Notes to Consolidated Financial Statements
(Unaudited)
Note 1. Description of Business
Description of Business
MusclePharm
Corporation was incorporated in Nevada in 2006. Except as otherwise
indicated herein or the context requires otherwise, the terms
“MusclePharm,” the “Company,”
“we,” “our” and “us” refer to
MusclePharm Corporation and its subsidiaries. The Company is a
scientifically-driven, performance lifestyle company
that develops, manufactures, markets and distributes
branded sports nutrition products and nutritional
supplements. Our portfolio of
recognized brands, including MusclePharm®
and FitMiss®,
is marketed and sold in more than 100 countries
globally. The Company is headquartered in Burbank,
California and, as of September 30, 2019, had the following
wholly-owned operating subsidiaries: MusclePharm Canada Enterprises
Corp., MusclePharm Ireland Limited and MusclePharm Australia Pty
Limited.
The Company has incurred significant losses and experienced
negative cash flows since inception. As of September 30,
2019, the Company had cash of $1.5 million, a decline of $0.8
million from the December 31, 2018 balance of $2.3 million. As of
September 30, 2019, we had a working capital deficit of $26.3
million, a stockholders’ deficit of $24.6 million and an
accumulated deficit of $192.4 million resulting from recurring
losses from operations. As a result of
our history of losses and financial condition, there is substantial
doubt about our ability to continue as a going concern.
For financial information concerning
more recent periods, see our reports for such periods filed with
the Securities and Exchange Commission.
The ability to continue as a going concern is dependent upon us
generating profits in the future and/or obtaining the necessary
financing to meet our obligations and repay our liabilities arising
from normal business operations when they come due. Management is
evaluating different strategies to obtain financing to fund our
expenses and achieve a level of revenue adequate to support our
current cost structure. Financing strategies may include, but are
not limited to, private placements of capital stock, debt
borrowings, partnerships and/or collaborations.
In response to the Company’s continued losses, in 2018,
management implemented the following plans to improve the
Company’s operating costs:
1)
reduced
our workforce;
2)
renegotiated
or terminated a number of contracts with endorsers in a strategic
shift away from such arrangements and toward more cost-effective
marketing and advertising efforts; and
3)
discontinued
a number of stock keeping units (“SKUs”) and wrote down
inventory to net realizable value, or to zero in cases where the
product was discontinued.
Despite these measures, during 2019, the Company continued to incur
substantial losses.
In order to improve the Company’s operating results,
management has continued to focus on its 2018 initiatives. In
addition, during the fourth quarter of 2019, management implemented
the following measures to improve gross margin:
1)
reduced
or eliminated sales to low or negative margin
customers;
2)
reduced
product discounts and promotional activity;
3)
implemented
a more aggressive SKU reduction; and
4)
formed
a pricing committee to review all orders to better align gross
margin expectations with product availability.
As a result of these measures, as well as a reduction in protein
prices, the Company realized increased gross margins in the fourth
quarter of 2019, a trend which continued through the first
and second quarters of 2020.
Beginning in April 2020, the Company began to experience a
slowdown, which has continued to date, in sales from its retail
customers, including its largest customer. This decline has been
partially offset by a growth in sales to our largest online
customer, although there can be no assurances that such growth will
continue, or that the Company will have the financial resources to
produce the additional quantities required by this
customer.
Management believes reductions in operating costs, and continued
focus on gross margin, primarily pricing controls and a reduction
in product discounts and promotional activity with the
Company’s customers, will allow us to ultimately achieve
profitability, however, the Company can give no assurances that
this will occur.
To manage cash flow, the Company has entered into multiple
financing arrangements. See additional information in “Note
8. Debt.”
Our results of operations are affected by economic conditions,
including macroeconomic conditions and levels of business
confidence. There continues to be significant volatility and
economic uncertainty in many markets and the ongoing COVID-19
pandemic has increased that level of volatility and uncertainty and
has created economic disruption. We are actively managing our
business to respond to the impact.
Note 2. Summary of Significant Accounting Policies
Basis of Presentation and Principles of Consolidation
The
accompanying Consolidated Financial Statements have been prepared
using the accrual method of accounting in accordance with generally
accepted accounting principles in the United States
(“GAAP”) and have been
prepared on a going concern basis, which contemplates the
realization of assets and the settlement of liabilities in the
normal course of business. The Consolidated Financial
Statements include the accounts of MusclePharm Corporation and its
wholly-owned subsidiaries. All significant intercompany balances
and transactions have been eliminated in
consolidation.
Unaudited Interim Financial Information
The
accompanying unaudited interim 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 Consolidated Financial Statements
include all adjustments of a normal recurring nature necessary for
the fair presentation of the Company’s financial position as
of September 30, 2019,
results of operations for the three and nine months ended
September 30, 2019 and 2018,
and cash flows for the nine months ended September 30, 2019 and 2018. The results of
operations for the three and nine months ended September 30, 2019 are not necessarily
indicative of the results to be expected for the year
ended December 31, 2019.
These
unaudited interim Consolidated Financial Statements should be read
in conjunction with the consolidated financial statements and
related notes included in the Company’s Annual Report on Form
10-K for the year ended December 31, 2019, filed with the SEC
on August 24, 2020.
Use of Estimates
The preparation of consolidated financial statements in conformity
with GAAP requires management to make estimates and assumptions
that affect the amounts reported and disclosed in the consolidated
financial statements and accompanying notes. Such estimates
include, but are not limited to, allowance for doubtful accounts,
revenue discounts and allowances, the valuation of inventory and
deferred tax assets, the assessment of useful lives, recoverability
and valuation of long-lived assets, likelihood and range of
possible losses on contingencies, restructuring liabilities,
valuations of equity securities and intangible assets, fair value
of derivatives, warrants and options, present value of lease
liabilities among others. Actual results could differ from those
estimates.
Revenue Recognition
The
Company adopted ASC 606, “Revenue from Contracts with
Customers,” effective January 1, 2018. With the
adoption of the new standard, revenue is recognized when control of
the promised goods or services is transferred to the
Company’s customers in an amount that reflects the
consideration the Company expects to be entitled to in exchange for
those goods or services.
|
a.
|
Nature of Goods and Services
|
The
Company sells a variety of protein products through a broad
distribution platform that includes supermarkets, mass
merchandisers, wholesale clubs, drugstores, convenience stores,
home stores, specialty stores and websites and other e-commerce
channels, all of which sell our products to consumers.
|
b.
|
When Performance Obligations are Satisfied
|
For
performance obligations related to the shipping and invoicing of
products, control transfers at the point in time upon which
finished goods are delivered to the Company’s customers or
when finished goods are picked up by a customer or a
customer’s carrier, depending on shipping terms. Once a
product has been delivered or picked up by the customer, the
customer is able to direct the use of, and obtain substantially all
of the remaining benefits from the asset. The Company considers
control to have transferred upon delivery or customer receipt
because the Company has an enforceable right to payment at
that time, the customer has legal title to the asset,
the Company has transferred physical possession of the asset,
and the customer has significant risk and rewards of ownership of
the asset.
|
c.
|
Variable Consideration
|
The
Company conducts extensive promotional activities, primarily
through the use of off-list discounts, slotting, coupons,
cooperative advertising, periodic price reduction arrangements, and
end-aisle and other in-store displays. The costs of such
activities are netted against sales and are recorded when the
related sale takes place. The reserves for sales returns
and consumer and trade promotion liabilities are established based
on the Company’s best estimate of the amounts necessary to
settle future and existing obligations for products sold as of the
balance sheet date. To determine the
appropriate timing of recognition of consideration payable to a
customer, all consideration payable to our customers is reflected
in the transaction price at inception and reassessed
routinely.
The
Company expenses incremental direct costs of obtaining a contract
(broker commissions) when the related sale takes place since the
amortization period of the commissions paid for the sale of
products is less than a year. These costs are recorded in
“Selling, general and
administrative” expense in the accompanying
consolidated statements of operations.
The Company accounts for shipping and handling costs as fulfillment
activities which are therefore recognized upon shipment of the
goods. Shipping and handling costs related to inbound purchases of
raw material and finished goods are included in cost of
revenues in our consolidated statements of operations. For
the nine months ended September 30, 2019 and 2018, the Company
incurred $0.9 million and $1.4 million, respectively, of inbound
shipping and handling costs. Shipping and handling costs related to
shipments to our customers is included in “Selling, general
and administrative” expense in our consolidated statements of
operations. For the nine months ended September 30, 2019 and 2018,
the Company incurred $2.9 million and $3.2 million, respectively,
of shipping and handling costs related to shipments to our
customers.
The
Company excludes from its revenue any amounts collected from
customers for sales (and similar) taxes. During the nine months
ended September 30, 2019 and 2018, the Company recorded discounts,
and to a lesser degree, sales returns, totaling $22.5 million and
$24.1 million, respectively, which accounted for 27% and 26% of
gross revenue in each period, respectively.
The Company adopted ASC 606 using the modified retrospective method
and the cumulative effect of this change in accounting method for
the expected value of customer credits related to certain contracts
in place, as defined by ASC 606, is presented below:
|
Balance at December 31, 2017
|
|
Balance at January 1, 2018
|
Accounts
receivable, net
|
$11,105
|
$(1,053)
|
$10,052
|
Accumulated
deficit
|
$(165,069)
|
$(1,053)
|
$(166,122)
|
Concentrations
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of cash and
accounts receivable. The Company minimizes its credit risk
associated with cash by periodically evaluating the credit quality
of its primary financial institution. The cash balance at times may
exceed federally insured limits. Management believes the financial
risk associated with these balances is minimal and has not
experienced any losses to date.
Significant customers are those that represent more than 10% of the
Company’s net revenue or accounts receivable for each period
presented. For each significant customer, percentage of net revenue
and accounts receivable are as follows:
|
Percentage of
Net Revenue for the
Three Months
Ended September 30,
|
Percentage of
Net Revenue for the
Nine Months
Ended September 30,
|
Percentage of
Net Accounts
Receivable as
of
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Costco
|
34%
|
33%
|
33%
|
31%
|
34%
|
16%
|
Amazon
|
16%
|
17%
|
13%
|
12%
|
20%
|
22%
|
iHerb
|
18%
|
14%
|
16%
|
10%
|
*
|
*
|
|
|
|
|
|
|
|
*
Represents less than 10% of net revenue or net accounts
receivable.
The
Company uses a limited number of non-affiliated suppliers for
contract manufacturing of its products.
The
Company had the following concentration of purchases with contract
manufacturers:
|
For the Three
Months Ended
September
30,
|
For the Nine
Months Ended
September
30,
|
|
|
|
|
|
|
|
|
|
|
Nutra
Blend
|
19%
|
10%
|
25%
|
14%
|
S.K.
Laboratories
|
26%
|
22%
|
36%
|
23%
|
Bakery
Barn
|
10%
|
12%
|
*
|
13%
|
Prinova
|
*
|
32%
|
*
|
21%
|
JW
Nutritional
|
12%
|
*
|
*
|
*
|
Mill Haven
Foods
|
11%
|
*
|
*
|
*
|
|
|
|
|
|
*Represents
less than 10% of total purchases.
Share-Based Payments and Stock-Based Compensation
Share-based compensation awards, including stock options and
restricted stock awards, are recorded at estimated fair value on
the applicable awards’ grant date, based on the estimated
number of awards that are expected to vest. The grant date fair
value is amortized on a straight-line basis over the time in which
the awards are expected to vest, or immediately if no vesting is
required. Share-based compensation awards issued to non-employees
for services are recorded at fair value on the grant date. The fair
value of restricted stock awards is based on the fair value of the
stock underlying the awards on the grant date as there is no
exercise price.
The fair value of stock options is estimated using the
Black-Scholes option-pricing model. The determination of the fair
value of each stock award using this option-pricing model is
affected by the Company’s assumptions regarding a number of
complex and subjective variables. These variables include, but are
not limited to, the expected stock price volatility over the term
of the awards and the expected term of the awards based on an
analysis of the actual and projected employee stock option exercise
behaviors and the contractual term of the awards. Due to the
Company’s limited experience with the expected term of
options, the simplified method was utilized in determining the
expected option term as prescribed in Staff Accounting Bulletin No.
110. The Company recognizes stock-based compensation expense over
the requisite service period, which is generally consistent with
the vesting of the awards, based on the estimated fair value of all
stock-based payments issued to employees and directors that are
expected to vest.
Recent Accounting Pronouncements
In
February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which supersedes
Topic 840, Leases
(“ASU 2016-02”). The guidance in this new standard
requires lessees to put most leases on their balance sheets but
recognize expenses on their income statements in a manner similar
to the current accounting. The new lease standards also provide
practical expedients for an entity's ongoing accounting. In July
2018, the FASB issued ASU No. 2018-11, Leases (842), Targeted Improvements
(“ASU 2018-11”), which provides an additional
transition election to not restate comparative periods for the
effects of applying the new standard. This transition election
permits entities to apply ASU 2016-02 on the adoption date and
recognize a cumulative-effect adjustment to the opening balance of
accumulated deficit. These ASU's are effective for fiscal years,
and interim periods within those years, beginning after December
15, 2018.
The
Company adopted the ASUs, as of January 1, 2019, using the modified
retrospective transition method prescribed by ASU 2018-11. Under
this transition method, financial results reported in periods prior
to the first quarter of 2019 are unchanged. As a result of the
adoption of the ASUs, the Company recorded a right-of-use
(“ROU”) asset and liability of $2.1 million. Also as a
result of the adoption, the Company reclassified $0.2 million of
liabilities on its consolidated balance sheets as of January 1,
2019 against the operating lease ROU asset. The adoption of these
ASUs did not result in a cumulative-effect adjustment to the
opening balance of accumulated deficit.
In
addition, the Company elected the package of practical expedients
permitted by the transition guidance. The adoption of these
ASU’s did not have an impact on the Company’s
consolidated statements of operations or cash flows.
In July 2016, the FASB issued ASU No.
2016-13, Financial Instruments –
Credit Losses (Topic 326): Measurement of Credit Losses on
Financial Instruments (“ASU 2016-13”), which among other
things, these amendments require the measurement of all expected
credit losses of financial assets held at the reporting date based
on historical experience, current conditions, and reasonable and
supportable forecasts. Financial institutions and other
organizations will now use forward-looking information to better
inform their credit loss estimates. In addition, the ASU amends the
accounting for credit losses on available-for-sale debt securities
and purchased financial assets with credit deterioration. ASU
2016-13 is effective for periods beginning after December 15, 2019,
and interim periods within those fiscal years. The Company is in
the process of evaluating the impact of the
pronouncement.
On September 20, 2018, FASB issued Accounting Standards Update No.
2018-07, “Compensation - Stock Compensation” (Topic
718): Improvements to Nonemployee Share-Based Payment Accounting
(“ASU 2018-07”). ASU 2018-07 is intended to
reduce cost and complexity and to improve financial reporting for
share-based payments issued to non-employees. This ASU expands the
scope of ASC Topic 718, “Compensation - Stock
Compensation”, which currently only includes share-based
payments issued to employees, to also include share-based payments
issued to non-employees for goods and services. Consequently, the
accounting for share-based payments to non-employees and employees
will be substantially aligned. ASU 2018-07 supersedes ASC
Subtopic 505-50, “Equity - Equity-Based Payments to
Non-Employees”. The amendments in this ASU are effective for
public companies for fiscal years beginning after December 15,
2018, including interim periods within that fiscal year. The new
standard has been adopted by the Company. The Company has evaluated
the impact of ASU 2018-07 on its consolidated financial
statements and it did not have a material impact.
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic
740): Simplifying the
Accounting for Income Taxes, expected to reduce cost and complexity
related to the accounting for income taxes. The ASU
removes specific exceptions to the general principles in Topic 740
in GAAP. It eliminates the need for an organization to analyze
whether the following apply in a given period: exception to the
incremental approach for intra-period tax allocation; exceptions to
accounting for basis differences when there are ownership changes
in foreign investments; and exception in interim period income tax
accounting for year-to-date losses that exceed anticipated
losses. The ASU also improves financial statement
preparers’ application of income tax-related guidance and
simplifies GAAP for: franchise taxes that are partially based on
income; transactions with a government that result in a step up in
the tax basis of goodwill; separate financial statements of legal
entities that are not subject to tax; and enacted changes in tax
laws in interim periods. The Company is evaluating the
impact of the pronouncement.
Note 3. Fair Value of Financial Instruments
Management believes the fair values of the Company’s debt
obligations approximate carrying value because the debts carry
market rates of interest available to the Company. As of September
30, 2019 and December 31, 2018, the Company held no assets or
liabilities that required re-measurement at fair value on a
recurring basis.
Purchase Commitment
Upon
the completion of the sale of a former subsidiary, BioZone
Laboratories Inc. (“Biozone”), on May 9, 2016, the
Company entered into a manufacturing and supply agreement whereby
the Company agreed to minimum purchase
requirements of products from BioZone over a three-year period. The
Company fell below the requirements, and as a result, the
Company reserved a total amount of $0.7 million to cover the
estimated purchase commitment shortfall during the year ended
December 31, 2018. In July 2019, the Company settled this matter through the payment of $0.6
million and the issuance of 150,000 shares of the Company’s
common stock, which was valued at $60,000 on the settlement
date.
Note 4. Restructuring
As part
of an effort to better focus and align the Company’s
resources toward profitable growth, on August 24, 2015, the
Board authorized the Company to undertake steps to commence a
restructuring of the business and operations, which concluded
during the third quarter of 2016.
As of
December 31, 2018, the Company had a balance of $0.4 million,
representing contract termination costs and $0.1 million
representing abandoned lease facilities. During the first quarter
of 2019, the Company made payments to settle $0.2 million of the
outstanding contract termination costs, while the remaining balance
of $0.2 million was paid in the second quarter of 2019. As a result
of the adoption of the new lease standards, the restructuring
liability for the Company’s abandoned lease facilities was
used to reduce the ROU asset, in accordance with the new standards.
See additional information in “Note 6.
Leases.”
Note 5. Balance Sheet Components
Inventory
Inventory consisted solely of finished goods and raw
materials, used to manufacture our products at one of our
co-manufacturers as of September 30,
2019 and December 31, 2018.
The Company records charges for obsolete and slow-moving inventory
based on the age of the product as determined by the expiration
date or otherwise determined to be obsolete. Products within one
year of their expiration dates are considered for write-off
purposes. Historically, the Company has had minimal returns with
established customers. Other than write-off of inventory during
restructuring activities, the Company incurred insignificant
inventory write-offs during each of the nine months ended September
30, 2019 and 2018. Inventory write-downs, once established, are not
reversed as they establish a new cost basis for the
inventory.
Property and Equipment
Property and equipment consisted of the following as of September
30, 2019 and December 31, 2018 (in thousands):
|
|
|
Furniture,
fixtures and equipment
|
$2,586
|
$3,511
|
Leasehold
improvements
|
236
|
236
|
Vehicles
|
39
|
39
|
Displays
|
453
|
453
|
Website
|
497
|
497
|
Property
and equipment, gross
|
3,811
|
4,736
|
Less:
accumulated depreciation and amortization
|
(3,531)
|
(4,223)
|
Property
and equipment, net
|
$280
|
$513
|
Depreciation
and amortization expense related to property and equipment was
$75,000 and $0.1 million for the three months ended September 30,
2019 and 2018, respectively. Depreciation and amortization expense
was $0.3 million and $0.4 million for the nine months ended
September 30, 2019 and 2018, respectively. Depreciation and
amortization expense is included in “Selling, general, and
administrative” expense in the accompanying consolidated
statements of operations.
Intangible Assets
Intangible assets consisted of the following (in
thousands):
|
|
|
|
|
|
Remaining Weighted-
Average Useful Lives
(years)
|
Amortized Intangible Assets
|
|
|
|
|
|
$2,244
|
$(1,488)
|
$756
|
2.4
|
|
$2,244
|
$(1,488)
|
$756
|
|
|
|
|
|
|
|
Remaining Weighted-
Average Useful Lives
(years)
|
Amortized Intangible Assets
|
|
|
|
|
|
$2,244
|
$(1,247)
|
$997
|
3.1
|
|
$2,244
|
$(1,247)
|
$997
|
|
Intangible assets amortization expense was $0.1 million for each of
the three months ended September 30, 2019 and 2018, respectively,
and $0.2 million for each of the nine months ended September 30,
2019 and 2018, respectively, which is included in “Selling,
general and administrative” expense in the accompanying
consolidated statements of operations.
As of September 30, 2019, the estimated future amortization expense
of intangible assets is as follows (in thousands):
For the Year Ending December 31,
|
|
Remainder
of 2019
|
$80
|
2020
|
320
|
2021
|
320
|
2022
|
36
|
Total
amortization expense
|
$756
|
Note 6. Leases
The Company has operating leases for warehouse facilities and
office spaces across the U.S. The remaining lease terms for these
leases range from 1 to 4 years. The Company also leases
manufacturing and warehouse equipment under finance lease
arrangements, which expire at various dates through July 2020. The
Company does not intend to extend the lease terms expiring in
2020.
In
adopting the new lease standards (“ASC 842”), the
Company has elected the “package of practical
expedients,” which permit it not to reassess under the new
standard its prior conclusions about lease identification, lease
classification and initial direct costs. The Company did not elect
the use-of-hindsight or the practical expedient pertaining to land
easements, as the latter is not applicable to the Company. In
addition, the Company elected not to apply ASC 842 to arrangements
with lease terms of 12 month or less.
The
Company determines if a contract contains a lease when the contract
conveys the right to control the use of identified property, plant,
or equipment for a period of time in exchange for consideration.
Upon identification and commencement of a lease, we establish a ROU
asset and a lease liability. ROU assets and lease liabilities are
measured and recognized based on the present value of the future
minimum lease payments over the lease term at the commencement
date. At adoption, the Company reduced the ROU asset through a
derecognition of the restructuring liability for its abandoned
lease facilities. Subsequent to adoption, the Company no longer
recognized lease expense on a straight-line basis, as the impact of
the derecognition resulted in a front-loading of the lease
expenses.
Supplemental
balance sheet information related to leases was as follows (in
thousands):
|
Balance
Sheet Classification
|
|
Assets
|
|
|
Operating
|
ROU assets,
net
|
$1,364
|
Finance
|
Property and
equipment, net
|
87
|
Total
Assets
|
|
1,451
|
|
|
Liabilities
|
|
|
Current
liabilities:
|
|
|
Operating
|
Operating lease
liability - current
|
$706
|
Finance
|
Current accrued
liability
|
84
|
Total current
liabilities
|
|
790
|
|
|
Non-current
liabilities:
|
|
|
Operating
|
Operating lease
liability - long term
|
841
|
Finance
|
Other long term
liabilities
|
—
|
Total non-current
liabilities
|
|
841
|
Total lease
liabilities
|
$1,631
|
|
|
The
Company has elected the practical expedient to combine lease and
non-lease components into a single component for all of its leases.
Fixed lease costs represent the explicitly quantified lease
payments prescribed by the lease agreement and are included in the
measurement of the ROU asset and corresponding lease liability.
Some leasing arrangements require variable payments that are
dependent on usage, output, or may vary for other reasons, such as
insurance and tax payments. The variable lease payments are not
presented as part of the initial ROU asset or lease liability. The
Company's lease agreements do not contain any material restrictive
covenants.
The
components of lease cost for operating and finance leases for the
three and nine months ended September 30, 2019 were as follows (in
thousands):
|
Income Statement
Classification
|
Three months
ended
September 30,
2019
|
Nine months
ended
September 30,
2019
|
Operating lease
cost
|
Selling, general
and administrative
|
$264
|
$786
|
|
|
|
Finance lease
cost:
|
|
|
|
Amortization of ROU
asset
|
Selling, general
and administrative
|
30
|
88
|
Interest on lease
liabilities
|
Selling, general
and administrative
|
1
|
5
|
Total finance lease
cost
|
|
31
|
93
|
|
|
|
Variable lease
payments
|
Selling, general
and administrative
|
55
|
169
|
Sublease
income
|
Other
income
|
(72)
|
(262)
|
|
|
|
Total lease
cost
|
|
$278
|
$786
|
The
Company had no short-term leases as of September 30, 2019. The
Company's leases do not provide an implicit rate; therefore, the
Company uses its incremental borrowing rate based on the
information available at the effective date in determining the
present value of future payments for those leases.
Supplemental
cash flow information related to leases was as
follows:
|
Nine months
ended
September 30,
2019
|
Cash paid for
amounts included in the measurement of lease liabilities (in
thousands):
|
|
Operating cash flows
from operating leases
|
$570
|
Operating cash
flows from finance leases
|
5
|
Financing cash
flows from finance leases
|
88
|
|
|
The weighted
average remaining lease term was as follows:
|
|
Operating leases
(in years)
|
2.4
|
Finance leases (in
years)
|
0.7
|
The weighted
average discount rate was as follows:
|
|
Operating
leases
|
18%
|
Finance
leases
|
5%
|
The
maturities of lease liabilities at September 30, 2019 were as
follows (in thousands):
|
|
|
|
|
|
Remaining three
months of the year ending 2019
|
$266
|
$33
|
2020
|
808
|
55
|
2021
|
481
|
—
|
2022
|
369
|
—
|
Thereafter
|
—
|
—
|
Total future
undiscounted lease payments
|
1,924
|
88
|
Less amounts
representing interest
|
(377)
|
(2)
|
Present value of
lease liabilities
|
$$1,547
|
$86
|
Note 7. Interest and other expense, net
For the three and nine months ended September 30, 2019 and 2018,
“Interest and other expense, net” consisted of the
following (in thousands):
|
For the
Three Months
Ended September 30,
|
For the
Nine Months
Ended September 30,
|
|
|
|
|
|
|
|
|
|
|
Interest
expense, related party
|
$(458)
|
$(559)
|
$(1,528)
|
$(1,653)
|
Interest
expense, related party debt discount
|
(30)
|
(15)
|
(60)
|
(45)
|
Interest
expense, other
|
(162)
|
(28)
|
(619)
|
(160)
|
Interest
expense, secured borrowing arrangement
|
(335)
|
(251)
|
(840)
|
(906)
|
Foreign
currency transaction loss
|
(11)
|
(4)
|
(224)
|
(197)
|
Other
|
73
|
7
|
264
|
9
|
Total
interest and other expense, net
|
$(923)
|
$(850)
|
$(3,007)
|
$(2,952)
|
“Other”
for 2019 includes sublease income and interest income.
Note 8. Debt
As of September 30, 2019 and December 31, 2018, the Company’s
debt consisted of the following (in thousands):
|
|
|
Refinanced
convertible note, related party
|
$1,159
|
$18,000
|
Obligations
under secured borrowing arrangement
|
3,340
|
1,285
|
Line
of credit – inventory financing
|
3,000
|
1,500
|
Unamortized
debt discount, related party
|
—
|
(60)
|
Total
debt
|
7,499
|
20,725
|
Less:
current portion
|
(7,499)
|
(20,725)
|
Long
term debt
|
$—
|
$—
|
Related-Party Refinanced Convertible Note
On November 3, 2017, the Company entered into the refinancing with
Mr. Ryan Drexler, the Company’s Chairman of the Board of
Directors, Chief Executive Officer and President (the
“Refinancing”). As part of
the Refinancing, the Company issued to Mr. Drexler an amended and
restated convertible secured promissory note (the “Refinanced
Convertible Note”) in the original principal amount of
$18,000,000, which amended and restated (i) a convertible secured
promissory note dated as of December 7, 2015, amended as of January
14, 2017, in the original principal amount of $6,000,000 with an
interest rate of 8% prior to the amendment and 10% following the
amendment (the “2015 Convertible Note”), (ii) a
convertible secured promissory note dated as of November 8, 2016,
in the original principal amount of $11,000,000 with an interest
rate of 10% (the “2016 Convertible Note”) , and (iii) a
secured demand promissory note dated as of July 27, 2017, in the
original principal amount of $1,000,000 with an interest rate of
15% (the “2017 Note”, and together with the 2015
Convertible Note and the 2016 Convertible Note, collectively, the
“Prior Notes”). The due date of the 2015 Convertible
Note and the 2016 Convertible Note was November 8, 2017. The 2017
Note was due on demand.
The $18.0 million Refinanced Convertible Note bears interest at the
rate of 12% per annum. Interest payments are due on the last day of
each quarter. At the Company’s option (as determined by its
independent directors), the Company may repay up to one-sixth of
any interest payment by either adding such amount to the principal
amount of the note or by converting such interest amount into an
equivalent amount of the Company’s common stock. Any interest
not paid when due shall be capitalized and added to the principal
amount of the Refinanced Convertible Note and bear interest on the
applicable interest payment date along with all other unpaid
principal, capitalized interest, and other capitalized obligations.
Both the principal and the interest under the Refinanced
Convertible Note were due on December 31, 2019, unless converted
earlier. Mr. Drexler may convert the outstanding principal and
accrued interest into shares of the Company’s common stock at
a conversion price of $1.11 per share at any time. The Company may
prepay the Refinanced Convertible Note by giving Mr. Drexler
between 15 and 60 days’ notice depending upon the specific
circumstances, subject to Mr. Drexler’s conversion
right.
The Refinanced Convertible Note contains customary events of
default, including, among others, the failure by the Company to
make a payment of principal or interest when due. Following an
event of default, interest will accrue at the rate of 14% per
annum. In addition, following an event of default, any conversion,
redemption, payment or prepayment of the Refinanced Convertible
Note will be at a premium of 105%. The Refinanced Convertible Note
also contains customary restrictions on the ability of the Company
to, among other things, grant liens or incur indebtedness other
than certain obligations incurred in the ordinary course of
business. The restrictions are also subject to certain additional
qualifications and carveouts, as set forth in the Refinanced
Convertible Note. The Refinanced Convertible Note is subordinated
to certain other indebtedness of the Company.
As part of the Refinancing, the Company and Mr. Drexler entered
into a restructuring agreement (the “Restructuring
Agreement”) pursuant to which the parties agreed to amend and
restate the security agreement, resulting in a Third Amended and
Restated Security Agreement (the “Amended Security
Agreement”) in which the Prior Notes were secured by all of
the assets and properties of the Company and its subsidiaries
whether tangible or intangible. Pursuant to the Restructuring
Agreement, the Company agreed to pay, on the effective date of the
Refinancing, all outstanding interest on the Prior Notes through
November 8, 2017 and certain fees and expenses incurred by Mr.
Drexler in connection with the Restructuring.
On September 16, 2019, Mr. Ryan Drexler, the Chief Executive
Officer, President and Chairman of the Board of Directors of
MusclePharm Corporation, a Nevada corporation (the
“Company”), delivered a notice to the Company and its
independent directors of his election to convert, effective as of
September 16, 2019 (the “Notice Date”), $18,000,000 of
the amount outstanding under that certain Amended and Restated
Convertible Secured Promissory Note, dated as of November 8, 2017
(the “Note”), issued by the Company to Mr. Drexler,
into shares of the Company’s common stock, par value $0.001
per share (the “Common Stock”), at a conversion price
of $1.11 per share, pursuant to the terms and conditions of the
Note (the “Partial Conversion”). As of the Notice Date,
the total amount outstanding under the Note (including principal
and accrued and unpaid interest) was equal to $19,262,910. Pursuant
to the terms of the Note, the Company instructed the transfer agent
for its shares to issue to Mr. Drexler 16,216,216 shares (the
“Shares”) of its Common Stock in respect of the Partial
Conversion.
The
outstanding principal and the interest, due on December 31, 2019,
were refinanced under a new agreement on July 1, 2020. See
additional information in “Note 16. Subsequent
Events.”
For the three months ended September 30, 2019 and 2018, interest
expense, including the amortization of debt discount, related to
the related party convertible secured promissory notes was $0.5
million and $0.6 million, respectively. During the three months
ended September 30, 2019 and 2018, $0.4 million and $0.6 million,
respectively, in interest was paid in cash to Mr.
Drexler.
For the nine months ended September 30, 2019 and 2018, interest
expense, including the amortization of debt discount, related to
the related party convertible secured promissory notes was $1.6
million and $1.8 million, respectively. During the nine months
ended September 30, 2019 and 2018, $0.8 million and $1.4 million,
respectively, in interest was paid in cash to Mr.
Drexler.
Related-Party Revolving Note
On October 4, 2019, the Company entered into a secured revolving
promissory note (the “Revolving Note”) with Mr.
Drexler. Under the terms of the Revolving Note, the Company can
borrow up to $3.0 million. The Revolving Note bears interest at the
rate of 12% annually. The use of funds will be solely for the
purchase of whey protein to be used in the manufacturing of
MusclePharm products. The Company may prepay the Revolving Note by
giving Mr. Drexler one days’ written notice.
The Revolving Note contains customary events of default, including,
among others, the failure by the Company to make a payment of
principal or interest when due. Following an event of default, Mr.
Drexler is entitled to accelerate the entire indebtedness under the
Revolving Note. The Revolving Note also contains customary
restrictions on the ability of the Company to, among other things,
grant liens or incur indebtedness other than certain obligations
incurred in the ordinary course of business. The restrictions are
also subject to certain additional qualifications and carveouts.
The Revolving Note is subordinated to certain other indebtedness of
the Company held by Crossroads
Financial Group, LLC (“Crossroads”).
In connection with the Revolving Note, the Company and Mr. Drexler
entered into a security agreement dated October 4, 2019 pursuant to
which the Revolving Note is secured by all of the assets and
properties of the Company and its subsidiaries whether tangible or
intangible. As of December 31, 2019, the outstanding balance on the
revolving note was $1.2 million. Both the outstanding
principal and all accrued interest, which became due on March 31,
2020, were refinanced under a new agreement on July 1, 2020. The
revolving note is included in “Line of credit” in the
consolidated balance sheets. See additional information in
“Note 16. Subsequent Events.”
Related-Party Note Payable
The
Company entered into a collateral
receipt and security agreement with Mr. Drexler, dated December 27,
2019 pursuant to which Mr. Drexler agreed to post bond relating to
the judgment ruled on the ThermoLife case, pending the appeal. The
amount paid by Mr. Drexler on behalf of the Company, including
fees, was $0.3 million. The amount, which was outstanding as of
December 31, 2019, was refinanced under a new agreement on
July 1, 2020. The note payable is included in “Convertible
note with a related party, net of discount” in the
consolidated balance sheets. See additional information in
“Note 16. Subsequent Events.”
Line of Credit - Inventory Financing
On
October 6, 2017, the Company entered into a Loan and Security
Agreement (“Security Agreement”) with Crossroads.
Pursuant to the Security Agreement, the Company may borrow up to
70% of its Inventory Cost or up to 75% of Net Orderly Liquidation
Value (each as defined in the Security Agreement), up to a maximum
amount of $3.0 million at an interest rate of 1.5% per month,
subject to a minimum monthly fee of $22,500. Subsequent to the end
of 2017, the maximum amount was increased to $4.0 million. The term
of the Security Agreement automatically extends in one-year
increments, unless earlier terminated pursuant to the terms of the
Security Agreement. The Security Agreement contains customary
events of default, including, among others, the failure to make
payments on amounts owed when due, default under any other material
agreement or the departure of Mr. Drexler. The Security Agreement
also contains customary restrictions on the ability of the Company
to, among other things, grant liens, incur debt, and transfer
assets. Under the Security Agreement, the Company agreed to grant
Crossroads a security interest in all of the Company’s
present and future accounts, chattel paper, goods (including
inventory and equipment), instruments, investment property,
documents, general intangibles, intangibles, letter of credit
rights, commercial tort claims, deposit accounts, supporting
obligations, documents, records and the proceeds
thereof.
As of September 30, 2019, and December 31, 2018, we owed Crossroads
$3 million and $1.5 million, respectively.
On April 1, 2019, the Company and Crossroads amended the terms of
the agreement. The agreement was extended until March 31, 2020, the
rate was modified to 1.33% per month, and increased the amount the
Company can borrow from $3.0 million to $4.0 million.
On February 26, 2020, the Company and Crossroads amended the terms
of the agreement. The agreement was extended until April 1, 2021
and the amount the Company can borrow was decreased from $4.0
million to $3.0 million.
Secured Borrowing Arrangement
In
January 2016, the Company entered into a Purchase and Sale
Agreement (the “Purchase and Sale Agreement”) with
Prestige Capital Corporation (“Prestige”) pursuant to
which the Company agreed to sell and assign and Prestige agreed to
buy and accept, certain accounts receivable owed to the Company
(“Accounts”). Under the terms of the Purchase and Sale
Agreement, upon the receipt and acceptance of each assignment of
Accounts, Prestige will pay the Company 80% of the net face
amount of the assigned Accounts, up to a maximum total borrowing of
$12.5 million subject to sufficient amounts of accounts receivable
to secure the loan. The remaining 20% will be paid to the Company
upon collection of the assigned Accounts, less any chargebacks
(including chargebacks for any customer amounts that remain
outstanding for over 90 days), disputes, or other amounts due to
Prestige. Prestige’s purchase of the assigned Accounts from
the Company will be at a discount fee which varies from 0.7% to 4%,
based on the number of days outstanding from the assignment of
Accounts to collection of the assigned Accounts. In addition, the
Company granted Prestige a continuing security interest in and lien
upon all accounts receivable, inventory, fixed assets, general
intangibles, and other assets. Prestige will have no recourse
against the Company if payments are not made due to the insolvency
of an account debtor within 90 days of invoice date, with the exception of
international and certain domestic customers. The Purchase
and Sale Agreement’s term was extended to April 1, 2020 at
which point the term now renews automatically for successive
one-year periods unless either party receives written notice of
cancellation from the other, at minimum, thirty days prior to the
expiration date. As of September 30,
2019 and December 31, 2018, the Company had outstanding borrowings
of approximately $3.3 million and $1.3 million,
respectively.
During the three months ended September 30, 2019 and 2018, the
Company assigned to Prestige accounts with an aggregate face amount
of approximately $14.8 million and $9.9 million, respectively, for
which Prestige paid to the Company approximately $11.9 million and
$7.9 million, respectively, in cash. During the three months ended
September 30, 2019 and 2018, $12.5 million and $10.1 million was
repaid to Prestige, respectively, including fees and
interest.
During the nine months ended September 30, 2019 and 2018, the
Company assigned to Prestige accounts with an aggregate face amount
of approximately $39.0 million and $39.6 million, respectively, for
which Prestige paid to the Company approximately $31.2 million and
$31.7 million, respectively, in cash. During the nine months ended
September 30, 2019 and 2018, $29.2 million and $36.5 million was
repaid to Prestige, respectively, including fees and
interest.
Note 9. Commitments and Contingencies
Leases
The
Company leases office and warehouse facilities under operating
leases, which expire at various dates through 2022. The Company
also leases manufacturing and warehouse equipment under finance
leases, which expire at various dates through July 2020. The
Company does not intend to extend the lease terms expiring in 2020.
See additional information in
“Note 6. Leases.”
Purchase Commitment
Upon
the completion of the sale of a former subsidiary, BioZone on May
9, 2016, the Company entered into a manufacturing and supply
agreement whereby the Company agreed
to minimum purchase requirements of products from BioZone over a
three-year period. The Company fell below the requirements, and as
a result, the Company reserved a total amount of $0.7
million to cover the estimated purchase commitment shortfall during
the year ended December 31, 2018. In July 2019, the Company
settled this matter through the
payment of $0.6 million and the issuance of 150,000 shares of the
Company’s common stock, which was valued at $60,000 on the
settlement date.
Settlements
Manchester City Football Group
The Company was engaged in a dispute with City Football Group
Limited (“CFG”), the owner of Manchester City Football
Group, concerning amounts allegedly owed by the Company under a
sponsorship agreement with CFG (the “Sponsorship
Agreement”). In August 2016, CFG commenced arbitration in the
United Kingdom against the Company, seeking approximately $8.3
million for the Company’s purported breach of the Sponsorship
Agreement.
On July 28, 2017, the Company approved a Settlement Agreement (the
“CFG Settlement Agreement”) with CFG effective July 7,
2017. The CFG Settlement Agreement represents a full and final
settlement of all litigation between the parties. Under the terms
of the agreement, the Company agreed to pay CFG a sum of $3
million, which was recorded as accrued expenses in 2017. The
settlement consists of a $1 million payment that was advanced by a
related party on July 7, 2017, a $1 million installment paid on
July 7, 2018 and a subsequent $1 million installment payment to be
paid by July 7, 2019. Of this amount, the Company
has remitted $0.3
million.
During the three months ended September 30, 2019 and 2018, the
Company recorded a charge of $19,000 and $29,000, respectively, and
during the nine months ended September 30, 2019 and 2018, the
Company recorded a charge of $77,000 and $0.1 million,
respectively. This charge,
representing imputed interest, is included in “Interest and
other expense, net” in the Company’s consolidated
statements of operations.
Former Executive Lawsuit
The Company was engaged in a dispute with Mr. Richard Estalella
(“Estalella”) concerning amounts allegedly owed by the
Company under an employment agreement with Estalella. Estalella was
seeking certain equitable relief and unspecified damages. On May 7,
2018, the Court vacated the trial in contemplation of the
parties’ settlement of this matter.
On June 19, 2018, the Company approved a settlement agreement (the
“Estalella Settlement Agreement”) with Estalella,
concerning amounts allegedly owed by the Company under an
employment agreement with Estalella (the “Employment
Litigation”). The Estalella Settlement Agreement represents a
full and final settlement of the Employment Litigation. Under the
terms of the agreement, the Company agreed to pay Estalella a sum
of $0.93 million consisting of a $0.33 million initial payment that
was made in July 2018, and subsequent payments of $0.15 million
installments to be paid within 90, 180, 270 and 360 days of the
initial payment, respectively. As of September 30, 2019, all
outstanding payments had been fully paid.
Manziel Matter
On July 15, 2014, JMAN2 General LP (“JMAN2”), Jonathan
Manziel and MusclePharm entered into an endorsement agreement,
pursuant to which the Endorser would provide certain endorsements
of MusclePharm’s businesses, products and services in
exchange for payments to JMAN2 by MusclePharm. On April 17, 2018,
JMAN2 commenced an action against MusclePharm in the District
Court, City and County of Denver, Colorado and on July 19, 2018
filed an amended complaint against MusclePharm, in which JMAN2
asserted various claims against MusclePharm concerning their rights
and obligations under the Endorsement Agreement.
On April 10, 2019, a settlement agreement was reached for an amount
of $0.1 million, which had been recorded as an accrued expense as
of December 31, 2018. Of this amount, $70,000 was paid in 2019,
while the balance was paid in the first quarter of
2020.
United World Wrestling Arbitration
In
November 2017, United World Wrestling (“UWW”), an
amateur wrestling governing body, initiated arbitration against the
Company before the Court of Arbitration for Sport in Lausanne,
Switzerland (“CAS”), alleging that the Company owed it
$0.6 million, comprised of a $0.4 million sponsorship fee plus
accrued interest, under the terms of a 2015 sponsorship agreement.
In September 2018, the CAS issued an order and decision in
UWW’s favor for $0.4 million, plus interest at 12% per annum,
as well as attorney’s fees in the amount of 5,000 Swiss
Francs. On January 25, 2019, the two parties reached a settlement
agreement for $0.4 million, which had been recorded as an accrued
expense as of December 31, 2018. As of June 30, 2019, all amounts
owed to UWW had been paid.
Durnford Matter
On July
28, 2015, Plaintiff, Tucker Durnford, filed a First Amended Class
Action Complaint which alleged that the Company’s (now
discontinued) Arnold Iron Mass product violates consumer protection
laws by misleading consumers about the amount and sources of
protein in the product. On February 10, 2016, the court granted our
motion to dismiss the complaint on federal preemption grounds. On
October 12, 2018, the Ninth Circuit reversed the dismissal. On
October 8, 2019, the parties successfully mediated the case to a
settlement of $0.15 million, which had been recorded as an accrued
expense as of December 31, 2018. Of
the settlement amount, $0.1 million was paid during the
fourth quarter of 2019 and the balance was paid during the first
quarter of 2020.
Contingencies
In the normal course of business or otherwise, the Company may
become involved in legal proceedings. The Company will accrue a
liability for such matters when it is probable that a liability has
been incurred and the amount can be reasonably estimated. When only
a range of possible loss can be established, the most probable
amount in the range is accrued. If no amount within this range is a
better estimate than any other amount within the range, the minimum
amount in the range is accrued. The accrual for a litigation loss
contingency might include, for example, estimates of potential
damages, outside legal fees and other directly related costs
expected to be incurred. The Company provides disclosures
for material contingencies when there is a reasonable possibility
that a loss or an additional loss may be incurred. In assessing
whether a loss is a reasonable possibility, the Company may
consider the following factors, among others: the nature of the
litigation, claim or assessment, available information, opinions or
views of legal counsel and other advisors, and the experience
gained from similar cases. As of
September 30, 2019, the Company was involved in the following
material legal proceedings described below.
ThermoLife International
In January 2016, ThermoLife International LLC
(“ThermoLife”), a supplier of nitrates to MusclePharm,
filed a complaint against the Company in Arizona state court.
ThermoLife alleged that the Company failed to meet minimum purchase
requirements contained in the parties’ supply agreement. In
March 2016, the Company filed counterclaims alleging that
ThermoLife’s products were defective. Through orders issued
in September and November 2018, the court dismissed
MusclePharm’s counterclaims and found that the Company was
liable to ThermoLife for failing to meet its minimum purchase
requirements.
The court held a bench trial on the issue of damages in
October 2019, and on December 4, 2019, the court entered
judgment in favor of ThermoLife and against the Company in the
amount of $1.6 million, comprised of $0.9 million in damages,
interest in the amount of $0.3 million and attorneys’ fees
and costs in the amount of $0.4 million. The Company recorded $1.6
million in accrued expenses as of December 31, 2018. In the
interim, the Company filed an appeal, which is in the process of
being briefed, and has posted bonds in the total amount of
$0.6 million in order to stay execution on the judgment
pending appeal. Of the $0.6 million,
$0.25 million (including fees) was paid by Mr. Drexler on behalf of
the Company on December 31, 2019. See “Note 8. Debt”
for additional information. Subsequent to December 31, 2019, the
balance of $0.35 million was secured by a personal guaranty from
Mr. Drexler, while the associated fees of $12,500 was paid by the
Company.
The
Company intends to vigorously pursue its defenses, including on
appeal.
White Winston Select Asset Fund Series MP-18, LLC et al., v
MusclePharm Corp., et al., (Nev. Dist. Ct.; Cal. Superior Court;
Colorado Dist. Ct.; Mass.
Super. Ct.)
On
August 21, 2018, White Winston Select Asset Fund Series MP-18, LLC
and White Winston Select Asset Fund, LLC (together “White
Winston”) initiated a derivative action against MusclePharm
and its directors (collectively the “director
defendants”). White Winston alleges that the director
defendants breached their fiduciary duties by improperly approving
the refinancing of three promissory notes issued by MusclePharm to
Drexler (the “Amended Note”), in exchange for
$18.0 million in loans. White Winston alleges that this
refinancing improperly diluted their economic and voting power and
constituted an improper distribution in violation of Nevada law. In
its complaint, White Winston sought the appointment of a receiver
over MusclePharm, a permanent injunction against the exercise of
Drexler’s conversion right under the Amended Note, and other
unspecified monetary damages. On September 13, 2018, White Winston
filed an amended complaint, which added a former MusclePharm
executive, as a plaintiff (together with White Winston, the
“White Winston Plaintiffs”). On December 9, 2019, the
White Winston Plaintiffs filed a Second Amended Complaint, in which
they added allegations relating to the resignation of
MusclePharm’s auditor, Plante & Moran PLLC (“Plante
Moran”). MusclePharm has moved to dismiss the Second Amended
Complaint. That motion has not yet been fully briefed.
Along
with its complaint, the White Winston Plaintiffs also filed a
motion for a temporary restraining order (“TRO”) and
preliminary injunction enjoining the exercise of Drexler’s
conversion right under the Amended Note. On August 23, 2018,
the Nevada district court issued an ex parte TRO. On September 14, 2018,
the court let the TRO expire and denied the White Winston
Plaintiffs’ request for a preliminary injunction, finding,
among other things, that the White Winston Plaintiffs did not show
a likelihood of success on the merits of the underlying action and
failed to establish irreparable harm. Following the court’s
decision, MusclePharm filed a motion seeking to recoup the legal fees and costs it
incurred in responding to the preliminary injunction motion. On
October 31, 2019, the court awarded MusclePharm $56,000 in fees and
costs. The White Winston Plaintiffs have appealed that
award.
Due to
the uncertainty associated with determining our liability, if any,
and due to our inability to ascertain with any reasonable degree of
likelihood, as of the date of this report, the outcome of the
trial, the Company has not recorded an estimate for its potential
liability.
On June
17, 2019, the White Winston Plaintiffs moved for the appointment of
a temporary receiver over MusclePharm, citing Plante Moran’s
resignation. The court granted the White Winston Plaintiffs’
request to hold an evidentiary hearing on the motion, but the date
for that hearing was not set as of the date hereof.
On July
30, 2019, the White Winston Plaintiffs filed an action in the
Superior Court of the State of California in and for the County of
Los Angeles, seeking access to MusclePharm’s books and
records. MusclePharm has answered the petition, asserting as a
defense that the request does not have a proper
purpose. A trial on the
petition has been set for February 25, 2021.
The Company intends to vigorously defend these
actions.
IRS Audit
On April 6, 2016, the Internal Revenue Service (“IRS”)
selected our 2014 Federal Income Tax Return for audit. As a result
of the audit, the IRS proposed certain adjustments with respect to
the tax reporting of our former executives’ 2014 restricted
stock grants. Due to the Company’s current and historical
loss position, the proposed adjustments would have no material
impact on the Company’s Federal income tax. On October 5,
2016, the IRS commenced an audit of our employment and withholding
tax liability for 2014. The IRS contends that the Company
inaccurately reported the value of the restricted stock grants and
improperly failed to provide for employment taxes and Federal tax
withholding on these grants. In addition, the IRS is proposing
certain penalties associated with the Company’s filings. On
April 4, 2017, the Company received a “30-day letter”
from the IRS asserting back taxes and penalties of approximately
$5.3 million, of which $4.4 million related to withholding taxes,
specifically, income withholding and Social Security taxes, and
$0.9 million related to penalties. Additionally, the IRS asserts
that the Company owes information reporting penalties of
approximately $2.0 million.
The Company’s counsel has submitted a formal protest to the
IRS disputing on several grounds all of the proposed adjustments
and penalties on the Company’s behalf, and the Company has
been pursuing this matter vigorously through the IRS appeal
process. An Appeals Conference was held with the IRS in Denver,
Colorado on July 31, 2019. At the conference, the Company made
substantial arguments challenging the IRS’s claims for
employment taxes and penalties. On December 16, 2019, a further
Appeals Conference was held with the IRS by telephone. At the
telephone conference, the Appeals Officer confirmed that he agreed
with the Company’s argument that the failure to deposit
penalties should be conceded by the IRS. The failure to deposit
penalties total about $2 million. Thus, with this concession, the
IRS’s claims have been reduced from approximately $7.3
million to about $5.3 million.
The remaining issue in dispute in this matter involves the fair
market value of restricted stock units in the Company granted to
certain former officers (the “Former Officers”) of the
Company under Internal Revenue Code § 83. The Company and the
IRS disagree as to the value of the restricted stock on the date of
the grants, i.e., October 1, 2014. The Company and the IRS have
exchanged expert valuation reports on the fair market value of the
stock and have had extensive negotiations on this issue. The
parties, however, have not been able to reach an agreement with
respect to the value of the stock. The IRS has also made parallel
claims regarding the restricted stock units against the Former
Officers of the Company. The IRS has asserted that the Former
Officers received ordinary income from the stock grants, and that
they owe additional personal income taxes based on the fair market
value of the stock. The Former Officers’ cases, unlike the
Company’s case, are pending before the United States Tax
Court. In the Tax Court litigation, the Former Officers are
challenging the IRS’s determinations regarding the fair
market value of the restricted stock grants on October 1, 2014. The
Former Officers have separate counsel from the Company. The same
IRS Appeals Officer and Revenue Agents assigned to the
Company’s case are also involved in the cases for the Former
Officers. Throughout the proceedings, the Company has argued to the
IRS that it is the Former Officers who are directly and principally
liable for the amount of any tax due, and not the Company. The
Former Officers cases were scheduled for trial in Tax Court on
March 9, 2020. The trial of the cases was continued by the Court on
February 4, 2020. The basis for the continuance was that the IRS
and the Former Officers had made progress toward a settlement of
the valuation issue involving the grants of the restricted stock.
The outcome of these settlement negotiations will be relevant to
the Company’s case. The Company is closely monitoring the
settlement discussions between the IRS and the Former Officers. The
Tax Court has ordered the Former Officers to file status reports
regarding progress of their settlement negotiations with the IRS on
or before October 22, 2020.
Due to the uncertainty associated with determining our liability
for the asserted taxes and penalties, if any, and to our inability
to ascertain with any reasonable degree of likelihood, as of the
date of this report, the outcome of the IRS appeals process, the
Company has not recorded an estimate for its potential liability,
if any, associated with these taxes.
On August 22, 2018, Richard Estalella filed an action against
the Company and two other defendants in the Colorado District Court
for the County of Denver, seeking damages arising out of the
IRS’s assertion of tax liability and penalties relating to
the 2014 restricted stock grants. The Company has answered
Estalella’s complaint, asserted counterclaims against
Estalella for his failure to ensure that all withholding taxes were
paid in connection with the 2014 restricted stock grants, and filed
cross-claims against a valuation firm named in the action for
failing to properly value the 2014 restricted stock grants for tax
purposes. The Company is waiting on the next steps from the court
and will continue to vigorously litigate the matter.
4Excelsior Matter
On March 18, 2019, 4Excelsior, a manufacturer of MusclePharm
products, filed an action against MusclePharm in the Superior Court
of the State of California for the County of Los Angeles, claiming
approximately $6.2 million in damages relating to allegedly
unpaid invoices, as well as approximately $7.8 million in
consequential damages. On January 27, 2020, MusclePharm
filed a counterclaim against 4Excelsior seeking unidentified
damages relating to, among other things, 4Excelsior’s failure
to fulfill a purchase order. MusclePharm also moved to strike
4Excelsior’s consequential damages on the grounds that they
are unrecoverable under the Uniform Commercial Code. The
court denied that motion, and the action has proceeded to
discovery. The Company recognized a liability of $5.2 million (past
due invoices plus interest) as of September 30, 2019. Trial has not
yet been set, although a Trial Setting Conference has been set for
September 21, 2020.
The Company intends to vigorously defend this action.
Nutrablend Matter
On February 27, 2020, Nutrablend, a manufacturer of
MusclePharm products, filed an action against MusclePharm in the
United States District Court for the Eastern District of
California, claiming approximately $3.1 million in allegedly
unpaid invoices. These invoices relate to the third and fourth
quarter of 2019, and a liability has been recorded in the books for
the related periods. Trial has been set for November 17,
2020.
The Company intends to vigorously defend this action.
Note 10. Stockholders’ Deficit
Common Stock
For the nine months ended September 30, 2019, the Company had the
following transactions related to its common stock including
restricted stock awards (in thousands, except share and per share
data):
Transaction Type
|
|
|
|
Stock
issued for note conversion
|
16,216,216
|
$18,000
|
$1.11
|
Stock
issued for consulting services
|
22,222
|
10
|
0.45
|
Stock
issued in relation to Biozone settlement
|
150,000
|
60
|
0.40
|
Restricted
stock issued to directors
|
595,238
|
250
|
0.42
|
Stock
issued for advertising services
|
647,957
|
583
|
0.90
|
Total
|
17,631,633
|
$18,903
|
$0.40 to 1.11
|
For the nine months ended September 30, 2018, the Company had the
following transactions related to its common stock including
restricted stock awards (in thousands, except share and per share
data):
Transaction Type
|
|
|
|
Stock
issued to related party for interest
|
81,113
|
53
|
0.65
|
Restricted
stock issued to directors
|
250,000
|
250
|
1.00
|
Total
|
331,113
|
$303
|
$0.65 to 1.00
|
The fair value of all stock issuances above is based upon the
quoted closing trading price on the date of issuance. Common stock
outstanding as of September 30, 2019 and December 31, 2018 includes
shares legally outstanding even if subject to future
vesting.
Warrants
For the
nine months ended September 30, 2019 and 2018, the Company did not
issue any warrants. As of September 30, 2019 and 2018, the Company
had outstanding warrants of 1,289,378 and 1,389,378 shares,
respectively.
Treasury Stock
For the nine months ended September 30, 2019 and 2018, the Company
did not repurchase any shares of its common stock and held 875,621
shares in treasury as of both September 30, 2019 and
2018.
Note 11. Stock-Based Compensation
Restricted Stock
The Company’s stock-based compensation for the nine months
ended September 30, 2019 and 2018 consisted primarily of restricted
stock awards. The activity of restricted stock awards granted to
employees, executives and Board members during the nine
months ended September 30, 2019 was as
follows:
|
Unvested Restricted Stock Awards
|
|
|
Weighted Average
Grant Date Fair
Value
|
Unvested
balance – December 31, 2018
|
197,500
|
$1.05
|
Granted
|
595,238
|
0.42
|
Vested
|
(197,500)
|
1.05
|
Unvested
balance – September 30, 2019
|
595,238
|
0.42
|
The Company issued 595,238 shares of restricted stock to its Board
members for the three and nine months ended September 30, 2019,
respectively. The Company issued 250,000 shares of restricted stock
to its Board members for the three and nine months ended September
30, 2018, respectively. The total fair value of restricted stock
awards granted to the Board was $0.3 million for the three and nine
months ended September 30,2019, respectively. For the three and
nine months ended September 30, 2018, the total fair value of
restricted stock awards granted to the Board was $0.3 million,
respectively.
As of September 30, 2019, the total unrecognized expense for
unvested restricted stock awards, net of expected forfeitures, was
$0.2 million, which is expected to be amortized over a weighted
average period of 0.8 years.
Stock Options
The
Company may grant options to purchase shares of the Company’s
common stock to certain employees and directors pursuant to the
2015 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 plan administrator under the 2015 Plan.
No stock option may be exercisable more than ten years after the
date it is granted.
Stock Options Summary Table
The following table describes the total options outstanding,
granted, exercised, expired and forfeited as of and during the nine
months ended September 30, 2019. Shares obtained from the exercise
of our options are subject to various trading
restrictions.
|
Options Pursuant to the 2015 Plan
|
Weighted Average Exercise Price Per Share
|
Weighted Average Fair Value of Options
|
Weighted Average Remaining Contractual Life (Years)
|
Aggregate Intrinsic Value
|
Issued
and outstanding as of December 31, 2018
|
171,703
|
$1.89
|
$1.72
|
7.17
|
—
|
Granted
|
—
|
—
|
—
|
—
|
—
|
Exercised
|
—
|
—
|
—
|
—
|
—
|
Forfeited
|
—
|
—
|
—
|
—
|
—
|
Issued
and outstanding as of September 30, 2019
|
171,703
|
1.89
|
1.72
|
6.42
|
—
|
Exercisable
as of September 30, 2019
|
171,703
|
1.89
|
1.72
|
6.42
|
—
|
For the
three and nine months ended September 30, 2019, the Company
recorded no stock compensation expense related to options. The
Company recorded no stock compensation expense related to options,
for the three months ended September 30, 2018. The Company recorded
stock compensation expense of $16,000 related to options, for the
nine months ended September 30, 2018.
Note 12. Net Loss per Share
Basic net loss per share is computed by dividing net loss for the
period by the weighted average number of shares of common stock
outstanding during each period. There was no dilutive effect for
the outstanding potentially dilutive securities for the three and
nine months ended September 30, 2019 or the three and nine months
ended September 30, 2018, as the Company reported a net loss for
all periods.
The following table sets forth the computation of the
Company’s basic and diluted net loss per share for the
periods presented (in thousands, except share and per share
data):
|
For the Three Months
Ended September 30,
|
For the Nine Months
Ended September 30,
|
|
|
|
|
|
Net
loss
|
$(5,079)
|
$(1,422)
|
$(15,468)
|
$(4,213)
|
Weighted
average common shares used in computing net loss per share, basic
and diluted
|
18,527,438
|
15,037,666
|
16,443,945
|
14,998,099
|
Net
loss per share, basic and diluted
|
$(0.27)
|
$(0.09)
|
$(0.94)
|
$(0.28)
|
Diluted net income per share is computed by dividing net income for
the period by the weighted average number of shares of common
stock, common stock equivalents and potentially dilutive securities
outstanding during each period. The Company uses the treasury stock
method to determine whether there is a dilutive effect of
outstanding potentially dilutive securities, and the if-converted
method to assess the dilutive effect of the convertible
notes.
There was no dilutive effect for the outstanding awards for the
three and nine months ended September 30, 2019 and 2018, as the
Company reported a net loss for both periods. However, if the
Company had net income for the three and nine months ended
September 30, 2019, the potentially dilutive securities included in
the earnings per share computation would have been 2,988,293. If
the Company had net income for the three and nine months ended
September 30, 2018, the potentially dilutive securities included in
the earnings per share computation would have been
18,054,297.
Total outstanding potentially dilutive securities were comprised of
the following:
|
|
|
|
|
Stock
options
|
171,703
|
171,703
|
Warrants
|
1,289,378
|
1,389,378
|
Unvested
restricted stock
|
595,238
|
277,000
|
Convertible
notes
|
931,974
|
16,216,216
|
Total
common stock equivalents
|
2,988,293
|
18,054,297
|
Note 13. Income Taxes
The Company recorded a tax provision of $53,000 and tax income of
$3,000 for the three months ended September 30, 2019 and 2018,
respectively, and $89,000 and $0.1 million for the nine months
ended September 30, 2019 and 2018, respectively.
Income taxes are provided for the tax effects of transactions
reported in the consolidated financial statements and consist of
taxes currently due. Deferred taxes relate to differences between
the basis of assets and liabilities for financial and income tax
reporting which will be either taxable or deductible when the
assets or liabilities are recovered or settled. In assessing the
realizability of deferred tax assets, management considers whether
it is more likely than not that some portion or all of the deferred
income tax assets will not be realized. The ultimate realization of
deferred income tax assets is dependent upon the generation of
future taxable income during the periods in which those temporary
differences become deductible. Management considers the scheduled
reversal of deferred income tax liabilities, projected future
taxable income, and tax planning strategies in making this
assessment. Based on consideration of these items, management has
established a full valuation allowance as it is more likely than
not that the tax benefits will not be realized as of September 30,
2019.
Utilization
of net operating losses and R&D credits may be limited due to
potential ownership changes under Section 382 of the IRS Code. The
Company will undergo a review of its net operating losses in
connection with the conversion of Mr. Drexler’s convertible
note in September 2019. It is anticipated that a majority of the
net operating losses carry-forwards will be utilized as a result of
the conversion. These net operating loss carry-forwards and federal
R&D credits have expiration dates starting in 2030 through
2037.
Note 14. Segments, Geographical Information
The Company’s chief operating decision maker reviews
financial information presented on a consolidated basis for
purposes of allocating resources and evaluating financial
performance. As such, the Company currently has a single reporting
segment and operating unit structure. In addition, substantially
all long-lived assets are attributable to operations in the U.S.
for both periods presented.
Revenue, net by geography is based on the company addresses of the
customers. The following table sets forth revenue, net by
geographic area (in thousands):
|
For the Three Months
Ended September 30,
|
For the Nine Months
Ended September 30,
|
|
|
|
|
|
Revenue,
net:
|
|
|
|
|
United
States
|
$15,632
|
$15,216
|
$44,798
|
$41,605
|
International
|
5,543
|
6,719
|
17,451
|
26,343
|
Total
revenue, net
|
$21,175
|
$21,935
|
$62,249
|
$67,948
|
Note 15. Changes and Correction
of Errors in Previously Reported Consolidated Financial
Statements
Background on the Restatement
In February 2019, the Company was made aware, as part of the
year-end sales cut-off testing procedures performed during the
Company’s 2018 annual audit, by its then independent
auditors, Plante & Moran, PLLC, that sales transactions may
have been recognized as revenue prematurely which could have a
material impact on revenue recognition for the year ended December
31, 2018. Upon such notification, the Company reviewed its revenue
recognition reporting system, practices and underlying documents
supporting the appropriateness of revenue under the Company’s
previously established accounting policies for each quarterly
period in the year ended December 31, 2018. In addition to the 2018
year-end period, the Company initially concluded that a potential
material misstatement in revenue recognition was isolated to the
previously issued quarterly financial statements for the three and
nine months ended September 30, 2018.
Audit Committee Investigation
In March 2019, following management’s presentation of their
initial assessment of the revenue recognition issue, the Audit
Committee of the Board of Directors engaged independent legal
counsel and a forensic accountant to conduct an investigation and
to work with the Company to determine the potential impact on
accounting for revenues. The investigation included the review of
the Company’s initial assessment, interviews with key
personnel, correspondence and document review, among other
procedures. In April 2019, as a result of the findings of the Audit
Committee's investigation to date, the Company determined that
certain of its employees had engaged in deliberate inappropriate
conduct, which resulted in revenue being intentionally recorded in
periods prior to the criteria for revenue recognition under GAAP
being satisfied. Further, the investigation discovered that revenue
had been prematurely recorded in prior periods as well as the
periods initially identified by management.
The investigation revealed that certain customer orders had been
invoiced, triggering revenue recognition, prior to the actual
shipment leaving the Company’s control. Such orders from
customers had been marked as fulfilled in the Company’s
enterprise reporting platform (“ERP”), thereby
triggering the generation of an invoice and the recognition of
revenue, in advance of shipments from both the Company’s
distribution center in Tennessee and for orders that were
drop-shipped directly to key customers from certain contract
manufacturers. In addition, it was discovered during the
investigation that certain orders had been moved to third-party
locations at the respective cut-off periods and not actually
shipped to the end customer until after the cut-off period
resulting in the premature issuance of invoices to customers and
recognition of revenue.
As a result of the Audit Committee's investigation, certain
employees were terminated, and others received written reprimands
related to their conduct as it relates to their behavior. In
connection with the improprieties identified during the
investigation resulting in the restatement of previously reported
financial statements, the Company identified control deficiencies
in its internal control over financial reporting that constitute
material weaknesses.
Other Adjustments Resulting from Reconsidering Previously Issued
Financial Statements
As a result of issues identified during the Audit Committee
investigation, management reconsidered the Company’s
previously issued consolidated financial statements and as a result
additional corrections to the Company’s previously issued
consolidated financial statements for each of the quarterly
reporting periods ended September 30, 2018 and for the year ended
December 31, 2017 were identified. These errors, for each period
presented below, were primarily due to the following:
●
Improper
classification of trade promotions, payable to the Company’s
customers, as operating expenses instead of a reduction in
revenues;
●
Improper
cut-off related to sales transactions recorded prior to transfer of
control to customers in 2018 and risk of loss transferred to the
customer in 2017;
●
Corrections
of estimates of the expected value of customer payments, in the
form of credits, issued to customers;
●
Untimely
recording of the change in the estimated useful life of leasehold
improvements and an asset retirement obligation related to a
modification to the lease of the Company’s former
headquarters;
●
Incorrect
treatment of debt discounts related to the related-party
convertible note; and
●
Other period-end
expense cutoff.
Other adjustments include, but are not limited to the following;
purchase price variances, accrual for legal fees, payroll tax
adjustment on restricted stock, rebate receivable and recognizing
revenue on a net versus gross basis.
Accumulated deficit has been adjusted to reflect changes to net
loss, for each period restated.
Restatement Adjustments
Several restatement adjustments were made to the Company's
previously filed consolidated financial statements in order to
reflect revenue recognition in the appropriate periods as discussed
above. Accordingly, for the subject sales transactions, revenue and
accounts receivable balances were reduced by an equivalent amount
in the period that the sale was originally recorded as revenue, and
revenue was increased in the subsequent period in which the
criteria for revenue recognition were met. Further, for the subject
sales transactions, cost of revenue was reduced, and inventory was
increased, in the period that the sale was originally recorded as
revenue, and cost of revenue was increased, and inventory was
reduced, in the period the sale was ultimately recorded as
revenue.
In addition, (i) revenue and operating expenses were reduced by an
equivalent amount relating to the reclassification of customer
payments, which were originally recorded on a gross versus net
basis; (ii) revenue was increased or decreased each period, as
appropriate, relating to revised estimates of the expected value of
credits issued to customers, (iii) untimely recording of the change
in the estimated useful life of leasehold improvements and an asset
retirement obligation related to a modification to the lease of the
Company’s former headquarters and (iv) other adjustments as
referred to above.
September 30, 2018 Restatement (unaudited)
As of and for the three and nine months ended September 30, 2018,
the Company recorded the following restatement adjustments and
charges:
Impact on consolidated statements of operations for the three
months ended September 30, 2018 (in thousands) - increase
(decrease):
Sales
cutoff – ($3,445)
Correction
of estimate of expected value of customer credits –
$897
Reclassification
of payments to customers – ($2,905)
Sales
cutoff – ($2,170)
Accrual
for rebate receivable – ($144)
Reclassification of
advertising expenses directly related to product sales -
$103
●
Advertising
and promotion:
Reclassification
of payments to customers – ($2,871)
Reclassification of
advertising expenses directly related to product sales and
commissions – ($201)
●
Selling,
general and administrative:
Depreciation
adjustment for facility relocation – ($56)
Retirement
of asset obligation – $151
Reclassification
of payments to customers – ($36)
Reclassification of
advertising expenses representing commissions - $99
Recorded
in wrong period – ($743)
●
Interest and other expense, net: adjusted
debt discount amortization – ($140)
Impact on consolidated statements of operations for the nine months
ended September 30, 2018 - increase (decrease):
Reversal
of December 31, 2017 accrual for credits –
$1,281
Sales
cutoff – ($5,183)
Correction
of estimate of expected value of customer credits –
$142
Reclassification
of payments to customers – ($9,288)
Recognizing
revenue on a net versus gross basis– ($43)
Reversal
of December 31, 2017 purchase price variance - $154
Sales
cutoff – ($3,279)
Accrual
for rebate receivable – ($494)
Recognizing
revenue on a net versus gross basis– ($43)
Reclassification of
advertising expenses directly related to product sales -
$452
●
Advertising
and promotion:
Reversal
of December 31, 2017 accrual for credits - ($90)
Reclassification
of payments to customers – ($9,247)
Sales
cutoff – $3
Reclassification of
advertising expenses directly related to product sales and
commissions – ($697)
●
Selling,
general and administrative:
Reversal
of December 31, 2017 accrual for credits – ($72)
Depreciation
adjustment for facility relocation – ($168)
Asset
retirement obligation - $151
Reclassification
of payments to customers – ($43)
Reclassification of
advertising expenses representing commissions - $246
●
Professional fees: reversal of December
2017 legal over accrual – $148
Recorded
in wrong period – ($743)
●
Interest and other
expense, net: adjusted debt discount amortization –
($511)
Impact on consolidated balance sheets - increase
(decrease):
●
Accounts
receivable, net of allowance for doubtful accounts:
Sales
cutoff – ($9,330)
Correction
of estimate of expected value of customer credits –
$138
ASC
606 modified retrospective transition – ($1,053)
●
Inventory:
sales cutoff – $3,054
●
Prepaid
expenses and other current assets: accrual for rebate receivable -
$491
●
Accounts
payable: sales cutoff - ($3,066)
Payroll
tax adjustment on restricted stock – ($231)
Sales
cut off – ($29)
●
Convertible
note with a related party, net of discount: debt discount
adjustment net of amortization – $699
●
Other
long term liabilities: Asset retirement obligation -
$152
●
Additional
paid-in capital: debt discount adjustment –
($1,212)
●
Accumulated
deficit: $3,013
The unaudited restated consolidated balance sheets as of September
30, 2018 is presented below (in thousands, except per share
data):
|
|
|
|
|
|
ASSETS
|
|
|
|
Current
assets:
|
|
|
|
Cash
|
$1,749
|
$—
|
$1,749
|
Accounts
receivable, net of allowance for doubtful accounts of
$1,985
|
16,235
|
(10,245)
|
5,990
|
Inventory
|
7,324
|
3,054
|
10,378
|
Prepaid
expenses and other current assets
|
1,120
|
491
|
1,611
|
Total
current assets
|
26,428
|
(6,700)
|
19,728
|
Property
and equipment, net
|
576
|
—
|
576
|
Intangible
assets, net
|
1,077
|
—
|
1,077
|
Other
assets
|
267
|
—
|
267
|
TOTAL
ASSETS
|
$28,348
|
$(6,700)
|
$21,648
|
LIABILITIES AND STOCKHOLDERS’ DEFICIT
|
|
|
|
Current
liabilities:
|
|
|
|
Obligation
under secured borrowing arrangement
|
$594
|
$—
|
$594
|
Line
of credit
|
1,500
|
—
|
1,500
|
Accounts
payable
|
20,672
|
(3,066)
|
17,606
|
Accrued
liabilities
|
5,238
|
(260)
|
4,978
|
Accrued
restructuring charges, current
|
463
|
—
|
463
|
Total
current liabilities
|
28,467
|
(3,326)
|
25,141
|
Convertible
note with a related party, net of discount
|
17,226
|
699
|
17,925
|
Accrued
restructuring charges, long-term
|
58
|
—
|
58
|
Other
long-term liabilities
|
74
|
152
|
226
|
Total
liabilities
|
45,825
|
(2,475)
|
43,350
|
Commitments
and contingencies (Note 9)
|
|
|
|
Stockholders'
deficit:
|
|
|
|
Common
stock, par value of $0.001 per share; 100,000,000 shares authorized
16,190,288 shares issued as of September 30, 2018; 15,314,667
shares outstanding as of September 30, 2018
|
15
|
—
|
15
|
Additional
paid-in capital
|
160,038
|
(1,212)
|
158,826
|
Treasury
stock, at cost; 875,621 shares
|
(10,039)
|
—
|
(10,039)
|
Accumulated
other comprehensive loss
|
(169)
|
—
|
(169)
|
Accumulated
deficit
|
(167,322)
|
(3,013)
|
(170,335)
|
TOTAL
STOCKHOLDERS’ DEFICIT
|
(17,477)
|
(4,225)
|
(21,702)
|
TOTAL
LIABILITIES AND STOCKHOLDERS’ DEFICIT
|
$28,348
|
$(6,700)
|
$21,648
|
The unaudited restated quarterly consolidated statements of
operations for the three months ended September 30, 2018 is
presented below (in thousands, except per share data):
|
Three Months Ended September 30, 2018
|
|
|
|
|
Revenue,
net
|
$27,388
|
$(5,453)
|
$21,935
|
Cost
of revenue
|
18,595
|
(2,211)
|
16,384
|
Gross
profit
|
8,793
|
(3,242)
|
5,551
|
Operating
expenses:
|
|
|
|
Advertising
and promotion
|
3,589
|
(3,072)
|
517
|
Salaries
and benefits
|
1,856
|
—
|
1,856
|
Selling,
general and administrative
|
2,974
|
158
|
3,132
|
Research
and development
|
185
|
—
|
185
|
Professional
fees
|
436
|
—
|
436
|
Impairment
of assets
|
743
|
(743)
|
—
|
Total
operating expenses
|
9,783
|
(3,657)
|
6,126
|
Loss
from operations
|
(990)
|
415
|
(575)
|
Interest
and other expense, net
|
(990)
|
140
|
(850)
|
Loss
before provision for income taxes
|
(1,980)
|
555
|
(1,425)
|
Provision
for income (benefit) taxes
|
(3)
|
—
|
(3)
|
Net
loss
|
$(1,977)
|
$555
|
(1,422)
|
|
|
|
|
Net
loss per share, basic and diluted
|
$(0.13)
|
$0.04
|
(0.09)
|
|
|
|
|
Weighted
average shares used to compute net loss per share, basic and
diluted
|
15,029,312
|
8,354
|
15,037,666
|
The unaudited restated consolidated statements of operations for
the nine months ended September 30, 2018 is presented below (in
thousands, except per share data):
|
Nine Months Ended September 30, 2018
|
|
|
|
|
Revenue,
net
|
$81,039
|
$(13,091)
|
$67,948
|
Cost
of revenue
|
55,875
|
(3,210)
|
52,665
|
Gross
profit
|
25,164
|
(9,881)
|
15,283
|
Operating
expenses:
|
|
|
|
Advertising
and promotion
|
12,241
|
(10,031)
|
2,210
|
Salaries
and benefits
|
6,305
|
—
|
6,305
|
Selling,
general and administrative
|
8,175
|
114
|
8,289
|
Research
and development
|
605
|
—
|
605
|
Professional
fees
|
1,634
|
148
|
1,782
|
Impairment
of assets
|
743
|
(743)
|
—
|
Total
operating expenses
|
29,703
|
(10,512)
|
19,191
|
Loss
from operations
|
(4,539)
|
631
|
(3,908)
|
Gain
on settlement of obligation
|
2,747
|
—
|
2,747
|
Interest
and other expense, net
|
(3,463)
|
511
|
(2,952)
|
Loss
before provision for income taxes
|
(5,255)
|
1,142
|
(4,113)
|
Provision
for income taxes
|
100
|
—
|
100
|
Net
loss
|
$(5,355)
|
$1,142
|
(4,213)
|
|
|
|
|
Net
loss per share, basic and diluted
|
$(0.36)
|
$0.08
|
(0.28)
|
|
|
|
|
Weighted
average shares used to compute net loss per share, basic and
diluted
|
14,783,669
|
214,430
|
14,998,099
|
The unaudited restated consolidated statements of cash flows for
the nine months ended September 30, 2018 is presented below (in
thousands):
|
Nine Months Ended September 30, 2018
|
|
|
|
|
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
Net
loss
|
$(5,355)
|
$1,142
|
$(4,213)
|
Adjustments
to reconcile net loss to net cash provided by (used in) operating
activities:
|
|
|
|
Depreciation
and amortization
|
822
|
(169)
|
653
|
Settlement
of obligation
|
(2,747)
|
2,747
|
—
|
Bad
debt expense
|
822
|
—
|
822
|
Impairment
of assets
|
743
|
(743)
|
—
|
Amortization
of debt discount
|
557
|
(513)
|
44
|
Inventory
provision
|
—
|
130
|
130
|
Stock-based
compensation
|
377
|
—
|
377
|
Changes
in operating assets and liabilities:
|
|
|
|
Accounts
receivable
|
(454)
|
3,629
|
3,175
|
Inventory
|
(755)
|
(193)
|
(948)
|
Prepaid
expenses and other current assets
|
(114)
|
(491)
|
(605)
|
Other
assets
|
(44)
|
—
|
(44)
|
Accounts
payable and accrued liabilities
|
8,365
|
(5,539)
|
2,826
|
Accrued
restructuring charges
|
(194)
|
—
|
(194)
|
Net
cash provided by operating activities
|
2,023
|
—
|
2,023
|
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
Purchase
of property and equipment
|
(86)
|
—
|
(86)
|
Net
cash used in investing activities
|
(86)
|
—
|
(86)
|
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
|
|
Payments
on line of credit
|
(1,500)
|
—
|
(1,500)
|
Proceeds
from secured borrowing arrangement, net of reserves
|
31,677
|
—
|
31,677
|
Payments
on secured borrowing arrangement, net of fees
|
(36,469)
|
—
|
(36,469)
|
Repayment
of capital lease obligations
|
(101)
|
—
|
(101)
|
Net
cash used in financing activities
|
(6,393)
|
—
|
(6,393)
|
Effect
of exchange rate changes on cash
|
(23)
|
—
|
(23)
|
NET
CHANGE IN CASH
|
(4,479)
|
—
|
(4,479)
|
CASH
— BEGINNING OF PERIOD
|
6,228
|
—
|
6,228
|
|
$1,749
|
$—
|
$1,749
|
SUPPLEMENTAL
DISCLOSURE OF CASH FLOW INFORMATION:
|
|
|
|
|
$2,727
|
$—
|
$2,727
|
|
$173
|
$—
|
$173
|
SUPPLEMENTAL
DISCLOSURE OF NON-CASH ACTIVITIES:
|
|
|
|
Purchase
of property and equipment included in current
liabilities
|
$12
|
$—
|
$12
|
Interest
paid through issuance of shares of common stock
|
$53
|
$—
|
$53
|
Note 16. Subsequent Events
GAAP requires an entity to disclose events that occur after the
balance sheet date but before financial statements are issued or
are available to be issued (“subsequent events”) as
well as the date through which an entity has evaluated subsequent
events. There are two types of subsequent events. The first type
consists of events or transactions that provide additional evidence
about conditions that existed at the date of the balance sheet,
including the estimates inherent in the process of preparing
financial statements, (“recognized subsequent events”).
The second type consists of events that provide evidence about
conditions that did not exist at the date of the balance sheet but
arose subsequent to that date (“non-recognized subsequent
events”).
Recognized Subsequent Events
ThermoLife International
In
January 2016, ThermoLife, a supplier of nitrates to MusclePharm,
filed a complaint against us in Arizona state court. ThermoLife
alleged that we failed to meet minimum purchase requirements
contained in the parties’ supply agreement. In March 2016, we
filed counterclaims alleging that ThermoLife’s products were
defective. Through orders issued in September and
November 2018, the court dismissed MusclePharm’s
counterclaims and found that the Company was liable to ThermoLife
for failing to meet its minimum purchase requirements.
The court held a bench trial on the issue of damages in
October 2019, and on December 4, 2019, the court entered
judgment in favor of ThermoLife and against the Company in the
amount of $1.6 million, comprised of $0.9 million in damages,
interest in the amount of $0.3 million and attorneys’ fees
and costs in the amount of $0.4 million. The Company recorded $1.6
million in accrued expenses as of December 31, 2018. In the
interim, the Company filed an appeal, which is in the process of
being briefed, and has posted bonds in the total amount of
$0.6 million in order to stay execution on the judgment
pending appeal. Of the $0.6 million,
$0.25 million (including fees) was paid by Mr. Drexler on behalf of
the Company on December 31, 2019. See “Note 8. Debt”
for additional information. Subsequent to December 31, 2019, the
balance of $0.35 million was secured by a personal guaranty from
Mr. Drexler, while the associated fees of $12,500 was paid by the
Company.
The
Company intends to vigorously pursue its defenses on
appeal.
Durnford Matter
On July
28, 2015, Plaintiff, Tucker Durnford, filed a First Amended Class
Action Complaint which alleged that the Company’s (now
discontinued) Arnold Iron Mass product violates consumer protection
laws by misleading consumers about the amount and sources of
protein in the product. On February 10, 2016, the court granted our
motion to dismiss the complaint on federal preemption grounds. On
October 12, 2018, the Ninth Circuit reversed the dismissal. On
October 8, 2019, the parties successfully mediated the case to a
settlement of $0.15 million, which had been recorded as an accrued
expense as of December 31, 2018. Of
the settlement amount, $0.1 million was paid during the
fourth quarter of 2019 and the balance was paid during the first
quarter of 2020.
Unrecognized Subsequent Events
CARES Act
On
March 27, 2020, President Trump signed into law the Coronavirus
Aid, Relief, and Economic Security Act (“CARES” Act).
Among the changes to the U.S. federal income tax, the CARES Act
restored net operating loss carryback rules that were eliminated by
2017 Tax Cuts and Jobs Act, modified the limit on the deduction for
net interest expense and accelerated the timeframe for refunds of
AMT credits. Based on an analysis of the impact of the CARES Act,
the Company has not identified any overall material effect on the
2018 and 2019 tax liabilities.
HSBF Note
Due to
economic uncertainty as a result of the ongoing pandemic
(COVID-19), on May 14, 2020, the Company received an aggregate
principal amount of $964,910 pursuant to the borrowing arrangement
(“Note”) with Harvest Small Business Finance, LLC
(“HSBF”) and agreed to pay the principal amount plus
interest at a 1% fixed interest rate per year, on the unpaid
principal balance. No payments are due on the Note until November
16, 2020 (the “Deferment Period”). However, interest
will continue to accrue during the Deferment Period. The Note will
mature on May 16, 2022. The Note includes forgiveness provisions in
accordance with the requirements of the Paycheck Protection
Program, Section 1106 of the CARES Act. The Company has not
determined the amount of forgiveness in connection with the loan,
partly due to the ongoing routine changes in the method of
calculating the amount.
Related-Party Refinanced Convertible Note
On July 1, 2020, the Company entered into the refinancing with Mr.
Ryan Drexler, the Company’s Chairman of the Board of
Directors, Chief Executive Officer and President (the
“Refinancing”). As part of
the Refinancing, the Company issued to Mr. Drexler an amended and
restated convertible secured promissory note (the “Refinanced
Convertible Note”) in the original principal amount of
$2,735,199, which amended and restated (i) a convertible secured
promissory note dated as of November 8, 2017, $1,134,483 of which
was outstanding as of July 1, 2020 (ii) a collateral receipt and
security agreement with Mr. Drexler dated as of December 27, 2019,
$252,500 of which was outstanding as of July 1, 2020, and (iii) a
secured revolving promissory note dated as of October 4, 2019,
$1,348,216 of which was outstanding as of July 1,
2020.
The $2.7 million Refinanced Convertible Note bears interest at the
rate of 12% per annum. Unless earlier converted or repaid, all
outstanding principal and any accrued but unpaid interest under the
Refinanced Convertible Note shall be due and payable on November
30, 2020.
Any interest not paid when due shall be capitalized and added to
the principal amount of the Refinanced Convertible Note and bear
interest on the applicable interest payment date along with all
other unpaid principal, capitalized interest, and other capitalized
obligations. Mr. Drexler may convert the outstanding principal and
accrued interest into shares of the Company’s common stock at
a conversion price equal to or greater than (i) the closing price
per share of the common stock on the last business day immediately
preceding November 30, 2020 or (ii) $0.17. The Company may prepay
the Refinanced Convertible Note by giving Mr. Drexler between 15
and 60 days’ notice depending upon the specific
circumstances, subject to Mr. Drexler’s conversion right. The
Refinanced Convertible Note also contains customary restrictions on
the ability of the Company to, among other things, grant liens or
incur indebtedness other than certain obligations incurred in the
ordinary course of business. The restrictions are also subject to
certain additional qualifications and carveouts, as set forth in
the Refinanced Convertible Note. The Refinanced Convertible Note is
subordinated to certain other indebtedness of the
Company.
There
are no other events subsequent to September 30, 2019 that have not
been described in the accompanying footnotes.