, net of fees
|
(36,469)
|
—
|
(36,469)
|
Repayment
of capital lease obligations
|
(101)
|
—
|
(101)
|
Net
cash (used in) provided by financing activities
|
(6,393)
|
—
|
(6,393)
|
Effect
of exchange rate changes on cash
|
(23)
|
—
|
(23)
|
NET
CHANGE IN CASH
|
(4,479)
|
—
|
(4,479)
|
CASH
— BEGINNING OF PERIOD
|
6,228
|
—
|
6,228
|
CASH
— END OF PERIOD
|
$1,749
|
$—
|
$1,749
|
SUPPLEMENTAL
DISCLOSURE OF CASH FLOW INFORMATION:
|
|
|
|
Cash
paid for interest
|
$2,727
|
$—
|
$2,727
|
Cash
paid for taxes
|
$173
|
$—
|
$173
|
SUPPLEMENTAL
DISCLOSURE OF NON-CASH ACTIVITIES:
|
|
|
|
Purchase
of property and equipment included in current
liabilities
|
$12
|
$—
|
$12
|
Interest
paid through issuance of shares of common stock
|
$53
|
$—
|
$53
|
Note 17. 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
None
Unrecognized Subsequent Events
CARES Act
On
March 27, 2020, President Trump signed into law the CARES Act.
Among the changes to the U.S. federal income tax, the CARES Act
restored net operating loss carryback rules that were eliminated by
2017 Tax Cuts and Jobs Act, modified the limit on the deduction for
net interest expense and accelerated the timeframe for refunds of
AMT credits. Based on an analysis of the impact of the CARES Act,
the Company has not identified any overall material effect on the
2018 and 2019 tax liabilities.
HSBF Note
Due to
economic uncertainty as a result of the ongoing pandemic
(COVID-19), on May 14, 2020, the Company received an aggregate
principal amount of $964,910 pursuant to the borrowing arrangement
(“Note”) with Harvest Small Business Finance, LLC
(“HSBF”) and agreed to pay the principal amount plus
interest at a 1% fixed interest rate per year, on the unpaid
principal balance. No payments are due on the Note until November
16, 2020 (the “Deferment Period”). However, interest
will continue to accrue during the Deferment Period. The Note will
mature on May 16, 2022.
The
Note includes forgiveness provisions in accordance with the
requirements of the Paycheck Protection Program, Section 1106 of
the CARES Act. The Company has not determined the amount of
forgiveness in connection with the loan, partly due to the ongoing
routine changes in the method of calculating the
amount.
Related-Party Refinanced Convertible Note
On July 1, 2020, the Company entered into the refinancing with Mr.
Ryan Drexler, the Company’s Chairman of the Board of
Directors, Chief Executive Officer and President (the
“Refinancing”). 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
$2,735,199, which amended and restated (i) a convertible secured
promissory note dated as of November 8, 2017, $1,134,483 of which
was outstanding as of July 1, 2020 (ii) a collateral receipt and
security agreement with Mr. Drexler dated as of December 27, 2019,
$252,500 of which was outstanding as of July 1, 2020, and (iii) a
secured revolving promissory note dated as of October 4, 2019,
$1,348,216 of which was outstanding as of July 1,
2020.
The $2.7 million Refinanced Convertible Note bears interest at the
rate of 12% per annum. Unless earlier converted or repaid, all
outstanding principal and any accrued but unpaid interest under the
Refinanced Convertible Note shall be due and payable on November
30, 2020.
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. Mr. Drexler may convert the outstanding principal and
accrued interest into shares of the Company’s common stock at
a conversion price equal to or greater than (i) the closing price
per share of the common stock on the last business day immediately
preceding November 30, 2020 or (ii) $0.17. 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 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.
There
are no other events subsequent to December 31, 2019 that have not
been described in the accompanying footnotes.