Notes
to Consolidated Financial Statements
(Unaudited)
Note
1. Description of Business
Description
of Business
MusclePharm
Corporation was incorporated in Nevada in 2006. Except as otherwise indicated herein or the context requires otherwise, the terms
“MusclePharm,” the “Company,” “we,” “our” and “us” refer to MusclePharm
Corporation and its subsidiaries. The Company is a scientifically-driven, performance lifestyle company that develops, markets
and distributes branded sports nutrition products and nutritional supplements that are manufactured by the Company’s co-manufacturers.
Our portfolio of recognized brands, including MusclePharm® and FitMiss®, is marketed and sold globally.
The Company is headquartered in Calabasas, California and, as of September 30, 2020, 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, 2020, the Company
had cash of $1.1 million, a decline of $0.4 million from the December 31, 2019 balance of $1.5 million. As of September 30, 2020,
we had a working capital deficit of $25.4 million, a stockholders’ deficit of $27.3 million and an accumulated deficit of
$195.5 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.
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 net loss in 2019, management implemented the following measures to improve gross profit:
|
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;
|
|
4)
|
formed
a pricing committee to review all orders to better align gross profit expectations with product availability.
|
As
a result of these measures, as well as a reduction in protein prices, the Company realized increased gross profit in the fourth
quarter of 2019, a trend which continued into the third quarter of 2020. Beginning in April 2020, the Company experienced
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 customers, 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 these customers.
In 2020, the Company also negotiated lower costs of goods sold with our co-manufacturers. Management believes reductions in operating
costs and continued focus on gross profit 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 7. 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 unaudited interim consolidated financial statements have been prepared in accordance with generally accepted accounting
principles in the United States (“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 consolidated financial statements include the accounts of MusclePharm Corporation and its
wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
The
Company’s management believes the unaudited interim consolidated financial statements include all adjustments of a normal
recurring nature necessary for the fair presentation of the Company’s financial position as of September 30, 2020, results
of operations for the three and nine months ended September 30, 2020 and 2019, and cash flows for the nine months ended September
30, 2020 and 2019. The results of operations for the three and nine months ended September 30, 2020 are not necessarily indicative
of the results to be expected for the year ended December 31, 2020. Certain prior period amounts have been conformed to the current
period’s presentation.
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 25, 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, valuations of equity securities and intangible assets, warrants and options, present value
of lease liabilities, among others. Actual results could differ from those estimates.
Revenue
Recognition
Revenue
is recognized when control of the promised goods or services is transferred to the Company’s customers in an amount that
reflects the consideration the Company expects to be entitled to in exchange for those goods or services.
|
a.
|
Nature
of Goods and Services
|
The
Company sells a variety of protein products through a broad distribution platform that includes supermarkets, mass merchandisers,
wholesale clubs, drugstores, convenience stores, home stores, specialty stores and websites and other e-commerce channels, all
of which sell our products to consumers.
|
b.
|
When
Performance Obligations are Satisfied
|
For
performance obligations related to the shipping and invoicing of products, control transfers at the point in time upon which finished
goods are delivered to the Company’s customers or when finished goods are picked up by a customer or a customer’s
carrier, depending on shipping terms. Once a product has been delivered or picked up by the customer, the customer is able to
direct the use of, and obtain substantially all of the remaining benefits from the asset. The Company considers control to have
transferred upon delivery or customer receipt because the Company has an enforceable right to payment at that time, the customer
has legal title to the asset, the Company has transferred physical possession of the asset, and the customer has significant risk
and rewards of ownership of the asset.
|
c.
|
Variable
Consideration
|
The
Company conducts extensive promotional activities, primarily through the use of off-list discounts, slotting, coupons, cooperative
advertising, periodic price reduction arrangements, and end-aisle and other in-store displays. The costs of such activities are
netted against sales and are recorded when the related sale takes place. The reserves for sales returns and consumer and trade
promotion liabilities are established based on the Company’s best estimate of the amounts necessary to settle future and
existing obligations for products sold as of the balance sheet date. To determine the appropriate timing of recognition of consideration
payable to a customer, all consideration payable to our customers is reflected in the transaction price at inception and reassessed
routinely.
The
Company expenses incremental direct costs of obtaining a contract (broker commissions) when the related sale takes place, since
the amortization period of the commissions paid for the sale of products is less than a year. These costs are recorded in “Selling,
general and administrative” expenses in the accompanying consolidated statements of income.
The
Company accounts for shipping and handling costs as fulfillment activities, which are therefore recognized upon shipment of the
goods.
For
the three and nine months ended September 30, 2020, the Company incurred $0.2 million and $0.9 million, respectively, of inbound
shipping and handling costs. For the three and nine months ended September 30, 2019, the Company incurred $0.3 million and $0.9
million, respectively, of inbound shipping and handling costs. Shipping and handling costs related to inbound purchases of raw
material and finished goods are included in cost of revenues in our consolidated statements of operations.
For
the three and nine months ended September 30, 2020, the Company incurred $0.6 million and $1.7 million, respectively, of shipping
and handling costs related to shipments to our customers. For the three and nine months ended September 30, 2019, the Company
incurred $0.9 million and $2.9 million, respectively, of shipping and handling costs related to shipments to our customers. Shipping
and handling costs related to shipments to our customers is included in selling, general and administrative expenses in our consolidated
statements of operations.
The
Company excludes from its revenue any amounts collected from customers for sales (and similar) taxes. During the three months
ended September 30, 2020 and 2019, the Company recorded discounts, and to a lesser degree, sales returns, totaling $4.1 million
and $7.0 million, respectively, which accounted for 20% and 25% of gross revenue in each period, respectively. During the nine
months ended September 30, 2020 and 2019, the Company recorded discounts, and to a lesser degree, sales returns, totaling $11.7
million and $22.5 million, respectively, which accounted for 19% and 27% of gross revenue in each period, respectively.
Concentrations
Financial
instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and accounts receivable.
The Company minimizes its credit risk associated with cash by periodically evaluating the credit quality of its primary financial
institution. The cash balance, at times, may exceed federally insured limits. Management believes the financial risk associated
with these balances is minimal and has not experienced any losses to date.
Significant
customers are those that represent more than 10% of the Company’s revenue, net or accounts receivable for each period presented.
For each significant customer, percentage of revenue, net and accounts receivable are as follows:
|
|
Percentage of
Revenue, net for the Three Months Ended
September 30,
|
|
|
Percentage of
Revenue, net for the Nine Months Ended
September 30,
|
|
|
Percentage of Net
Accounts Receivable as of
|
|
|
|
2020
|
|
|
2019
|
|
|
2020
|
|
|
2019
|
|
|
September 30, 2020
|
|
|
December 31, 2019
|
|
Customers
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Costco
|
|
|
46
|
%
|
|
|
34
|
%
|
|
|
37
|
%
|
|
|
33
|
%
|
|
|
37
|
%
|
|
|
34
|
%
|
Amazon
|
|
|
10
|
%
|
|
|
16
|
%
|
|
|
19
|
%
|
|
|
13
|
%
|
|
|
20
|
%
|
|
|
20
|
%
|
iHerb
|
|
|
*
|
|
|
|
18
|
%
|
|
|
*
|
|
|
|
16
|
%
|
|
|
*
|
|
|
|
*
|
|
Coupang Global, LLC
|
|
|
*
|
|
|
|
*
|
|
|
|
13
|
%
|
|
|
*
|
|
|
|
11
|
%
|
|
|
*
|
|
*
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,
|
|
|
|
2020
|
|
|
2019
|
|
|
2020
|
|
|
2019
|
|
Vendor
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nutra Blend
|
|
|
*
|
|
|
|
19
|
%
|
|
|
*
|
|
|
|
25
|
%
|
S.K. Laboratories
|
|
|
10
|
%
|
|
|
26
|
%
|
|
|
26
|
%
|
|
|
36
|
%
|
Mill Haven Foods LLC
|
|
|
*
|
|
|
|
11
|
%
|
|
|
22
|
%
|
|
|
*
|
|
Innovations in Nutrition and Wellness
|
|
|
37
|
%
|
|
|
*
|
|
|
|
23
|
%
|
|
|
*
|
|
Bakery Barn
|
|
|
*
|
|
|
|
10
|
%
|
|
|
*
|
|
|
|
*
|
|
JW Nutritional
|
|
|
*
|
|
|
|
12
|
%
|
|
|
*
|
|
|
|
*
|
|
*
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
award’s 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
July 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit
Losses on Financial Instruments (“ASU 2016-13”), which among other things, these amendments require the measurement
of all expected credit losses of financial assets held at the reporting date based on historical experience, current conditions,
and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information
to better inform their credit loss estimates. In addition, the ASU amends the accounting for credit losses on available-for-sale
debt securities and purchased financial assets with credit deterioration. ASU 2016-13 is effective for periods beginning after
December 15, 2022, and interim periods within those fiscal years. The Company will evaluate the impact of the pronouncement closer
to the effective date.
In
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. This guidance is effective for fiscal years and interim periods within those years beginning after December 15, 2020
with early adoption permitted. Amendments are to be applied prospectively, except for certain amendments that are to be applied
either retrospectively or with a modified retrospective approach through a cumulative effect adjustment recorded to retained earnings.
The Company is evaluating the impact of the pronouncement.
On
August 5, 2020, the FASB issued ASU No. 2020-06, Debt - Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives
and Hedging - Contracts in Entity’s Own Equity (Subtopic 815-40). The new ASU eliminates the beneficial conversion and
cash conversion accounting models for convertible instruments. It also amends the accounting for certain contracts in an entity’s
own equity that are currently accounted for as derivatives because of specific settlement provisions. In addition, the new guidance
modifies how particular convertible instruments and certain contracts that may be settled in cash or shares impact the diluted
EPS computation. This guidance is effective for fiscal years beginning after December 15, 2023, including interim periods within
those fiscal years. Early adoption is permitted, but no earlier than fiscal years beginning after December 15, 2020, including
interim periods within those fiscal years. The FASB also specified that an entity should adopt the guidance as of the beginning
of its annual fiscal year and is not permitted to adopt the guidance in an interim period. The Company will evaluate the impact
of the pronouncement closer to the effective date.
Note
3. Fair Value of Financial Instruments
As of September 30, 2020, and December
31, 2019, the Company held no assets or liabilities that required re-measurement at fair value on a recurring basis. Cash balances
as of September 30, 2020 and December 31, 2019 were $1.1 million and $1.5 million, respectively. The carrying amounts of the cash
balances reported in the consolidated balance sheets approximate the fair value.
Note
4. Balance Sheet Components
Inventory
Inventory
consisted of raw materials and finished goods, which were located either at one of our co-manufacturers or our warehouse as of
September 30, 2020 and December 31, 2019.
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. The Company incurred insignificant inventory write-offs
during each of the nine months ended September 30, 2020 and 2019. 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, 2020 and December 31, 2019 (in thousands):
|
|
As of
September 30, 2020
|
|
|
As of
December 31, 2019
|
|
Furniture, fixtures and equipment
|
|
$
|
1,762
|
|
|
$
|
2,592
|
|
Leasehold improvements
|
|
|
7
|
|
|
|
236
|
|
Vehicles
|
|
|
39
|
|
|
|
39
|
|
Displays
|
|
|
453
|
|
|
|
453
|
|
Website
|
|
|
497
|
|
|
|
497
|
|
Property and equipment, gross
|
|
|
2,757
|
|
|
|
3,817
|
|
Less: accumulated depreciation and amortization
|
|
|
(2,711
|
)
|
|
|
(3,601
|
)
|
Property and equipment, net
|
|
$
|
46
|
|
|
$
|
216
|
|
Depreciation
and amortization expense related to property and equipment was $24,000 and $75,000 for the three months ended September 30, 2020
and 2019, respectively. Depreciation and amortization expense was $0.1 million and $0.3 million for the nine months ended September
30, 2020 and 2019, 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):
|
|
As of September 30, 2020
|
|
|
|
Gross Value
|
|
|
Accumulated
Amortization
|
|
|
Net
Carrying
Value
|
|
|
Remaining Weighted-
Average
Useful Lives
(years)
|
|
Amortized Intangible Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Brand (apparel rights)
|
|
$
|
2,244
|
|
|
$
|
(1,808
|
)
|
|
$
|
436
|
|
|
|
1.4
|
|
Total intangible assets
|
|
$
|
2,244
|
|
|
$
|
(1,808
|
)
|
|
$
|
436
|
|
|
|
|
|
|
|
As of December 31, 2019
|
|
|
|
Gross
Value
|
|
|
Accumulated
Amortization
|
|
|
Net
Carrying
Value
|
|
|
Remaining
Weighted-
Average
Useful Lives
(years)
|
|
Amortized Intangible Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Brand (apparel rights)
|
|
$
|
2,244
|
|
|
$
|
(1,568
|
)
|
|
$
|
676
|
|
|
|
2.1
|
|
Total intangible assets
|
|
$
|
2,244
|
|
|
$
|
(1,568
|
)
|
|
$
|
676
|
|
|
|
|
|
Intangible
assets amortization expense was $0.1 million for each of the three months ended September 30, 2020 and 2019, respectively, and
$0.2 million for each of the nine months ended September 30, 2020 and 2019, respectively, which is included in “Selling,
general and administrative” expense in the accompanying consolidated statements of operations.
As
of September 30, 2020, the estimated future amortization expense of intangible assets is as follows (in thousands):
For the Year Ending December 31,
|
|
|
|
Remainder of 2020
|
|
$
|
80
|
|
2021
|
|
|
320
|
|
2022
|
|
|
36
|
|
Total amortization expense
|
|
$
|
436
|
|
Note
5. Interest and other expense, net
For
the three and nine months ended September 30, 2020 and 2019, “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,
|
|
|
|
2020
|
|
|
2019
|
|
|
2020
|
|
|
2019
|
|
Interest and other expense, net:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense, related party
|
|
$
|
(76
|
)
|
|
$
|
(458
|
)
|
|
$
|
(228
|
)
|
|
$
|
(1,528
|
)
|
Interest expense, related party debt discount
|
|
|
—
|
|
|
|
(30
|
)
|
|
|
—
|
|
|
|
(60
|
)
|
Interest expense, other
|
|
|
(249
|
)
|
|
|
(162
|
)
|
|
|
(581
|
)
|
|
|
(619
|
)
|
Interest expense, secured borrowing arrangement
|
|
|
(312
|
)
|
|
|
(335
|
)
|
|
|
(1,060
|
)
|
|
|
(840
|
)
|
Foreign currency transaction loss
|
|
|
(2
|
)
|
|
|
(11
|
)
|
|
|
(20
|
)
|
|
|
(224
|
)
|
Other
|
|
|
183
|
|
|
|
73
|
|
|
|
350
|
|
|
|
264
|
|
Total interest and other expense, net
|
|
$
|
(456
|
)
|
|
$
|
(923
|
)
|
|
$
|
(1,539
|
)
|
|
$
|
(3,007
|
)
|
“Other”
primarily includes sublease income and gain on disposal of fixed assets.
Note
6. Leases
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.
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 2 years. The Company also leased manufacturing and warehouse equipment under finance lease arrangements, which
expired at various dates through July 2020. The Company does not intend to extend the lease terms expiring in 2020. The lease
rental agreement, in which the Company leased a Tennessee warehouse, expired on June 30, 2020. Subsequent to the expiration of
the lease, the Company utilized the warehouse and made payments to the landlord on a month-to-month basis between July and August
2020.
On
July 24, 2020, the Company entered into a sublease agreement (“Sublease Agreement”) with a third-party to
sublease the office building at Burbank. The sublease commenced on September 15, 2020 and would be in effect through the
remainder of the Company’s lease term (September 15, 2020 through September 30, 2022). Rent will be abated between
November 1, 2020 and December 31, 2020 for a total of one and a half months. In September 2020, the Company assessed its
existing leases for impairment as the remaining lease costs exceeded the anticipated sublease income on these leases. As a
result of the impairment analysis, the Company recorded an impairment charge of $0.2 million.
Supplemental
balance sheet information related to leases was as follows (in thousands):
|
|
Balance Sheet Classification
|
|
September 30, 2020
|
|
|
December 31, 2019
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
Operating
|
|
ROU assets, net
|
|
$
|
541
|
|
|
$
|
1,175
|
|
Finance
|
|
Property and equipment, net
|
|
|
9
|
|
|
|
57
|
|
Total Assets
|
|
|
|
|
550
|
|
|
|
1,232
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
|
|
Operating
|
|
Operating lease liability - current
|
|
$
|
395
|
|
|
$
|
624
|
|
Finance
|
|
Current accrued liability
|
|
|
—
|
|
|
|
54
|
|
Total current liabilities
|
|
|
|
|
395
|
|
|
|
678
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-current liabilities:
|
|
|
|
|
|
|
|
|
|
|
Operating
|
|
Operating lease liability - long term
|
|
|
447
|
|
|
|
723
|
|
Total non-current liabilities
|
|
|
|
|
447
|
|
|
|
723
|
|
Total lease liabilities
|
|
|
|
$
|
842
|
|
|
$
|
1,401
|
|
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, 2020 were as follows
(in thousands):
|
|
Income Statement Classification
|
|
Three months ended September 30, 2020
|
|
|
Nine months ended September 30, 2020
|
|
Operating lease cost
|
|
Selling, general and administrative
|
|
$
|
139
|
|
|
$
|
614
|
|
|
|
|
|
|
|
|
|
|
|
|
Finance lease cost:
|
|
|
|
|
|
|
|
|
|
|
Amortization of right-of-use asset
|
|
Selling, general and administrative
|
|
|
7
|
|
|
|
52
|
|
Interest on lease liabilities
|
|
Selling, general and administrative
|
|
|
—
|
|
|
|
1
|
|
Total finance lease cost
|
|
|
|
|
7
|
|
|
|
53
|
|
|
|
|
|
|
|
|
|
|
|
|
Variable lease payments
|
|
Selling, general and administrative
|
|
|
94
|
|
|
|
260
|
|
Sublease income
|
|
Other income
|
|
|
(22
|
)
|
|
|
(168
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Total lease cost
|
|
|
|
$
|
218
|
|
|
$
|
759
|
|
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 right-of-use 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, 2020 and 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, 2020
|
|
|
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
|
|
$
|
506
|
|
|
$
|
570
|
|
Operating cash flows from finance leases
|
|
|
1
|
|
|
|
5
|
|
Financing cash flows from finance leases
|
|
|
54
|
|
|
|
88
|
|
|
|
|
|
|
|
|
|
|
The weighted average remaining lease term was as follows:
|
|
|
|
|
|
|
|
|
Operating leases (in years)
|
|
|
1.8
|
|
|
|
2.4
|
|
Finance leases (in years)
|
|
|
0.0
|
|
|
|
0.7
|
|
The
weighted average discount rate was as follows:
Operating leases
|
|
|
18
|
%
|
|
|
18
|
%
|
Finance leases
|
|
|
5
|
%
|
|
|
5
|
%
|
The
maturities of lease liabilities at September 30, 2020 were as follows (in thousands):
|
|
Operating
|
|
|
Finance
|
|
|
|
|
|
|
|
|
Remaining three months of the year ending 2020
|
|
$
|
153
|
|
|
$
|
—
|
|
2021
|
|
|
481
|
|
|
|
—
|
|
2022
|
|
|
369
|
|
|
|
—
|
|
Thereafter
|
|
|
—
|
|
|
|
—
|
|
Total future undiscounted lease payments
|
|
|
1,003
|
|
|
|
|
|
Less amounts representing interest
|
|
|
(162
|
)
|
|
|
—
|
|
Present value of lease liabilities
|
|
$
|
841
|
|
|
$
|
—
|
|
Note
7. Debt
As
of September 30, 2020, and December 31, 2019, the Company’s debt consisted of the following (in thousands):
|
|
As of
September 30, 2020
|
|
|
As of
December 31, 2019
|
|
Refinanced convertible note, related party
|
|
$
|
2,735
|
|
|
$
|
1,034
|
|
Bonds payable
|
|
|
—
|
|
|
|
253
|
|
Revolving line of credit, related party
|
|
|
—
|
|
|
|
1,239
|
|
Obligations under secured borrowing arrangement
|
|
|
2,916
|
|
|
|
4,443
|
|
Line of credit – inventory financing
|
|
|
514
|
|
|
|
2,965
|
|
Notes payable
|
|
|
278
|
|
|
|
247
|
|
Paycheck Protection Program loan
|
|
|
965
|
|
|
|
—
|
|
Total debt
|
|
|
7,408
|
|
|
|
10,181
|
|
Less: current portion
|
|
|
(6,443
|
)
|
|
|
(10,130
|
)
|
Long term debt
|
|
$
|
965
|
|
|
$
|
51
|
|
Related-Party
Refinanced Convertible Note
On
November 3, 2017, the Company entered into the refinancing with Mr. Ryan Drexler, the Company’s Chairman of the Board of
Directors, Chief Executive Officer and President (the “Refinancing”). As part of the Refinancing, the Company issued
to Mr. Drexler an amended and restated convertible secured promissory note (the “Refinanced Convertible Note”) in
the original principal amount of $18.0 million, 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 $6.0 million 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 $11.0 million 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 $1.0 million 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.
Interest
rate on the $18.0 million Refinanced Convertible Note was 12% per annum, and interest payments were due on the last day of each
quarter. At the Company’s option (as determined by its independent directors), the Company could 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 would 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 could 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 could 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 contained 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 would 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
would be at a premium of 105%. The Refinanced Convertible Note also contained 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.
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 delivered a notice to the Company and its independent directors of his election to convert,
effective as of September 16, 2019 (the “Notice Date”), $18.0 million 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 $19.3 million. Pursuant to the terms of the Note, the Company instructed the transfer agent to issue to Mr. Drexler 16,216,216
shares (the “Shares”) of its Common Stock in respect of the Partial Conversion.
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. 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.
On
December 27, 2019, the Company entered into a collateral receipt and security agreement with Mr. Drexler, pursuant to which Mr.
Drexler agreed to post bond relating to the judgment ruled against the Company in connection with the litigation between the Company
and ThermoLife International LLC (“ThermoLife”), pending the appeal. The amount paid by Mr. Drexler on behalf of the
Company, including fees, was $0.3 million.
On
August 21, 2020, the Company entered into a refinancing agreement with Mr. Ryan Drexler, the Company’s Chairman of the Board
of Directors, Chief Executive Officer and President (the “2020 Refinancing”), with an effective date of July 1, 2020.
As part of the 2020 Refinancing, the Company issued to Mr. Drexler an amended and restated convertible secured promissory note
(the 2020 “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 2020 Refinanced Convertible Note bears interest at the rate of 12% per annum.
The
2020 Refinanced Convertible Note contains customary restrictions on the ability of the Company to, among other things, grant liens
or incur indebtedness other than certain obligations incurred in the ordinary course of business. The restrictions are also subject
to certain additional qualifications and carveouts, as set forth in the 2020 Refinanced Convertible Note. The 2020 Refinanced
Convertible Note is subordinated to certain other indebtedness of the Company held by Prestige Capital Corporation (“Prestige”)
and Crossroads Financial Group, LLC (“Crossroads”). The Company may prepay the 2020 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. 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 1, 2020 or (ii) $0.17.
All
outstanding principal and accrued but unpaid interest under the 2020 Refinanced Convertible Note were due and payable on November
1, 2020. The Note is currently in default and the Company is in negotiations with Mr. Drexler to either convert the 2020 Refinanced
Convertible Note or amend the 2020 Refinancing by the end of November 2020. Interest accrued but unpaid will be capitalized on
the due date and added to the principal amount of the 2020 Refinanced Convertible Note.
For
the three months ended September 30, 2020 and 2019, interest expense, related to the related party convertible notes was $80,000
and $0.5 million, respectively. During the three months ended September 30, 2020, no interest was paid in cash to Mr. Drexler.
During the three months ended September 30, 2019, $0.4 million in interest was paid in cash to Mr. Drexler.
For
the nine months ended September 30, 2020 and 2019, interest expense, related to the related party convertible notes was $0.2 million
and $1.6 million, respectively. During the nine months ended September 30, 2020, no interest was paid in cash to Mr. Drexler.
During the nine months ended September 30, 2019, $0.8 million in interest was paid in cash to Mr. Drexler.
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. The Security Agreement has second priority lien on the Company’s assets and is subordinated
to the Company’s indebtedness held by Prestige. As of September 30, 2020, and December 31, 2019, we owed Crossroads $0.5
million and $3.0 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,
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 based on the number of days outstanding from the assignment
of Accounts to collection of the assigned Accounts. In addition, the Company granted Prestige a continuing security interest in
and first priority lien upon all accounts receivable, inventory, fixed assets, general intangibles, and other assets. Prestige
will have no recourse against the Company if payments are not made due to the insolvency of an account debtor within 90 days of
invoice date, with the exception of international and certain domestic customers.
As of September 30, 2020 and December 31, 2019, the Company had outstanding borrowings of approximately $3.0 million and $4.4
million, respectively.
During
the three months ended September 30, 2020 and 2019, the Company assigned to Prestige accounts with an aggregate face amount of
approximately $14.6 million and $14.8 million, respectively, for which Prestige paid to the Company approximately $11.6 million
and $11.9 million, respectively, in cash. During the three months ended September 30, 2020 and 2019, $11.6 million and $12.5 million
was repaid to Prestige, respectively, including fees and interest.
During
the nine months ended September 30, 2020 and 2019, the Company assigned to Prestige accounts with an aggregate face amount of
approximately $41.0 million and $39.0 million, respectively, for which Prestige paid to the Company approximately $32.8 million
and $31.2 million, respectively, in cash. During the nine months ended September 30, 2020 and 2019, $34.3 million and $29.2 million
was repaid to Prestige, respectively, including fees and interest.
On
April 10, 2019, the Company and Prestige amended the terms of the agreement. The agreement was extended until April 1, 2020. Thereafter
the agreement shall renew itself automatically for one (1) year periods unless either party receives written notice of cancellation
from the other, at minimum, thirty (30) days prior to the expiration date.
Paycheck
Protection Program Loan
Due
to economic uncertainty as a result of the ongoing pandemic (COVID-19), on May 14, 2020, the Company received an aggregate principal
amount of $964,910 pursuant to the borrowing arrangement (“Note”) with Harvest Small Business Finance, LLC (“HSBF”)
and agreed to pay the principal amount plus interest at a 1% fixed interest rate per year, on the unpaid principal balance. The
Note includes forgiveness provisions in accordance with the requirements of the Paycheck Protection Program, Section 1106 of the
CARES Act.
The
Note is expected to mature on May 16, 2022. Payments were due by November 16, 2020 (the “Deferment Period”) and interest
was accrued during the Deferment Period. However, the Flexibility Act, which was signed into law on June 5, 2020, extended the
Deferment Period to the date that the forgiven amount is remitted by the United States Small Business Administration (“SBA”)
to HSBF. The Company is in the process of filling out the forgiveness application form. As of September 30, 2020, the Company
owed approximately $1.0 million (principal plus accrued interest), and the amount is recorded in “Other long-term liabilities”
in the consolidated balance sheets.
Note
8. Commitments and Contingencies
Settlements
Manchester
City Football Group
The
Company was engaged in a dispute with City Football Group Limited (“CFG”), the owner of Manchester City Football Group,
concerning amounts allegedly owed by the Company under a sponsorship agreement with CFG (the “Sponsorship Agreement”).
In August 2016, CFG commenced arbitration in the United Kingdom against the Company, seeking approximately $8.3 million for the
Company’s purported breach of the Sponsorship Agreement.
On
July 28, 2017, the Company approved a Settlement Agreement (the “CFG Settlement Agreement”) with CFG effective July
7, 2017. The CFG Settlement Agreement represents a full and final settlement of all litigation between the parties. Under the
terms of the agreement, the Company agreed to pay CFG a sum of $3 million, which was recorded as accrued expenses in 2017. The
settlement consists of a $1 million payment that was advanced by a related party on July 7, 2017, a $1 million installment paid
on July 7, 2018 and a subsequent $1 million installment payment to be paid by July 7, 2019. Of this amount, the Company has remitted
$0.3 million.
During
each of the three months ended September 30, 2020 and 2019, the Company recorded a charge of $19,000 and during the nine months
ended September 30, 2020 and 2019, the Company recorded a charge of $56,000 and $77,000, respectively. This charge, representing
imputed interest, is included in “Interest and other expense, net” in the Company’s consolidated statements
of operations.
Nutrablend
Matter
On
February 27, 2020, Nutrablend, a manufacturer of MusclePharm products, filed an action against MusclePharm in the United States
District Court for the Eastern District of California, claiming approximately $3.1 million in allegedly unpaid invoices. These
invoices relate to the third and fourth quarter of 2019, and a liability has been recorded in the books for the related periods.
On
September 25, 2020, the parties successfully mediated the case to a settlement and the Company agreed to (i) pay approximately
$3.1 million (“Owed Amount”) in monthly payments (“Monthly Payments”) from September 1, 2020 through June
30, 2023 and (ii) issue monthly purchase orders (“Purchase Orders”) at minimum amounts accepted by Nutrablend.
MusclePharm
agreed to issue Purchase Orders in a combined total amount of at least (i) $1,500,000 from September 1, 2020 through November
30, 2020; (ii) $1,800,000 from December 1, 2020 through February 28, 2021; (iii) $2,100,000 from March 31, 2021 through May 31,
2021; (iv) $2,100,000 from June 1, 2021 through August 31, 2021; and (v) $1,400,000 from September 1, 2021 through October 30,
2021. Beginning on November 1, 2021, MusclePharm will be required to issue monthly Purchase Orders to Nutrablend in a minimum
amount of $700,000 until the Owed Amount is paid in full to Nutrablend. In the event that MusclePharm pays the Owed Amount in
full before September 1, 2021, MusclePharm is entitled to a rebate on all completed Purchase Orders. Further, once the monthly
payments, and any additional payments that MusclePharm has made on the Owed Amount, reduce the outstanding balance of the Owed
Amount to below $2.0 million, MusclePharm is eligible for an extension of a line of credit from Nutrablend in an amount of up
to $3.0 million.
The
Company determined that approximately $1.0 million dollars of the Owed Amount was due within a year, and this amount was recorded
in “Accrued and other liabilities” in the consolidated balance sheets. The present value of the remaining Owed Amount
that was due after a year was $1.6 million, and the amount was recorded in “Other long term liabilities” in the consolidated
balance sheets. The Company made the first payment of $60,000 in September 2020.
During
the three and nine months ended September 30, 2020, the Company recorded $0.5 million as a gain on the settlement of the liability,
and interest expense of $3,000, in the consolidated statements of operations.
Contingencies
In
the normal course of business or otherwise, the Company may become involved in legal proceedings. The Company will accrue a liability
for such matters when it is probable that a liability has been incurred and the amount can be reasonably estimated. When only
a range of possible loss can be established, the most probable amount in the range is accrued. If no amount within this range
is a better estimate than any other amount within the range, the minimum amount in the range is accrued. The accrual for a litigation
loss contingency might include, for example, estimates of potential damages, outside legal fees and other directly related costs
expected to be incurred. The Company provides disclosures for material contingencies when there is a reasonable possibility that
a loss or an additional loss may be incurred. In assessing whether a loss is a reasonable possibility, the Company may consider
the following factors, among others: the nature of the litigation, claim or assessment, available information, opinions or views
of legal counsel and other advisors, and the experience gained from similar cases. As of September 30, 2020, the Company was involved
in the following material legal proceedings described below.
ThermoLife
International
In
January 2016, 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 7. 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.
For
both the three months ended September 30, 2020 and 2019, interest expense recognized on the awarded damages was $22,000. For both
the nine months ended September 30, 2020 and 2019, interest expense recognized on the awarded damages was $66,000.
The
Company intends to continuously vigorously pursuing its defenses, including on appeal.
White
Winston Select Asset Fund Series MP-18, LLC et al., v MusclePharm Corp., et al., (Nev. Dist. Ct.; Cal. Superior Court; Colorado
Dist. Ct.; Mass. Super. Ct.)
On
August 21, 2018, White Winston Select Asset Fund Series MP-18, LLC and White Winston Select Asset Fund, LLC (together “White
Winston”) initiated a derivative action against MusclePharm and its directors (collectively the “director defendants”).
White Winston alleges that the director defendants breached their fiduciary duties by improperly approving the refinancing of
three promissory notes issued by MusclePharm to Drexler (the “Amended Note”), in exchange for $18.0 million in loans.
White Winston alleges that this refinancing improperly diluted their economic and voting power and constituted an improper distribution
in violation of Nevada law. In its complaint, White Winston sought the appointment of a receiver over MusclePharm, a permanent
injunction against the exercise of Drexler’s conversion right under the Amended Note, and other unspecified monetary damages.
On September 13, 2018, White Winston filed an amended complaint, which added a former MusclePharm executive, as a plaintiff (together
with White Winston, the “White Winston Plaintiffs”). On December 9, 2019, the White Winston Plaintiffs filed a Second
Amended Complaint, in which they added allegations relating to the resignation of MusclePharm’s auditor, Plante & Moran
PLLC (“Plante Moran”). MusclePharm has moved to dismiss the Second Amended Complaint. That motion has not yet been
fully briefed.
Along
with its complaint, the White Winston Plaintiffs also filed a motion for a temporary restraining order (“TRO”) and
preliminary injunction enjoining the exercise of Drexler’s conversion right under the Amended Note. On August 23, 2018,
the Nevada district court issued an ex parte TRO. On September 14, 2018, the court let the TRO expire and denied the White Winston
Plaintiffs’ request for a preliminary injunction, finding, among other things, that the White Winston Plaintiffs did not
show a likelihood of success on the merits of the underlying action and failed to establish irreparable harm. Following the court’s
decision, MusclePharm filed a motion seeking to recoup the legal fees and costs it incurred in responding to the preliminary injunction
motion. On October 31, 2019, the court awarded MusclePharm $56,000 in fees and costs. The White Winston Plaintiffs have appealed
that award.
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 $2.0
million. Thus, with this concession, the IRS’s claims have been reduced from approximately $7.3 million to about $5.3 million.
The
remaining issue in dispute in this matter involves the fair market value of restricted stock units in the Company granted to certain
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, on the other hand, is relying on a separate valuation report prepared by a different valuation firm in
its defense to the IRS case. This new valuation firm supports the Company’s position. 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 had a liability
of $5.7 million and $5.3 million as of September 30, 2020 and December 31, 2019, respectively. This liability, which represents
past due invoices (May 2018 through March 2019) plus interest, is recorded in “Accounts Payable” in the consolidated
balance sheets. Trial has not yet been set, although a Trial Setting Conference was set for December 17, 2020.
On
November 16, 2020, the Company and 4Excelsior entered into a stipulation of settlement that provided that the Company would pay
to 4Excelsior a total of $4,750,000, in four monthly payments of $70,000, beginning January 5, 2021, and thereafter in monthly
payments of $100,000. The parties have not yet entered into a settlement agreement giving effect to the stipulation of settlement.
Note
9. Stockholders’ Deficit
Common
Stock
The
fair value of all stock issuances is based upon the quoted closing trading price on the date of issuance. Common stock outstanding
as of September 30, 2020 includes shares legally outstanding, even if subject to future vesting. For the nine months ended September
30, 2020, the Company had the following transactions related to its common stock, including restricted stock awards (in thousands,
except share and per share data):
Transaction Type
|
|
Quantity (Shares)
|
|
|
Valuation
|
|
|
Range of
Value per Share
|
|
Stock issued for advertising services
|
|
|
129,627
|
|
|
$
|
117
|
|
|
$
|
0.90
|
|
Total
|
|
|
129,627
|
|
|
$
|
117
|
|
|
$
|
0.90
|
|
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
|
|
Quantity (Shares)
|
|
|
Valuation ($)
|
|
|
Range of Value
per Share
|
|
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
|
|
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, 2020 and December 31, 2019 includes shares legally outstanding even if subject to future vesting.
Warrants
For
the nine months ended September 30, 2020 and 2019, the Company did not issue any warrants. As of both September 30, 2020 and 2019,
the Company had outstanding warrants of 1,289,378 shares.
Treasury
Stock
For
the nine months ended September 30, 2020 and 2019, the Company did not repurchase any shares of its common stock and held 875,621
shares in treasury as of both September 30, 2020 and 2019.
Note
10. Stock-Based Compensation
Restricted
Stock
The
Company’s stock-based compensation for the nine months ended September 30, 2020 and 2019 consist 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, 2020 was as follows:
|
|
Unvested Restricted Stock Awards
|
|
|
|
Number of
Shares
|
|
|
Weighted Average
Grant Date Fair
Value
|
|
Unvested balance – December 31, 2019
|
|
|
690,132
|
|
|
$
|
0.42
|
|
Granted
|
|
|
—
|
|
|
|
—
|
|
Vested
|
|
|
(568,280
|
)
|
|
|
0.42
|
|
Forfeited
|
|
|
(121,852
|
)
|
|
|
0.42
|
|
Unvested balance – September 30, 2020
|
|
|
—
|
|
|
|
—
|
|
There
were no restricted stock awards granted for both the three and nine months ended September 30, 2020. The Company issued 595,238
shares of restricted stock to its Board members for both the three and nine months ended September 30, 2019. The total fair value
of restricted stock awards granted to the Board for both the three and nine months ended September 30, 2019 was $0.3 million.
As
of September 30, 2020, there was no unrecognized expense for unvested restricted stock awards.
Stock
Options
The
Company may grant options to purchase shares of the Company’s common stock to certain employees and directors pursuant to
the 2015 Incentive Compensation Plan (the “2015 Plan”). Under the 2015 Plan, all stock options are granted with an
exercise price equal to or greater than the fair market value of a share of the Company’s common stock on the date of grant.
Vesting is generally determined by the Compensation Committee of the Board within limits set forth in the 2015 Plan. No stock
option will be exercisable more than ten years after the date it is granted.
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, 2020. 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, 2019
|
|
|
171,703
|
|
|
$
|
1.89
|
|
|
$
|
1.72
|
|
|
|
6.17
|
|
|
|
—
|
|
Granted
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Exercised
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Forfeited
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Issued and outstanding as of September 30, 2020
|
|
|
171,703
|
|
|
|
1.89
|
|
|
|
1.72
|
|
|
|
5.39
|
|
|
|
—
|
|
Exercisable as of September 30, 2020
|
|
|
171,703
|
|
|
|
1.89
|
|
|
|
1.72
|
|
|
|
5.39
|
|
|
|
—
|
|
For
the three and nine months ended September 30, 2020 and 2019, the Company recorded no stock compensation expense related to options.
Note
11. Net Income (Loss) per Share
Basic
net income (loss) per share is computed by dividing net income (loss) for the period by the weighted average number of shares
of common stock outstanding during each period. The following table sets forth the computation of the Company’s basic and
diluted net income (loss) per share for the periods presented (in thousands, except share and per share data):
|
|
For the Three Months
Ended September 30,
|
|
|
For the Nine Months
Ended September 30,
|
|
|
|
2020
|
|
|
2019
|
|
|
2020
|
|
|
2019
|
|
Net income (loss)
|
|
$
|
678
|
|
|
$
|
(5,079
|
)
|
|
$
|
365
|
|
|
$
|
(15,468
|
)
|
Weighted average common shares used in computing net income (loss) per share, basic
|
|
|
33,008,189
|
|
|
|
18,527,438
|
|
|
|
32,746,147
|
|
|
|
16,443,945
|
|
Potentially diluted securities
|
|
|
16,089,406
|
|
|
|
—
|
|
|
|
16,089,406
|
|
|
|
—
|
|
Weighted average common shares used in computing net income (loss) per share, diluted
|
|
|
49,097,595
|
|
|
|
18,527,438
|
|
|
|
48,835,553
|
|
|
|
16,443,945
|
|
Net income (loss) per share, basic
|
|
$
|
0.02
|
|
|
$
|
(0.27
|
)
|
|
$
|
0.01
|
|
|
$
|
(0.94
|
)
|
Net income (loss) per share,
diluted
|
|
$
|
0.01
|
|
|
$
|
(0.27
|
)
|
|
$
|
0.01
|
|
|
$
|
(0.94
|
)
|
Diluted
net income (loss) per share is computed by dividing net income (loss) for the period by the weighted average number of shares
of common stock, common stock equivalents and potentially dilutive securities outstanding during each period. The Company uses
the treasury stock method to determine whether there is a dilutive effect of outstanding potentially dilutive securities, and
the if-converted method to assess the dilutive effect of the convertible notes.
The
Company reported a net income for the three and nine months ended September 30, 2020. The 2020 Refinanced Convertible Note issued
to Mr. Drexler was assumed to have been converted on the effective date of July 1, 2020, at a conversion price of $0.17. The resulting
shares of 16,089,406, which represented potentially dilutive securities was included in the computations for the diluted net income
per share for the three and nine months ended September 30, 2020.
There
was no dilutive effect for the outstanding awards for the three and nine months ended September 30, 2019, as the Company reported
a net loss for both periods. The following securities were excluded from the computations of the diluted net income (loss) per
share, as the effect of the securities would be anti-dilutive:
|
|
As
of September 30,
|
|
|
|
2020
|
|
|
2019
|
|
Stock options
|
|
|
171,703
|
|
|
|
171,703
|
|
Warrants
|
|
|
1,289,378
|
|
|
|
1,289,378
|
|
Unvested
restricted stock
|
|
|
—
|
|
|
|
595,238
|
|
2017
Refinanced Convertible notes
|
|
|
—
|
|
|
|
931,974
|
|
Total
common stock equivalents
|
|
|
1,461,081
|
|
|
|
2,988,293
|
|
Note
12. Income Taxes
The
Company recorded a tax expense of $20,000 and tax income of $53,000 for the three months ended September 30, 2020 and 2019, respectively,
and $64,000 and $89,000 for the nine months ended September 30, 2020 and 2019, 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, 2020.
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 2025
through 2037.
Note
13. Segments, Geographical Information
The
Company’s chief operating decision maker reviews financial information presented on a consolidated basis for purposes of
allocating resources and evaluating financial performance. As such, the Company currently has a single reporting segment and operating
unit structure. In addition, substantially all long-lived assets are attributable to operations in the U.S. for both periods presented.
Revenue, net by geography is based on the Company addresses of the customers. The following table sets forth revenue, net by geographic
area (in thousands):
|
|
For the Three Months Ended September 30,
|
|
|
For the Nine Months
Ended September 30,
|
|
|
|
2020
|
|
|
2019
|
|
|
2020
|
|
|
2019
|
|
Revenue, net:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
10,072
|
|
|
$
|
15,632
|
|
|
$
|
35,433
|
|
|
$
|
44,798
|
|
International
|
|
|
6,013
|
|
|
|
5,543
|
|
|
|
13,876
|
|
|
|
17,451
|
|
Total revenue, net
|
|
$
|
16,085
|
|
|
$
|
21,175
|
|
|
$
|
49,309
|
|
|
$
|
62,249
|
|
Note
14. Subsequent Events
GAAP
requires an entity to disclose events that occur after the balance sheet date but before financial statements are issued or are
available to be issued (“subsequent events”) as well as the date through which an entity has evaluated subsequent
events. There are two types of subsequent events. The first type consists of events or transactions that provide additional evidence
about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial
statements, (“recognized subsequent events”). The second type consists of events that provide evidence about conditions
that did not exist at the date of the balance sheet but arose subsequent to that date (“non-recognized subsequent events”).
Related
Party Secured Revolving Promissory Note
On
October 15, 2020, the Company entered into a secured revolving promissory note (the “Revolving Note”) with Ryan Drexler,
the Chief Executive Officer, President and Chairman of the Board of Directors of the Company. Under the terms of the Revolving
Note, the Company can borrow up to $3.0 million. The Revolving Note bears interest at the rate of 12% per annum. The use of funds
will be used for the purchase of whey protein and other general corporate purposes. Both the outstanding principal, if any, and
all accrued interest under the Revolving Note are due on March 31, 2021. The Company may prepay the Revolving Note by giving Mr.
Drexler one days’ advance written notice. The Revolving Note contains customary events of default, including, among others,
the failure by the Company to make a payment of principal or interest when due. Following an event of default, Mr. Drexler is
entitled to accelerate the entire indebtedness under the Revolving Note. The Revolving Note also contains customary restrictions
on the ability of the Company to, among other things, grant liens or incur indebtedness other than certain obligations incurred
in the ordinary course of business. The restrictions are also subject to certain additional qualifications and carveouts, as set
forth in the Revolving Note. The Revolving Note is subordinated to certain other indebtedness of the Company held by Prestige
and Crossroads. In connection with the Revolving Note, the Company and Mr. Drexler entered into a fifth amended and restated security
agreement dated October 15, 2020 (the “Security Agreement”) pursuant to which the Revolving Note is secured by all
of the assets and properties of the Company and its subsidiaries whether tangible or intangible.
There
are no events subsequent to September 30, 2020 that have not been described in the accompanying footnotes.