UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

FORM 10-Q

 

 

 

(Mark one)

 

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended: March 31, 2021 or

 

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ______ to _____

 

Commission file number: 000-53166

 

 

 

 

MusclePharm Corporation

(Exact name of registrant as specified in its charter)

 

Nevada   77-0664193

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

4500 Park Granada, Suite 202

Calabasas, CA

  91302
(Address of principal executive offices)   (Zip code)

 

(800) 292-3909

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

  Trading Symbol(s)   Name of each exchange on which registered

N/A

       

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [  ] Yes [X] No

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). [  ] Yes [X] No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   [  ]   Accelerated filer   [  ]
Non-accelerated filer   [X]   Smaller reporting company   [X]
        Emerging growth company   [  ]

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [  ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). [  ] Yes [X] No

 

Number of shares of the registrant’s common stock outstanding at May 20, 2021: 33,479,886 (excludes 875,621 shares of common stock held in treasury).

 

 

 

 

 

 

MusclePharm Corporation

Form 10-Q

 

TABLE OF CONTENTS

 

    Page
     
Forward-Looking Statements 1
   
PART I – FINANCIAL INFORMATION  
     
Item 1. Financial Statements 2
     
  Consolidated Balance Sheets as of March 31, 2021 (unaudited) and December 31, 2020 2
     
  Consolidated Statements of Operations for the three months ended March 31, 2021 and 2020 (unaudited) 3
     
  Consolidated Statements of Changes in Stockholders’ Deficit for the three months ended March 31, 2021 and 2020 (unaudited) 4
     
  Consolidated Statements of Cash Flows for the three months ended March 31, 2021 and 2020 (unaudited) 5
     
  Notes to Consolidated Financial Statements (unaudited) 6
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 20
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 28
     
Item 4. Controls and Procedures 28
   
PART II – OTHER INFORMATION  
     
Item 1. Legal Proceedings 33
     
Item 1A. Risk Factors 33
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 33
     
Item 3. Defaults Upon Senior Securities. 33
     
Item 4. Mine Safety Disclosures 33
     
Item 5. Other Information 33
     
Item 6. Exhibits 34
     
  Signatures 35

 

 

 

 

Forward-Looking Statements

 

Except as otherwise indicated herein, the terms “MusclePharm,” “Company,” “we,” “our” and “us” refer to MusclePharm Corporation and its subsidiaries. This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (“the Exchange Act”), and Section 27A of the Securities Act of 1933, as amended. All statements contained in this Quarterly Report on Form 10-Q other than statements of historical fact, including statements regarding our future results of operations and financial position, including our future profits, financing sources and our ability to satisfy our liabilities, our business strategy and plans, and our objectives for future operations, are forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “projects,” “intends,” “predicts,” “potential,” or “continue” or other comparable terminology. We have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives, and financial needs.

 

These forward-looking statements are not guarantees of future performance and involve risks, uncertainties, estimates and assumptions that are difficult to predict and are subject to a number of risks, uncertainties and assumptions, including those described in Item 1A, “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020, filed with the SEC on March 29, 2021. Moreover, we operate in a very competitive and rapidly changing environment. In particular, we have experienced a slowdown in sales from our retail customers due to the ongoing COVID-19 pandemic, and we cannot predict the ultimate impact of the COVID-19 pandemic on our business. New risks may emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the future events and trends discussed in this Quarterly Report on Form 10-Q may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.

 

We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements, except as required by law. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.

 

Note Regarding Trademarks

 

We have proprietary rights to a number of registered and unregistered trademarks worldwide that we believe are important to our business, including, but not limited to: “MusclePharm” and “FitMiss”. We have, in certain cases, omitted the ®, © and ™ designations for these and other trademarks used in this Form 10-Q. Nevertheless, all rights to such trademarks are reserved. These and other trademarks referenced in this Form 10-Q are the property of their respective owners and they will assert, to the fullest extent under applicable law, their rights thereto.

 

1

 

 

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

MusclePharm Corporation

Consolidated Balance Sheets

(In thousands, except share and per share data)

 

   

March 31,

2021

   

December 31,

2020

 
      (Unaudited)          
ASSETS                
Current assets:                
Cash   $ 592     $ 2,003  
Accounts receivable, net     6,221       7,488  
Inventory     1,353       1,032  
Prepaid expenses and other current assets     814       1,341  
Total current assets     8,980       11,864  
Property and equipment, net     13       13  
Intangible assets, net     275       356  
Operating lease right-of-use assets     406       474  
Other assets     275       295  
TOTAL ASSETS   $ 9,949     $ 13,002  
LIABILITIES AND STOCKHOLDERS’ DEFICIT                
Current liabilities:                
Obligation under secured borrowing arrangement   $ 4,740     $ 7,098  
Line of credit     1,705       743  
Operating lease liability, current     402       381  
Convertible note with a related party, net of discount     2,872       2,872  
Accounts payable     13,759       14,719  
Accrued and other liabilities     6,028       6,194  
Total current liabilities     29,506       32,007  
Operating lease liability, long-term     233       343  
Other long-term liabilities     4,535       5,071  
Total liabilities     34,274       37,421  
Commitments and contingencies (Note 7)                
Stockholders’ deficit:                
Common stock, par value of $0.001 per share; 100,000,000 shares authorized, 34,261,821 and 33,980,905 shares issued as of March 31, 2021 and December 31, 2020, respectively; 33,386,200 and 33,105,284 shares outstanding as of March 31, 2021 and December 31, 2020, respectively     32       32  
Additional paid-in capital     178,261       178,261  
Treasury stock, at cost; 875,621 shares     (10,039 )     (10,039 )
Accumulated deficit     (192,579 )     (192,673 )
TOTAL STOCKHOLDERS’ DEFICIT     (24,325 )     (24,419 )
TOTAL LIABILITIES AND STOCKHOLDERS’ DEFICIT   $ 9,949     $ 13,002  

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

2

 

 

MusclePharm Corporation

Consolidated Statements of Operations

(In thousands, except share and per share data)

(Unaudited)

 

   

Three Months Ended

March 31,

 
    2021    

2020

 
Revenue, net   $ 13,121     $ 16,231  
Cost of revenue     9,432       11,422  
Gross profit     3,689       4,809  
Operating expenses:                
Advertising and promotion     345       125  
Salaries and benefits     1,048       1,681  
Selling, general and administrative     1,397       1,911  
Professional fees     627       541  
Total operating expenses     3,417       4,258  
Income from operations     272       551  
Other expense:                
Interest and other expense, net     (178 )     (589 )
Income (loss) before provision for income taxes     94       (38 )
Provision for income taxes           22  
Net income (loss)   $ 94     $ (60 )
                 
Net income (loss) per share, basic and diluted   $ 0.00     $ (0.00 )
                 
Weighted average shares used to compute net income (loss) per share, basic     33,119,549       32,459,675  
Weighted average shares used to compute net income (loss) per share, diluted     45,492,621       32,459,675  

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

3

 

 

MusclePharm Corporation

Consolidated Statements of Changes in Stockholders’ Deficit

(In thousands, except share data)

(Unaudited)

 

                Additional                 Total  
    Common Stock     Paid-in     Treasury     Accumulated     Stockholders’  
    Shares     Amount     Capital     Stock     Deficit     Deficit  
Balance - December 31, 2019     33,000,412     $ 31     $ 177,914     $ (10,039 )   $ (195,858 )   $     (27,952 )
Stock-based compensation for issuance and amortization of restricted stock awards to employees, executives, and directors                 100                   100  
Issuance of shares of common stock related to the payment of advertising services     101,454             47                   47  
Net loss                             (60 )     (60 )
Balance - March 31, 2020     33,101,866     $ 31     $ 178,061     $ (10,039 )   $ (195,918 )   $ (27,865 )

 

Balance - December 31, 2020     33,105,284     $ 32     $ 178,261     $ (10,039 )   $ (192,673 )   $ (24,419 )
Stock-based compensation for issuance and amortization of restricted stock awards to employees, executives, and directors     280,916                                  
Net income                             94       94  
Balance - March 31, 2021     33,386,200     $ 32     $ 178,261     $ (10,039 )   $ (192,579 )   $ (24,325 )

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

4

 

 

MusclePharm Corporation

Consolidated Statements of Cash Flows

(Unaudited, in thousands)

 

   

Three Months Ended

March 31,

 
    2021     2020  
CASH FLOWS FROM OPERATING ACTIVITIES:                
Net income (loss)   $ 94     $ (60 )
Adjustments to reconcile net loss to net cash provided by operating activities:                
Depreciation and amortization of property and equipment     4       63  
Amortization of intangible assets     80       80  
Bad debt expense (recovery)     (11 )     11  
Gain on disposal of property and equipment           (11 )
Inventory provision     86       12  
Stock-based compensation           100  
Issuance of common stock to non-employees           47  
Changes in operating assets and liabilities:                
Accounts receivable     1,278       (781 )
Inventory     (406 )     (268 )
Prepaid expenses and other current assets     527       (459 )
Other assets     87       174  
Accounts payable and accrued liabilities     (1,641 )     1,253  
Net cash provided by operating activities     98       161  
CASH FLOWS FROM INVESTING ACTIVITIES:                
Purchase of property and equipment     (4 )      
Proceeds from disposal of property and equipment           11  
Net cash (used in) provided by investing activities     (4 )     11  
CASH FLOWS FROM FINANCING ACTIVITIES:                
Proceeds from line of credit     1,061        
Payments on line of credit     (100 )     (393 )
Proceeds from secured borrowing arrangement, net of reserves     11,423       9,377  
Payments on secured borrowing arrangement, net of fees     (13,781 )     (9,993 )
Repayment of finance lease obligations           (29 )
Repayment of notes payable     (108 )     (48 )
Net cash used in financing activities     (1,505 )     (1,086 )
                 
NET CHANGE IN CASH     (1,411 )     (914 )
CASH — BEGINNING OF PERIOD     2,003       1,532  
CASH — END OF PERIOD   $ 592     $ 618  
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                
Cash paid for interest   $ 101     $ 168  

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

5

 

 

MusclePharm Corporation

Notes to Consolidated Financial Statements

(Unaudited)

 

Note 1. Description of Business

 

Description of Business

 

MusclePharm Corporation was incorporated in Nevada in 2006. Except as otherwise indicated herein or the context requires otherwise, the terms “MusclePharm,” the “Company,” “we,” “our” and “us” refer to MusclePharm Corporation and its subsidiaries. The Company is a scientifically-driven, performance lifestyle company that develops, markets and distributes branded sports nutrition products and nutritional supplements that are manufactured by the Company’s co-manufacturers. Our portfolio of recognized brands, including MusclePharm and FitMiss, is marketed and sold globally.

 

Although the Company has historically incurred significant losses and experienced negative cash flows since inception, we generated net income of $0.1 million for the period ended March 31, 2021 and had cash of $0.6 million, a decline of $1.4 million from the December 31, 2020 balance of $2.0 million. As of March 31, 2021, the Company had a working capital deficit of $20.5 million, a stockholders’ deficit of $24.3 million and an accumulated deficit of $192.6 million resulting from recurring losses from operations. As a result of our history of losses and financial condition, there is substantial doubt about our ability to continue as a going concern. For financial information concerning more recent periods, see our reports for such periods filed with the SEC.

 

The ability to continue as a going concern is dependent upon us generating profits in the future and/or obtaining the necessary financing to meet our obligations and repay our liabilities arising from normal business operations when they come due. Management is evaluating different strategies to obtain financing to fund our expenses and achieve a level of revenue adequate to support our current cost structure. Financing strategies may include, but are not limited to, private placements of capital stock, debt borrowings, partnerships and/or collaborations.

 

During the fourth quarter of 2019, the Company focused on cost containment and improving gross margins by focusing on customers with higher margins, reducing product discounts and promotional activity, along with reducing the number of SKU’s and negotiate cost for raw materials. These steps improved gross margins in the fourth quarter of 2019 and this trend has continued through March 31, 2021.

 

During 2020, the Company experienced a slowdown in sales from retail customers, including our largest customer, which was partially offset by an increase in sales from our largest online customer. In addition, the Company negotiated lower cost of sold with its co-manufactures.

 

In 2021, the Company announced its entrance into the functional energy space with its partnership with a former Rockstar Energy executive. The Company plans to launch 3 new energy products in the summer of 2021.

 

The Company believes reductions in operating costs with continued focus on gross profit and top line sales growth will allow it to ultimately achieve sustained profitability, however, the Company can give no assurances that this will occur. In particular, the cost of protein may have a material impact on the Company’s profitability, and the ability of our third-party manufacturers to meet our customer’s demands. In addition, the Company believes entering the functional energy space will help to increase sales and gross margin, however, the Company can give no assurances that this will occur. To manage cash flow, the Company has entered into multiple financing arrangements. See additional information in “Note 6. Debt.”

 

The Company’s results of operations are affected by economic conditions, including macroeconomic conditions and levels of business confidence. There continues to be significant volatility and economic uncertainty in many markets and the ongoing COVID-19 pandemic has increased that level of volatility and uncertainty and has created economic disruption. The Company is actively managing its business to respond to the impact. There were no adjustments recorded in the financial statements that might result from the outcome of these uncertainties.

 

6

 

 

Note 2. Summary of Significant Accounting Policies

 

Basis of Presentation and Principles of Consolidation

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, these statements do not include all the information and notes required by U.S. GAAP for complete financial statements. The consolidated financial statements include the accounts of MusclePharm Corporation and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

 

The Company’s management believes the unaudited interim consolidated financial statements include all adjustments of a normal recurring nature necessary for the fair presentation of the Company’s financial position as of March 31, 2021, results of operations for the three months ended March 31, 2021 and 2020, and cash flows for the three months ended March 31, 2021 and 2020. The results of operations for the three months ended March 31, 2021 are not necessarily indicative of the results to be expected for the year ended December 31, 2021.

 

These unaudited interim consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, filed with the SEC on March 29, 2021.

 

Use of Estimates

 

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported and disclosed in the consolidated financial statements and accompanying notes. Such estimates include, but are not limited to, allowance for doubtful accounts, revenue discounts and allowances, the valuation of inventory and deferred tax assets, the assessment of useful lives, recoverability and valuation of long-lived assets, likelihood and range of possible losses on contingencies, present value of lease liabilities, among others. Actual results could differ from those estimates.

 

Shipping and handling

 

The Company accounts for shipping and handling costs as fulfillment activities, which are therefore recognized upon shipment of the goods.

 

For the three months ended March 31, 2021 and 2020, the Company incurred $0.5 million and $0.4 million, respectively, of inbound shipping and handling costs. Shipping and handling costs related to inbound purchases of raw material and finished goods are included in cost of revenue in our consolidated statements of operations.

 

For the three months ended March 31, 2021 and 2020, the Company incurred $0.7 million and $0.6 million, respectively, of shipping and handling costs related to shipments to our customers. Shipping and handling costs related to shipments to our customers is included in “Selling, general and administrative” expense in our consolidated statements of operations.

 

Sales discounts and returns

 

The Company excludes from its revenue any amounts collected from customers for sales (and similar) taxes. During the three months ended March 31, 2021 and 2020, the Company recorded discounts, and to a lesser degree, sales returns, totaling $2.4 million and $4.0 million, respectively, which accounted for 15% and 20% of gross revenue in each period, respectively.

 

Concentrations

 

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and accounts receivable. The Company minimizes its credit risk associated with cash by periodically evaluating the credit quality of its primary financial institution. The cash balance, at times, may exceed federally insured limits. Management believes the financial risk associated with these balances is minimal and has not experienced any losses to date.

 

7

 

 

Significant customers are those that represent more than 10% of the Company’s revenue, net or accounts receivable for each period presented.

 

During the period ended March 31, 2021, the Company had three customers who individually accounted for 28%, 17% and 14% of our net revenue, and two customers that accounted for 32% and 21% of our accounts receivable, net as of March 31, 2021. During the period ended March 31, 2020, the Company had three customers who individually accounted for approximately 36%, 21% and 10% of our net revenue and three customers that accounted for 30%, 23% and 14% of our accounts receivable, net as of March 31, 2020.

 

The Company uses a limited number of non-affiliated suppliers for contract manufacturing of its products. During the period ended March 31, 2021, the Company had three suppliers who individually accounted for approximately 32%, 21% and 21% of our purchases with contract manufactures and raw material providers. During the period ended March 31, 2020, the Company had four suppliers who individually accounted for approximately 34%, 30%, 13% and 11% of our purchases with contract manufactures and raw material providers.

 

Recent Accounting Pronouncements

 

In July 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”), which among other things, these amendments require the measurement of all expected credit losses of financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. ASU 2016-13 is effective for periods beginning after December 15, 2022, and interim periods within those fiscal years. The Company will evaluate the impact of the pronouncement closer to the effective date.

 

In August 2020, the FASB issued ASU No. 2020-06, Debt - Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging - Contracts in Entity’s Own Equity (Subtopic 815-40). The new ASU eliminates the beneficial conversion and cash conversion accounting models for convertible instruments. It also amends the accounting for certain contracts in an entity’s own equity that are currently accounted for as derivatives because of specific settlement provisions. In addition, the new guidance modifies how particular convertible instruments and certain contracts that may be settled in cash or shares impact the diluted EPS computation. This guidance is effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted, but not earlier than fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. The FASB also specified that an entity should adopt the guidance as of the beginning of its annual fiscal year and is not permitted to adopt the guidance in an interim period. The Company will evaluate the impact of the pronouncement closer to the effective date.

 

In May 2021, the FASB issued ASU 2021-04, Earnings Per Share (Topic 260), Debt-Modifications and Extinguishments (Subtopic 470-50), Compensation-Stock Compensation (Topic 718), and Derivatives and Hedging-Contracts in Entity’s Own Equity (Subtopic 815-40). The new ASU addresses issuer’s accounting for certain modifications or exchanges of freestanding equity-classified written call options. This amendment is effective for all entities, for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. Early adoption is permitted. The Company will evaluate the impact of the pronouncement closer to the effective date.

 

Recently Adopted Accounting Pronouncements

 

In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, expected to reduce cost and complexity related to the accounting for income taxes. The ASU removes specific exceptions to the general principles in Topic 740 in U.S. GAAP. It eliminates the need for an organization to analyze whether the following apply in a given period: exception to the incremental approach for intra-period tax allocation; exceptions to accounting for basis differences when there are ownership changes in foreign investments; and exception in interim period income tax accounting for year-to-date losses that exceed anticipated losses. The ASU also improves financial statement preparers’ application of income tax-related guidance and simplifies U.S. GAAP for: franchise taxes that are partially based on income; transactions with a government that result in a step up in the tax basis of goodwill; separate financial statements of legal entities that are not subject to tax; and enacted changes in tax laws in interim periods. The Company adopted this ASU effective January 1, 2021, with certain provisions applied retrospectively and other provisions applied prospectively. Adoption of this ASU did not have a material impact to the Company’s condensed consolidated balance sheet, statements of operations, or cash flows.

 

8

 

 

Note 3. Accrued and Other Liabilities

 

As of March 31, 2021 and December 31, 2020, the Company’s accrued and other liabilities consisted of the following

(in thousands):

 

   

As of

March 31,

2021

   

As of

December 31,

2020

 
Accrued professional fees   $ 123     $ 242  
Accrued interest     693       644  
Accrued payroll and bonus     368       738  
Settlements – short term (Nutrablend and 4Excelsior)     2,181       2,005  
Accrued expenses - ThermoLife     1,364       1,364  
Accrued and other short-term liabilities     1,299       1,201  
Accrued and other liabilities   $ 6,028     $ 6,194  

 

Note 4. Interest and other expense, net

 

For the three months ended March 31, 2021 and 2020, “Interest and other expense, net” consisted of the following (in thousands):

 

   

For the Three Months

Ended March 31,

    2021   2020
         
Interest expense, related party   $ (120 )   $ (76 )
Interest expense, other     (227 )     (157 )
Interest expense, secured borrowing arrangement     (163 )     (365 )
Foreign currency transaction loss     (1 )     (34 )
Loss on settlement obligation           (50 )
Gain on legal settlement     200        
Other     133       93  
Total interest and other expense, net   $ (178 )   $ (589 )

 

“Other” includes sublease income.

 

9

 

 

Note 5. Leases

 

A summary of the Company’s lease portfolio as of March 31, 2021 and December 31, 2020 is presented in the table below (in thousands):

 

    Balance Sheet Classification   March 31, 2021   December 31, 2020
Assets                    
Operating   ROU assets, net   $ 406     $ 474  
                     
Liabilities                    
Current liabilities:                    
Operating   Operating lease liability - current   $ 402     $ 381  
                     
Non-current liabilities:                    
Operating   Operating lease liability - long term     233       343  
Total lease liabilities       $ 635     $ 724  

 

Fixed lease costs represent the explicitly quantified lease payments prescribed by the lease agreement and are included in the measurement of the ROU asset and corresponding lease liability. Some leasing arrangements require variable payments that are dependent on usage, output, or may vary for other reasons, such as insurance and tax payments. The variable lease payments are not presented as part of the initial ROU asset or lease liability. The Company’s lease agreements do not contain any material restrictive covenants.

 

The components of lease cost for operating and finance leases for the three months ended March 31, 2021 and 2020 were as follows (in thousands):

 

    Income Statement Classification   Three months ended
March 31, 2021
  Three months ended
March 31, 2020
             
Operating lease cost   Selling, general and administrative   $ 115     $ 243  
                     
Finance lease cost:                    
Amortization of ROU asset   Selling, general and administrative           27  
                     
Total finance lease cost               27  
                     
Variable lease payments   Selling, general and administrative     32       103  
Sublease income   Other income     (134 )     (36 )
                     
Total lease (income) cost       $ 13   $ 337  

 

The Company had no short-term leases as of both March 31, 2021 and 2020. The Company’s leases do not provide an implicit rate; therefore, the Company uses its incremental borrowing rate based on the information available at the effective date in determining the present value of future payments for those leases.

 

10

 

 

Supplemental cash flow information related to leases was as follows:

 

    Three months ended March 31, 2021     Three months ended March 31, 2020  
Cash paid for amounts included in the measurement of lease liabilities (in thousands):                
Operating cash flows from operating leases   $ 88     $ 197  
                 
Financing cash flows from finance leases           29  
                 
The weighted average remaining lease term was as follows:                
Operating leases (in years)     1.4       2.1  
Finance leases (in years)           0.3  
The weighted average discount rate was as follows:                
Operating leases     18 %     18 %
Finance leases           5 %

 

Note 6. Debt

 

As of March 31, 2021, and December 31, 2020, the Company’s debt consisted of the following (in thousands):

 

   

As of

March 31, 2021

   

As of

December 31, 2020

 
Refinanced convertible note, related party   $ 2,872     $ 2,872  
Revolving line of credit, related party     1,705       743  
Obligations under secured borrowing arrangement     4,740       7,098  
Notes payable     59       167  
Paycheck Protection Program loan     965       965  
Total debt     10,341       11,845  
Less: current portion     (9,537 )     (10,880 )
Long term debt   $ 804     $ 965  

 

Related-Party Refinanced Convertible Note

 

On November 29, 2020, the Company entered into a refinancing agreement with Mr. Ryan Drexler, the Company’s Chairman of the Board of Directors and Chief Executive Officer (the “November 2020 Refinancing”), in which the Company issued to Mr. Drexler a convertible secured promissory note (the November 2020 “Convertible Note”) in the original principal amount of $2,871,967, which amended and restated a convertible secured promissory note dated as of August 21, 2020. The $2.9 million November 2020 Convertible Note bears interest at the rate of 12% per annum. Unless earlier converted or repaid, all outstanding principal and any accrued but unpaid interest under the November 2020 Convertible Note shall be due and payable on July 1, 2021. Any interest not paid when due shall be capitalized and added to the principal amount of the November 2020 Convertible Note and bear interest on the applicable interest payment date along with all other unpaid principal, capitalized interest, and other capitalized obligations.

 

Mr. Drexler may, at any time, and from time to time, upon written notice to the Company, convert the outstanding principal and accrued interest into shares of Common Stock, at a conversion price of $0.23 per share. At the election of the Company, one-sixth of the interest may be paid in kind (“PIK Interest”) by adding such amount to the principal amount of the note, or through the issuance of shares of the Company’s common stock to Mr. Drexler. The PIK Interest is convertible to common stock at the closing price per share on the last business day of each calendar quarter. In no event will the conversion price of such PIK Interest be less than $0.10. The Company may prepay the Note by giving Mr. Drexler between 15- and 60-days’ notice depending upon the specific circumstances, subject to Mr. Drexler’s conversion right. The Company intends to pay all interest due on the Convertible Note to Mr. Drexler at the end of each calendar quarter.

 

The November 2020 Convertible Note contains customary restrictions on the ability of the Company to, among other things, grant liens or incur indebtedness other than certain obligations incurred in the ordinary course of business. The restrictions are also subject to certain additional qualifications and carveouts, as set forth in the November 2020 Convertible Note. The November 2020 Convertible Note is subordinated to certain other indebtedness of the Company held by Prestige Capital Corporation (“Prestige”) and Crossroads Financial Group, LLC (“Crossroads”).

 

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For the three months ended March 31, 2021 and 2020, interest expense related to the related party convertible secured promissory notes was $85,000 and $76,000, respectively. During the three months ended March 31, 2021, $85,000 in interest was paid in cash to Mr. Drexler; for the three months ended March 31, 2020, no interest was paid in cash to Mr. Drexler.

 

Related Party Secured Revolving Promissory Note

 

On October 15, 2020, the Company entered into a secured revolving promissory note (the “Revolving Note”) with Ryan Drexler. Under the terms of the Revolving Note, the Company can borrow up to $3.0 million. The Revolving Note bears interest at the rate of 12% per annum. The use of funds will be used for the purchase of whey protein and other general corporate purposes. Both the outstanding principal, if any, and all accrued interest under the Revolving Note were due on March 31, 2021, however, the Company and Mr. Drexler agreed to an extension until June 30, 2021. The Company may prepay the Revolving Note by giving Mr. Drexler one days’ advance written notice. The Revolving Note contains customary events of default, including, among others, the failure by the Company to make a payment of principal or interest when due. Following an event of default, Mr. Drexler is entitled to accelerate the entire indebtedness under the Revolving Note. The Revolving Note also contains customary restrictions on the ability of the Company to, among other things, grant liens or incur indebtedness other than certain obligations incurred in the ordinary course of business. The restrictions are also subject to certain additional qualifications and carveouts, as set forth in the Revolving Note. The Revolving Note is subordinated to certain other indebtedness of the Company held by Prestige and Crossroads. In connection with the Revolving Note, the Company and Mr. Drexler entered into a fifth amended and restated security agreement dated October 15, 2020 (the “Security Agreement”) pursuant to which the Revolving Note is secured by all of the assets and properties of the Company and its subsidiaries whether tangible or intangible.

 

As of March 31, 2021, the outstanding balance on the revolving note was $1.7 million. During the period ended March 31, 2021, interest paid in cash to Mr. Drexler was $16,000.

 

Secured Borrowing Arrangement

 

In January 2016, the Company entered into a Purchase and Sale Agreement (the “Purchase and Sale Agreement”) with Prestige, pursuant to which the Company agreed to sell and assign and Prestige agreed to buy and accept, certain accounts receivable owed to the Company (“Accounts”). Under the terms of the Purchase and Sale Agreement, upon the receipt and acceptance of each assignment of Accounts, Prestige will pay the Company 80% of the net face amount of the assigned Accounts, up to a maximum total borrowing of $12.5 million subject to sufficient amounts of accounts receivable to secure the loan. The remaining 20% will be paid to the Company upon collection of the assigned Accounts, less any chargebacks (including chargebacks for any customer amounts that remain outstanding for over 90 days), disputes, or other amounts due to Prestige. Prestige’s purchase of the assigned Accounts from the Company will be at a discount fee which varies from 0.7% to 4%, based on the number of days outstanding from the assignment of Accounts to collection of the assigned Accounts. In addition, the Company granted Prestige a continuing security interest in and first priority lien upon all accounts receivable, inventory, fixed assets, general intangibles, and other assets. Prestige will have no recourse against the Company if payments are not made due to the insolvency of an account debtor within 90 days of invoice date, with the exception of international and certain domestic customers. On April 10, 2019, the Company and Prestige amended the terms of the agreement. The agreement was extended until April 1, 2020 and automatically renews for one (1) year periods unless either party receives written notice of cancellation from the other, at minimum, thirty (30) days prior to the expiration date thereafter.

 

As of March 31, 2021, and December 31, 2020, the Company had outstanding borrowings of approximately $4.7 million and $7.1 million, respectively.

 

During the three months ended March 31, 2021 and 2020, the Company assigned to Prestige, accounts with an aggregate face amount of approximately $11.1 million and $11.7 million, respectively, for which Prestige paid to the Company approximately $8.8 million and $9.4 million, respectively, in cash. During the three months ended March 31, 2021 and 2020, $11.2 million and $10.0 million, respectively, was repaid to Prestige, including fees and interest.

 

12

 

 

Paycheck Protection Program Loan

 

Due to economic uncertainty as a result of the ongoing pandemic (COVID-19), on May 14, 2020, the Company received an aggregate principal amount of $964,910 pursuant to the borrowing arrangement (“Note”) with Harvest Small Business Finance, LLC (“HSBF”) and agreed to pay the principal amount plus interest at a 1% fixed interest rate per year, on the unpaid principal balance. The Note includes forgiveness provisions in accordance with the requirements of the Paycheck Protection Program, Section 1106 of the CARES Act.

 

The Note is expected to mature on May 16, 2023. Payments were due by November 16, 2020 (the “Deferment Period”) and interest was accrued during the Deferment Period. However, the Flexibility Act, which was signed into law on June 5, 2020, extended the Deferment Period to the date that the forgiven amount is remitted by the United States Small Business Administration (“SBA”) to HSBF. The Company is in the process of filling out the forgiveness application form. As of March 31, 2021, the Company owed approximately $1.0 million (principal plus accrued interest). Of this amount, the short-term portion of $0.2 million is recorded in “Accrued and other liabilities” and the remaining liability of $0.8 million is recorded in “Other long-term liabilities” in the consolidated balance sheets.

 

Note 7. Commitments and Contingencies

 

Settlements

 

Manchester City Football Group

 

The Company was engaged in a dispute with City Football Group Limited (“CFG”), the owner of Manchester City Football Group, concerning amounts allegedly owed by the Company under a sponsorship agreement with CFG (the “Sponsorship Agreement”). In August 2016, CFG commenced arbitration in the United Kingdom against the Company, seeking approximately $8.3 million for the Company’s purported breach of the Sponsorship Agreement.

 

On July 28, 2017, the Company approved a Settlement Agreement (the “CFG Settlement Agreement”) with CFG effective July 7, 2017. The CFG Settlement Agreement represents a full and final settlement of all litigation between the parties. Under the terms of the agreement, the Company agreed to pay CFG a sum of $3 million, which was recorded as accrued expenses in 2017. The settlement consists of a $1 million payment that was advanced by a related party on July 7, 2017, a $1 million installment paid on July 7, 2018 and a subsequent $1 million installment payment to be paid by July 7, 2019. Of this amount, the Company has remitted $0.3 million.

 

During the three months ended March 31, 2021 and 2020, the Company recorded a charge of $18,000 and $19,000, respectively. This charge, representing imputed interest, is included in “Interest and other expense, net” in the Company’s consolidated statements of operations.

 

Nutrablend Matter

 

On February 27, 2020, Nutrablend, a manufacturer of MusclePharm products, filed an action against MusclePharm in the United States District Court for the Eastern District of California, claiming approximately $3.1 million in allegedly unpaid invoices. These invoices relate to the third and fourth quarter of 2019, and a liability has been recorded in the books for the related periods.

 

On September 25, 2020, the parties successfully mediated the case to a settlement and the Company agreed to (i) pay approximately $3.1 million (“Owed Amount”) in monthly payments (“Monthly Payments”) from September 1, 2020 through June 30, 2023 and (ii) issue monthly purchase orders (“Purchase Orders”) at minimum amounts accepted by Nutrablend.

 

13

 

 

MusclePharm agreed to issue Purchase Orders in a combined total amount of at least (i) $1,500,000 from September 1, 2020 through November 30, 2020; (ii) $1,800,000 from December 1, 2020 through February 28, 2021; (iii) $2,100,000 from March 31, 2021 through May 31, 2021; (iv) $2,100,000 from June 1, 2021 through August 31, 2021; and (v) $1,400,000 from September 1, 2021 through October 30, 2021. Beginning on November 1, 2021, MusclePharm will be required to issue monthly Purchase Orders to Nutrablend in a minimum amount of $700,000 until the Owed Amount is paid in full to Nutrablend. In the event that MusclePharm pays the Owed Amount in full before September 1, 2021, MusclePharm is entitled to a rebate on all completed Purchase Orders. Further, once the monthly payments, and any additional payments that MusclePharm has made on the Owed Amount, reduce the outstanding balance of the Owed Amount to below $2.0 million, MusclePharm is eligible for an extension of a line of credit from Nutrablend in an amount of up to $3.0 million.

 

The Company determined that approximately $1.0 million dollars of the Owed Amount was due within a year, and this amount was recorded in “Accrued and other liabilities” in the consolidated balance sheets. The present value of the remaining Owed Amount that was due after a year was $1.2 million, and the amount was recorded in “Other long-term liabilities” in the consolidated balance sheets. The Company made payments of $0.5 million as of March 31, 2021.

 

During the period ended March 31, 2021, the Company recorded interest expense of $64,000, in the consolidated statements of operations.

 

4Excelsior Matter

 

On March 18, 2019, Excelsior Nutrition, Inc. (“4Excelsior”), a manufacturer of MusclePharm products, filed an action against MusclePharm in the Superior Court of the State of California for the County of Los Angeles, claiming approximately $6.2 million in damages relating to allegedly unpaid invoices, as well as approximately $7.8 million in consequential damages. On January 27, 2020, MusclePharm filed a counterclaim against 4Excelsior seeking unidentified damages relating to, among other things, 4Excelsior’s failure to fulfill a purchase order. MusclePharm also moved to strike 4Excelsior’s consequential damages on the grounds that they are unrecoverable under the Uniform Commercial Code. The court denied that motion, and the action proceeded to discovery.

 

On November 16, 2020, the Company and 4Excelsior entered into a stipulation of settlement that provided that the Company would pay to 4Excelsior a total of $4.75 million in four monthly payments of $70,000, beginning January 5, 2021, and thereafter in monthly payments of $0.1 million.

 

On December 16, 2020, MusclePharm and 4Excelsior entered into a Settlement Agreement and Mutual Release (“the Agreement”), pursuant to which the parties resolved and settled the civil action pending in the Superior Court of the State of California for the County of Los Angeles (the “Litigation”). The parties agreed to a mutual general release of claims and to jointly file within 10 business days of the effective date of the Agreement a stipulation and proposed order of dismissal, dismissing with prejudice all claims and counterclaims asserted in the Litigation. MusclePharm agreed to pay $4.75 million (the “Settlement Amount”) in four monthly payments of $70,000, beginning January 5, 2021, and thereafter in monthly payments of $0.1 million until the Settlement Amount is fully paid. MusclePharm may prepay all or any portion of the Settlement Amount at any time without penalty or premium. The Agreement provides that, in the event of a Default (as defined in the Agreement) by MusclePharm, the entire outstanding balance of the Settlement Amount will become immediately due and payable, plus accrued interest at a rate of 18% per annum, commencing from the date of default.

 

The Company determined that approximately $1.1 million dollars of the Settlement Amount was due within a year, and this amount was recorded in “Accrued and other liabilities” in the consolidated balance sheets. The present value of the remaining Settlement Amount that was due after a year was $2.4 million, and the amount was recorded in “Other long-term liabilities” in the consolidated balance sheets. The Company made payments of $0.2 million as of March 31, 2021.

 

During the period ended March 31, 2021, the Company recorded interest expense of $0.1 million, in the consolidated statements of operations.

 

14

 

 

Contingencies

 

In the normal course of business or otherwise, the Company may become involved in legal proceedings. The Company will accrue a liability for such matters when it is probable that a liability has been incurred and the amount can be reasonably estimated. When only a range of possible loss can be established, the most probable amount in the range is accrued. If no amount within this range is a better estimate than any other amount within the range, the minimum amount in the range is accrued. The accrual for a litigation loss contingency might include, for example, estimates of potential damages, outside legal fees and other directly related costs expected to be incurred. The Company provides disclosures for material contingencies when there is a reasonable possibility that a loss or an additional loss may be incurred. In assessing whether a loss is a reasonable possibility, the Company may consider the following factors, among others: the nature of the litigation, claim or assessment, available information, opinions or views of legal counsel and other advisors, and the experience gained from similar cases. As of March 31, 2021, the Company was involved in the following material legal proceedings described below.

 

ThermoLife International

 

In January 2016, ThermoLife International LLC (“ThermoLife”), a supplier of nitrates to MusclePharm, filed a complaint against us in Arizona state court. ThermoLife alleged that we failed to meet minimum purchase requirements contained in the parties’ supply agreement. In March 2016, we filed counterclaims alleging that ThermoLife’s products were defective. Through orders issued in September and November 2019, the court dismissed MusclePharm’s counterclaims and found that the Company was liable to ThermoLife for failing to meet its minimum purchase requirements.

 

The court held a bench trial on the issue of damages in October 2019, and on December 4, 2019, the court entered judgment in favor of ThermoLife and against the Company in the amount of $1.6 million, comprised of $0.9 million in damages, interest in the amount of $0.3 million and attorneys’ fees and costs in the amount of $0.4 million. The Company recorded $1.6 million in accrued expenses in 2018. As of December 31, 2020, the total amount accrued, including interest, was $1.8 million. In the interim, the Company filed an appeal and posted bonds in the total amount of $0.6 million in order to stay execution on the judgment pending appeal. Of the $0.6 million, $0.25 million (including fees) was paid by Mr. Drexler on behalf of the Company. See “Note 8. Debt” for additional information. The balance of $0.35 million was secured by a personal guaranty from Mr. Drexler, while the associated fees of $12,500 were paid by the Company. On April 27, 2021, the appellate court issued a decision largely affirming the trial court judgement, except vacating the judgement’s $0.3 million prejudgment interest award and remanding for a recalculation of prejudgment interest. On May 18, 2021, ThermoLife filed a motion asking the trial court to increase MusclePharm’s appeal bond to the full amount of the judgment, or $1.8 million, which MusclePharm intends to vigorously oppose.

 

For both the three months ended March 31, 2021 and 2020, interest expense recognized by the Company on the awarded damages was $22,000.

 

The Company intends to vigorously continue pursuing its defenses, including an appeal to the Arizona Supreme Court, which it has until June 25, 2021 to file a petition for review.

 

White Winston Select Asset Fund Series MP-18, LLC et al., v. MusclePharm Corp., et al., (Nev. Dist. Ct.; Cal. Superior Court; Colorado Dist. Ct.; Mass. Super. Ct.)

 

On August 21, 2018, White Winston Select Asset Fund Series MP-18, LLC and White Winston Select Asset Fund, LLC (together “White Winston”) initiated a derivative action against MusclePharm and its directors (the “director defendants”). White Winston alleges that the director defendants breached their fiduciary duties by improperly approving the refinancing of three promissory notes issued by MusclePharm to Mr. Drexler (the “Amended Note”) in exchange for $18.0 million in loans. White Winston alleges that this refinancing improperly diluted their economic and voting power and constituted an improper distribution in violation of Nevada law. In its complaint, White Winston sought the appointment of a receiver over MusclePharm, a permanent injunction against the exercise of Mr. Drexler’s conversion right under the Amended Note, and other unspecified monetary damages. On September 13, 2018, White Winston filed an amended complaint, which added a former MusclePharm executive, as a plaintiff (together with White Winston, the “White Winston Plaintiffs”). On December 9, 2019, the White Winston Plaintiffs filed a Second Amended Complaint, in which they added allegations relating to the resignation of MusclePharm’s auditor, Plante & Moran PLLC (“Plante Moran”). MusclePharm has moved to dismiss the Second Amended Complaint. That motion has not yet been fully briefed.

 

15

 

 

Along with its complaint, White Winston also filed a motion for a temporary restraining order (“TRO”) and preliminary injunction enjoining the exercise of Mr. Drexler’s conversion right under the Amended Note. On August 23, 2018, the Nevada district court issued an ex parte TRO. On September 14, 2018, the court let the TRO expire and denied White Winston’s request for a preliminary injunction, finding, among other things, that White Winston did not show a likelihood of success on the merits of the underlying action and failed to establish irreparable harm. Following the court’s decision, MusclePharm filed a motion seeking to recoup the legal fees and costs it incurred in responding to the preliminary injunction motion. On October 31, 2019, the court awarded MusclePharm $56,000 in fees and costs.

 

Due to the uncertainty associated with determining our liability, if any, and due to our inability to ascertain with any reasonable degree of likelihood, as of the date of this report, the outcome of the trial, the Company has not recorded an estimate for its potential liability.

 

On June 17, 2019, White Winston moved for the appointment of a temporary receiver over MusclePharm, citing Plante Moran’s resignation. The court granted White Winston’s request to hold an evidentiary hearing on the motion, but subsequently stayed the action pending the parties’ attempts to resolve their dispute. Although the parties have been unable to reach a resolution, the litigation has not yet resumed. On July 30, 2019, White Winston filed an action in the Superior Court of the State of California in and for the County of Los Angeles, seeking access to MusclePharm’s books and records and requesting the appointment of an independent auditor for the company. On February 25, 2021, the court ordered MusclePharm to produce certain documents, denied White Winston’s request for an auditor, and ordered MusclePharm to pay a $1,500 penalty. White Winston also seeks its attorneys’ fees and cost relating to the books-and-records action.

 

MusclePharm intends to challenge White Winston’s request for fees and costs.

 

IRS Audit

 

On April 6, 2016, the Internal Revenue Service (“IRS”) selected our 2014 Federal Income Tax Return for audit. As a result of the audit, the IRS proposed certain adjustments with respect to the tax reporting of our former executives’ 2014 restricted stock grants. Due to the Company’s current and historical loss position, the proposed adjustments would have no material impact on the Company’s Federal income tax. On October 5, 2016, the IRS commenced an audit of our employment and withholding tax liability for 2014. The IRS contends that the Company inaccurately reported the value of the restricted stock grants and improperly failed to provide for employment taxes and Federal tax withholding on these grants. In addition, the IRS is proposing certain penalties associated with the Company’s filings. On April 4, 2017, the Company received a “30-day letter” from the IRS asserting back taxes and penalties of approximately $5.3 million, of which $4.4 million related to withholding taxes, specifically, income withholding and Social Security taxes, and $0.9 million related to penalties. Additionally, the IRS asserts that the Company owes information reporting penalties of approximately $2.0 million.

 

The Company’s counsel has submitted a formal protest to the IRS disputing on several grounds all of the proposed adjustments and penalties on the Company’s behalf, and the Company has been pursuing this matter vigorously through the IRS appeal process. An Appeals Conference was held with the IRS in Denver, Colorado on July 31, 2019. At the conference, the Company made substantial arguments challenging the IRS’s claims for employment taxes and penalties. On December 16, 2019, a further Appeals Conference was held with the IRS by telephone. At the telephone conference, the Appeals Officer confirmed that he agreed with the Company’s argument that the failure to deposit penalties should be conceded by the IRS. The failure to deposit penalties total about $2 million. Thus, with this concession, the IRS’s claims have been reduced from approximately $7.3 million to about $5.3 million.

 

The remaining issue in dispute in this matter involves the fair market value of restricted stock units in the Company granted to certain former officers (the “Former Officers”) of the Company under Internal Revenue Code § 83. The Company and the IRS disagree as to the value of the restricted stock on the date of the grants, i.e., October 1, 2014. The Company and the IRS have exchanged expert valuation reports on the fair market value of the stock and have had extensive negotiations on this issue. The parties, however, have not been able to reach an agreement with respect to the value of the stock. The IRS has also made parallel claims regarding the restricted stock units against the Former Officers of the Company. The IRS has asserted that the Former Officers received ordinary income from the stock grants, and that they owe additional personal income taxes based on the fair market value of the stock. The Former Officers’ cases, unlike the Company’s case, are pending before the United States Tax Court. In the Tax Court litigation, the Former Officers are challenging the IRS’s determinations regarding the fair market value of the restricted stock grants on October 1, 2014. The Former Officers have separate counsel from the Company. The same IRS Appeals Officer and Revenue Agents assigned to the Company’s case are also involved in the cases for the Former Officers. Throughout the proceedings, the Company has argued to the IRS that it is the Former Officers who are directly and principally liable for the amount of any tax due, and not the Company.

 

16

 

 

The Former Officers cases were scheduled for trial in Tax Court on March 9, 2020. The trial of the cases was continued by the Court on February 4, 2020. The basis for the continuance was that the IRS and the Former Officers had made progress toward a settlement of the valuation issue involving the grants of the restricted stock. The outcome of these settlement negotiations will be relevant to the Company’s case. The Company is closely monitoring the settlement discussions between the IRS and the Former Officers. The Tax Court ordered the Former Officers to file status reports regarding progress of their settlement negotiations with the IRS on or before February 28, 2021. The IRS and the Former Officers filed status reports with the Tax Court on February 26, 2021. After receiving the status reports, the Tax Court issued an order directing the parties to file further status reports on or before July 9, 2021. The Tax Court has not set a trial dates in the cases of the Former Officers.

 

Due to the uncertainty associated with determining our liability for the asserted taxes and penalties, if any, and to our inability to ascertain with any reasonable degree of likelihood, as of the date of this report, the outcome of the IRS appeals process, the Company has not recorded an estimate for its potential liability, if any, associated with these taxes.

 

During the time period of the IRS audit and Appeals Office consideration of the Company’s case, the Company and the IRS signed a series of consents to extend the statutes of limitations for assessment for both the employment tax and corporation income tax of the Corporation for 2014. The Company’s records show that the last consents that the Company signed extended the statutes of limitations for employment tax and corporation income tax for 2014 through and including December 15, 2020. The Company has no record of any consents being signed by the Company and the IRS extending the statutes of limitations beyond December 15, 2020. Based on these facts, the Company believes that the statutes of limitations for assessment of additional employment tax and corporation income tax against the Corporation for 2014 expired on December 15, 2020. The Company does not know whether the IRS agrees with the Corporation’s statements regarding the current status of the statutes of limitations described herein.

 

On August 22, 2018, Richard Estalella filed an action against us and two other defendants in the Colorado District Court for the County of Denver, seeking damages arising out of the IRS’s assertion of tax liability and penalties relating to the 2014 restricted stock grants. We have answered Estalella’s complaint, asserted counterclaims against Estalella for his failure to ensure that all withholding taxes were paid in connection with the 2014 restricted stock grants, and filed cross-claims against two valuation firms named in the action (as well as their principals) for failing to properly value the 2014 restricted stock grants for tax purposes. Trial in the matter has been scheduled for February 7, 2022. There are no amounts accrued related to this matter.

 

The Company will continue to vigorously litigate the matter.

 

Note 8. Stock-Based Compensation

 

Restricted Stock

 

There were no restricted stock awards granted during the three months ended March 31, 2021 or 2020, respectively.

 

As of March 31, 2021 there was no unrecognized expense for unvested restricted stock awards. For the three months ended March 31, 2021 and 2020, the Company recorded $0.0 and $0.1 million of stock-based compensation expense related to restricted stock.

 

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Stock Options

 

For the three months ended March 31, 2021 and 2020, the Company recorded no stock compensation expense related to options.

 

Note 9. Net Income (Loss) per Share

 

Basic net income (loss) per share is computed by dividing net income (loss) for the period by the weighted average number of shares of common stock outstanding during each period.

 

The following table sets forth the computation of the Company’s basic and diluted net income (loss) per share for the periods presented (in thousands, except share and per share data):

 

   

For the Three Months

Ended March 31,

 
    2021    

2020

 
Net income (loss)   $ 94     $ (60 )
Weighted average common shares used in computing net income (loss) per share, basic     33,119,549       32,459,675  
Potentially diluted securities     12,373,071        
Weighted average common shares used in computing net income (loss) per share, diluted     45,492,621       32,459,675  
Net income (loss) per share, basic and diluted   $ 0.00     $ (0.00 )

 

Diluted net income (loss) per share is computed by dividing net income (loss) for the period by the weighted average number of shares of common stock, common stock equivalents and potentially dilutive securities outstanding during each period. The Company uses the treasury stock method to determine whether there is a dilutive effect of outstanding potentially dilutive securities, and the if-converted method to assess the dilutive effect of the convertible notes.

 

The Company reported net income for the three months ended March 31, 2021. The weighted average shares of 12,373,071, which represented potentially dilutive securities related to Mr. Drexler’s convertible notes outstanding in 2020, were included in the computations for the diluted net income per share for the three months ended March 31, 2021.

 

The following securities were excluded from the computations of the diluted net income (loss) per share, as the effect of the securities would be antidilutive:

 

    As of March 31,  
    2021     2020  
Stock options     171,703       171,703  
Warrants           1,289,378  
Unvested restricted stock           541,322  
Convertible notes     12,373,071       931,974  
Total common stock equivalents     12,554,774       2,934,377  

 

Note 10. Income Taxes

 

The Company recorded a tax provision of $0 and $22,000 for the three months ended March 31, 2021 and 2020, respectively.

 

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Income taxes are provided for the tax effects of transactions reported in the consolidated financial statements and consist of taxes currently due. Deferred taxes relate to differences between the basis of assets and liabilities for financial and income tax reporting which will be either taxable or deductible when the assets or liabilities are recovered or settled. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred income tax assets will not be realized. The ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible.

 

Management considers the scheduled reversal of deferred income tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based on consideration of these items, management has determined that enough uncertainty exists relative to the realization of the deferred income tax asset balances to warrant the application of a full valuation allowance as of March 31, 2021.

 

Note 11. Segments, Geographical Information

 

The Company’s chief operating decision maker reviews financial information presented on a consolidated basis for purposes of allocating resources and evaluating financial performance. As such, the Company currently has a single reporting segment and operating unit structure. In addition, substantially all long-lived assets are attributable to operations in the U.S. for both periods presented.

 

Revenue, net by geography is based on the company addresses of the customers. The following table sets forth revenue, net by geographic area (in thousands):

 

    For the Three Months Ended
March 31,
 
    2021     2020  
Revenue, net:                
United States   $ 9,274     $ 11,847  
International     3,847       4,384  
Total revenue, net   $ 13,121     $ 16,231  

 

Note 12. Subsequent Events

 

On May 12, 2021, the Company entered into an Agreement (the “Agreement”) with Joseph Cannata (“Cannata”), pursuant to which the Company has engaged Cannata on a non-exclusive basis to assist with the growth of the Company’s energy beverage product line.

 

In connection with entry into the Agreement, the Company issued to Cannata an option to purchase 1,673,994 shares of the Company’s common stock at a price per share of $1.12. The option has an exercise term of 10 years (subject to potential acceleration upon a sale of the Company) and will vest in two equal tranches upon the achievement of certain net revenue milestones related to the Company’s energy beverage products.

 

In addition, the Company agreed to make quarterly payments to Cannata during the term of the Agreement in amounts equal to 17.5% of the gross profit attributable to the applicable products, excluding products sold through certain excluded sales channels.

 

The Agreement continues in effect unless terminated by the mutual agreement of the parties, upon the sale of the Company and upon other specified termination events.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q (the “Form 10-Q”), and with our audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2020 (the “2020 Form 10-K”), as filed with the Securities and Exchange Commission on March 29, 2021. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below and those discussed in the section entitled “Risk Factors” included elsewhere in this Form 10-Q. Except as otherwise indicated herein, the terms “MusclePharm,” “Company,” “we,” “our” and “us” refer to MusclePharm Corporation and its subsidiaries.

 

Overview

 

MusclePharm is a scientifically-driven, performance lifestyle company that develops, manufactures, markets and distributes branded sports nutrition products and nutritional supplements. We offer a broad range of performance powders, capsules, tablets, gels and on-the-go ready to eat snacks that satisfy the needs of enthusiasts and professionals alike. Our portfolio of recognized brands, MusclePharm and FitMiss, is marketed and sold in more than 100 countries globally.

 

Our offerings are clinically developed through a six-stage research process, and all of our manufactured products are rigorously vetted for banned substances by the leading quality assurance program, Informed-Choice. While we initially drove growth in the Specialty retail channel, in recent years we have expanded our focus to drive sales and retailer growth across leading e-commerce, Food Drug & Mass (“FDM”), and Club retail channels. Our primary distribution channels are Specialty, International and FDM.

 

COVID-19

 

Our results of operations have been 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. As COVID-19 infections have been reported throughout the United States, certain federal, state and local governmental authorities have issued stay-at-home orders, proclamations and/or directives aimed at minimizing the spread of the infection. Additionally, more restrictive proclamations and/or directives may be issued in the future.

 

The ultimate impact of the COVID-19 pandemic on the Company’s operations is unknown and will depend on future developments, which are highly uncertain and cannot be predicted with confidence, including the duration of the COVID-19 outbreak, new information which may emerge concerning the severity of the COVID-19 pandemic, and any additional preventative and protective actions that governments, or the Company, may direct, which may result in an extended period of continued business disruption, reduced customer traffic and reduced operations. Any resulting financial impact cannot be reasonably estimated at this time but may have a material impact on our business, financial condition and results of operations. Management continues to monitor the business environment for any significant changes that could impact the Company’s operations. The Company has taken proactive steps to manage costs and discretionary spending, such as remote working and reducing facility related expense.

 

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Results of Operations

 

Comparison of the Three Months Ended March 31, 2021 to the Three Months Ended March 31, 2020 ($ in thousands):

 

   

For the Three

Months Ended

March 31,

         
    2021     2020     $ Change     % Change  
Revenue, net   $ 13,121     $ 16,231     $ (3,110 )     (19 )%
Cost of revenue     9,432       11,422       1,990       (17 )
Gross profit     3,689       4,809       (1,120 )     (23 )
Operating expenses:                                
Advertising and promotion     345       125       220       176  
Salaries and benefits     1,048       1,681       (633 )     (38 )
Selling, general and administrative     1,397       1,911       (514 )     (27 )
Professional fees     627       541       86       16  
Total operating expenses     3,417       4,258       (841 )     (20 )
Income from operations     272       551       (279 )     (51 )
Other expense:                                
Interest and other expense, net     (178 )     (589 )     411       (70 )
Income (loss) before provision for income taxes     94       (38 )     132       (347 )
Provision for income taxes           22       (22 )     (100 )
Net income (loss)   $ 94     $ (60 )   $ 154       (257 )%

  

The following table presents our operating results as a percentage of revenue, net for the periods presented:

 

     For the Three Months Ended March 31,  
    2021      2020  
Revenue, net     100 %     100 %
Cost of revenue     (72 )     (70 )
Gross profit     28       30  
Operating expenses:                
Advertising and promotion     3       1  
Salaries and benefits     8       10  
Selling, general and administrative     11       12  
Professional fees     5       3  
Total operating expenses     26       26  
Income from operations     2       3  
Other expense:                
Interest and other expense, net     (1 )     (3 )
Income (loss) before provision for income taxes     1        
Provision for income taxes            
Net income (loss)     1 %     %

 

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Revenue, net

 

We derive our revenue through the sales of our various branded nutritional supplements. Revenue is recognized when control of a promised good is transferred to a customer in an amount that reflects the consideration that the Company expects to be entitled to in exchange for that good. This usually occurs when finished goods are delivered to the Company’s customers or when finished goods are picked up by a customer or a customer’s carrier.

 

The MusclePharm brands are marketed across major global retail distribution channels. Below is a table of revenue, net by our major distribution channel (in thousands):

 

    For the Three Months Ended March 31,  
    2021     % of
Total
    2020     % of
Total
 
Distribution Channel                                
Specialty   $ 6,795       52 %   $ 8,036       50 %
International     3,847       29 %     4,384       27 %
FDM     2,479       19 %     3,811       23 %
Total   $ 13,121       100 %   $ 16,231       100 %

 

Revenue, net reflects the transaction prices for contracts, which includes products shipped at selling list prices reduced by variable consideration. We record sales incentives as a direct reduction of revenue for various discounts provided to our customers consisting primarily of volume incentive rebates and promotional related credits. We accrue for sales discounts over the period they are earned. Sales discounts are a significant part of our marketing plan to our customers as they help drive increased sales and brand awareness with end users through promotions that we support through our distributors and re-sellers.

 

Revenue, net decreased $3.1 million, or 19%, to $13.1 million for the three months ended March 31, 2021, compared to $16.2 million for the three months ended March 31, 2020. Revenue, net for the three months ended March 31, 2021 decreased primarily due to an industry wide supply shortages on components, which delayed production of our products.

 

Discounts and sales allowances decreased to 15% of gross revenue, or $2.4 million, for the three months ended March 31, 2021, from 20% of gross revenue, or $4.0 million for the same period in 2020. The reduction in discounts as a percent of gross revenue was due to changes in customer mix and discretionary promotional activity.

 

During the three months ended March 31, 2021 and 2020, our largest customer, accounted for approximately 28% and 36% of our revenue, net, respectively.

 

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Cost of Revenue and Gross Profit

 

Cost of revenue for MusclePharm products is directly related to the production, manufacturing, and freight-in of the related products purchased from third party contract manufacturers. We use contract manufacturers to drop ship products directly to our customers, as well as ship product from our warehouse in Tennessee where we own the related inventory.

 

Our gross profit fluctuates due to several factors, including sales incentives, new product introductions and upgrades to existing product lines, changes in customer and product mixes, the mix of product demand, shipment volumes, our product costs, pricing, and inventory write-downs. Our cost of revenue for the three months ended March 31, 2021 decreased from the same period in 2020 primarily as a result of lower sales volume.

 

Costs of revenue decreased 17% to $9.4 million for the three months ended March 31, 2021, compared to $11.4 million for the same period in 2020. This decrease was due to lower sales volume. Gross profit for the three months ended March 31, 2021 decreased 1% to $3.7 million, compared to $4.8 million for the same period in 2020. Gross profit was 28% of revenue, net for the three months ended March 31, 2021 compared to 30% of revenue, net for the same period in 2020. Negatively impacting the gross profit percentage was higher commodity and freight costs.

 

Operating Expenses

 

Advertising and Promotion

 

Our advertising and promotion expense consists primarily of digital, print and media advertising, athletic endorsements and sponsorships, promotional giveaways, trade show events and various partnering activities with our trading partners. Historically, advertising and promotions were a large part of both our growth strategy and brand awareness, in particular strategic partnerships with sports athletes and fitness enthusiasts through endorsements, licensing, and co-branding agreements. Additionally, we co-developed products with sports athletes and teams. In connection with our restructuring plan, we terminated the majority of these contracts in a strategic shift away from such costly arrangements and moved toward more cost-effective programs, including digital advertising, ambassador programs and sampling/promotional materials.

 

Advertising and promotion expense increased 176% to $0.3 million for the three months ended March 31, 2021, or 3% of revenue, net compared to $0.1 million, or 1% of revenue, net for the same period in 2020. Advertising and promotion expense primarily include expenses related to club demonstrations, print and online advertising, trade shows and strategic partnerships with athletes and sports teams. The increase for 2021 is related to increased demonstrations and sampling due to the launch of a new flavor with one of our largest customers.

 

Salaries and Benefits

 

Salaries and benefits consist primarily of salaries, bonuses, benefits, and stock-based compensation. Personnel costs are a significant component of our operating expenses.

 

Salaries and benefits decreased 38% to $1.0 million, or 8% of revenue, net for the three months ended March 31, 2021 compared to $1.7 million, or 10% of revenue, net for the same period in 2020 primarily due to a reduction in headcount as we have focused on reducing operating costs.

 

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Selling, General and Administrative

 

Our selling, general and administrative expenses consist primarily of depreciation and amortization, research and development, information technology equipment and network costs, facilities related expenses, director’s fees, which include both cash and stock-based compensation, insurance, rental expenses related to equipment leases, supplies, legal settlement costs, and other corporate expenses.

 

Selling, general and administrative expenses decreased 27% to $1.4 million, or 11% of revenue, net for three months ended March 31, 2021, compared to $1.9 million, or 12% of revenue, net for the three months ended March 31, 2020 primarily due to a reduction in board member compensation and office expenses associated with closure of headquarters and warehouses.

 

Professional Fees

 

Professional fees consist primarily of legal fees, accounting and audit fees, consulting fees, which includes both cash and stock-based compensation, and investor relations costs.

 

Professional fees increased 16% to $0.6 million, or 5% of revenue, net for the three months ended March 31, 2021, compared to $0.5 million, or 3% of revenue, net for the same period in 2020 primarily due to increased consulting fees.

 

Interest and other expense, net

 

For the three months ended March 31, 2021 and 2020, “Interest and other expense, net” consisted of the following (in thousands):

 

   

For the Three Months

Ended March 31,

 
    2021    

2020

 
             
Interest expense, related party   $ (120 )   $ (76 )
Interest expense, other     (227 )     (157 )
Interest expense, secured borrowing arrangement     (163 )     (365 )
Foreign currency transaction loss     (1 )     (34 )
Loss on settlement obligation           (50 )
Gain on legal settlement     200        
Other     133       93  
Total interest and other expense, net   $ (178 )   $ (589 )

 

“Other” includes sublease income.

 

Net interest and other expense for the three months ended March 31, 2021 decreased 70%, or $0.4 million, compared to the same period in 2020. The decrease is primarily related to reduced interest expense and gain on legal settlements.

 

Provision for Income Taxes

 

Provision for income taxes consists primarily of federal and state income taxes in the U.S. and income taxes in foreign jurisdictions in which we conduct business. Due to uncertainty as to the realization of benefits from our deferred tax assets, including net operating loss carry-forwards, research and development and other tax credits, we have a full valuation allowance reserved against such assets. We expect to maintain this full valuation allowance at least in the near term.

 

24

 

 

Liquidity and Capital Resources

 

The Company has incurred significant losses and experienced negative cash flows since inception. As of March 31, 2021, the Company had cash of $0.6 million, a decline of $1.4 million from the December 31, 2020 balance of $2.0 million. As of March 31, 2021, we had a working capital deficit of $20.5 million, a stockholders’ deficit of $24.3 million and an accumulated deficit of $192.6 million resulting from recurring losses from operations. As a result of our history of losses and financial condition, there is substantial doubt about our ability to continue as a going concern. For financial information concerning more recent periods, see our reports for such periods filed with the SEC.

 

The ability to continue as a going concern is dependent upon us generating profitable operations in the future and/or obtaining the necessary financing to meet our obligations and repay our liabilities arising from normal business operations when they come due. Management is evaluating different strategies to obtain financing to fund our expenses and achieve a level of revenue adequate to support our current cost structure. Financing strategies may include, but are not limited to, private placements of capital stock, debt borrowings, partnerships and/or collaborations.

 

During the fourth quarter of 2019, the Company focused on cost containment and improving gross margins by focusing on customers with higher margins, reducing product discounts and promotional activity, along with reducing the number of SKU’s and negotiate cost for raw materials. These steps improved gross margins in the fourth quarter of 2019 and this trend has continued through March 31, 2021.

 

During 2020, the Company experienced a slowdown in sales from retail customers, including our largest customer, which was partially offset an increase in sale from our largest online customer. In addition, the Company negotiated lower cost of sold with its co-manufactures.

 

In 2021, the Company announced its entrance into the functional energy space with its partnership with a former Rockstar Energy executive. The Company plans to launch 3 new energy products in the summer of 2021.

 

The Company believes reductions in operating costs with continued focus on gross profit will allow it to ultimately achieve sustained profitability, however, the Company can give no assurances that this will occur. In particular, the cost of protein may have a material impact on the Company’s profitability, and the ability of our third-party manufacturers to meet our customer’s demands. In addition, the Company believes entering the functional energy space will help to increase sales and gross margin, however, the Company can give no assurances that this will occur.

 

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, we have entered into numerous financing arrangements outlined below.

 

Our net consolidated cash flows are as follows (in thousands):

 

   

For the Three Months

Ended March 31,

 
    2021     2020  
Consolidated Statements of Cash Flows Data:            
Net cash provided by operating activities   $ 98     $ 161  
Net cash (used in) provided by investing activities     (4 )     11  
Net cash used in financing activities     (1,505 )     (1,086 )
Net change in cash   $ (1,411 )   $ (914 )

 

Operating Activities

 

Our cash provided by operating activities is driven primarily by sales of our products and vendor provided credit. Our primary uses of cash from operating activities have been for inventory purchases, advertising and promotion expenses, personnel-related expenditures, manufacturing costs, professional fees, costs related to our facilities, and legal fees. Our cash flows provided by operating activities will continue to be affected principally by the results of operations and the extent to which we increase spending on personnel expenditures, sales and marketing activities, and our working capital requirements.

 

25

 

 

Our operating cash inflows decreased by $64,000 for the period ended March 31, 2021 to $0.1 million compared to $0.2 million for 2020.

 

During the three months ended March 31, 2021, the change in net operating assets and liabilities was primarily the result of an increase in inventory of $0.4 million and an increase in accounts payable and other liabilities of $1.6 million, offset by a decrease in accounts receivable of $1.3 million and prepaid and other assets of $0.6 million.

 

During the three months ended March 31, 2020, the net cash provided by operating activities of $0.2 million primarily relates to net loss of $60,000, adjusted for noncash charges, which resulted in a source of cash of $0.2 million, and a net change in net operating assets and liabilities, which resulted in a use of cash of $81,000. Included in the change in net operating assets and liabilities was an increase in our inventory balance of $0.3 million and an increase in accounts receivable balance of $0.8 million.

 

Investing Activities

 

During the three months ended March 31, 2021, cash used was for the purchase of computer equipment. During the three months ended March 31, 2020, we received $11,000 of proceeds from the disposal of property and equipment.

 

Financing Activities

 

Cash used in financing activities for the three months ended March 31, 2021 was $1.5 million, as compared to $1.1 million for the three months ended March 31, 2020. Cash used for repayments on secured borrowing arrangement in both periods was offset by repayments of outstanding debt.

 

Indebtedness Agreements

 

For information regarding our indebtedness agreements, see “Note 6. Debt” to the Notes to Consolidated Financial Statements (unaudited) contained herein.

 

Contingencies

 

For information regarding contingencies, see “Note 7. Commitments and Contingencies” to the Notes to Consolidated Financial Statements (unaudited) contained herein.

 

Off-Balance Sheet Arrangements

 

We did not have any off-balance sheet arrangements as of March 31, 2021.

 

Non-GAAP Adjusted EBITDA

 

In addition to disclosing financial results calculated in accordance with U.S. GAAP, this Form 10-Q discloses Adjusted EBITDA, which is net loss adjusted for items such as stock-based compensation, gain or loss on disposal of property and equipment, gain on settlements, interest and other expense, net, depreciation of property and equipment, amortization of intangible assets, provision for doubtful accounts and taxes.

 

Management uses Adjusted EBITDA as a supplement to U.S. GAAP measures to further evaluate period-to-period operating performance, as well as the Company’s ability to meet future working capital requirements. The exclusion of non-cash charges, including stock-based compensation and depreciation and amortization, is useful in measuring the Company’s cash available for operations and performance of the Company. Management believes these non-U.S. GAAP measures will provide investors with important additional perspectives in evaluating the Company’s ongoing business performance.

 

The U.S. GAAP measure most directly comparable to Adjusted EBITDA is net income (loss). The non-GAAP financial measure of Adjusted EBITDA should not be considered as an alternative to net income (loss). Adjusted EBITDA is not a presentation made in accordance with U.S. GAAP and has important limitations as an analytical tool and should not be considered in isolation or as a substitute for analysis of our results as reported under U.S. GAAP. Because Adjusted EBITDA excludes some, but not all, items that affect net loss and is defined differently by different companies, our definition of Adjusted EBITDA may not be comparable to similarly titled measures of other companies.

 

26

 

 

Set forth below are reconciliations of our reported U.S. GAAP net income (loss) to Adjusted EBITDA (in thousands):

 

    For the Three Months ended     For the Three Months ended  
    March 31, 2021     March 31, 2020  
             
Net income (loss)   $ 94       (60 )
                 
Non-GAAP adjustments:                
Stock-based compensation           100  
Gain on disposal of property and equipment           (11 )
Gain on settlements     (200 )      
Interest and other expense, net     512       539  
Depreciation and amortization of property and equipment     3       63  
Amortization of intangible assets     80       80  
Provision for doubtful accounts     (11 )     11  
Provision for income taxes           22  
Adjusted EBITDA   $ 478     $ 744  

 

Critical Accounting Policies and Estimates

 

The preparation of the accompanying consolidated financial statements and related disclosures in conformity with U.S. GAAP and our discussion and analysis of our financial condition and operating results require our management to make judgments, assumptions and estimates that affect the amounts reported in these consolidated financial statements and accompanying notes. Management bases its estimates on historical experience and on various other assumptions we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates, and such differences may be material.

 

Our critical accounting estimates are detailed in Part I, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2020.

 

There have been no material changes to our critical accounting policies and estimates.

 

27

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

The Company qualifies as a smaller reporting company as defined in Item 10(f)(1) of SEC Regulation S-K and is not required to provide the information required by this Item.

 

Item 4. Controls and Procedures

 

i) Background

 

In February 2019, management 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, management reviewed the Company’s 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, management 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 management to determine the potential impact on accounting for revenues. The investigation included the review of management’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 U.S. 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 a result of 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.

 

The investigatory adjustments are further described in Note 16, “Changes and Correction of Errors in Previously Reported Consolidated Financial Statements” located in Item 8 of the 2019 Form 10-K.

 

Other Adjustments Resulting from Reconsidering Previously Issued Financial Statements

 

28

 

 

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 revenue;
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 cut off.

 

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.

 

(ii) Evaluation of disclosure controls and procedures

 

The principal executive officer and principal financial officer have evaluated the Company’s disclosure controls and procedures as of March 31, 2021. Based on this evaluation, they concluded that because of the material weaknesses in our internal control over financial reporting discussed below, the disclosure controls and procedures were not effective as required under Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

 

Disclosure controls and procedures are designed to ensure that the information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms and to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

 

(iii) Management’s report on internal control over financial reporting

 

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Exchange Act Rule 13a-15(f). The Company’s internal control over financial reporting is a process affected by the Company’s management to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external purposes in accordance with U.S. GAAP.

 

In designing and evaluating our internal controls and procedures, our management recognized that internal controls and procedures, no matter how well conceived and operated, can provide only a reasonable, not absolute, assurance that the objectives of the internal controls and procedures are met. In addition, any evaluation of the effectiveness of internal controls over financial reporting in future periods is subject to risk that those internal controls may become inadequate because of changes in conditions or the degree of compliance with the policies or procedures may deteriorate.

 

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.

 

29

 

 

The Company’s management assessed the effectiveness of its internal control over financial reporting as of December 31, 2020. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission’s 2013 Internal Control-Integrated Framework. Based on its assessment, as well as factors identified during the Audit Committee investigation and subsequent audit process, management has concluded that the Company’s internal control over financial reporting as of December 31, 2020 was not effective due to the existence of the material weaknesses in internal control over financial reporting described below.

 

(iv) Material Weaknesses Identified in connection with the Audit Committee Investigation.

 

Based on the principal findings of the investigation conducted by the Audit Committee, management has concluded that it did not maintain an appropriate control environment, inclusive of structure and responsibility including proper segregation of duties, and risk assessment and monitoring activities which led to revenue recognition and tonal concerns and which constituted the following material weaknesses:

 

A. Pressure to achieve sales targets gave rise to the premature and/or inappropriate recognition of revenues, typically occurring at or near the end of financial reporting periods;
   
B. The Company’s internal controls failed and/or were not adequate to ensure that there was effective testing of period end sales cutoff, including a proper review and comparison of invoice dates and related proof of delivery; and
   
C. Inadequate segregation of duties, allowing for an improper alignment of sales and operations under common leadership.

 

(v) Material Weaknesses Resulting from Reconsidering Previously Issued Financial Statements.

 

As described above, management reconsidered the Company’s previously issued financial statements resulting in corrections to our unaudited consolidated financial statements for each of the quarterly periods ended September 30, 2018 and our audited consolidated financial statements as of and for the year ended December 31, 2017, which are contained in Note 16, “Changes and Correction of Errors in Previously Reported Consolidated Financial Statements” located in Item 8 of the 2019 Annual Report on Form 10-K filed with the SEC on August 25, 2020.

 

We have identified the following material weaknesses in connection with these issues:

 

CONTROL ENVIRONMENT AND CONTROL ACTIVITIES

 

Management did not maintain an effective control environment, including ensuring that required accounting methodologies, policies, and technical accounting personnel were in place. This control deficiency led to a series of corrections related to the years 2018 and 2017 and resulted in a restatement to the respective previously issued financial statements.
The Company did not properly classify payments to customers, primarily for promotional activity, as a reduction in the transaction price with its customers, instead treating such payments as an advertising and promotions activity, a component of operating expense.
The Company reported certain sales transactions prior to transfer of control of goods, inconsistent with customer sales agreements and the Company’s customary practices.
The Company did not properly estimate the expected value of customer payments, in the form of credits, at each quarter period end in 2018. In addition, the Company understated its accrual for customers’ credits for the year ended December 31, 2017.
The Company did not adjust the estimated useful life of its leasehold improvements nor an asset retirement obligation in the proper period for its former headquarters.

 

THE COMPANY DOES NOT MAINTAIN ADEQUATE INTERNAL CONTROL DOCUMENTATION AND TESTING PROCEDURES

 

30

 

 

The Company lacks the proper internal control documentation and testing, and therefore internal controls were not consistently performed. Management has concluded that the foregoing was attributable to several factors including the lack of finance leadership, not retaining a third-party professional Sarbanes-Oxley (“SOX”) testing consultant, and significant management turnover. Therefore, management has not documented and enforced an appropriate level of review and controls, including properly documented entity level, information technology general controls including appropriate user access controls, and business process controls.

 

Remediation

 

Our remedial actions to date and remediation plans to be undertaken in response to the findings of the Audit Committee’s investigation and the material weaknesses on internal control over financial reporting and our conclusions reached in evaluating the effectiveness of our disclosure controls and procedures and internal controls over financial reporting as of March 31, 2021, are described below.

 

  Terminations and reprimands

 

The Company terminated certain employees directly responsible in the deliberate inappropriate conduct and other employees received written reprimands as a result of their behavior.

 

  Implementation of enhanced quarterly sales cut-off procedures

 

The Company has implemented internal controls and procedures to conduct enhanced revenue recognition cutoff testing on a quarterly basis.

 

  Mandatory training for the sales and operations department.

 

The Company has commenced a series of compliance outreach and training for its sales and operations departments relating to potential improper customer transactions identified by the internal investigation. These trainings will also include a review of the Company’s Code of Business Conduct and Ethics (the “Code of Conduct”) and the Employee Complaints & Whistleblower Policy (the “Whistleblower Policy”).

 

  Company-wide training about compliance matters, including with respect to employee complaints and concerns and enhancement of the customer contracting process.

 

The Company is implementing Company-wide training sessions. These sessions will focus on a number of areas related to sensitivity training/tonal concerns, including increased promotion and training around the Code of Conduct and the Whistleblower Policy. The Company will design and implement a more formalized compliance program with the goal of sustaining a culture of compliance.

 

  Consider appropriate employment actions relating to certain employees

 

The Company implemented a senior leadership reorganization to strengthen the MusclePharm leadership team and set the company up for long term profitable growth. During 2021, the Company hired an experienced President and Chief Financial Officer with a Fortune 500 c-suite background and an experienced VP, Controller with public company reporting expertise and experience remediating material weaknesses. In addition, the Company promoted from within an SVP of sales along with hiring an experienced VP of Supply Chain.

 

  Establishment of a disclosure committee

 

The Company has implemented a disclosure committee to assist the Chief Executive Officer and Chief Financial Officer in preparing the disclosures required under the Securities Exchange Committee (SEC) rules and to help ensure that the Company’s disclosure controls and procedures are properly implemented.

 

  Enhancing the internal compliance and legal functions, and authorizing management to retain the appropriate individual or individuals.

 

As part of the senior leadership reorganization referred to above, the Company engaged an outside firm which is in the process of revamping our internal control documentation and testing. In addition, the Company will continue to review the qualifications of our internal financial organization to ensure our personnel have the appropriate technical and SOX related expertise.

 

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The Company has enhanced its Whistleblower Policy by including our Audit Committee Chair in the investigation, documentation, and resolution process.

 

We are committed to continuing to improve our internal control processes related to these matters and will continue to review our financial reporting controls and procedures. As we continue to evaluate and work to improve our internal control over financial reporting, we may take additional measures to address deficiencies or modify certain of the remediation measures described above.

 

We expect that our remediation efforts, including design and implementation, will continue through fiscal year 2021, with the goal to fully remediate all remaining material weaknesses by year-end. In particular, as noted above, the Company has implemented enhanced controls regarding sales cut-off, as well as customer discounts. In addition, the Company’s inventory balance has decreased significantly, and the Company’s inventory is maintained and controlled by third-part manufacturers, or the Company’s warehouse which is now operated by a third-party logistics provider.

 

Due to the considerable time and effort management of the Company undertook in order to bring its delinquent filings current, which was completed on November 24, 2020, and despite ongoing remediation efforts through the first quarter of 2021, the Company was not able to complete a majority of its remediation efforts during the period ended March 31, 2021.

 

Other than the ongoing remediation efforts described above, there have been no changes during the quarter ended March 31, 2021 in the Company’s internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, internal controls over financial reporting.

 

Notwithstanding the material weaknesses described in this Item 9A, our management has concluded that the consolidated financial statements and related financial information included in this Form 10-Q presents fairly, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with U.S. GAAP. Management’s position is based on a number of factors, including, but not limited to:

 

The completion of the Audit Committee’s investigation and the substantial resources expended (including the use of external consultants) and the resulting adjustments we made to our previously issued financial statements, including the restatement of our 2017 audited financial statements and our unaudited quarterly financial statements for the periods ended September 30, 2018, June 30, 2018 and March 31, 2018;
   
The reconsideration of significant accounting policies and accounting practices previously employed by the Company, resulting in other adjustments to previously issued consolidated financial statements.

 

Based on the actions described above, we have updated, and in some cases corrected, our accounting policies and have applied those to our consolidated financial statements for all periods presented.

 

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PART II—OTHER INFORMATION

 

Item 1. Legal Proceedings

 

For information regarding legal proceedings, see Note 7 to the Notes to Consolidated Financial Statements (unaudited) contained herein, which is incorporated by reference into this part II, Item 1.

 

Item 1A. Risk Factors

 

The information to be reported under this Item is not required for smaller reporting companies.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

None.

 

Item 3. Defaults Upon Senior Securities

 

None.

 

Item 4. Mine Safety Disclosures

 

None.

 

Item 5. Other Information

 

None

 

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Item 6. Exhibit Index

 

        Incorporated by Reference

Exhibit

No.

  Description   Form  

SEC File

Number

  Exhibit   Filing Date
                     
10.1**   Letter agreement, dated April 1, 2021 between the Company and Sabina Rizvi.                
                     
31.1**   Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                
                     
31.2**   Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                
                     
32.1***   Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                
                     
32.2***   Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                
                     
101**   The following materials from MusclePharm Corporation’s quarterly report on Form 10-Q for the three months ended March 31, 2021 formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets; (ii) the Consolidated Statements of Operations; (iii) the Consolidated Statements of Comprehensive Income; (iv) the Consolidated Statement of Changes in Stockholders’ Deficit; (v) the Consolidated Statements of Cash Flows; and (vi) related notes to these financial statements.

 

** Filed herewith
*** Furnished herewith

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

  MUSCLEPHARM CORPORATION
     
Date: May 24, 2021 By: /s/ Sabina Rizvi
  Name: Sabina Rizvi
  Title:

Chief Financial Officer

(Principal Financial Officer and Principal Accounting Officer)

 

35

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