Notes
to Consolidated Financial Statements
(Unaudited)
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, markets and distributes branded sports nutrition
products and nutritional supplements that are manufactured by the Company’s co-manufacturers. Our portfolio of recognized brands,
including MusclePharm and FitMiss, is marketed and sold globally.
Although
the Company has historically incurred significant losses and experienced negative cash flows since inception, we generated net income
of $0.1 million for the period ended March 31, 2021 and had cash of $0.6 million, a decline of $1.4 million from the December 31, 2020
balance of $2.0 million. As of March 31, 2021, the Company had a working capital deficit of $20.5 million, a stockholders’ deficit
of $24.3 million and an accumulated deficit of $192.6 million resulting from recurring losses from operations. 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.
During
the fourth quarter of 2019, the Company focused on cost containment and improving gross margins by focusing on customers with higher
margins, reducing product discounts and promotional activity, along with reducing the number of SKU’s and negotiate cost for raw
materials. These steps improved gross margins in the fourth quarter of 2019 and this trend has continued through March 31, 2021.
During
2020, the Company experienced a slowdown in sales from retail customers, including our largest customer, which was partially offset by
an increase in sales from our largest online customer. In addition, the Company negotiated lower cost of sold with its co-manufactures.
In
2021, the Company announced its entrance into the functional energy space with its partnership with a former Rockstar Energy executive.
The Company plans to launch 3 new energy products in the summer of 2021.
The
Company believes reductions in operating costs with continued focus on gross profit and top line sales growth will allow it to ultimately
achieve sustained profitability, however, the Company can give no assurances that this will occur. In particular, the cost of protein
may have a material impact on the Company’s profitability, and the ability of our third-party manufacturers to meet our customer’s
demands. In addition, the Company believes entering the functional energy space will help to increase sales and gross margin, 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 6. Debt.”
The
Company’s 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. The Company is actively managing its business
to respond to the impact. There were no adjustments recorded in the financial statements that might result from the outcome of these
uncertainties.
Note
2. Summary of Significant Accounting Policies
Basis
of Presentation and Principles of Consolidation
The
accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles
in the United States (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10
of Regulation S-X. Accordingly, these statements do not include all the information and notes required by U.S. GAAP for complete financial
statements. 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.
The
Company’s management believes the unaudited interim consolidated financial statements include all adjustments of a normal recurring
nature necessary for the fair presentation of the Company’s financial position as of March 31, 2021, results of operations for
the three months ended March 31, 2021 and 2020, and cash flows for the three months ended March 31, 2021 and 2020. The results of operations
for the three months ended March 31, 2021 are not necessarily indicative of the results to be expected for the year ended December 31,
2021.
These
unaudited interim consolidated financial statements should be read in conjunction with the consolidated financial statements and related
notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, filed with the SEC on March 29,
2021.
Use
of Estimates
The
preparation of consolidated financial statements in conformity with U.S. 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,
present value of lease liabilities, among others. Actual results could differ from those estimates.
Shipping
and handling
The
Company accounts for shipping and handling costs as fulfillment activities, which are therefore recognized upon shipment of the goods.
For
the three months ended March 31, 2021 and 2020, the Company incurred $0.5 million and $0.4 million, respectively, of inbound shipping
and handling costs. Shipping and handling costs related to inbound purchases of raw material and finished goods are included in cost
of revenue in our consolidated statements of operations.
For
the three months ended March 31, 2021 and 2020, the Company incurred $0.7 million and $0.6 million, respectively, of shipping and handling
costs related to shipments to our customers. Shipping and handling costs related to shipments to our customers is included in “Selling,
general and administrative” expense in our consolidated statements of operations.
Sales
discounts and returns
The
Company excludes from its revenue any amounts collected from customers for sales (and similar) taxes. During the three months ended March
31, 2021 and 2020, the Company recorded discounts, and to a lesser degree, sales returns, totaling $2.4 million and $4.0 million, respectively,
which accounted for 15% and 20% of gross revenue in each period, respectively.
Concentrations
Financial
instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and accounts receivable.
The Company minimizes its credit risk associated with cash by periodically evaluating the credit quality of its primary financial institution.
The cash balance, at times, may exceed federally insured limits. Management believes the financial risk associated with these balances
is minimal and has not experienced any losses to date.
Significant
customers are those that represent more than 10% of the Company’s revenue, net or accounts receivable for each period presented.
During
the period ended March 31, 2021, the Company had three customers who individually accounted for 28%, 17% and 14% of our net revenue,
and two customers that accounted for 32% and 21% of our accounts receivable, net as of March 31, 2021. During the period ended March
31, 2020, the Company had three customers who individually accounted for approximately 36%, 21% and 10% of our net revenue and three
customers that accounted for 30%, 23% and 14% of our accounts receivable, net as of March 31, 2020.
The
Company uses a limited number of non-affiliated suppliers for contract manufacturing of its products. During the period ended March 31,
2021, the Company had three suppliers who individually accounted for approximately 32%, 21% and 21% of our purchases with contract manufactures
and raw material providers. During the period ended March 31, 2020, the Company had four suppliers who individually accounted for approximately
34%, 30%, 13% and 11% of our purchases with contract manufactures and raw material providers.
Recent
Accounting Pronouncements
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, 2022, and interim periods within
those fiscal years. The Company will evaluate the impact of the pronouncement closer to the effective date.
In
August 2020, the FASB issued ASU No. 2020-06, Debt - Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives
and Hedging - Contracts in Entity’s Own Equity (Subtopic 815-40). The new ASU eliminates the beneficial conversion and cash
conversion accounting models for convertible instruments. It also amends the accounting for certain contracts in an entity’s own
equity that are currently accounted for as derivatives because of specific settlement provisions. In addition, the new guidance modifies
how particular convertible instruments and certain contracts that may be settled in cash or shares impact the diluted EPS computation.
This guidance is effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early
adoption is permitted, but not earlier than fiscal years beginning after December 15, 2020, including interim periods within those fiscal
years. The FASB also specified that an entity should adopt the guidance as of the beginning of its annual fiscal year and is not permitted
to adopt the guidance in an interim period. The Company
will evaluate the impact of the pronouncement closer to the effective date.
In
May 2021, the FASB issued ASU 2021-04, Earnings Per Share (Topic 260), Debt-Modifications and Extinguishments (Subtopic 470-50), Compensation-Stock
Compensation (Topic 718), and Derivatives and Hedging-Contracts in Entity’s Own Equity (Subtopic 815-40). The new ASU addresses
issuer’s accounting for certain modifications or exchanges of freestanding equity-classified written call options. This amendment
is effective for all entities, for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years.
Early adoption is permitted. The Company will evaluate the impact of the pronouncement closer to the effective date.
Recently
Adopted Accounting Pronouncements
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 U.S. 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 U.S. 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 adopted this ASU effective January 1, 2021,
with certain provisions applied retrospectively and other provisions applied prospectively. Adoption of this ASU did not have a material
impact to the Company’s condensed consolidated balance sheet, statements of operations, or cash flows.
Note
3. Accrued and Other Liabilities
As
of March 31, 2021 and December 31, 2020, the Company’s accrued and other liabilities consisted of the following
(in
thousands):
|
|
As of
March 31,
2021
|
|
|
As of
December 31,
2020
|
|
Accrued professional fees
|
|
$
|
123
|
|
|
$
|
242
|
|
Accrued interest
|
|
|
693
|
|
|
|
644
|
|
Accrued payroll and bonus
|
|
|
368
|
|
|
|
738
|
|
Settlements – short term (Nutrablend and 4Excelsior)
|
|
|
2,181
|
|
|
|
2,005
|
|
Accrued expenses - ThermoLife
|
|
|
1,364
|
|
|
|
1,364
|
|
Accrued and other short-term liabilities
|
|
|
1,299
|
|
|
|
1,201
|
|
Accrued and other liabilities
|
|
$
|
6,028
|
|
|
$
|
6,194
|
|
Note
4. Interest and other expense, net
For
the three months ended March 31, 2021 and 2020, “Interest and other expense, net” consisted of the following (in thousands):
|
|
For the Three Months
Ended March 31,
|
|
|
2021
|
|
2020
|
|
|
|
|
|
Interest expense, related party
|
|
$
|
(120
|
)
|
|
$
|
(76
|
)
|
Interest expense, other
|
|
|
(227
|
)
|
|
|
(157
|
)
|
Interest expense, secured borrowing arrangement
|
|
|
(163
|
)
|
|
|
(365
|
)
|
Foreign currency transaction loss
|
|
|
(1
|
)
|
|
|
(34
|
)
|
Loss on settlement obligation
|
|
|
—
|
|
|
|
(50
|
)
|
Gain on legal settlement
|
|
|
200
|
|
|
|
—
|
|
Other
|
|
|
133
|
|
|
|
93
|
|
Total interest and other expense, net
|
|
$
|
(178
|
)
|
|
$
|
(589
|
)
|
“Other”
includes sublease income.
Note
5. Leases
A
summary of the Company’s lease portfolio as of March 31, 2021 and December 31, 2020 is presented in the table below (in thousands):
|
|
Balance Sheet Classification
|
|
March 31, 2021
|
|
December 31, 2020
|
Assets
|
|
|
|
|
|
|
|
|
|
|
Operating
|
|
ROU assets, net
|
|
$
|
406
|
|
|
$
|
474
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
|
|
Operating
|
|
Operating lease liability - current
|
|
$
|
402
|
|
|
$
|
381
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-current liabilities:
|
|
|
|
|
|
|
|
|
|
|
Operating
|
|
Operating lease liability - long term
|
|
|
233
|
|
|
|
343
|
|
Total lease liabilities
|
|
|
|
$
|
635
|
|
|
$
|
724
|
|
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 three months ended March 31, 2021 and 2020 were as follows (in thousands):
|
|
Income Statement Classification
|
|
Three months ended
March 31, 2021
|
|
Three months ended
March 31, 2020
|
|
|
|
|
|
|
|
Operating lease cost
|
|
Selling, general and administrative
|
|
$
|
115
|
|
|
$
|
243
|
|
|
|
|
|
|
|
|
|
|
|
|
Finance lease cost:
|
|
|
|
|
|
|
|
|
|
|
Amortization of ROU asset
|
|
Selling, general and administrative
|
|
|
—
|
|
|
|
27
|
|
|
|
|
|
|
|
|
|
|
|
|
Total finance lease cost
|
|
|
|
|
—
|
|
|
|
27
|
|
|
|
|
|
|
|
|
|
|
|
|
Variable lease payments
|
|
Selling, general and administrative
|
|
|
32
|
|
|
|
103
|
|
Sublease income
|
|
Other income
|
|
|
(134
|
)
|
|
|
(36
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Total lease (income) cost
|
|
|
|
$
|
13
|
|
|
$
|
337
|
|
The
Company had no short-term leases as of both March 31, 2021 and 2020. 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:
|
|
Three months ended March 31, 2021
|
|
|
Three months ended March 31, 2020
|
|
Cash paid for amounts included in the measurement of lease liabilities (in thousands):
|
|
|
|
|
|
|
|
|
Operating cash flows from operating leases
|
|
$
|
88
|
|
|
$
|
197
|
|
|
|
|
|
|
|
|
|
|
Financing cash flows from finance leases
|
|
|
—
|
|
|
|
29
|
|
|
|
|
|
|
|
|
|
|
The weighted average remaining lease term was as follows:
|
|
|
|
|
|
|
|
|
Operating leases (in years)
|
|
|
1.4
|
|
|
|
2.1
|
|
Finance leases (in years)
|
|
|
—
|
|
|
|
0.3
|
|
The weighted average discount rate was as follows:
|
|
|
|
|
|
|
|
|
Operating leases
|
|
|
18
|
%
|
|
|
18
|
%
|
Finance leases
|
|
|
—
|
|
|
|
5
|
%
|
Note
6. Debt
As
of March 31, 2021, and December 31, 2020, the Company’s debt consisted of the following (in thousands):
|
|
As of
March 31, 2021
|
|
|
As of
December 31, 2020
|
|
Refinanced convertible note, related party
|
|
$
|
2,872
|
|
|
$
|
2,872
|
|
Revolving line of credit, related party
|
|
|
1,705
|
|
|
|
743
|
|
Obligations under secured borrowing arrangement
|
|
|
4,740
|
|
|
|
7,098
|
|
Notes payable
|
|
|
59
|
|
|
|
167
|
|
Paycheck Protection Program loan
|
|
|
965
|
|
|
|
965
|
|
Total debt
|
|
|
10,341
|
|
|
|
11,845
|
|
Less: current portion
|
|
|
(9,537
|
)
|
|
|
(10,880
|
)
|
Long term debt
|
|
$
|
804
|
|
|
$
|
965
|
|
Related-Party
Refinanced Convertible Note
On
November 29, 2020, the Company entered into a refinancing agreement with Mr. Ryan Drexler, the Company’s Chairman of the Board
of Directors and Chief Executive Officer (the “November 2020 Refinancing”), in which the Company issued to Mr. Drexler a
convertible secured promissory note (the November 2020 “Convertible Note”) in the original principal amount of $2,871,967,
which amended and restated a convertible secured promissory note dated as of August 21, 2020. The $2.9 million November 2020 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 November 2020 Convertible Note shall be due and payable on July 1, 2021. Any interest not paid when due shall be capitalized
and added to the principal amount of the November 2020 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, at any time, and from time to time, upon written notice to the Company, convert the outstanding principal and accrued interest
into shares of Common Stock, at a conversion price of $0.23 per share. At the election of the Company, one-sixth of the interest may
be paid in kind (“PIK Interest”) by adding such amount to the principal amount of the note, or through the issuance of shares
of the Company’s common stock to Mr. Drexler. The PIK Interest is convertible to common stock at the closing price per share on
the last business day of each calendar quarter. In no event will the conversion price of such PIK Interest be less than $0.10. The Company
may prepay the Note by giving Mr. Drexler between 15- and 60-days’ notice depending upon the specific circumstances, subject to
Mr. Drexler’s conversion right. The Company intends to pay all interest due on the Convertible Note to Mr. Drexler at the end of
each calendar quarter.
The
November 2020 Convertible Note 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 November 2020 Convertible Note. The November 2020 Convertible Note is subordinated
to certain other indebtedness of the Company held by Prestige Capital Corporation (“Prestige”) and Crossroads Financial Group,
LLC (“Crossroads”).
For
the three months ended March 31, 2021 and 2020, interest expense related to the related party convertible secured promissory notes was
$85,000 and $76,000, respectively. During the three months ended March 31, 2021, $85,000 in interest was paid in cash to Mr. Drexler;
for the three months ended March 31, 2020, no interest was paid in cash to Mr. Drexler.
Related
Party Secured Revolving Promissory Note
On
October 15, 2020, the Company entered into a secured revolving promissory note (the “Revolving Note”) with Ryan 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%
per annum. The use of funds will be used for the purchase of whey protein and other general corporate purposes. Both the outstanding
principal, if any, and all accrued interest under the Revolving Note were due on March 31, 2021, however, the Company and Mr. Drexler
agreed to an extension until June 30, 2021. The Company may prepay the Revolving Note by giving Mr. Drexler one days’
advance 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, as set forth in the Revolving Note. The Revolving Note is subordinated
to certain other indebtedness of the Company held by Prestige and Crossroads. In connection with the Revolving Note, the Company and
Mr. Drexler entered into a fifth amended and restated security agreement dated October 15, 2020 (the “Security Agreement”)
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 March 31, 2021, the outstanding balance on the revolving note was $1.7 million. During the period ended March 31, 2021, interest paid
in cash to Mr. Drexler was $16,000.
Secured
Borrowing Arrangement
In
January 2016, the Company entered into a Purchase and Sale Agreement (the “Purchase and Sale Agreement”) with 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 first priority 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. On April 10, 2019, the Company and Prestige amended the terms of the agreement. The agreement
was extended until April 1, 2020 and automatically renews 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 thereafter.
As
of March 31, 2021, and December 31, 2020, the Company had outstanding borrowings of approximately $4.7 million and $7.1 million, respectively.
During
the three months ended March 31, 2021 and 2020, the Company assigned to Prestige, accounts with an aggregate face amount of approximately
$11.1 million and $11.7 million, respectively, for which Prestige paid to the Company approximately $8.8 million and $9.4 million, respectively,
in cash. During the three months ended March 31, 2021 and 2020, $11.2 million and $10.0 million, respectively, was repaid to Prestige,
including fees and interest.
Paycheck
Protection Program Loan
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. The Note
includes forgiveness provisions in accordance with the requirements of the Paycheck Protection Program, Section 1106 of the CARES Act.
The
Note is expected to mature on May 16, 2023. Payments were due by November 16, 2020 (the “Deferment Period”) and interest
was accrued during the Deferment Period. However, the Flexibility Act, which was signed into law on June 5, 2020, extended the Deferment
Period to the date that the forgiven amount is remitted by the United States Small Business Administration (“SBA”) to HSBF.
The Company is in the process of filling out the forgiveness application form. As of March 31, 2021, the Company owed approximately $1.0
million (principal plus accrued interest). Of this amount, the short-term portion of $0.2 million is recorded in “Accrued and other
liabilities” and the remaining liability of $0.8 million is recorded in “Other long-term liabilities” in the consolidated
balance sheets.
Note
7. Commitments and Contingencies
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 three months ended March 31, 2021 and 2020, the Company recorded a charge of $18,000 and $19,000, respectively. This charge, representing
imputed interest, is included in “Interest and other expense, net” in the Company’s consolidated statements of operations.
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. These invoices relate
to the third and fourth quarter of 2019, and a liability has been recorded in the books for the related periods.
On
September 25, 2020, the parties successfully mediated the case to a settlement and the Company agreed to (i) pay approximately $3.1 million
(“Owed Amount”) in monthly payments (“Monthly Payments”) from September 1, 2020 through June 30, 2023 and (ii)
issue monthly purchase orders (“Purchase Orders”) at minimum amounts accepted by Nutrablend.
MusclePharm
agreed to issue Purchase Orders in a combined total amount of at least (i) $1,500,000 from September 1, 2020 through November 30, 2020;
(ii) $1,800,000 from December 1, 2020 through February 28, 2021; (iii) $2,100,000 from March 31, 2021 through May 31, 2021; (iv) $2,100,000
from June 1, 2021 through August 31, 2021; and (v) $1,400,000 from September 1, 2021 through October 30, 2021. Beginning on November
1, 2021, MusclePharm will be required to issue monthly Purchase Orders to Nutrablend in a minimum amount of $700,000 until the Owed Amount
is paid in full to Nutrablend. In the event that MusclePharm pays the Owed Amount in full before September 1, 2021, MusclePharm is entitled
to a rebate on all completed Purchase Orders. Further, once the monthly payments, and any additional payments that MusclePharm has made
on the Owed Amount, reduce the outstanding balance of the Owed Amount to below $2.0 million, MusclePharm is eligible for an extension
of a line of credit from Nutrablend in an amount of up to $3.0 million.
The
Company determined that approximately $1.0 million dollars of the Owed Amount was due within a year, and this amount was recorded in
“Accrued and other liabilities” in the consolidated balance sheets. The present value of the remaining Owed Amount that was
due after a year was $1.2 million, and the amount was recorded in “Other long-term liabilities” in the consolidated balance
sheets. The Company made payments of $0.5 million as of March 31, 2021.
During
the period ended March 31, 2021, the Company recorded interest expense of $64,000, in the consolidated statements of operations.
4Excelsior
Matter
On
March 18, 2019, Excelsior Nutrition, Inc. (“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 proceeded to discovery.
On
November 16, 2020, the Company and 4Excelsior entered into a stipulation of settlement that provided that the Company would pay to 4Excelsior
a total of $4.75 million in four monthly payments of $70,000, beginning January 5, 2021, and thereafter in monthly payments of $0.1 million.
On
December 16, 2020, MusclePharm and 4Excelsior entered into a Settlement Agreement and Mutual Release (“the Agreement”), pursuant
to which the parties resolved and settled the civil action pending in the Superior Court of the State of California for the County of
Los Angeles (the “Litigation”). The parties agreed to a mutual general release of claims and to jointly file within 10 business
days of the effective date of the Agreement a stipulation and proposed order of dismissal, dismissing with prejudice all claims and counterclaims
asserted in the Litigation. MusclePharm agreed to pay $4.75 million (the “Settlement Amount”) in four monthly payments of
$70,000, beginning January 5, 2021, and thereafter in monthly payments of $0.1 million until the Settlement Amount is fully paid. MusclePharm
may prepay all or any portion of the Settlement Amount at any time without penalty or premium. The Agreement provides that, in the event
of a Default (as defined in the Agreement) by MusclePharm, the entire outstanding balance of the Settlement Amount will become immediately
due and payable, plus accrued interest at a rate of 18% per annum, commencing from the date of default.
The
Company determined that approximately $1.1 million dollars of the Settlement Amount was due within a year, and this amount was recorded
in “Accrued and other liabilities” in the consolidated balance sheets. The present value of the remaining Settlement Amount
that was due after a year was $2.4 million, and the amount was recorded in “Other long-term liabilities” in the consolidated
balance sheets. The Company made payments of $0.2 million as of March 31, 2021.
During
the period ended March 31, 2021, the Company recorded interest expense of $0.1 million, in the consolidated statements of operations.
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 March 31, 2021, 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
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 2019, 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 in 2018. As of December
31, 2020, the total amount accrued, including interest, was $1.8 million. In the interim, the Company filed an appeal and 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 were paid by the Company. On April
27, 2021, the appellate court issued a decision largely affirming the trial court judgement, except vacating the judgement’s $0.3
million prejudgment interest award and remanding for a recalculation of prejudgment interest. On May 18, 2021, ThermoLife filed a motion
asking the trial court to increase MusclePharm’s appeal bond to the full amount of the judgment, or $1.8 million, which MusclePharm
intends to vigorously oppose.
For
both the three months ended March 31, 2021 and 2020, interest expense recognized by the Company on the awarded damages was $22,000.
The
Company intends to vigorously continue pursuing its defenses, including an appeal to the Arizona Supreme Court, which it has until June
25, 2021 to file a petition for review.
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 (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 Mr. 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 Mr. 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, White Winston also filed a motion for a temporary restraining order (“TRO”) and preliminary injunction
enjoining the exercise of Mr. 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 White Winston’s request for a preliminary
injunction, finding, among other things, that White Winston 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.
Due
to the uncertainty associated with determining our liability, if any, and due to our inability to ascertain with any reasonable degree
of likelihood, as of the date of this report, the outcome of the trial, the Company has not recorded an estimate for its potential liability.
On
June 17, 2019, White Winston moved for the appointment of a temporary receiver over MusclePharm, citing Plante Moran’s resignation.
The court granted White Winston’s request to hold an evidentiary hearing on the motion, but subsequently stayed the action pending
the parties’ attempts to resolve their dispute. Although the parties have been unable to reach a resolution, the litigation has
not yet resumed. On July 30, 2019, White Winston 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 and requesting the appointment of an independent auditor for
the company. On February 25, 2021, the court ordered MusclePharm to produce certain documents, denied White Winston’s request for
an auditor, and ordered MusclePharm to pay a $1,500 penalty. White Winston also seeks its attorneys’ fees and cost relating to
the books-and-records action.
MusclePharm
intends to challenge White Winston’s request for fees and costs.
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 ordered the
Former Officers to file status reports regarding progress of their settlement negotiations with the IRS on or before February 28, 2021.
The IRS and the Former Officers filed status reports with the Tax Court on February 26, 2021. After receiving the status reports, the
Tax Court issued an order directing the parties to file further status reports on or before July 9, 2021. The Tax Court has not set a
trial dates in the cases of the Former Officers.
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.
During
the time period of the IRS audit and Appeals Office consideration of the Company’s case, the Company and the IRS signed a series
of consents to extend the statutes of limitations for assessment for both the employment tax and corporation income tax of the Corporation
for 2014. The Company’s records show that the last consents that the Company signed extended the statutes of limitations for employment
tax and corporation income tax for 2014 through and including December 15, 2020. The Company has no record of any consents being signed
by the Company and the IRS extending the statutes of limitations beyond December 15, 2020. Based on these facts, the Company believes
that the statutes of limitations for assessment of additional employment tax and corporation income tax against the Corporation for 2014
expired on December 15, 2020. The Company does not know whether the IRS agrees with the Corporation’s statements regarding the
current status of the statutes of limitations described herein.
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 two valuation firms named in the
action (as well as their principals) for failing to properly value the 2014 restricted stock grants for tax purposes. Trial in the matter
has been scheduled for February 7, 2022. There are no amounts accrued related to this matter.
The
Company will continue to vigorously litigate the matter.
Note
8. Stock-Based Compensation
Restricted
Stock
There
were no restricted stock awards granted during the three months ended March 31, 2021 or 2020, respectively.
As
of March 31, 2021 there was no unrecognized expense for unvested restricted stock awards. For the three months ended March 31, 2021 and
2020, the Company recorded $0.0 and $0.1 million of stock-based compensation expense related to restricted stock.
Stock
Options
For
the three months ended March 31, 2021 and 2020, the Company recorded no stock compensation expense related to options.
Note
9. Net Income (Loss) per Share
Basic
net income (loss) per share is computed by dividing net income (loss) for the period by the weighted average number of shares of common
stock outstanding during each period.
The
following table sets forth the computation of the Company’s basic and diluted net income (loss) per share for the periods presented
(in thousands, except share and per share data):
|
|
For the Three Months
Ended March 31,
|
|
|
|
2021
|
|
|
2020
|
|
Net income (loss)
|
|
$
|
94
|
|
|
$
|
(60
|
)
|
Weighted average common shares used in computing net income (loss) per share, basic
|
|
|
33,119,549
|
|
|
|
32,459,675
|
|
Potentially diluted securities
|
|
|
12,373,071
|
|
|
|
—
|
|
Weighted average common shares used in computing net income (loss) per share, diluted
|
|
|
45,492,621
|
|
|
|
32,459,675
|
|
Net income (loss) per share, basic and diluted
|
|
$
|
0.00
|
|
|
$
|
(0.00
|
)
|
Diluted
net income (loss) per share is computed by dividing net income (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.
The
Company reported net income for the three months ended March 31, 2021. The weighted average shares of 12,373,071, which represented potentially
dilutive securities related to Mr. Drexler’s convertible notes outstanding in 2020, were included in the computations for the diluted
net income per share for the three months ended March 31, 2021.
The
following securities were excluded from the computations of the diluted net income (loss) per share, as the effect of the securities
would be antidilutive:
|
|
As of March 31,
|
|
|
|
2021
|
|
|
2020
|
|
Stock options
|
|
|
171,703
|
|
|
|
171,703
|
|
Warrants
|
|
|
—
|
|
|
|
1,289,378
|
|
Unvested restricted stock
|
|
|
—
|
|
|
|
541,322
|
|
Convertible notes
|
|
|
12,373,071
|
|
|
|
931,974
|
|
Total common stock equivalents
|
|
|
12,554,774
|
|
|
|
2,934,377
|
|
Note
10. Income Taxes
The
Company recorded a tax provision of $0 and $22,000 for the three months ended March 31, 2021 and 2020, respectively.
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. 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 March 31, 2021.
Note
11. Segments, Geographical Information
The
Company’s chief operating decision maker reviews financial information presented on a consolidated basis for purposes of allocating
resources and evaluating financial performance. As such, the Company currently has a single reporting segment and operating unit structure.
In addition, substantially all long-lived assets are attributable to operations in the U.S. for both periods presented.
Revenue,
net by geography is based on the company addresses of the customers. The following table sets forth revenue, net by geographic area (in
thousands):
|
|
For the Three Months Ended
March 31,
|
|
|
|
2021
|
|
|
2020
|
|
Revenue, net:
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
9,274
|
|
|
$
|
11,847
|
|
International
|
|
|
3,847
|
|
|
|
4,384
|
|
Total revenue, net
|
|
$
|
13,121
|
|
|
$
|
16,231
|
|
Note
12. Subsequent Events
On
May 12, 2021, the Company entered into an Agreement (the “Agreement”) with Joseph Cannata (“Cannata”), pursuant
to which the Company has engaged Cannata on a non-exclusive basis to assist with the growth of the Company’s energy beverage product
line.
In
connection with entry into the Agreement, the Company issued to Cannata an option to purchase 1,673,994 shares of the Company’s
common stock at a price per share of $1.12. The option has an exercise term of 10 years (subject to potential acceleration upon a sale
of the Company) and will vest in two equal tranches upon the achievement of certain net revenue milestones related to the Company’s
energy beverage products.
In
addition, the Company agreed to make quarterly payments to Cannata during the term of the Agreement in amounts equal to 17.5% of the
gross profit attributable to the applicable products, excluding products sold through certain excluded sales channels.
The
Agreement continues in effect unless terminated by the mutual agreement of the parties, upon the sale of the Company and upon other specified
termination events.