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 Burbank, California and as of March 31, 2018 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, the continued reduction
in ongoing operating costs and expense controls, and growth
strategy, will enable us to ultimately achieve profitability.
Management believes that the Company has sufficiently reduced its
operating expenses, and that the Company’s ongoing sources of
revenue that will be sufficient to cover these expenses for the
foreseeable future. The Company can give no assurances that this
will occur.
As of March 31, 2018, the Company had a stockholders’ deficit
of $14.6 million and recurring losses from operations. To manage
cash flow, the Company entered into a secured borrowing
arrangement, pursuant to which the Company has the ability to
borrow up to $12.5 million subject to sufficient amounts of
accounts receivable to secure the loan. The secured borrowing
arrangement’s term has been extended to July 31, 2018. In
October 2017, the Company also entered into a loan and security
agreement to borrow against the Company’s inventory up to a
maximum of $3.0 million for an initial six-month term which was
automatically extended for six additional months. As of March 31,
2018, the Company owed $2.0 million under this loan and security
agreement.
On November 3, 2017, the Company entered into a refinancing
transaction with Mr. Ryan Drexler, the Company’s Chairman of
the Board, Chief Executive Officer and President, to restructure
all of the $18.0 million in notes payable to him, which are now due
on December 31, 2019. Accordingly, such debt is classified as a
long-term liability at March 31, 2018.
As of March 31, 2018, the Company had approximately $5.1 million in
cash and $0.3 million in working capital.
The accompanying Condensed Consolidated Financial Statements as of
and for the quarter ended March 31, 2018 was 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 could be necessary should we be required to
liquidate our assets.
The Company’s ability to continue as a going concern and
raise capital for specific strategic initiatives could also depend
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.
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 the Company can
give no assurances that Mr. Drexler will be willing or able to do
so at a future date and/or that he will not demand payment of his
refinanced convertible note on December 31, 2019.
Our capital resources as of March 31, 2018, available borrowing
capacity and current operating plans are expected to be sufficient
to fund the planned operations for at least twelve months from the
date of filing this report.
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, 2018, results of operations
for the three months ended March 31, 2018 and 2017, and cash
flows for the three months ended March 31, 2018 and 2017. The
results of operations for the three ended March 31, 2018 are
not necessarily indicative of the results to be expected for the
year ending December 31, 2018.
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, 2017,
filed with the SEC on April 2, 2018.
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
The Company's previous revenue recognition policy was to recognize
revenue when persuasive evidence of an arrangement existed,
delivery had occurred, the fee was fixed or determinable and
collection was reasonably assured.
The Company’s standard terms and conditions of sale allowed
for product returns or replacements in certain cases. Estimates of
expected future product returns were recognized at the time of sale
based on analyses of historical return trends by customer type.
Upon recognition, the Company reduced revenue and cost of revenue
for the estimated return. Return rates could fluctuate over time,
but were sufficiently predictable with established customers to
allow the Company to estimate expected future product returns, and
an accrual was recorded for future expected returns when the
related revenue was recognized.
The Company also offered sales incentives through various programs,
consisting primarily of volume incentive rebates and sales
incentive reserves. Volume incentive rebates were provided to
certain customers based on contractually agreed upon percentages
once certain thresholds had been met. Sales incentive reserves were
computed based on historical trending and budgeted discount
percentages, which were typically based on historical discount
rates with adjustments for any known changes, such as future
promotions or one-time historical promotions that would not repeat
for each customer. The Company recorded sales incentive reserves
and volume rebate reserves as a reduction to revenue.
With the adoption of ASC 606, the Company reviewed its previous
revenue recognition policy as described above and under ASC 606 the
Company determined that there were no material changes resulting
from the adoption. Revenue would be recognized when control of the
promised goods or services is transferred to the Company’s
customers in an amount that reflects the consideration the Company
expects to be entitled to in exchange for those goods or services.
This is consistent with the revenue recognition policy previously
used by the Company. The Company also reviewed the timing and
recognition of accounts receivable within the different
distribution channels for which the Company generates
revenue.
During the three months ended March 31, 2018 and 2017, the Company
recorded discounts, and to a lesser degree, sales returns, totaling
$4.9 million and $8.0 million, respectively, which accounted for
16% and 23% 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,
|
|
|
|
Customers
|
|
|
Costco
Wholesale Corporation
|
37
%
|
35
%
|
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
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.
Note 3. Fair Value of Financial Instruments
Management believes the fair values of the obligations under the
secured borrowing arrangements and the convertible notes with a
related party approximate carrying value because the debt carries
market rates of interest available to the Company. The
Company’s remaining financial instruments consisted primarily
of accounts receivable, accounts payable, accrued liabilities and
accrued restructuring charges, all of which are short-term in
nature with fair values approximating carrying value. As of March
31, 2018 and December 31, 2017, the Company held no assets or
liabilities that required re-measurement 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 following table illustrates the provision of the restructuring
charges and the accrued restructuring charges balance as of March
31, 2018 (in thousands):
|
Contract Termination Costs
|
Purchase Commitment of Discontinued Inventories Not Yet
Received
|
Abandoned Lease Facilities
|
|
Balance
as of December 31, 2017
|
$
308
|
$
175
|
$
232
|
$
715
|
Expensed
|
—
|
—
|
132
|
132
|
Cash
payments
|
—
|
—
|
(177
)
|
(177
)
|
Balance
as of March 31, 2018
|
308
|
175
|
187
|
670
|
The total future payments under the restructuring plan as of March
31, 2018 are as follows (in thousands):
|
For the Years Ending December 31,
|
Outstanding Payments
|
|
|
|
|
Contract
termination costs
|
$
308
|
$
—
|
$
—
|
$
308
|
Purchase
commitment of discontinued inventories not yet
received
|
175
|
—
|
—
|
175
|
Abandoned
leased facilities
|
67
|
91
|
29
|
187
|
Total
future payments
|
$
550
|
$
91
|
$
29
|
$
670
|
Note 5. Balance Sheet Components
Inventory
Inventory consisted solely of finished goods as of March 31, 2018
and December 31, 2017.
The Company records charges for obsolete and slow-moving inventory
based on the age of the product as determined by the expiration
date or otherwise determined to be obsolete. Products within one
year of their expiration dates are considered for write-off
purposes. Historically, the Company has had minimal returns with
established customers. Other than write-off of inventory during
restructuring activities, the Company incurred insignificant
inventory write-offs during the three months ended March 31, 2018
and 2017. Inventory write-downs, once established, are not reversed
as they establish a new cost basis for the inventory.
Property and Equipment
Property and equipment consisted of the following as of March 31,
2018 and December 31, 2017 (in thousands):
|
|
|
Furniture,
fixtures and equipment
|
$
3,614
|
$
3,597
|
Leasehold
improvements
|
2,044
|
2,044
|
Manufacturing
and lab equipment
|
3
|
3
|
Vehicles
|
86
|
86
|
Displays
|
484
|
485
|
Website
|
462
|
462
|
Property
and equipment, gross
|
6,693
|
6,677
|
Less:
accumulated depreciation and amortization
|
(5,061
)
|
(4,855
)
|
Property
and equipment, net
|
$
1,632
|
$
1,822
|
Depreciation and amortization expense related to property and
equipment was $0.2 million and $0.3 million for the three months
ended March 31, 2018 and 2017, respectively, which is included in
“Selling, general, and administrative” expense in the
accompanying Condensed Consolidated Statements of
Operations.
Intangible Assets
Intangible assets consisted of the following (in
thousands):
|
|
|
|
|
|
Remaining Weighted-Average Useful Lives (years)
|
Amortized Intangible Assets
|
|
|
|
|
Brand
(apparel rights)
|
$
2,244
|
$
(1,007
)
|
$
1,237
|
3.9
|
Total
intangible assets
|
$
2,244
|
$
(1,007
)
|
$
1,237
|
|
|
|
|
|
|
|
Remaining Weighted-Average Useful Lives (years)
|
Amortized Intangible Assets
|
|
|
|
|
Brand
(apparel rights)
|
$
2,244
|
$
(927
)
|
$
1,317
|
4.1
|
Total
intangible assets
|
$
2,244
|
$
(927
)
|
$
1,317
|
|
Intangible assets amortization expense was $0.1 million for each of
the three months ended March 31, 2018 and 2017, respectively, which
is included in “Selling, general, and administrative”
expense in the accompanying Condensed Consolidated Statements of
Operations.
As of March 31, 2018, the estimated future amortization expense of
intangible assets is as follows (in thousands):
For the Year Ending December 31,
|
|
Remainder
of 2018
|
$
241
|
2019
|
321
|
2020
|
321
|
2021
|
321
|
2022
|
33
|
Total
amortization expense
|
$
1,237
|
Note 6. Other Expense, net
For the three months ended March 31, 2018 and 2017, “Other
expense, net” consisted of the following (in
thousands):
|
For the Three Months
Ended March 31,
|
|
|
|
Other
expense, net:
|
|
|
Interest
expense, related party
|
$
(541
)
|
$
(422
)
|
Interest
expense, related party debt discount
|
(248
)
|
-
|
Interest
expense, other
|
(67
)
|
(159
)
|
Interest
expense, secured borrowing arrangement
|
(346
)
|
(104
)
|
Foreign
currency transaction loss
|
(113
)
|
(12
)
|
Other
|
5
|
(281
)
|
Total
other expense, net
|
$
(1,310
)
|
$
(978
)
|
Note 7. Debt
As of March 31, 2018 and December 31, 2017, the Company’s
debt consisted of the following (in thousands):
|
|
|
2017
Refinanced Convertible Note due December 31, 2019 with a related
party
|
$
18,000
|
$
18,000
|
Obligations
under secured borrowing arrangement
|
5,547
|
5,385
|
Secured
line of credit
|
2,000
|
3,000
|
Unamortized
debt discount with a related party
|
(1,083
)
|
(1,331
)
|
Total
debt
|
24,464
|
25,054
|
Less:
current portion
|
(7,547
)
|
(8,385
)
|
Long
term debt
|
$
16,917
|
$
16,669
|
Related-Party Notes Payable
On
November 3, 2017, the Company entered into a refinancing
transaction (the “Refinancing”) with Mr. Ryan Drexler,
the Company’s Chairman of the Board of Directors, Chief
Executive Officer and President. As part of the Refinancing, the
Company issued to Mr. Drexler an amended and restated convertible
secured promissory note (the “Refinanced Convertible
Note”) in the original principal amount of $18,000,000, which
amends and restates (i) a convertible secured promissory note dated
as of December 7, 2015, and amended as of January 14, 2017, in the
original principal amount of $6,000,000 with an interest rate of 8%
prior to the amendment and 10% following an amendment (the
“2015 Convertible Note”), (ii) a convertible secured
promissory note dated as of November 8, 2016, in the original
principal amount of $11,000,000 with an interest rate of 10% (the
“2016 Convertible Note”) , and (iii) a secured demand
promissory note dated as of July 27, 2017, in the original
principal amount of $1,000,000 with an interest rate of 15% (the
“2017 Note”, and together with the 2015 Convertible
Note and the 2016 Convertible Note, collectively, the “Prior
Notes”). The due date of the 2015 Convertible Note and the
2016 Convertible Note was November 8, 2017. The 2017 Note was due
on demand.
The
$18.0 million Refinanced Convertible Note bears interest at the
rate of 12% per annum. Interest payments are due on the last day of
each quarter. At the Company’s option (as determined by its
independent directors), the Company may repay up to one-sixth of
any interest payment by either adding such amount to the principal
amount of the note or by converting such interest amount into an
equivalent amount of the Company’s common stock. Any interest
not paid when due shall be capitalized and added to the principal
amount of the Refinanced Convertible Note and bear interest on the
applicable interest payment date along with all other unpaid
principal, capitalized interest, and other capitalized
obligations.
Both
the principal and the interest under the Refinanced Convertible
Note are due on December 31, 2019, unless converted
earlier.
Mr.
Drexler may convert the outstanding principal and accrued interest
into shares of the Company’s common stock at a conversion
price of $1.11 per share at any time. The Company may prepay the
Refinanced Convertible Note by giving Mr. Drexler between 15 and 60
days’ notice depending upon the specific circumstances,
subject to Mr. Drexler’s conversion right.
The
Refinanced Convertible Note contains customary events of default,
including, among others, the failure by the Company to make a
payment of principal or interest when due. Following an event of
default, interest will accrue at the rate of 14% per annum. In
addition, following an event of default, any conversion,
redemption, payment or prepayment of the Refinanced Convertible
Note will be at a premium of 105%. The Refinanced Convertible Note
also contains customary restrictions on the ability of the Company
to, among other things, grant liens or incur indebtedness other
than certain obligations incurred in the ordinary course of
business. The restrictions are also subject to certain additional
qualifications and carveouts, as set forth in the Refinanced
Convertible Note. The Refinanced Convertible Note is subordinated
to certain other indebtedness of the Company.
As part
of the Refinancing, the Company and Mr. Drexler entered into a
restructuring agreement (the “Restructuring Agreement”)
pursuant to which the parties agreed to enter into the Refinanced
Convertible Note and to amend and restate the security agreement
pursuant to which the Prior Notes were secured by all of the assets
and properties of the Company and its subsidiaries whether tangible
or intangible, by entering into the Third Amended and Restated
Security Agreement (the “Amended Security Agreement”).
Pursuant to the Restructuring Agreement, the Company agreed to pay,
on the effective date of the Refinancing, all outstanding interest
on the Prior Notes through November 8, 2017 and certain fees and
expenses incurred by Mr. Drexler in connection with the
Restructuring.
In
connection with the refinancing, the Company recorded a debt
discount of $1.2 million. The debt discount is equal to the change
in the fair value of the conversion option between the Refinanced
Convertible Note and the Prior Notes. The fair value of the
conversion option was determined using a Monte Carlo simulation and
the model of stock price behavior known as GBM which simulates a
future period as a random step from a previous period. Significant
assumptions were: expected stock price premium of 40%, expected
trading days of 252 days, and volatility of 60%.
In
addition, the Refinanced Convertible Note contains two embedded
derivatives for default interest and an event of default put. Due
to the unlikely event of default, the embedded derivatives have a
de minimis value as of March 31, 2018.
For the
three months ended March 31, 2018 and 2017, interest expense
related to the related party
notes was
$0.8 million and $0.4 million, respectively. During the three
months ended March 31, 2018 and 2017, $0.3
million and $0.4
million, respectively, in interest was paid in cash to Mr.
Drexler.
Inventory Financing
On
October 6, 2017, the Company and its affiliate (together with the
Company, “Borrower”) entered into a Loan and Security
Agreement (“Security Agreement”) with Crossroads
Financial Group, LLC (“Crossroads”). Pursuant to the
Security Agreement, the Company may borrow up to 70% of its
Inventory Cost
or up to
75% of Net Orderly Liquidation Value (each as defined in the
Security Agreement), up to a maximum amount of $3.0 million at an
interest rate of 1.5% per month, subject to a minimum monthly fee
of $22,500. The initial term of the Security Agreement is six
months from the date of execution, and such initial term is
extended automatically in six-month increments, unless earlier
terminated pursuant to the terms of the Security Agreement. The
Security Agreement contains customary events of default, including,
among others, the failure to make payments on amounts owed when
due, default under any other material agreement or the departure of
Mr. Drexler. The Security Agreement also contains customary
restrictions on the ability of the Company to, among other things,
grant liens, incur debt and transfer assets. Under the Security
Agreement, the Company has agreed to grant Crossroads a security
interest in all of the Company’s present and future accounts,
chattel paper, goods (including inventory and equipment),
instruments, investment property, documents, general intangibles,
intangibles, letter of credit rights, commercial tort claims,
deposit accounts, supporting obligations, documents, records and
the proceeds ther
eof. As of March 31,
2018, the Company owed $2.0 million to Crossroads under this
agreement.
Secured Borrowing Arrangement
In January 2016, the Company entered into a Purchase and Sale
Agreement (the “Purchase and Sale Agreement”) with
Prestige Capital Corporation (“Prestige”) pursuant to
which the Company agreed to sell and assign and Prestige agreed to
buy and accept, certain accounts receivable owed to the Company
(“Accounts”). Under the terms of the Purchase and Sale
Agreement, upon the receipt and acceptance of each assignment of
Accounts, Prestige will pay the Company 80% of the net face
amount of the assigned Accounts, up to a maximum total borrowings
of $12.5 million subject to sufficient amounts of accounts
receivable to secure the loan. The remaining 20% will be paid to
the Company upon collection of the assigned Accounts, less any
chargeback, disputes, or other amounts due to Prestige.
Prestige’s purchase of the assigned Accounts from the Company
will be at a discount fee which varies based on the number of days
outstanding from the assignment of Accounts to collection of the
assigned Accounts. In addition, the Company granted Prestige a
continuing security interest in and lien upon all accounts
receivable, inventory, fixed assets, general intangibles and other
assets. The Purchase and Sale Agreement’s term has been
extended to July 31, 2018. At March 31, 2018, we had approximately
$5.5 million of outstanding borrowings under the Purchase and Sale
Agreement.
During
the three months ended March 31, 2018, the Company sold to Prestige
accounts with an aggregate face amount of approximately $16.9
million, for which Prestige paid to the Company approximately $13.5
million in cash. During the three months ended March 31, 2018,
$13.3 million was repaid to Prestige, including fees and
interest.
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 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 2022. The amounts
reflected in the table below are for the aggregate future minimum
lease payments under non-cancelable facility operating leases for
properties that have not been abandoned as part of the
restructuring plan. See Note 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 $0.2 million and $0.1 million
for the three months ended March 31, 2018 and 2017,
respectively.
As of March 31, 2018, future minimum lease payments are as follows
(in thousands):
For the Year Ending December 31,
|
|
Remainder
of 2018
|
$
645
|
2019
|
845
|
2020
|
735
|
2021
|
481
|
2022
|
369
|
Thereafter
|
—
|
Total
minimum lease payments
|
$
3,075
|
Capital Leases
As of March 31, 2018, the Company was leasing two vehicles under a
fleet leasing agreement which were included in “Property and
equipment, net” in the accompanying Consolidated Balance
Sheets. The original cost of leased assets was $86,000 and the
associated accumulated depreciation was $60,000 as of March 31,
2018
.
The Company also leases manufacturing and
warehouse equipment under capital leases, which expire at various
dates through February 2020.
As of March 31, 2018 and December 31, 2017, short-term capital
lease liabilities of $119,000 and $126,000, respectively, were
included as a component of current accrued liabilities, and the
long-term capital lease liabilities of $119,000 and $146,000,
respectively, were included as a component of long-term liabilities
in the accompanying Condensed Consolidated Balance
Sheets.
As of March 31, 2018, the Company’s future minimum lease
payments under capital lease agreements, are as follows (in
thousands):
For the Year Ending December 31,
|
|
Remainder
of 2018
|
$
99
|
2019
|
101
|
2020
|
50
|
Total
minimum lease payments
|
250
|
Less
amounts representing interest
|
(12
)
|
Present
value of minimum lease payments
|
$
238
|
Purchase Commitment
Upon the completion of the sale of BioZone, the Company entered
into a manufacturing and supply agreement whereby the Company is
required to purchase a minimum of approximately $2.5 million of
products per year from BioZone annually for an initial term of
three years. If the minimum order quantities of specific products
are not met, a $3.0 million minimum purchase of other products must
be met in order to waive the shortfall, which is at 25% of the
realized shortfall. Due to the timing of achieving the minimum
purchase quantities, we are below these targets. As a result, we
have provided for the estimated purchase commitment shortfall
adjustment in the three months ended March 31, 2018.
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 has agreed to pay CFG a sum of $3
million, consisting of a $1 million payment that was advanced by a
related party on July 7, 2017, and subsequent $1 million
installments to be paid by July 7, 2018 and July 7, 2019,
respectively. The 2018 payment is accrued in current liabilities
and the 2019 payment is accrued in other long-term
liabilities.
The Company recorded a charge in its Statement of Operations for
the year ended December 31, 2017 for approximately $1.5 million,
representing the discounted value of the unrecorded settlement
amount. During the three months ended March 31, 2018, the Company
recorded a charge of $0.1 million, representing imputed
interest.
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, 2018, the Company was
involved in the following material legal proceedings described
below.
ThermoLife
In January 2016, ThermoLife International LLC
(“ThermoLife”), a supplier of nitrates to MusclePharm,
filed a complaint against the Company in Arizona state court. In
its complaint, ThermoLife alleges that the Company failed to meet
minimum purchase requirements contained in the parties’
supply agreement and seeks monetary damages for the deficiency in
purchase amounts. In March 2016, the Company filed an answer
to ThermoLife’s complaint, denying the allegations contained
in the complaint, and filed a counterclaim alleging that ThermoLife
breached its express warranty to MusclePharm because
ThermoLife’s products were defective and could not be
incorporated into the Company’s products. Therefore, the
Company believes that ThermoLife’s complaint is without
merit. The lawsuit continues to be in the discovery
phase.
Former Executive Lawsuit
In December 2015, the Company accepted notice by Mr. Richard
Estalella (“Estalella”) to terminate his employment as
the Company’s President. Although Estalella sought to
terminate his employment with the Company for “Good
Reason,” as defined in Estalella’s employment agreement
with the Company (the “Employment Agreement”), the
Company advised Estalella that it deemed his resignation to be
without Good Reason.
In February 2016, Estalella filed a complaint in Colorado state
court against the Company and Ryan Drexler, Chairman of the Board,
Chief Executive Officer and President, alleging, among other
things, that the Company breached the Employment Agreement, and
seeking certain equitable relief and unspecified damages. The
Company believes Estalella’s claims are without merit. As of
the date of this report, the Company has evaluated the potential
outcome of this lawsuit and recorded the liability consistent with
its policy for accruing for contingencies. The discovery phase of
the lawsuit has concluded and the Company was preparing for trial
which was scheduled to commence on May 7, 2018. On May 7, 2018, the
Court vacated the trial in contemplation of the parties’
settlement of this matter. Settlement discussions are in
progress.
Insurance Carrier Lawsuit
The Company is engaged in litigation with an insurance carrier,
Liberty Insurance Underwriters, Inc. (“Liberty”),
arising out of Liberty’s denial of coverage. In 2014, the
Company sought coverage under an insurance policy with Liberty
for claims against directors and officers of the Company arising
out of an investigation by the Securities and Exchange Commission
(“SEC”). Liberty denied coverage, and, on February 12,
2015, the Company filed a complaint in the District Court, City and
County of Denver, Colorado against Liberty claiming wrongful and
unreasonable denial of coverage for the cost and expenses incurred
in connection with the SEC investigation and related matters.
Liberty removed the complaint to the United States District Court
for the District of Colorado, which in August 2016 granted
Liberty’s motion for summary judgment, denying coverage and
dismissing the Company’s claims with prejudice, and denied
the Company’s motion for summary judgment. The Company filed
an appeal in November 2016. The Company filed its opening brief on
February 1, 2017 and Liberty filed its response brief on April 7,
2017. The Company filed its reply brief on May 5, 2017. The case
moved to the 10
th
Circuit Court of Appeals. In October
2017, the 10
th
Circuit affirmed the lower
court’s grant of summary judgment in favor of Liberty. The
Company is currently working with Liberty to determine what amounts
are recoverable under the policy that fall outside of the
litigation.
IRS Audit
On April 6, 2016, the Internal Revenue Service (“IRS”)
selected the Company’s 2014 Federal Income Tax Return for
audit. As a result of the audit, the IRS proposed certain
adjustments with respect to the tax reporting of the
Company’s former executives’ 2014 restricted stock
grants. Due to the Company’s current and historical loss
position, the proposed adjustments would have no material impact on
its Federal income tax. On October 5, 2016, the IRS commenced an
audit of the Company’s employment and withholding tax
liability for 2014. The IRS is contending that the Company
inaccurately reported the value of the restricted stock grants and
improperly failed to provide for employment taxes and federal tax
withholding on these grants. In addition, the IRS is proposing
certain penalties associated with the Company’s filings. On
April 4, 2017, the Company received a “30-day letter”
from the IRS asserting back taxes and penalties of approximately
$5.3 million, of which $0.4 million related to employment taxes and
$4.9 million related to federal tax withholding and penalties.
Additionally, the IRS is asserting that the Company owes
information reporting penalties of approximately $2.0 million. The
Company’s counsel has submitted a formal protest to the IRS
disputing on several grounds all of the proposed adjustments and
penalties on the Company’s behalf, and the Company intends to
pursue this matter vigorously through the IRS appeal process. Due
to the uncertainty associated with determining the Company’s
liability for the asserted taxes and penalties, if any, and to the
Company’s inability to ascertain with any reasonable degree
of likelihood, as of the date of this report, the outcome of the
IRS appeals process, the Company has recorded an estimate for its
potential liability, if any, associated with these
taxes.
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, 2018 are as follows (in
thousands):
|
For the Years Ending December 31,
|
|
|
|
|
Outstanding Payments
|
|
|
|
Endorsement
|
$
191
|
$
62
|
$
253
|
Sponsorship
|
67
|
55
|
122
|
Total
future payments
|
$
258
|
$
117
|
$
375
|
Note 9. Stockholders’ Deficit
Common Stock
For the three months ended March 31, 2018, the Company had the
following transactions related to its common stock including
restricted stock awards (in thousands, except share and per share
data):
Transaction Type
|
|
|
|
Stock
issued to related party for interest
|
81,133
|
$
52
|
0.65
|
Total
|
81,133
|
$
52
|
$
0.65
|
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 March 31, 2018 and December 31, 2017
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 related to the settlement of a dispute between the Company
and Capstone. 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.
Note 10. Stock-Based Compensation
Restricted Stock
The Company’s stock-based compensation for the three months
ended March 31, 2018 and 2017 consist primarily of restricted stock
awards. The activity of restricted stock awards granted to
employees, executives and Board members was as
follows:
|
Unvested Restricted Stock Awards
|
|
|
Weighted Average
Grant
Date
Fair
Value
|
Unvested
balance – December 31, 2017
|
487,267
|
$
2.32
|
Granted
|
—
|
—
|
Vested
|
(383,423
)
|
1.95
|
Cancelled
|
—
|
—
|
Unvested
balance – March 31, 2018
|
103,844
|
3.70
|
The total fair value of restricted stock awards granted to
employees and the Board was $0.7 million for the three months ended
March 31, 2017. There were no restricted stock awards granted
during the three months ended March 31, 2018. As of March 31, 2018,
the total unrecognized expense for unvested restricted stock
awards, net of expected forfeitures, was $0.4 million, which is
expected to be amortized over a weighted average period of 0.6
years.
Restricted Stock Awards Issued to Ryan Drexler, Chairman of the
Board, Chief Executive Officer and President
In January 2017, the Company issued Mr. Drexler 350,000 shares of
restricted stock pursuant to an Amended and Restated Executive
Employment Agreement dated November 18, 2016 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 vested in full upon the first anniversary of
the grant date.
Accelerated Vesting of Restricted Stock Awards Related to
Terminations of Employment
In March 2017, Brent Baker, the Company’s former Executive
Vice President of International Business, terminated employment
with the Company. In connection with his termination of employment
in March 2017, 10,000 shares of restricted stock held by Mr. Baker
vested in full upon his termination of employment 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 $42,902, which is included in
“Salaries and Benefits” in the accompanying
Consolidated Statements of Operations for the three months ended
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 Incentive Compensation Plan (the “2015
Plan”). Under the 2015 Plan, all stock options are granted
with an exercise price equal to or greater than the fair market
value of a share of the Company’s common stock on the date of
grant. Vesting is generally determined by the Compensation
Committee of the Board within limits set forth in the 2015 Plan. No
stock option will be exercisable more than ten years after the date
it is granted.
In February 2016, the Company issued options to purchase 137,362
shares of its common stock to Mr. Drexler, the Company’s
Chairman of the Board, Chief Executive Officer, and President, and
options to purchase 54,945 shares of its common stock to Michael
Doron, the former Lead Director of the Board. Upon resignation from
the Board of Directors in June 2017, Mr. Doron forfeited 20,604 of
the options issued. These stock options were granted with an
exercise price of $1.89 per share, a contractual term of 10 years
and a grant date fair value of $1.72 per share, or $0.3 million in
the aggregate, which 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-range used
|
118.4%-131.0%
|
|
Expected volatility-weighted average
|
125.7%
|
|
Risk-free interest rate-range used
|
1.27%-1.71%
|
|
For the three months ended March 31, 2018 and 2017, the Company
recorded stock compensation expense related to options of $16,000
and $0.1 million, 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, 2018 and 2017, 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,
|
|
|
|
Net
loss
|
$
(2,305
)
|
$
(3,149
)
|
Weighted
average common shares used in computing net loss per share, basic
and diluted
|
14,615,677
|
13,773,508
|
Net
loss per share, basic and diluted
|
$
(0.16
)
|
$
(0.23
)
|
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, 2018 and 2017, as the Company reported
a net loss for both periods. However, if the Company had net income
for the three months ended March 31, 2018, the potentially dilutive
securities included in the earnings per share computation would
have been 17,881,141
.
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 10,871,479.
Total outstanding potentially dilutive securities were comprised of
the following:
|
|
|
|
|
Stock
options
|
171,703
|
192,307
|
Warrants
|
1,389,378
|
1,389,378
|
Unvested
restricted stock
|
103,844
|
670,170
|
Convertible
notes
|
16,216,216
|
8,619,624
|
Total
common stock equivalents
|
17,881,141
|
10,871,479
|
Note 12. Income Taxes
The Company recorded a tax provision of $69,000 and $28,000 for the
three months ended March 31, 2018 and 2017,
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, 2018.
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,
|
|
|
|
Revenue,
net:
|
|
|
United
States
|
$
15,300
|
$
17,590
|
International
|
11,247
|
8,419
|
Total
revenue, net
|
$
26,547
|
$
26,009
|
Note 14. 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.