Notes to Condensed Consolidated Financial
Statements
(Unaudited)
Note 1. Description of Business
Description of Business
MusclePharm Corporation, or the Company, was incorporated
in Nevada in 2006. Except as otherwise indicated herein, the terms “Company,” “we,” “our”
and “us” refer to MusclePharm Corporation and its subsidiaries. The Company is a scientifically driven, performance
lifestyle company that develops, manufactures, markets and distributes branded nutritional supplements. The Company is
headquartered in Denver, Colorado and, as of March 31, 2017, had the following wholly-owned operating subsidiaries: MusclePharm
Canada Enterprises Corp (“MusclePharm Canada”), MusclePharm Ireland Limited (“MusclePharm Ireland”) and
MusclePharm Australia Pty Limited (“MusclePharm Australia”). A former subsidiary of the Company, BioZone Laboratories,
Inc. (“BioZone”), was sold on May 9, 2016.
Management’s Plans with Respect to Liquidity and Capital
Resources
Management believes the restructuring plan completed during
2016, the continued reduction in ongoing operating costs and expense controls, and our recently implemented growth strategy, will
enable the Company to ultimately be profitable. The Company has reduced its operating expenses sufficiently so that its ongoing
source of revenue is projected to cover these expenses for the next twelve months, which management believes will allow it to continue
as a going concern. The Company can give no assurances that this will occur.
As of March 31, 2017, the Company had an accumulated deficit
of $154.1 million and recurring losses from operations. To manage cash flow, in January 2016, the Company entered into a secured
borrowing arrangement, pursuant to which it has the ability to borrow up to $10.0 million subject to sufficient amounts of accounts
receivable to secure the loan. This arrangement was extended on March 22, 2017 for an additional six months with similar terms.
Under this arrangement, during the three months ended March 31, 2017, the Company received $4.4 million in cash and subsequently
repaid $5.1 million, including fees and interest, on or prior to March 31, 2017.
As of March 31, 2017, the Company had approximately $3.0 million
in cash and $11.5 million in working capital deficit. This working capital deficit is driven by $16.6 million in convertible notes.
The accompanying Condensed Consolidated Financial Statements as
of and for the three months ended March 31, 2017, were prepared on the basis of a going concern, which contemplates, among other
things, the realization of assets and satisfaction of liabilities in the ordinary course of business. Accordingly, they do not
give effect to adjustments that would be necessary should the Company be required to liquidate its assets.
The Company’s ability to meet its total liabilities of $38.5
million as of March 31, 2017, and to continue as a going concern, is partially dependent on meeting our operating plans, and partially
dependent on our Chairman of the Board, Chief Executive Officer and President, Ryan Drexler either converting or extending his
two notes prior to or upon their maturity. Mr. Drexler has verbally conveyed his intentions of doing so and this alone would enable
the Company to meet its obligations over the next twelve months. In addition, Mr. Drexler has verbally both stated his intent and
ability to put more capital into the business if necessary. However, Mr. Drexler is under no obligation to the Company to do so,
and we can give no assurances that Mr. Drexler will be willing or able to do so at a future date.
The Company’s ability to continue as a going concern
and raise capital for specific strategic initiatives is also dependent on obtaining adequate capital to fund operating losses until
it becomes profitable. The Company can give no assurances that any additional capital that it is able to obtain, if any, will be
sufficient to meet its needs, or that any such financing will be obtainable on acceptable terms.
If the Company is unable to obtain adequate capital, it could be
forced to cease operations or substantially curtail its commercial activities. These conditions, or significant unforeseen expenditures
including the unfavorable settlement of its legal disputes, could raise substantial doubt as to the Company’s ability to
continue as a going concern. The accompanying Condensed Consolidated Financial Statements do not include any adjustments relating
to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might
result from the outcome of these uncertainties.
Note 2. Summary of Significant Accounting Policies
Basis of Presentation and Principles of Consolidation
The accompanying Condensed Consolidated Financial Statements
have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”). The Condensed
Consolidated Financial Statements include the accounts of MusclePharm Corporation and its wholly-owned subsidiaries. All significant
intercompany balances and transactions have been eliminated in consolidation.
Unaudited Interim Financial Information
The accompanying unaudited interim Condensed Consolidated Financial
Statements have been prepared in accordance with GAAP and with the instructions to Form 10-Q and Article 10 of Regulation S-X for
interim financial information. Accordingly, these statements do not include all of the information and notes required by GAAP for
complete financial statements. The Company’s management believes the unaudited interim Condensed Consolidated Financial Statements
include all adjustments of a normal recurring nature necessary for the fair presentation of the Company’s financial position
as of March 31, 2017, results of operations for the three months ended March 31, 2017 and 2016, and cash flows for
the three months ended March 31, 2017 and 2016. The results of operations for the three ended March 31, 2017 are not
necessarily indicative of the results to be expected for the year ending December 31, 2017.
These unaudited interim Condensed Consolidated Financial Statements
should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual
Report on Form 10-K for the year ended December 31, 2016, filed with the SEC on March 15, 2017.
Use of Estimates
The preparation of consolidated financial statements in conformity
with GAAP requires management to make estimates and assumptions that affect the amounts reported and disclosed in the consolidated
financial statements and accompanying notes. Such estimates include, but are not limited to, allowance for doubtful accounts, revenue
discounts and allowances, the valuation of inventory and tax assets, the assessment of useful lives, recoverability and valuation
of long-lived assets, likelihood and range of possible losses on contingencies, restructuring liabilities, valuations of equity
securities and intangible assets, fair value of derivatives, warrants and options, among others. Actual results could differ from
those estimates.
Revenue Recognition
Revenue is recognized when all of
the following criteria are met:
|
·
|
Persuasive evidence of an arrangement exists.
Evidence
of an arrangement consists of an order from the Company’s distributors, resellers or customers.
|
|
·
|
Delivery has occurred.
Delivery is deemed
to have occurred when title and risk of loss has transferred, typically upon shipment of products to customers.
|
|
·
|
The fee is fixed or determinable.
The
Company assesses whether the fee is fixed or determinable based on the terms associated with the transaction.
|
|
·
|
Collection is reasonably assured.
The
Company assesses collectability based on credit analysis and payment history.
|
The Company’s standard
terms and conditions of sale allow for product returns or replacements in certain cases. Estimates of expected future product returns
are recognized at the time of sale based on analyses of historical return trends by customer type. Upon recognition, the Company
reduces revenue and cost of revenue for the estimated return. Return rates can fluctuate over time, but are sufficiently predictable
with established customers to allow the Company to estimate expected future product returns, and an accrual is recorded for future
expected returns when the related revenue is recognized. Product returns incurred from established customers were insignificant
for the three months ended March 31, 2017 and 2016, respectively.
The Company offers sales incentives
through various programs, consisting primarily of advertising related credits, volume incentive rebates, and sales incentive reserves.
The Company records advertising related credits with customers as a reduction to revenue as no identifiable benefit is received
in exchange for credits claimed by the customer. Volume incentive rebates are provided to certain customers based on contractually
agreed upon percentages once certain thresholds have been met. Sales incentive reserves are computed based on historical trending
and budgeted discount percentages, which are typically based on historical discount rates with adjustments for any known changes,
such as future promotions or one-time historical promotions that will not repeat for each customer. The Company records sales incentive
reserves and volume rebate reserves as a reduction to revenue.
During the three months ended March 31, 2017 and 2016, the
Company recorded discounts, and to a lesser degree, sales returns, totaling $8.0 million and $8.1 million, respectively, which
accounted for 23% and 16% of gross revenue in each period, respectively.
Concentrations
Financial instruments that potentially subject the Company
to concentrations of credit risk consist primarily of cash and accounts receivable. The Company minimizes its credit risk associated
with cash by periodically evaluating the credit quality of its primary financial institution. The cash balance at times may exceed
federally insured limits. Management believes the financial risk associated with these balances is minimal and has not experienced
any losses to date.
Significant customers are those which represent more than
10% of the Company’s net revenue for each period presented. For each significant customer, revenue as a percentage of total
revenue is as follows:
|
|
Percentage of Net Revenue
for the Three Months Ended
March 31,
|
|
|
2017
|
|
2016
|
Customers
|
|
|
|
|
Costco Wholesale Corporation
|
|
|
35
|
%
|
|
|
16
|
%
|
GNC Holdings Inc.
|
|
|
*
|
|
|
|
12
|
%
|
Bodybuilding.com
|
|
|
*
|
|
|
|
11
|
%
|
* Represents less than 10% of net revenue.
Share-Based Payments and Stock-Based Compensation
Share-based compensation awards, including stock options
and restricted stock awards, are recorded at estimated fair value on the applicable award’s grant date, based on estimated
number of awards that are expected to vest. The grant date fair value is amortized on a straight-line basis over the time in which
the awards are expected to vest, or immediately if no vesting is required. Share-based compensation awards issued to non-employees
for services are recorded at either the fair value of the services rendered or the fair value of the share-based payments whichever
is more readily determinable. The fair value of restricted stock awards is based on the fair value of the stock underlying the
awards on the grant date as there is no exercise price.
The fair value of stock options is estimated using the Black-Scholes
option-pricing model. The determination of the fair value of each stock award using this option-pricing model is affected by the
Company’s assumptions regarding a number of complex and subjective variables. These variables include, but are not limited
to, the expected stock price volatility over the term of the awards and the expected term of the awards based on an analysis of
the actual and projected employee stock option exercise behaviors and the contractual term of the awards. Due to the Company’s
limited experience with the expected term of options, the simplified method was utilized in determining the expected option term
as prescribed in Staff Accounting Bulletin No. 110. The Company recognizes stock-based compensation expense over the requisite
service period, which is generally consistent with the vesting of the awards, based on the estimated fair value of all stock-based
payments issued to employees and directors that are expected to vest.
Recent Accounting Pronouncements
During August 2016, the Financial Accounting Standards Board
(“FASB”) issued Accounting Standards Update (“ASU”) 2016-15,
Statement of Cash Flows - Classification
of Certain Cash Receipts and Cash Payments
, which addresses eight specific cash flow issues with the objective of reducing
the existing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement
of cash flows. The standard is effective for fiscal years beginning after December 15, 2017, including interim periods within those
fiscal years. Early adoption is permitted, including adoption in an interim period. The Company is currently in the process of
evaluating the impact of this new pronouncement on the Company’s Condensed Consolidated Statements of Cash Flows.
In May 2014, the FASB issued ASU No. 2014-09,
Revenue from Contracts
with Customers
(“ASU 2014-09”), which provides guidance for revenue recognition. ASU 2014-09 affects any entity
that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial
assets and supersedes the revenue recognition requirements in Topic 605,
Revenue Recognition
, and most industry-specific
guidance. This ASU also supersedes some cost guidance included in Subtopic 605-35,
Revenue Recognition- Construction-Type and
Production-Type Contracts
. ASU 2014-09’s core principle is that a company will recognize revenue when it transfers promised
goods or services to customers in an amount that reflects the consideration to which a company expects to be entitled in exchange
for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under today’s
guidance, including identifying performance obligations in the contract, estimating the amount of variable consideration to include
in the transaction price and allocating the transaction price to each separate performance obligation. In August 2015, the FASB
issued ASU No. 2015-14,
Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date
(“ASU
2015-14”), which delays the effective date of ASU 2014-09 by one year. The FASB also agreed to allow entities to choose to
adopt the standard as of the original effective date. As such, the updated standard will be effective for the Company in the first
quarter of 2018, with the option to adopt it in the first quarter of 2017. The Company may adopt the new standard under the full
retrospective approach or the modified retrospective approach. The Company plans to adopt this guidance under the modified retrospective
approach. We are monitoring the evolving interpretations and implementations guidance. Based on our preliminary assessment, we
do not expect the new standard to have a material impact on the Company’s financial position or results of operations.
In March 2016, the FASB issued ASU No. 2016-08,
Revenue from
Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net)
(“ASU
2016-08”) which clarified the revenue recognition implementation guidance on principal versus agent considerations and is
effective during the same period as ASU 2014-09. In April 2016, the FASB issued ASU No. 2016-10,
Revenue from Contracts with
Customers (Topic 606): Identifying Performance Obligations and Licensing
(“ASU 2016-10”) which clarified the revenue
recognition guidance regarding the identification of performance obligations and the licensing implementation and is effective
during the same period as ASU 2014-09. In May 2016, the FASB issued ASU No. 2016-12,
Revenue from Contracts with Customers (Topic
606): Narrow-Scope Improvements and Practical Expedients
(“ASU 2016-12”) which narrowly amended the revenue recognition
guidance regarding collectability, noncash consideration, presentation of sales tax and transition. ASU 2016-12 is effective during
the same period as ASU 2014-09. We are monitoring the evolving interpretations and implementations guidance. Based on our preliminary
assessment, we do not expect the new standard to have a material impact on the Company’s financial position or results of
operations.
In March 2016, the FASB issued ASU No. 2016-09,
Compensation
– Stock Compensation (Topic 718)
(“ASU 2016-09”). The standard identifies areas for simplification involving
several aspects of accounting for share-based payment transactions, including the income tax consequences, classification of awards
as either equity or liabilities, an option to recognize gross stock compensation expense with actual forfeitures recognized as
they occur, as well as certain classifications on the statement of cash flows. ASU 2016-09 was effective for fiscal years beginning
after December 15, 2016, and interim periods within those fiscal years, with early adoption permitted. The adoption of this guidance
did not have a significant impact on the Condensed Consolidated Financial Statements.
In February 2016, the FASB issued ASU No. 2016-02,
Leases (Topic
842)
, which supersedes Topic 840,
Leases
(“ASU 2016-02”). The guidance in this new standard requires lessees
to put most leases on their balance sheets but recognize expenses on their income statements in a manner similar to the current
accounting and eliminates the current real estate-specific provisions for all entities. The guidance also modifies the classification
criteria and the accounting for sales-type and direct financing leases for lessors. ASU 2016-02 is effective for fiscal years beginning
after December 15, 2018, and interim periods within those fiscal years, with early adoption permitted. The Company is currently
evaluating the impact of the adoption of ASU 2016-02.
In July 2015, the FASB issued ASU No. 2015-11,
Inventory
(Topic 330): Simplifying the Measurement of Inventory
(“ASU 2015-11”), which simplifies the subsequent measurement
of inventory by requiring inventory to be measured at the lower of cost and net realizable value. Net realizable value is the estimated
selling price of inventory in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation.
ASU 2015-11 was effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. The
adoption of this guidance did not have a significant impact on our Condensed Consolidated Financial Statements.
Note 3. Fair Value of Financial Instruments
Management believes the fair values of the obligations under
the secured borrowing arrangement and the convertible notes with a related party approximate carrying value because the debt carries
market rates of interest available to the Company, and are both short-term in nature. The Company’s remaining financial instruments
consisted primarily of accounts receivable, accounts payable, accrued liabilities and accrued restructuring charges, all of which
are short-term in nature with fair values approximating carrying value. As of March 31, 2017 and December 31, 2016, the Company
held no assets or liabilities that required remeasurement at fair value on a recurring basis.
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. The Company closed certain facilities,
reduced headcount, discontinued products and renegotiated certain contracts resulting in restructuring and other charges of $0.6 million
for the three months ended March 31, 2016.
For the three months ended March 31, 2016, the Company recorded
restructuring charges in “Cost of revenue” of $1.7 million related to the write-down of inventory identified to be
discontinued in the restructuring plan.
The following table illustrates the provision of the restructuring
charges and the accrued restructuring charges balance as of March 31, 2017 (in thousands):
|
|
Contract Termination Costs
|
|
Purchase Commitment of Discontinued Inventories Not Yet Received
|
|
Abandoned Lease Facilities
|
|
Total
|
Balance as of December 31, 2016
|
|
$
|
308
|
|
|
$
|
175
|
|
|
$
|
339
|
|
|
$
|
822
|
|
Expensed
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Cash payments
|
|
|
—
|
|
|
|
—
|
|
|
|
(72
|
)
|
|
|
(72
|
)
|
Balance as of March 31, 2017
|
|
|
308
|
|
|
|
175
|
|
|
|
267
|
|
|
|
750
|
|
The total future payments under the restructuring plan as
of March 31, 2017 are as follows (in thousands):
|
|
For the Year Ending December 31,
|
Outstanding Payments
|
|
Remainder of 2017
|
|
2018
|
|
2019
|
|
2020
|
|
2021
|
|
Total
|
Contract termination costs
|
|
$
|
308
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
308
|
|
Purchase commitment of discontinued inventories not yet received
|
|
|
175
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
175
|
|
Abandoned leased facilities
|
|
|
59
|
|
|
|
92
|
|
|
|
91
|
|
|
|
25
|
|
|
|
—
|
|
|
|
267
|
|
Total future payments
|
|
$
|
542
|
|
|
$
|
92
|
|
|
$
|
91
|
|
|
$
|
25
|
|
|
$
|
—
|
|
|
$
|
750
|
|
Note 5. Balance Sheet Components
Inventory
Inventory consisted of the following as of March 31, 2017
and December 31, 2016 (in thousands):
|
|
As of
March 31, 2017
|
|
As of December 31, 2016
|
Raw materials
|
|
$
|
—
|
|
|
$
|
—
|
|
Work-in-process
|
|
|
—
|
|
|
|
—
|
|
Finished goods
|
|
|
6,114
|
|
|
|
8,568
|
|
Inventory
|
|
$
|
6,114
|
|
|
$
|
8,568
|
|
The Company records charges for obsolete and slow moving
inventory based on the age of the product as determined by the expiration date. Products within one year of their expiration dates
are considered for write-off purposes. Historically, the Company has had minimal returns with established customers. Other than
write-off of inventory during restructuring activities, the Company incurred insignificant inventory write-offs during the three
months ended March 31, 2017 and 2016. Inventory write-downs, once established, are not reversed as they establish a new cost basis
for the inventory.
As disclosed further in Note 4, the Company executed a restructuring
plan in August 2015 and wrote off inventory related to discontinued products. For the three months ended March 31, 2016, discontinued
inventory of $1.7 million was written off and included as a component of “Cost of revenue” in the accompanying Condensed
Consolidated Statements of Operations.
Property and Equipment
Property and equipment consisted of the following as of March
31, 2017 and December 31, 2016 (in thousands):
|
|
As of
March 31, 2017
|
|
As of December 31, 2016
|
Furniture, fixtures and equipment
|
|
$
|
3,561
|
|
|
$
|
3,521
|
|
Leasehold improvements
|
|
|
2,504
|
|
|
|
2,504
|
|
Manufacturing and lab equipment
|
|
|
3
|
|
|
|
3
|
|
Vehicles
|
|
|
209
|
|
|
|
334
|
|
Displays
|
|
|
483
|
|
|
|
483
|
|
Website
|
|
|
462
|
|
|
|
462
|
|
Construction in process
|
|
|
36
|
|
|
|
55
|
|
Property and equipment, gross
|
|
|
7,258
|
|
|
|
7,362
|
|
Less: accumulated depreciation and amortization
|
|
|
(4,405
|
)
|
|
|
(4,119
|
)
|
Property and equipment, net
|
|
$
|
2,853
|
|
|
$
|
3,243
|
|
Depreciation and amortization expense related to property
and equipment was $0.3 million and $0.4 million for the three months ended March 31, 2017 and 2016, respectively, which is included
in “Selling, general, and administrative” expense in the accompanying Condensed Consolidated Statements of Operations.
Intangible Assets
Intangible assets consisted of the following (in thousands):
|
|
As of March 31, 2017
|
|
|
Gross Value
|
|
Accumulated
Amortization
|
|
Net
Carrying
Value
|
|
Remaining Weighted-
Average
Useful Lives
(years)
|
Amortized Intangible Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Brand
|
|
$
|
2,244
|
|
|
$
|
(686
|
)
|
|
$
|
1,558
|
|
|
|
4.9
|
|
Total intangible assets
|
|
$
|
2,244
|
|
|
$
|
(686
|
)
|
|
$
|
1,558
|
|
|
|
|
|
|
|
As of December 31, 2016
|
|
|
Gross Value
|
|
Accumulated
Amortization
|
|
Net
Carrying
Value
|
|
Remaining Weighted-
Average
Useful Lives
(years)
|
Amortized Intangible Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Brand
|
|
$
|
2,244
|
|
|
$
|
(606
|
)
|
|
$
|
1,638
|
|
|
|
5.1
|
|
Total intangible assets
|
|
$
|
2,244
|
|
|
$
|
(606
|
)
|
|
$
|
1,638
|
|
|
|
|
|
Intangible assets amortization expense was $0.1 million and
$0.2 million for the three months ended March 31, 2017 and 2016, respectively, which is included in the “Selling, general,
and administrative” expense in the accompanying Condensed Consolidated Statements of Operations.
As of March 31, 2017, the estimated future amortization expense
of intangible assets is as follows (in thousands):
For the Year Ending December 31,
|
|
|
|
Remainder of 2017
|
|
$
|
241
|
|
2018
|
|
|
321
|
|
2019
|
|
|
321
|
|
2020
|
|
|
321
|
|
2021
|
|
|
321
|
|
Thereafter
|
|
|
33
|
|
Total amortization expense
|
|
$
|
1,558
|
|
Note 6. Other Expense, net
For the three months ended March 31, 2017 and 2016, “Other
expense, net” consisted of the following (in thousands):
|
|
For the Three Months
Ended March 31,
|
|
|
2017
|
|
2016
|
Other expense, net:
|
|
|
|
|
|
|
|
|
Interest expense, related party
|
|
$
|
(422
|
)
|
|
$
|
(121
|
)
|
Interest expense, other
|
|
|
(159
|
)
|
|
|
(44
|
)
|
Interest expense, secured borrowing arrangement
|
|
|
(104
|
)
|
|
|
(354
|
)
|
Foreign currency transaction (loss) gain
|
|
|
(12
|
)
|
|
|
103
|
|
Other
|
|
|
(281
|
)
|
|
|
(296
|
)
|
Total other expense, net
|
|
$
|
(978
|
)
|
|
$
|
(712
|
)
|
Note 7. Debt
As of March 31, 2017 and December 31, 2016, the Company’s
debt consisted of the following (in thousands):
|
|
As of March 31, 2017
|
|
As of December 31,2016
|
2015 Convertible Note due November 2017 with a related party
|
|
$
|
6,000
|
|
|
$
|
6,000
|
|
2016 Convertible Note due November 2017 with a related party, net of discount
|
|
|
10,618
|
|
|
|
10,465
|
|
Obligations under secured borrowing arrangement
|
|
|
1,816
|
|
|
|
2,681
|
|
Total debt
|
|
|
18,434
|
|
|
|
19,146
|
|
Less: current portion
|
|
|
(18,434
|
)
|
|
|
(19,146
|
)
|
Long term debt
|
|
$
|
—
|
|
|
$
|
—
|
|
Related-Party Convertible Notes
In November 2016, the Company entered into a convertible
secured promissory note agreement (the “2016 Convertible Note”) with Mr. Ryan Drexler, the Company’s Chairman
of the Board, Chief Executive Officer and President, pursuant to which Mr. Drexler loaned the Company $11.0 million. Proceeds
from the 2016 Convertible Note were used to fund settlement of litigation. The 2016 Convertible Note is secured by all assets and
properties of the Company and its subsidiaries, whether tangible or intangible. The 2016 Convertible Note carries interest at a
rate of 10% per annum, or 12% if there is an event of default. Both the principal and the interest under the 2016 Convertible Note
are due on November 8, 2017, unless converted earlier. Mr. Drexler may convert the outstanding principal and accrued interest into
6,010,929 shares of the Company’s common stock for $1.83 per share at any time. The Company may prepay the 2016 Convertible
Note at the aggregate principal amount therein, plus accrued interest, by giving Mr. Drexler between 15 and 60 day-notice depending
upon the specific circumstances, provided that Mr. Drexler may convert the 2016 Convertible Note during the applicable notice period.
The Company recorded the 2016 Convertible Note as a liability in the balance sheet and also recorded a beneficial conversion feature
of $601,000 as a debt discount upon issuance of the convertible note, which is being amortized over the term of the debt using
the effective interest method. The beneficial conversion feature was calculated based on the difference between the fair value
of common stock on the transaction date and the effective conversion price of the convertible note. As of March 31, 2017, the 2016
Convertible Note had an outstanding principal balance of $11.0 million and a carrying value of $10.6 million. As of December 31,
2016, the 2016 Convertible Note had an outstanding principal balance of $11.0 million and a carrying value of $10.5 million.
In December 2015, the Company entered into a convertible
secured promissory note agreement (the “2015 Convertible Note”) with Mr. Drexler, pursuant to which he loaned
the Company $6.0 million. Proceeds from the 2015 Convertible Note were used to fund working capital requirements. The 2015
Convertible Note is secured by all assets and properties of the Company and its subsidiaries whether tangible or intangible. The
2015 Convertible Note originally carried an interest at a rate of 8% per annum, or 10% in the event of default. Both the principal
and the interest under the 2015 Convertible Note were originally due in January 2017, unless converted earlier. The due date
of the 2015 Convertible note was extended to November 8, 2017 and the interest rates were raised to 10% per annum, or 12% in the
event of default. Mr. Drexler may convert the outstanding principal and accrued interest into 2,608,695 shares of common stock
for $2.30 per share at any time. The Company may prepay the convertible note at the aggregate principal amount therein plus accrued
interest by giving the holder between 15 and 60 day-notice, depending upon the specific circumstances, provided that Mr. Drexler
may convert the 2016 Convertible Note during the applicable notice period. The Company recorded the 2015 Convertible Note as a
liability in the balance sheet and also recorded a beneficial conversion feature of $52,000 as a debt discount upon issuance of
the 2015 Convertible Note, which was amortized over the term of the debt using the effective interest method. The beneficial conversion
feature was calculated based on the difference between the fair value of common stock on the transaction date and the effective
conversion price of the convertible note. As of March 31, 2017 and December 31, 2016, the convertible note had an outstanding
principal balance of $6.0 million. In connection with the Company entering into the 2015 Convertible Note with Mr. Drexler,
the Company granted Mr. Drexler the right to designate two directors to the Board.
For the three months ended March 31, 2017 and 2016, interest
expense related to the related party convertible secured promissory notes was $0.4 million and $0.1 million, respectively. During
the three months ended March 31, 2017 and 2016, $0.4 million and $0.1 million, respectively, in interest was paid in cash to Mr.
Drexler.
Secured borrowing arrangement
In January 2016, the Company entered into a Purchase and
Sale Agreement (the “Agreement”) with Prestige Capital Corporation (“Prestige”) pursuant to which the Company
agreed to sell and assign and Prestige agreed to buy and accept, certain accounts receivable owed to the Company (“Accounts”).
Under the terms of the Agreement, upon the receipt and acceptance of each assignment of Accounts, Prestige will pay the Company
80% of the net face amount of the assigned Accounts, up to a maximum total borrowings of $10.0 million subject to sufficient
amounts of accounts receivable to secure the loan. The remaining 20% will be paid to the Company upon collection of the assigned
Accounts, less any chargeback, disputes, or other amounts due to Prestige. Prestige’s purchase of the assigned Accounts from
the Company will be at a discount fee which varies based on the number of days outstanding from the assignment of Accounts to collection
of the assigned Accounts. In addition, the Company granted Prestige a continuing security interest in and lien upon all accounts
receivable, inventory, fixed assets, general intangibles and other assets. The Agreement’s term has been extended to September
29, 2017. Prestige may cancel the Agreement with 30-day notice.
During the three months ended March 31, 2017, the Company
sold to Prestige accounts with an aggregate face amount of approximately $5.5 million, for which Prestige paid to the Company approximately
$4.4 million in cash. During the three months ended March 31, 2017, $5.1 million was subsequently repaid to Prestige, including
fees and interest.
During the three months ended March 31, 2016, the Company
sold to Prestige accounts with an aggregate face amount of approximately $28.9 million, for which Prestige paid to the Company
approximately $23.1 million in cash. During the three months ended March 31, 2016, $18.4 million was subsequently repaid to
Prestige, including fees and interest.
Note 8. Commitments and Contingencies
Operating Leases
The Company leases office and warehouse facilities under
operating leases, which expire at various dates through 2020. The amounts reflected in the table below are for the aggregate future
minimum lease payments under non-cancelable facility operating leases for properties that have not been abandoned as part of the
restructuring plan. See Note 4 for additional details regarding the restructured leases. Under lease agreements that contain escalating
rent provisions, lease expense is recorded on a straight-line basis over the lease term. Rent expense was $0.1 million and $0.3
million for the three months ended March 31, 2017 and 2016, respectively.
As of March 31, 2017, future minimum lease payments are as
follows (in thousands):
For the Year Ending December 31,
|
|
|
|
Remainder of 2017
|
|
$
|
327
|
|
2018
|
|
|
418
|
|
2019
|
|
|
392
|
|
2020
|
|
|
268
|
|
2021
|
|
|
—
|
|
Thereafter
|
|
|
—
|
|
Total minimum lease payments
|
|
$
|
1,405
|
|
Capital Leases
In December 2014, the Company entered into a capital lease
agreement providing for approximately $1.8 million in credit to lease up to 50 vehicles as part of a fleet lease program. As of
March 31, 2017, the Company was leasing six vehicles under the capital lease which were included in “Property and equipment,
net” in the Condensed Consolidated Balance Sheets. The original cost of leased assets was $205,000 and the associated accumulated
depreciation was $90,000. As of December 31, 2016, the Company was leasing 10 vehicles under the capital lease which were included
in “Property and equipment, net” in the Condensed Consolidated Balance Sheets. The original cost of leased assets was
$330,000 and the associated accumulated depreciation was $126,000. The Company also leases manufacturing and warehouse equipment
under capital leases, which expire at various dates through February 2020. Several of such leases were reclassified to the restructuring
liability during 2016, and related assets were written off to restructuring expense for the year ended December 31, 2016.
As of March 31, 2017 and December 31, 2016, short-term
capital lease liabilities of $157,000 and $173,000, respectively, were included as a component of current accrued liabilities,
and the long-term capital lease liabilities of $270,000 and $332,000, respectively, were included as a component of long-term liabilities
in the Condensed Consolidated Balance Sheets.
As of March 31, 2017, the Company’s future minimum
lease payments under capital lease agreements, are as follows (in thousands):
For the Year Ending December 31,
|
|
|
|
Remainder of 2017
|
|
$
|
133
|
|
2018
|
|
|
161
|
|
2019
|
|
|
113
|
|
2020
|
|
|
51
|
|
2021
|
|
|
—
|
|
Total minimum lease payments
|
|
|
458
|
|
Less amounts representing interest
|
|
|
(31
|
)
|
Present value of minimum lease payments
|
|
$
|
427
|
|
Purchase Commitment
Upon the completion of the sale of BioZone on May 9, 2016,
the Company entered into a manufacturing and supply agreement whereby the Company is required to purchase a minimum of approximately
$1.9 million of products per year from BioZone annually for an initial term of three years. If the minimum order quantities of
specific products are not met, a $3.0 million minimum purchase commitment kicks in and any shortfall will be paid at 25% of the
realized shortfall. Due to the timing of achieving the minimum purchase quantities, we believe that we will be slightly below these
targets. As a result, we have provided for the estimated purchase commitment shortfall adjustment in the three months ended March
31, 2017.
Settlements
Arnold Schwarzenegger
The Company was engaged in a dispute with Marine MP, LLC
(“Marine MP”), Arnold Schwarzenegger (“Schwarzenegger”), and Fitness Publications, Inc. (“Fitness,”
and together with Marine MP and Schwarzenegger, the “AS Parties”) concerning amounts allegedly owed under the parties’
Endorsement Licensing and Co-Branding Agreement (the “Endorsement Agreement”). In May 2016, the Company received written
notice that the AS Parties were terminating the Endorsement Licensing and Co-Branding Agreement by and among the Company and the
AS Parties, the Company provided written notice to the AS Parties that it was terminating the Endorsement Agreement, and the AS
Parties commenced arbitration, alleging that the Company breached the parties’ agreement and misappropriated Schwarzenegger’s
likeness. The Company filed its response and counterclaimed for breach of contract and breach of the implied covenant of good faith
and fair dealing.
On December 17, 2016, the Company entered into a Settlement
Agreement (the “Settlement Agreement”) with the AS Parties, effective January 4, 2017. Pursuant to the Settlement Agreement,
and to resolve and settle all disputes between the parties and release all claims between them, the Company agreed to pay the AS
Parties (a) $1.0 million, which payment was released to the AS Parties on January 5, 2017, and (b) $2.0 million within six months
of the effective date of the Settlement Agreement. If the Company fails to make the second payment when due, pursuant to a confession
of judgment entered into by the Company, the AS Parties will be entitled to an additional $1.0 million, for a total additional
payment of $3.0 million to satisfy the AS Parties’ contract claim, which the AS Parties claim is valued at $4.0 million.
The Company also has agreed that it will not sell any products from its Arnold Schwarzenegger product line, will donate to a charity
chosen by Arnold Schwarzenegger any remaining usable product, and otherwise destroy any products currently in inventory. This inventory
was written off to “Impairment of assets” in the Consolidated Statement of Operations during the year ended December
31, 2016. In addition, in connection with the transaction, the 780,000 shares of Company common stock held by Marine MP were sold
to a third party on January 4, 2017 in exchange for an aggregate payment by such third party of $1,677,000 to the AS Parties.
Contingencies
In the normal course of business or otherwise, the Company
may become involved in legal proceedings. The Company will accrue a liability for such matters when it is probable that a liability
has been incurred and the amount can be reasonably estimated. When only a range of possible loss can be established, the most probable
amount in the range is accrued. If no amount within this range is a better estimate than any other amount within the range, the
minimum amount in the range is accrued. The accrual for a litigation loss contingency might include, for example, estimates of
potential damages, outside legal fees and other directly related costs expected to be incurred. As of March 31, 2017, the Company
was involved in the following material legal proceedings described below.
Supplier Complaint
In January 2016, ThermoLife International LLC (“ThermoLife”),
a supplier of nitrates to MusclePharm, filed a complaint against the Company in Arizona state court. In its complaint, ThermoLife
alleges that the Company failed to meet minimum purchase requirements contained in the parties’ supply agreement. In March
2016, the Company filed an answer to ThermoLife’s complaint, denying the allegations contained in the complaint, and filed
a counterclaim alleging that ThermoLife breached its express warranty to MusclePharm because ThermoLife’s products were defective
and could not be incorporated into the Company’s products. Therefore, the Company believes that ThermoLife’s complaint
is without merit. The lawsuit is currently in the discovery phase.
Former Executive Lawsuit
In December 2015, the Company accepted notice by Mr. Richard
Estalella (“Estalella”) to terminate his employment as the Company’s President. Although Estalella sought
to terminate his employment with the Company for “Good Reason,” as defined in Estalella’s employment agreement
with the Company (the “Employment Agreement”), the Company advised Estalella that it deemed his resignation to be without
Good Reason.
In February 2016, Estalella filed a complaint in Colorado
state court against the Company and Ryan Drexler, Chairman of the Board, Chief Executive Officer and President, alleging, among
other things, that the Company breached the Employment Agreement, and seeking certain equitable relief and unspecified damages.
The Company believes Estalella’s claims are without merit. At the Company’s 2016 Annual Meeting of Stockholders in
June 2016, Estalella was not reelected to the Board and is no longer a member of the Board. As of the date of this report, the
Company has evaluated the potential outcome of this lawsuit and recorded the liability consistent with its policy. The lawsuit
is in the final discovery phase with trial expected to commence in July 2017.
Insurance Carrier Lawsuit
The Company is engaged in litigation with insurance carrier
Liberty Insurance Underwriters, Inc. arising out of Liberty’s denial of coverage. In 2014, the Company sought coverage under
an insurance policy with Liberty for claims against directors and officers of the Company arising out of an investigation
by the Securities and Exchange Commission. Liberty denied coverage, and, on February 12, 2015, the Company filed a complaint in
the District Court, City and County of Denver, Colorado against Liberty claiming wrongful and unreasonable denial of coverage for
the cost and expenses incurred in connection with the SEC investigation and related matters. Liberty removed the complaint to the
United States District Court for the District of Colorado, which in August 2016 granted Liberty’s motion for summary judgment,
denying coverage and dismissing the Company’s claims with prejudice, and denied the Company’s motion for summary judgment.
The Company filed an appeal in November 2016. The appeal is currently in the discovery phase.
Manchester City Football Group
The Company is engaged in a dispute with City Football Group
Limited (“CFG”), the owner of Manchester City Football Group, concerning amounts allegedly owed by the Company under
a Sponsorship Agreement with CFG. In August 2016, CFG commenced arbitration in the United Kingdom against the Company, seeking
approximately $8.3 million for the Company’s purported breach of the Agreement. The Company answered on October 7, 2016.
The dispute is currently in arbitration. As of the date of this report, the Company has evaluated the potential outcome of this
lawsuit and recorded the liability consistent with its policy.
IRS Audit
On April 6, 2016, The Internal Revenue Service (“IRS”)
selected the Company’s 2014 Federal Income Tax Return for audit. As a result of the audit, the IRS noted certain deficiencies
with the tax reporting of the Company’s former executive’s 2014 restricted stock grant. Due to the Company’s
current and historical loss position, any proposed adjustment would have no material impact on its Federal Income Tax Return. On
October 5, 2016, the IRS selected the Company’s 2014 Federal Income Tax Return for an Employment Tax Audit. The IRS is contending
that the Company inaccurately reported the value of the restricted stock grants and improperly failed to provide for employment
taxes and federal tax withholding on these grants. In addition, the IRS is proposing certain penalties and fines associated with
the delinquent filings. On April 4, 2017, we received the final IRS Determination Letter which orders back taxes and penalties
of approximately $5.3 million of which $0.4 million related to employment taxes and $4.9 million related to federal tax withholding
and penalties. The Company has provided for a liability for the employment taxes consistent with its policy for the three months
ended March 31, 2017. Additionally, due to the uncertainty associated with the Federal tax withholding, the Company is unable to
provide an estimate for its potential liability associated with these taxes. Accordingly, no liability has been recorded. The Company
intends to formally appeal this matter under the formal IRS appeal process and is unable to ascertain the likelihood of the outcome
of this process.
Sponsorship and Endorsement Contract Liabilities
The Company has various non-cancelable endorsement and sponsorship
agreements with terms expiring through 2019. The total value of future contractual payments as of March 31, 2017 are as follows
(in thousands):
|
|
For the Year Ending December 31,
|
|
|
|
|
Remainder of 2017
|
|
2018
|
|
2019
|
|
2020
|
|
2021
|
|
Thereafter
|
|
Total
|
Outstanding Payments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Endorsement
|
|
$
|
184
|
|
|
$
|
2
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
186
|
|
Sponsorship
|
|
|
1,810
|
|
|
|
2,460
|
|
|
|
1,040
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
5,310
|
|
Total future payments
|
|
$
|
1,994
|
|
|
$
|
2,462
|
|
|
$
|
1,040
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
5,496
|
|
Note 9. Stockholders’ Deficit
Common Stock
For the three months ended March 31, 2017, the Company had
the following transactions related to its common stock including restricted stock awards (in thousands, except share and per share
data):
Transaction Type
|
|
Quantity (Shares)
|
|
Valuation
($)
|
|
Range of
Value per Share
|
Stock issued to employees, executives and directors
|
|
|
350,000
|
|
|
$
|
686
|
|
|
$
|
1.96
|
|
Total
|
|
|
350,000
|
|
|
$
|
686
|
|
|
$
|
1.96
|
|
For the three months ended March 31, 2016, the Company issued
common stock including restricted stock awards, as follows (in thousands, except share and per share data):
Transaction Type
|
|
Quantity
(Shares)
|
|
Valuation
($)
|
|
Range of Value per Share
|
Stock issued to employees, executives and directors
|
|
|
145,245
|
|
|
$
|
289
|
|
|
$
|
1.89-2.21
|
|
Total
|
|
|
145,245
|
|
|
$
|
289
|
|
|
$
|
1.89-2.21
|
|
The fair value of all stock issuances above is based upon
the quoted closing trading price on the date of issuance.
Common stock outstanding as of December 31, 2016 and 2015
includes shares legally outstanding even if subject to future vesting.
Warrants
In November 2016, the Company issued a warrant to purchase
1,289,378 shares of its common stock to the parent company of Capstone Nutrition, the Company’s former product manufacturer,
pursuant to a settlement agreement. The exercise price of this warrant was $1.83 per share, with a contractual term of four years.
The Company has valued this warrant by utilizing the Black Scholes model at approximately $1.8 million with the following assumptions: contractual
life of four years, risk free interest rate of 1.27%, dividend yield of 0%, and expected volatility of 118.4%.
In July 2014, the Company issued a warrant to purchase 100,000
shares of its common stock related to an endorsement agreement. The exercise price of this warrant was $11.90 per share, with a
contractual term of five years. This warrant fully vested during 2016. The Company used the Black-Scholes model to determine the
estimated fair value of the warrants, with the following assumptions: contractual life of five years, risk free interest rate
of 1.7%, dividend yield of 0%, and expected volatility of 55%.
Treasury Stock
During the three months ended March 31, 2017 and the year
ended December 31, 2016, the Company did not repurchase any shares of its common stock and held 875,621 shares in treasury as of
March 31, 2017 and December 31, 2016.
Note 10. Stock-Based Compensation
Restricted Stock
The Company’s stock-based compensation for the three
months ended March 31, 2017 and 2016 consist primarily of restricted stock awards. The activity of restricted stock awards granted
to employees, executives and Board members was as follows:
|
|
|
|
|
Unvested Restricted Stock Awards
|
|
|
|
|
|
|
Number of
Shares
|
|
|
|
Weighted Average
Grant Date Fair
Value
|
|
|
Unvested balance – December 31, 2016
|
|
|
|
378,425
|
|
|
$
|
3.45
|
|
|
Granted
|
|
|
|
350,000
|
|
|
|
1.96
|
|
|
Vested
|
|
|
|
(58,255
|
)
|
|
|
2.99
|
|
|
Cancelled
|
|
|
|
—
|
|
|
|
—
|
|
|
Unvested balance – March 31, 2017
|
|
|
|
670,170
|
|
|
|
2.71
|
|
The total fair value of restricted stock awards granted to
employees and the Board was $0.7 million and $0.3 million for the three months ended March 31, 2017 and 2016, respectively. As
of March 31, 2017, the total unrecognized expense for unvested restricted stock awards, net of expected forfeitures, was $1.3 million,
which is expected to be amortized over a weighted average period of 1.2 years.
Restricted Stock Awards Issued to Ryan Drexler, Chairman
of the Board, Chief Executive Officer and President
In January 2017, the Company issued Mr. Ryan Drexler 350,000
shares of restricted stock pursuant to an Amended and Restated Executive Employment Agreement dated November 18, 2016 (“Employment
Agreement”) with a grant date value of $0.7 million based upon the closing price of the Company’s common stock on the
date of issuance. These shares of restricted stock vest in full upon the first anniversary of the grant date.
Accelerated Vesting of Restricted Stock Awards Related
to Termination of Employment Agreement with Brad Pyatt, Former Chief Executive Officer
In March 2016, Brad Pyatt, the Company’s former Chief
Executive Officer, terminated his employment with the Company. Pursuant to the terms of the separation agreement with the Company,
in exchange for a release of claims, the Company agreed to pay severance in the amount of $1.1 million, payable over a 12-month
period, a lump sum of $250,000 paid during March 2017 and reimbursement of COBRA premiums. In addition, the remaining unvested
restricted stock awards held by Brad Pyatt of 500,000 shares vested in full upon his termination in accordance with the original
grant terms. In connection with the accelerated vesting of these restricted stock awards, the Company recognized stock compensation
expense of $3.9 million, which is included in “Salaries and benefits” in the accompanying Condensed Consolidated Statements
of Operations for the three months ended March 31, 2016. All amounts due Mr. Pyatt were paid as of March 31, 2017.
Stock Options
The Company may grant options to purchase shares of the Company’s
common stock to certain employees and directors pursuant to the 2015 Plan. Under the 2015 Plan, all stock options are granted with
an exercise price equal to or greater than the fair market value of a share of the Company’s common stock on the date of
grant. Vesting is generally determined by the Compensation Committee of the Board within limits set forth in the 2015 Plan. No
stock option will be exercisable more than ten years after the date it is granted.
In February 2016, the Company issued options to purchase
137,362 shares of its common stock to Mr. Drexler, the Company’s Chief Executive Officer, President and Chairman of
the Board, and 54,945 to Michael Doron, the Lead Director of the Board. These stock options have an exercise price of $1.89 per
share, a contractual term of 10 years and a grant date fair value of $1.72 per share, or $0.3 million, which is amortized on a
straight-line basis over the vesting period of two years. The Company determined the fair value of the stock options using the
Black-Scholes model. The table below sets forth the assumptions used in valuing such options.
|
For the Year Ended
December 31, 2016
|
|
Expected term of options
|
6.5 years
|
|
Expected volatility
|
131.0%
|
|
Risk-free interest rate
|
1.71%
|
|
Expected dividend yield
|
0.0%
|
|
For the three months ended March 31, 2017 and 2016, the Company
recorded stock compensation expense related to options of $0.1 million and $14,000, respectively.
Note 11. 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 the three months ended March 31, 2017 and 2016, respectively, as the Company
reported a net loss for both periods.
The following table sets forth the computation of the Company’s
basic and diluted net loss per share for the periods presented (in thousands, except share and per share data):
|
|
For the Three Months
Ended March 31,
|
|
|
2017
|
|
2016
|
Net loss
|
|
$
|
(3,149
|
)
|
|
$
|
(6,605
|
)
|
Weighted average common shares used in computing net loss per share, basic and diluted
|
|
|
13,773,508
|
|
|
|
13,896,876
|
|
Net loss per share, basic and diluted
|
|
$
|
(0.23
|
)
|
|
$
|
(0.48
|
)
|
Diluted net income per share is computed by dividing net
income for the period by the weighted average number of shares of common stock, common stock equivalents and potentially dilutive
securities outstanding during each period. The Company uses the treasury stock method to determine whether there is a dilutive
effect of outstanding potentially dilutive securities, and the if-converted method to assess the dilutive effect of the convertible
notes.
There was no dilutive effect for the outstanding awards for
the three months ended March 31, 2017 and 2016, respectively, as the Company reported a net loss for both periods. However, if
the Company had net income for the three months ended March 31, 2017, the potentially dilutive securities included in the earnings
per share computation would have been 8,690,710. If the Company had net income for the three months ended March 31, 2016, the potentially
dilutive securities included in the earnings per share computation would have been 2,608,695.
Total outstanding potentially dilutive securities were comprised
of the following:
|
|
As of March 31,
|
|
|
2017
|
|
2016
|
Stock options
|
|
|
192,307
|
|
|
|
192,307
|
|
Warrants
|
|
|
1,389,378
|
|
|
|
100,000
|
|
Unvested restricted stock
|
|
|
670,170
|
|
|
|
350,999
|
|
Convertible notes
|
|
|
8,619,624
|
|
|
|
2,608,695
|
|
Total common stock equivalents
|
|
|
10,871,479
|
|
|
|
3,252,001
|
|
Note 12. Income Taxes
The Company recorded a tax provision of $28,000 and $0.1
million for the three months ended March 31, 2017 and 2016, respectively.
Income taxes are provided for the tax effects of transactions
reported in the Condensed Consolidated Financial Statements and consist of taxes currently due. Deferred taxes relate to differences
between the basis of assets and liabilities for financial and income tax reporting which will be either taxable or deductible when
the assets or liabilities are recovered or settled. In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred income tax assets will not be realized. The ultimate
realization of deferred income tax assets is dependent upon the generation of future taxable income during the periods in which
those temporary differences become deductible. Management considers the scheduled reversal of deferred income tax liabilities,
projected future taxable income, and tax planning strategies in making this assessment. Based on consideration of these items,
management has established a full valuation allowance as it is more likely than not that the tax benefits will not be realized
as of March 31, 2017.
Note 13. 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,
|
|
|
2017
|
|
2016
|
Revenue, net:
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
17,590
|
|
|
$
|
29,692
|
|
International
|
|
|
8,419
|
|
|
|
13,220
|
|
Total revenue, net
|
|
$
|
26,009
|
|
|
$
|
42,912
|
|
Note 14. Related Party Transactions
Chief Executive Officer, President
and Chairman Convertible Secured Promissory Note Agreements and Debt Guaranty
In November 2016, the Company entered into the 2016 Convertible
Note with Mr. Ryan Drexler, pursuant to which Mr. Drexler loaned the Company $11.0 million. Proceeds from the note were
used to fund settlement of litigation. The 2016 Convertible Note is secured by all assets and properties of the Company and its
subsidiaries, whether tangible or intangible. The 2016 Convertible Note was still outstanding as of March 31, 2017. See Note 7
for additional information.
In December 2015, the Company entered
into the 2015 Convertible Note with Mr. Drexler, pursuant to which he loaned the Company $6.0 million. Proceeds from
the note were used to fund working capital requirements. The convertible note is secured by all assets and properties of the Company
and its subsidiaries whether tangible or intangible. In connection with the Company entering into the 2015 Convertible Note with
Mr. Drexler, the Company granted Mr. Drexler the right to designate two directors to the Board. The Company agreed to
take all actions necessary to permit such designation. The 2015 Convertible Note was still outstanding as of March 31, 2017. See
additional information in Note 7.
For the three months ended March 31, 2017 and 2016, interest
expense related to the related party convertible secured promissory notes was $0.4 million and $0.1 million, respectively. During
the three months ended March 31, 2017 and 2016, $0.4 million and $0.1 million, respectively, in interest was paid in cash to Mr.
Drexler.
Key Executive Life Insurance
The Company had purchased split
dollar life insurance policies on certain key executives. These policies provide a split of 50% of the death benefit proceeds to
the Company and 50% to the officer’s designated beneficiaries. None of these key executives are currently employed by the
Company, and all policies were terminated or transferred to the former employees as of December 31, 2016.
Note 15. 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
None.