UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 2018
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)
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Nevada
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77-0664193
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(State or other jurisdiction of
incorporation or organization)
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(I.R.S. Employer
Identification No.)
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4400 Vanowen St.
Burbank, CA
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91505
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(Address of principal executive offices)
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(Zip code)
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(800) 292-3909
(Registrant’s telephone number, including area
code)
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 past 12 months, 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 or
a smaller reporting company. See definitions of “large
accelerated filer”, “accelerated filer” and
“smaller reporting company” in Rule 12b-2 of the
Exchange Act. (Check one):
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Large accelerated filer [ ]
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Accelerated filer [ ]
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Non-accelerated filer [
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Smaller reporting company [X]
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Emerging Growth Company [ ]
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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 [ ]
No [X]
Number of shares of the registrant’s common stock outstanding
at November 1, 2018: 15,314,667, excluding 875,621 shares of common
stock held in treasury.
MusclePharm Corporation
Form 10-Q
TABLE OF CONTENTS
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Page
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Note About Forward-Looking Statements
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1
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PART I – FINANCIAL INFORMATION
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Item 1.
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Financial
Statements
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Condensed
Consolidated Balance Sheets as of September 30, 2018 (unaudited)
and December 31, 2017
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2
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Condensed
Consolidated Statements of Operations for the three and nine months
ended September 30, 2018 and 2017 (unaudited)
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3
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Condensed
Consolidated Statements of Comprehensive Loss for the three and
nine months ended September 30, 2018 and 2017
(unaudited)
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4
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Condensed
Consolidated Statement of Changes in Stockholders’ Deficit
for the nine months ended September 30, 2018
(unaudited)
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5
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Condensed
Consolidated Statements of Cash Flows for the nine months ended
September 30, 2018 and 2017 (unaudited)
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6
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Notes
to Condensed Consolidated Financial Statements
(unaudited)
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7
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Item 2.
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Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
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24
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Item 3.
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Quantitative
and Qualitative Disclosures About Market Risk
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39
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Item 4.
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Controls
and Procedures
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39
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PART II – OTHER INFORMATION
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Item 1.
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Legal
Proceedings
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40
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Item 1A.
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Risk
Factors
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41
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Item 2.
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Unregistered
Sales of Equity Securities and Use of Proceeds
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41
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Item 3.
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Defaults
Upon Senior Securities
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42
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Item 4.
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Mine
Safety Disclosures
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42
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Item 5.
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Other
Information
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42
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Item 6.
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Exhibits
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42
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Signatures
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43
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Forward-Looking Statements
Except as otherwise
indicated herein, the terms “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 the Private Securities Litigation Reform Act of 1995. 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.
The words “believe,” “may,”
“will,” “estimate,” “continue,”
“anticipate,” “intend,”
“expect,” and similar expressions are intended to
identify forward-looking statements. 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 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 filed with the
Securities and Exchange Commission (the “SEC”) on April
2, 2018. Moreover, we operate in a very competitive and rapidly
changing environment. New risks 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.
1
PART I—FINANCIAL INFORMATION
Item 1. Financial Statements
MusclePharm Corporation
(In thousands, except share and per share data)
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September 30,
2018
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December 31,
2017
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(Unaudited)
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ASSETS
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Current
assets:
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Cash
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$1,749
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$6,228
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Accounts
receivable, net of allowance for doubtful accounts of $1,556 and
$1,363, respectively
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16,235
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16,668
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Inventory
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7,324
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6,484
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Prepaid
expenses and other current assets
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1,120
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1,082
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Total
current assets
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26,428
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30,462
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Property
and equipment, net
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576
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1,822
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Intangible
assets, net
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1,077
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1,317
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Other
assets
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267
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225
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TOTAL
ASSETS
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$28,348
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$33,826
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LIABILITIES AND STOCKHOLDERS’ DEFICIT
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Current
liabilities:
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Accounts
payable
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$20,672
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$11,742
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Accrued
liabilities
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5,238
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7,761
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Accrued
restructuring charges, current
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463
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595
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Obligation
under secured borrowing arrangement
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594
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5,385
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Line
of credit
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1,500
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3,000
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Total
current liabilities
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28,467
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28,483
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Convertible
note with a related party, net of discount
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17,226
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16,669
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Accrued
restructuring charges, long-term
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58
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120
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Other
long-term liabilities
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74
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1,088
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Total
liabilities
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45,825
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46,360
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Commitments
and contingencies (Note 8)
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Stockholders'
deficit:
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Common
stock, par value of $0.001 per share; 100,000,000 shares authorized
16,190,288 and 15,526,175 shares issued as of September 30, 2018
and December 31, 2017, respectively; 15,314,667 and 14,650,554
shares outstanding as of September 30, 2018 and December 31, 2017,
respectively
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15
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14
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Additional
paid-in capital
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160,038
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159,608
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Treasury
stock, at cost; 875,621 shares
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(10,039)
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(10,039)
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Accumulated
other comprehensive loss
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(169)
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(150)
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Accumulated
deficit
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(167,322)
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(161,967)
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TOTAL
STOCKHOLDERS’ DEFICIT
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(17,477)
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(12,534)
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TOTAL
LIABILITIES AND STOCKHOLDERS’ DEFICIT
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$28,348
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$33,826
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The accompanying notes are an integral part of these Condensed
Consolidated Financial Statements.
2
MusclePharm Corporation
Condensed Consolidated Statements of Operations
(In thousands, except share and per share data)
(Unaudited)
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Three Months Ended
September 30,
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Nine Months Ended
September 30,
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2018
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2017
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2018
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2017
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Revenue,
net
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$27,388
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$24,396
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$81,039
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$76,597
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Cost
of revenue
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18,595
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16,359
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55,875
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54,474
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Gross
profit
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8,793
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8,037
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25,164
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22,123
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Operating
expenses:
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Advertising
and promotion
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3,589
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1,952
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12,241
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6,079
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Salaries
and benefits
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1,856
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2,640
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6,305
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8,530
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Selling,
general and administrative
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2,975
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3,468
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8,175
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9,183
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Research
and development
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185
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199
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605
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488
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Professional
fees
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436
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1,034
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1,634
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2,643
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Impairment
of assets
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743
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—
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743
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—
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Settlement
of obligation
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—
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—
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(2,747)
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1,453
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Total
operating expenses
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9,784
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9,293
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26,956
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28,376
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Loss
from operations
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(991)
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(1,256)
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(1,792)
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(6,253)
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Gain
on settlement of accounts payable
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—
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—
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—
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471
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Interest
and other expense, net (Note 6)
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(990)
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(858)
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(3,463)
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(2,526)
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Loss
before income taxes
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(1,981)
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(2,114)
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(5,255)
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(8,308)
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Income
taxes/(benefit)
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(3)
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14
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100
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118
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Net
loss
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$(1,978)
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$(2,128)
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$(5,355)
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$(8,426)
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Net
loss per share, basic and diluted
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$(0.13)
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$(0.15)
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$(0.36)
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$(0.61)
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Weighted
average shares used to compute net loss per share, basic and
diluted
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15,029,312
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13,875,119
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14,783,699
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13,819,939
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The accompanying notes are an integral part of these Condensed
Consolidated Financial Statements.
3
MusclePharm Corporation
Condensed Consolidated Statements of Comprehensive
Loss
(In thousands)
(Unaudited)
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Three Months
Ended September 30,
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Nine Months
Ended September 30,
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2018
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2017
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2018
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2017
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Net
loss
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$(1,978)
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$(2,128)
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$(5,355)
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$(8,426)
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Other
comprehensive loss:
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Change
in foreign currency translation adjustment
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(4)
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143
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(19)
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160
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Comprehensive
loss
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$(1,982)
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$(1,985)
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$(5,374)
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$(8,266)
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The accompanying notes are an integral part of these Condensed
Consolidated Financial Statements.
4
MusclePharm Corporation
Condensed Consolidated Statement of Changes in Stockholders’
Deficit
(In thousands, except share data)
(Unaudited)
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Accumulated
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Additional
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Other
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Total
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Common Stock
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Paid-in
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Treasury
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Comprehensive
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Accumulated
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Stockholders’
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Shares
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Amount
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Capital
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Stock
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Loss
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Deficit
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Deficit
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Balance—December
31, 2017
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14,650,554
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$14
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$159,608
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$(10,039)
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$(150)
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$(161,967)
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$(12,534)
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Stock-based
compensation related to issuance and amortization of restricted
stock awards to employees, executives and directors
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250,000
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1
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361
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—
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—
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—
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362
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Stock-based
compensation related to issuance of stock options to an executive
and a director
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—
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—
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16
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—
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—
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—
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16
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Issuance
of shares of common stock related to the payment of interest on a
related party note
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81,113
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—
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53
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—
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—
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—
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53
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Issuance
of shares of common stock related to the settlement of litigation
(see Note 8)
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333,000
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—
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—
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—
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—
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—
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—
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Change
in foreign currency translation adjustment
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—
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—
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—
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—
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(19)
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—
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(19)
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Net
loss
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—
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—
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—
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—
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—
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(5,355)
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(5,355)
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Balance—September
30, 2018
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15,314,667
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$15
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$160,038
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$(10,039)
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$(169)
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$(167,322)
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$(17,477)
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The accompanying notes are an integral part of these Condensed
Consolidated Financial Statements.
5
MusclePharm Corporation
Condensed Consolidated Statements of Cash Flows
(Unaudited, in thousands)
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Nine Months Ended
September 30,
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2018
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2017
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CASH
FLOWS FROM OPERATING ACTIVITIES:
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Net
loss
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$(5,355)
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$(8,426)
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Adjustments
to reconcile net loss to net cash provided by/(used in) operating
activities:
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Depreciation
and amortization
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822
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1,144
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Gain
on settlement of accounts payable
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—
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(471)
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Settlement
of obligation
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(2,747)
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—
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Bad
debt expense
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822
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1,213
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Impairment
of assets
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743
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—
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Loss
on disposal of property and equipment
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—
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43
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Amortization
of debt discount
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557
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460
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Stock-based
compensation
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377
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1,688
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Write
off of prepaid financing costs
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—
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275
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Changes
in operating assets and liabilities:
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Accounts
receivable
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(454)
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(753)
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Inventory
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(755)
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2,351
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Prepaid
expenses and other current assets
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(114)
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(101)
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Other
assets
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(44)
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(75)
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Accounts
payable and accrued liabilities
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8,365
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417
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Accrued
restructuring charges
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(194)
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(102)
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Net
cash provided by/(used in) operating activities
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2,023
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(2,337)
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CASH
FLOWS FROM INVESTING ACTIVITIES:
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Purchase
of property and equipment
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(86)
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(27)
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Net
cash used in investing activities
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$(86)
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$(27)
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CASH
FLOWS FROM FINANCING ACTIVITIES:
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Payments
on line of credit
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(1,500)
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—
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Proceeds
from secured borrowing arrangement, net of reserves
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31,677
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22,292
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Payments
on secured borrowing arrangement, net of fees
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(36,469)
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(21,046)
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Proceeds
from related party loan
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—
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1,000
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Repayment
of capital lease obligations
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(101)
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(106)
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Net
cash (used)/provided by financing activities
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(6,393)
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2,140
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Effect
of exchange rate changes on cash
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(23)
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159
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NET
CHANGE IN CASH
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(4,479)
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(65)
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CASH
— BEGINNING OF PERIOD
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6,228
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4,943
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CASH
— END OF PERIOD
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$1,749
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$4,878
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SUPPLEMENTAL
DISCLOSURE OF CASH FLOW INFORMATION:
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Cash
paid for interest
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$2,727
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$1,848
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Cash
paid for taxes
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$173
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$86
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SUPPLEMENTAL
DISCLOSURE OF NON-CASH ACTIVITIES:
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Property
and equipment acquired in conjunction with capital
leases
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$—
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$12
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Purchase
of property and equipment included in current
liabilities
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$12
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$—
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Interest
paid through issuance of shares of common stock
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$53
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$—
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The accompanying notes are an integral part of these Condensed
Consolidated Financial Statements.
6
MusclePharm Corporation
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Note 1. Description of Business
Description of Business
MusclePharm Corporation, or the Company, was incorporated in Nevada
in 2006. Except as otherwise indicated herein, the terms
“Company,” “we,” “our” and
“us” refer to MusclePharm Corporation and its
subsidiaries. The Company is a scientifically driven, performance
lifestyle company that develops, manufactures, markets and
distributes branded nutritional supplements. The Company is
headquartered in Burbank, California and as of September 30, 2018
had the following wholly-owned operating subsidiaries: MusclePharm
Canada Enterprises Corp., MusclePharm Ireland Limited and
MusclePharm Australia Pty Limited. A former subsidiary of the
Company, BioZone Laboratories, Inc. (“BioZone”) was
sold on May 9, 2016.
Management’s Plans with Respect to Liquidity and Capital
Resources
Management believes that its previously announced restructuring
plan, the continued reduction in ongoing operating costs and
expense controls, and growth strategy, will enable us to ultimately
achieve profitability. Management believes that the Company has
sufficiently reduced its operating expenses, and the
Company’s ongoing sources of revenue together with our access
to capital will be sufficient to cover these expenses for the
foreseeable future. The Company can give no assurances that this
will occur.
As of September 30, 2018, the Company had a stockholders’
deficit of $17.5 million and recurring losses from operations. To
manage cash flow, the Company entered into a secured borrowing
arrangement, pursuant to which the Company has the ability to
borrow up to $12.5 million subject to sufficient amounts of
accounts receivable to secure the loan. The secured borrowing
arrangement’s term has been extended to November 30, 2018
which renews automatically for successive four-month periods unless
either party receives written notice of cancellation from the
other, at minimum, thirty days prior to the expiration date. In
October 2017, the Company also entered into a loan and security
agreement to borrow against the Company’s inventory up to a
maximum of $3.0 million for an initial six-month term which
automatically extends for successive six-month renewal terms. As of
September 30, 2018, the Company owed $1.5 million under this loan
and security agreement.
On November 3, 2017, the Company entered into a refinancing
transaction (the “Refinancing”) with Mr. Ryan Drexler,
the Company’s Chairman of the Board, Chief Executive Officer
and President, to restructure all of the $18.0 million in notes
payable to him, which are now due on December 31, 2019.
Accordingly, such debt is classified as a long-term liability at
September 30, 2018.
As of September 30, 2018, the Company had approximately $1.7
million in cash and a $2.0 million working capital
deficit.
The accompanying Condensed Consolidated Financial Statements as of
and for the three and nine months ended September 30, 2018 were
prepared on the basis of a going concern, which contemplates, among
other things, the realization of assets and satisfaction of
liabilities in the ordinary course of business. Accordingly, they
do not give effect to adjustments that could be necessary should we
be required to liquidate our assets.
The Company’s ability to continue as a going concern and
raise capital for specific strategic initiatives could also depend
on obtaining adequate capital to fund operating losses until it
becomes profitable. The Company can give no assurances that any
additional capital that it is able to obtain, if any, will be
sufficient to meet its needs, or that any such financing will be
obtainable on acceptable terms.
Mr. Drexler has verbally both stated his intent and ability to put
more capital into the business if necessary. However, Mr. Drexler
is under no obligation to the Company to do so, and the Company can
give no assurances that Mr. Drexler will be willing or able to do
so at a future date and/or that he will not demand payment of his
refinanced convertible note on December 31, 2019.
7
Our capital resources as of September 30, 2018, available borrowing
capacity and current operating plans are expected to be sufficient
to fund our planned operations for at least twelve months from the
date of filing this report.
Note 2. Summary of Significant Accounting Policies
Basis of Presentation and Principles of Consolidation
The accompanying Condensed Consolidated Financial Statements have
been prepared in accordance with generally accepted accounting
principles in the United States (“GAAP”). The Condensed
Consolidated Financial Statements include the accounts of
MusclePharm Corporation and its wholly-owned subsidiaries. All
significant intercompany balances and transactions have been
eliminated in consolidation.
Unaudited Interim Financial Information
The accompanying unaudited interim Condensed Consolidated Financial
Statements have been prepared in accordance with GAAP and with the
instructions to Form 10-Q and Article 10 of Regulation S-X for
interim financial information. Accordingly, these statements do not
include all of the information and notes required by GAAP for
complete financial statements. The Company’s management
believes the unaudited interim Condensed Consolidated Financial
Statements include all adjustments of a normal recurring nature
necessary for the fair presentation of the Company’s
financial position as of September 30, 2018, results of
operations for the three and nine months ended September 30,
2018 and 2017, and cash flows for the nine months ended September
30, 2018 and 2017. The results of operations for the three and
nine months ended September 30, 2018 are not necessarily indicative
of the results to be expected for the year ending December 31,
2018.
These unaudited interim Condensed Consolidated Financial Statements
should be read in conjunction with the consolidated financial
statements and related notes included in the Company’s Annual
Report on Form 10-K for the year ended December 31, 2017,
filed with the SEC on April 2, 2018.
Use of Estimates
The preparation of consolidated financial statements in conformity
with GAAP requires management to make estimates and assumptions
that affect the amounts reported and disclosed in the consolidated
financial statements and accompanying notes. Such estimates
include, but are not limited to, allowance for doubtful accounts,
revenue discounts and allowances, the valuation of inventory and
tax assets, the assessment of useful lives, recoverability and
valuation of long-lived assets, likelihood and range of possible
losses on contingencies, restructuring liabilities, valuations
of equity securities and intangible assets, fair value of
derivatives, warrants and options, among others. Actual results
could differ from those estimates.
Revenue Recognition
The Company has adopted ASC 606. Prior to the adoption of ASC 606
the Company's revenue recognition policy was to recognize revenue
when persuasive evidence of an arrangement existed, delivery had
occurred, the fee was fixed or determinable and collection was
reasonably assured.
The Company’s standard terms and conditions of sale allowed
for product returns or replacements in certain cases. Estimates of
expected future product returns were recognized at the time of sale
based on analyses of historical return trends by customer type.
Upon recognition, the Company reduced revenue and cost of revenue
for the estimated return. Return rates could fluctuate over time,
but were sufficiently predictable with established customers to
allow the Company to estimate expected future product returns, and
an accrual was recorded for future expected returns when the
related revenue was recognized.
The Company also offered sales incentives through various programs,
consisting primarily of volume incentive rebates and sales
incentive reserves. Volume incentive rebates were provided to
certain customers based on contractually agreed upon percentages
once certain thresholds had been met. Sales incentive reserves were
computed based on historical trending and budgeted discount
percentages, which were typically based on historical discount
rates with adjustments for any known changes, such as future
promotions or one-time historical promotions that would not repeat
for each customer. The Company recorded sales incentive reserves
and volume rebate reserves as a reduction to revenue.
8
With the adoption of ASC 606, effective January 1, 2018 the Company
reviewed its previous revenue recognition policy as described above
and under ASC 606 the Company determined that there were no
material changes resulting from the adoption. Revenue would be
recognized when control of the promised goods or services is
transferred to the Company’s customers in an amount that
reflects the consideration the Company expects to be entitled to in
exchange for those goods or services. This is consistent with the
revenue recognition policy previously used by the Company. The
Company also reviewed the timing and recognition of accounts
receivable within the different distribution channels for which the
Company generates revenue.
During the three months ended September 30, 2018 and 2017, the
Company recorded discounts and sales returns, totaling $6.4 million
and $2.1 million, respectively, which accounted for 19% and 8% of
gross revenue in each period, respectively. During the nine months
ended September 30, 2018 and 2017, the Company recorded discounts,
and to a lesser degree, sales returns, totaling $16.5 million and
$13.8 million, respectively, which accounted for 17% and 16% of
gross revenue in each period, respectively.
Concentrations
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of cash and
accounts receivable. The Company minimizes its credit risk
associated with cash by periodically evaluating the credit quality
of its primary financial institution. The cash balance at times may
exceed federally insured limits. Management believes the financial
risk associated with these balances is minimal and has not
experienced any losses to date.
Significant customers are those that represent more than 10% of the
Company’s net revenue or accounts receivable for each period
presented. For each significant customer, revenue as a percentage
of total revenue is as follows:
|
|
Percentage of Net Revenue
for the Three Months Ended September 30,
|
Percentage of Net Revenue
for the Nine Months Ended September 30,
|
Percentage of Net Accounts Receivable
as of
|
|||
|
|
2018
|
2017
|
2018
|
2017
|
September 30, 2018
|
December 31, 2017
|
|
Customers
|
|
|
|
|
|
|
|
Costco
Wholesale Corporation
|
38%
|
26%
|
25%
|
26%
|
36%
|
21%
|
|
Amazon
|
15%
|
16%
|
15%
|
11%
|
12%
|
14%
|
|
iHerb
|
18%
|
*
|
12%
|
*
|
*
|
*
|
●
Denotes
that customer represented less than 10% of net revenue or net
accounts receivable for the respective period.
Share-Based Payments and Stock-Based Compensation
Share-based compensation awards, including stock options and
restricted stock awards, are recorded at estimated fair value on
the applicable award’s grant date, based on estimated number
of awards that are expected to vest. The grant date fair value is
amortized on a straight-line basis over the time in which the
awards are expected to vest, or immediately if no vesting is
required. Share-based compensation awards issued to non-employees
for services are recorded at either the fair value of the services
rendered or the fair value of the share-based payments whichever is
more readily determinable. The fair value of restricted stock
awards is based on the fair value of the stock underlying the
awards on the grant date as there is no exercise
price.
9
The fair value of stock options is estimated using the
Black-Scholes option-pricing model. The determination of the fair
value of each stock award using this option-pricing model is
affected by the Company’s assumptions regarding a number of
complex and subjective variables. These variables include, but are
not limited to, the expected stock price volatility over the term
of the awards and the expected term of the awards based on an
analysis of the actual and projected employee stock option exercise
behaviors and the contractual term of the awards. Due to the
Company’s limited experience with the expected term of
options, the simplified method was utilized in determining the
expected option term as prescribed in Staff Accounting Bulletin No.
110. The Company recognizes stock-based compensation expense over
the requisite service period, which is generally consistent with
the vesting of the awards, based on the estimated fair value of all
stock-based payments issued to employees and directors that are
expected to vest.
Recent Accounting Pronouncements
In February 2016, the FASB issued ASU No. 2016-02,
Leases (Topic
842), which supersedes Topic
840, Leases (“ASU 2016-02”). The guidance in this
new standard requires lessees to put most leases on their balance
sheets but recognize expenses on their income statements in a
manner similar to the current accounting and eliminates the current
real estate-specific provisions for all entities. The guidance also
modifies the classification criteria and the accounting for
sales-type and direct financing leases for lessors. ASU 2016-02 is
effective for fiscal years beginning after December 15, 2018, and
interim periods within those fiscal years, with early adoption
permitted. The Company continues to make progress with its
preparation for the adoption and implementation of this new
accounting standard, including assessing the completeness of our
lease arrangements, evaluating practical expedients and accounting
policy elections, and implementing a tracking system to meet the
reporting requirements of this standard. We are still assessing the
impact to our consolidated financial statements as well as planning
for adoption and implementation of this standard, which includes
applying practical expedients provided in the standards update that
allow, among other things, for contracts that commenced prior to
the adoption to not be reassessed. We also anticipate to elect a
policy not to recognize right of use assets and lease liabilities
related to short-term leases.
Note 3. Fair Value of Financial Instruments
Management believes the fair values of the obligations under the
secured borrowing arrangements and the convertible note with Mr.
Drexler approximate carrying value because the debt carries market
rates of interest available to the Company. The Company’s
remaining financial instruments consisted primarily of accounts
receivable, accounts payable, accrued liabilities and accrued
restructuring charges, all of which are short-term in nature with
fair values approximating carrying value. As of September 30, 2018
and December 31, 2017, the Company held no assets or liabilities
that required re-measurement at fair value on a recurring
basis.
Note 4. Restructuring
As part of an effort to better focus and align the Company’s
resources toward profitable growth, on August 24, 2015, the
Board authorized the Company to undertake steps to commence a
restructuring of the business and operations, which concluded
during the third quarter of 2016.
The following table illustrates the provision of the restructuring
charges and the accrued restructuring charges balance as of
September 30, 2018 (in thousands):
|
|
Contract Termination Costs
|
Purchase Commitment of Discontinued Inventories Not Yet
Received
|
Abandoned Lease Facilities
|
Total
|
|
Balance
as of December 31, 2017
|
$308
|
$175
|
$232
|
$715
|
|
Expensed
|
—
|
—
|
310
|
310
|
|
Cash
payments
|
—
|
—
|
(396)
|
(396)
|
|
Change
in valuation
|
67
|
(175)
|
—
|
(108)
|
|
Balance
as of September 30, 2018
|
375
|
—
|
146
|
521
|
10
The total future payments under the restructuring plan as of
September 30, 2018 are as follows (in thousands):
|
|
For the Years Ending December 31,
|
|||
|
Outstanding
Payments
|
2018
|
2019
|
2020
|
Total
|
|
Contract
termination costs
|
$375
|
$—
|
$—
|
$375
|
|
Abandoned
leased facilities
|
22
|
92
|
32
|
146
|
|
Total
future payments
|
$397
|
$92
|
$32
|
$521
|
Note 5. Balance Sheet Components
Inventory
Inventory consisted solely of finished goods as of September 30,
2018 and December 31, 2017.
The Company records charges for obsolete and slow-moving inventory
based on the age of the product as determined by the expiration
date or otherwise determined to be obsolete. Products within one
year of their expiration dates are considered for write-off
purposes. Historically, the Company has had minimal returns with
established customers. Other than write-off of inventory during
restructuring activities, the Company incurred insignificant
inventory write-offs during the nine months ended September 30,
2018 and 2017. Inventory write-downs, once established, are not
reversed as they establish a new cost basis for the
inventory.
Property and Equipment
Property and equipment consisted of the following as of September
30, 2018 and December 31, 2017 (in thousands):
|
|
As of
September 30, 2018
|
As of
December 31, 2017
|
|
Furniture,
fixtures and equipment
|
$3,641
|
$3,597
|
|
Leasehold
improvements
|
236
|
2,044
|
|
Manufacturing
and lab equipment
|
3
|
3
|
|
Vehicles
|
39
|
86
|
|
Displays
|
453
|
485
|
|
Website
|
462
|
462
|
|
Property
and equipment, gross
|
4,834
|
6,677
|
|
Less:
accumulated depreciation and amortization
|
(4,258)
|
(4,855)
|
|
Property
and equipment, net
|
$576
|
$1,822
|
Depreciation and amortization expense related to property and
equipment was $0.2 million and $0.3 million for the three months
ended September 30, 2018 and 2017, respectively, and $0.6 million
and $0.8 million for the nine months ended September 30, 2018 and
2017, respectively, which is included in “Selling, general
and administrative” expense in the accompanying Condensed
Consolidated Statements of Operations.
During the three months ended September 30, 2018, the Company
subleased the former headquarters in Denver, CO. As a result, the
Company determined that the leasehold improvements had become fully
impaired. The Company recorded an impairment charge of $0.7 million
during the period.
11
Intangible Assets
Intangible assets consisted of the following (in
thousands):
|
|
As of September 30, 2018
|
|||
|
|
Gross Value
|
Accumulated Amortization
|
Net Carrying Value
|
Remaining Weighted-Average Useful Lives (years)
|
|
Amortized Intangible Assets
|
|
|
|
|
|
Brand
(apparel rights)
|
$2,244
|
$(1,167)
|
$1,077
|
3.4
|
|
Total
intangible assets
|
$2,244
|
$(1,167)
|
$1,077
|
|
|
|
As of December 31, 2017
|
|||
|
|
Gross Value
|
Accumulated Amortization
|
Net Carrying Value
|
Remaining Weighted-Average Useful Lives (years)
|
|
Amortized Intangible Assets
|
|
|
|
|
|
Brand
(apparel rights)
|
$2,244
|
$(927)
|
$1,317
|
4.1
|
|
Total
intangible assets
|
$2,244
|
$(927)
|
$1,317
|
|
Intangible assets amortization expense was $0.1 million for each of
the three months ended September 30, 2018 and 2017, respectively,
and $0.2 million for each of the nine months ended September 30,
2018 and 2017, respectively, which is included in “Selling,
general and administrative” expense in the accompanying
Condensed Consolidated Statements of Operations.
As of September 30, 2018, the estimated future amortization expense
of intangible assets is as follows (in thousands):
|
For the Year Ending December 31,
|
|
|
Remainder
of 2018
|
$81
|
|
2019
|
321
|
|
2020
|
321
|
|
2021
|
321
|
|
2022
|
33
|
|
Total
amortization expense
|
$1,077
|
12
Note 6. Interest and Other Expense, net
For the three and nine months ended September 30, 2018 and 2017,
“Interest and other expense, net” consisted of the
following (in thousands):
|
|
For the
Three Months
Ended September 30,
|
For the
Nine Months
Ended September 30,
|
||
|
|
2018
|
2017
|
2018
|
2017
|
|
Interest
and other expense, net:
|
|
|
|
|
|
Interest
expense, related party
|
$(559)
|
$(523)
|
$(1,652)
|
$(1,379)
|
|
Interest
expense, related party debt discount
|
(155)
|
(153)
|
(557)
|
(460)
|
|
Interest
expense, other
|
(28)
|
(6)
|
(160)
|
(14)
|
|
Interest
expense, secured borrowing arrangement
|
(251)
|
(172)
|
(906)
|
(397)
|
|
Foreign
currency transaction (loss) gain
|
(4)
|
16
|
(197)
|
49
|
|
Other
|
7
|
(20)
|
9
|
(325)
|
|
Total
interest and other expense, net
|
$(990)
|
$(858)
|
$(3,463)
|
$(2,526)
|
Note 7. Debt
As of September 30, 2018 and December 31, 2017, the Company’s
debt consisted of the following (in thousands):
|
|
As of
September 30, 2018
|
As of
December 31, 2017
|
|
2017
Refinanced Convertible Note due December 31, 2019 with a related
party
|
$18,000
|
$18,000
|
|
Obligations
under secured borrowing arrangement
|
594
|
5,385
|
|
Secured
line of credit
|
1,500
|
3,000
|
|
Unamortized
debt discount with a related party
|
(774)
|
(1,331)
|
|
Total
debt
|
19,320
|
25,054
|
|
Less:
current portion
|
(2,094)
|
(8,385)
|
|
Long
term debt
|
$17,226
|
$16,669
|
Related-Party Notes Payable
On November 3, 2017, the Company entered into the Refinancing with
Mr. Ryan Drexler, the Company’s Chairman of the Board of
Directors, Chief Executive Officer and President. As part of the
Refinancing, the Company issued to Mr. Drexler an amended and
restated convertible secured promissory note (the “Refinanced
Convertible Note”) in the original principal amount of
$18,000,000, which amends and restates (i) a convertible secured
promissory note dated as of December 7, 2015, and amended as of
January 14, 2017, in the original principal amount of $6,000,000
with an interest rate of 8% prior to the amendment and 10%
following the amendment (the “2015 Convertible Note”),
(ii) a convertible secured promissory note dated as of November 8,
2016, in the original principal amount of $11,000,000 with an
interest rate of 10% (the “2016 Convertible Note”) ,
and (iii) a secured demand promissory note dated as of July 27,
2017, in the original principal amount of $1,000,000 with an
interest rate of 15% (the “2017 Note”, and together
with the 2015 Convertible Note and the 2016 Convertible Note,
collectively, the “Prior Notes”). The due date of the
2015 Convertible Note and the 2016 Convertible Note was November 8,
2017. The 2017 Note was due on demand.
13
The $18.0 million Refinanced Convertible Note bears interest at the
rate of 12% per annum. Interest payments are due on the last day of
each quarter. At the Company’s option (as determined by its
independent directors), the Company may repay up to one-sixth of
any interest payment by either adding such amount to the principal
amount of the note or by converting such interest amount into an
equivalent amount of the Company’s common stock. Any interest
not paid when due shall be capitalized and added to the principal
amount of the Refinanced Convertible Note and bear interest on the
applicable interest payment date along with all other unpaid
principal, capitalized interest, and other capitalized
obligations.
Both the principal and the interest under the Refinanced
Convertible Note are due on December 31, 2019, unless converted
earlier.
Mr. Drexler may convert the outstanding principal and accrued
interest into shares of the Company’s common stock at a
conversion price of $1.11 per share at any time. The Company may
prepay the Refinanced Convertible Note by giving Mr. Drexler
between 15 and 60 days’ notice depending upon the specific
circumstances, subject to Mr. Drexler’s conversion
right.
The Refinanced Convertible Note contains customary events of
default, including, among others, the failure by the Company to
make a payment of principal or interest when due. Following an
event of default, interest will accrue at the rate of 14% per
annum. In addition, following an event of default, any conversion,
redemption, payment or prepayment of the Refinanced Convertible
Note will be at a premium of 105%. The Refinanced Convertible Note
also contains customary restrictions on the ability of the Company
to, among other things, grant liens or incur indebtedness other
than certain obligations incurred in the ordinary course of
business. The restrictions are also subject to certain additional
qualifications and carveouts, as set forth in the Refinanced
Convertible Note. The Refinanced Convertible Note is subordinated
to certain other indebtedness of the Company.
As part of the Refinancing, the Company and Mr. Drexler entered
into a restructuring agreement (the “Restructuring
Agreement”) pursuant to which the parties agreed to enter
into the Refinanced Convertible Note and to amend and restate the
security agreement pursuant to which the Prior Notes were secured
by all of the assets and properties of the Company and its
subsidiaries whether tangible or intangible, by entering into the
Third Amended and Restated Security Agreement (the “Amended
Security Agreement”). Pursuant to the Restructuring
Agreement, the Company agreed to pay, on the effective date of the
Refinancing, all outstanding interest on the Prior Notes through
November 8, 2017 and certain fees and expenses incurred by Mr.
Drexler in connection with the Restructuring.
In connection with the refinancing, the Company recorded a debt
discount of $1.2 million. The debt discount is equal to the change
in the fair value of the conversion option between the Refinanced
Convertible Note and the Prior Notes. The fair value of the
conversion option was determined using a Monte Carlo simulation and
the model of stock price behavior known as GBM which simulates a
future period as a random step from a previous period. Significant
assumptions were: expected stock price premium of 40%, expected
trading days of 252 days, and volatility of 60%.
In addition, the Refinanced Convertible Note contains two embedded
derivatives for default interest and an event of default put. Due
to the unlikely event of default, the embedded derivatives have a
de minimis value as of September 30, 2018.
For each of the three months ended September 30, 2018 and 2017,
interest expense, including the amortization of debt discount,
related to the related party convertible secured promissory notes
was $0.7 million, respectively. For the nine months ended September 30, 2018 and
2017, interest expense, including the amortization of debt
discount, related to the related party convertible secured
promissory notes was $2.2 million and $1.8 million, respectively.
During the nine months ended September 30, 2018 and 2017, $1.4
million and $1.8 million, respectively, in interest was paid in
cash to Mr. Drexler.
14
Inventory Financing
On October 6, 2017, the Company (“Borrower”) entered
into a Loan and Security Agreement (“Security
Agreement”) with Crossroads Financial Group, LLC
(“Crossroads”). Pursuant to the Security Agreement, the
Company may borrow up to 70% of its Inventory Cost or up to 75% of
Net Orderly Liquidation Value (each as defined in the Security
Agreement), up to a maximum amount of $3.0 million at an interest
rate of 1.5% per month, subject to a minimum monthly fee of
$22,500. The initial term of the Security Agreement was six months
from the date of execution, and such initial term is extended
automatically in six-month increments, unless earlier terminated
pursuant to the terms of the Security Agreement. The Security
Agreement contains customary events of default, including, among
others, the failure to make payments on amounts owed when due,
default under any other material agreement or the departure of Mr.
Drexler. The Security Agreement also contains customary
restrictions on the ability of the Company to, among other things,
grant liens, incur debt and transfer assets. Under the Security
Agreement, the Company has agreed to grant Crossroads a security
interest in all of the Company’s present and future accounts,
chattel paper, goods (including inventory and equipment),
instruments, investment property, documents, general intangibles,
intangibles, letter of credit rights, commercial tort claims,
deposit accounts, supporting obligations, documents, records and
the proceeds thereof. As of September 30, 2018, the Company owed
$1.5 million to Crossroads under this agreement.
Secured Borrowing Arrangement
In January 2016, the Company entered into a Purchase and Sale
Agreement (the “Purchase and Sale Agreement”) with
Prestige Capital Corporation (“Prestige”) pursuant to
which the Company agreed to sell and assign and Prestige agreed to
buy and accept, certain accounts receivable owed to the Company
(“Accounts”). Under the terms of the Purchase and Sale
Agreement, upon the receipt and acceptance of each assignment of
Accounts, Prestige will pay the Company 80% of the net face
amount of the assigned Accounts, up to a maximum total borrowings
of $12.5 million subject to sufficient amounts of accounts
receivable to secure the loan. The remaining 20% will be paid to
the Company upon collection of the assigned Accounts, less any
chargeback, disputes, or other amounts due to Prestige.
Prestige’s purchase of the assigned Accounts from the Company
will be at a discount fee which varies based on the number of days
outstanding from the assignment of Accounts to collection of the
assigned Accounts. In addition, the Company granted Prestige a
continuing security interest in and lien upon all accounts
receivable, inventory, fixed assets, general intangibles and other
assets. The Purchase and Sale Agreement’s term was extended
to November 30, 2018 at which point the term now renews
automatically for successive four-month periods unless either party
receives written notice of cancellation from the other, at minimum,
thirty days prior to the expiration date. At September 30, 2018, we
had approximately $0.6 million of outstanding borrowings under the
Purchase and Sale Agreement.
During the three months ended September 30, 2018, the Company
assigned to Prestige accounts with an aggregate face amount of
approximately $9.9 million, for which Prestige paid to the Company
approximately $7.9 million in cash. During the three months ended
September 30, 2018, $10.7 million was repaid to Prestige, including
fees and interest. During the
nine months ended September 30, 2018, the Company assigned to
Prestige accounts with an aggregate face amount of approximately
$39.6 million, for which Prestige paid to the Company approximately
$31.7 million in cash. During the nine months ended September 30,
2018, $37.1 million was repaid to Prestige, including fees and
interest.
During the three months ended September 30, 2017, the Company sold
to Prestige accounts with an aggregate face amount of approximately
$13.3 million, for which Prestige paid to the Company approximately
$10.6 million in cash. During the three months ended September 30,
2017, $9.8 million was subsequently repaid to Prestige,
including fees and interest. During the nine months ended September
30, 2017, the Company sold to Prestige accounts with an aggregate
face amount of approximately $27.9 million, for which Prestige paid
to the Company approximately $22.3 million in cash. During the nine
months ended September 30, 2017, $21.4 million was
subsequently repaid to Prestige, including fees and
interest.
Note 8. Commitments and Contingencies
Operating Leases
The Company leases office and warehouse facilities under operating
leases, which expire at various dates through 2022. The amounts
reflected in the table below are for the aggregate future minimum
lease payments under non-cancelable facility operating leases for
properties that have not been abandoned as part of the
restructuring plan. See Note 4 for additional details regarding the
restructured leases. Under lease agreements that contain escalating
rent provisions, lease expense is recorded on a straight-line basis
over the lease term. During the three months ended September 30,
2018 and 2017, rent expense was $0.2 million and $0.1 million,
respectively. During the nine months ended September 30, 2018 and
2017, rent expense was $0.7 million and $0.3 million,
respectively.
15
As of September 30, 2018, future minimum lease payments are as
follows (in thousands):
|
For the Year Ending December
31,
|
|
|
Remainder
of 2018
|
$217
|
|
2019
|
674
|
|
2020
|
649
|
|
2021
|
481
|
|
2022
|
369
|
|
Thereafter
|
—
|
|
Total
minimum lease payments
|
$2,390
|
The Company has subleased its Denver office space and anticipates
receiving approximately $330,000 in sublease payments. These
sublease payments are not reflected in the above
table.
Capital Leases
As of September 30, 2018, the Company was leasing one vehicle under
a fleet leasing agreement which are included in “Property and
equipment, net” in the accompanying Consolidated Balance
Sheets. The original cost of leased assets was $39,000 and the
associated accumulated depreciation was $25,000 as of September 30,
2018. The Company also leases manufacturing and warehouse equipment
under capital leases, which expire at various dates through
February 2020.
As of September 30, 2018 and December 31, 2017, short-term capital
lease liabilities of $97,000 and $126,000, respectively, were
included as a component of current accrued liabilities, and the
long-term capital lease liabilities of $74,000 and $146,000,
respectively, were included as a component of long-term liabilities
in the accompanying Condensed Consolidated Balance
Sheets.
As of September 30, 2018, the Company’s future minimum lease
payments under capital lease agreements, are as follows (in
thousands):
|
For the Year Ending December
31,
|
|
|
Remainder
of 2018
|
$27
|
|
2019
|
101
|
|
2020
|
50
|
|
Total
minimum lease payments
|
178
|
|
Less
amounts representing interest
|
(7)
|
|
Present
value of minimum lease payments
|
$171
|
Purchase Commitment
Upon the completion of the sale of BioZone, the Company entered
into a manufacturing and supply agreement whereby the Company is
required to purchase a minimum of approximately $2.5 million of
products per year from BioZone annually for an initial term of
three years. If the minimum order quantities of specific products
are not met, a $3.0 million minimum purchase of other products must
be met in order to waive the shortfall, which is at 25% of the
realized shortfall. Due to the timing of achieving the minimum
purchase quantities, we are below these targets. As a result, we
have provided for the estimated purchase commitment shortfall
adjustment in the three and nine months ended September 30,
2018.
16
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, we agreed to pay CFG a sum of $3 million,
consisting of a $1 million payment that was advanced by a related
party on July 7, 2017, a $1 million installment paid on July 7,
2018 and a subsequent $1 million installment payment to be paid by
July 7, 2019. The 2019 payment is accrued in current
liabilities.
The Company recorded a charge in its Statement of Operations for
the year ended December 31, 2017 for approximately $1.5 million,
representing the discounted value of the unrecorded settlement
amount. During the three and nine months ended September 30, 2018,
the Company recorded a charge of $30,000 and $148,000,
respectively, representing imputed interest.
Former Executive Lawsuit
The Company was engaged in a dispute with Mr. Richard Estalella
(“Estalella”) concerning amounts allegedly owed by the
Company under an employment agreement with Estalella. Estalella was
seeking certain equitable relief and unspecified damages. On May 7,
2018, the Court vacated the trial in contemplation of the
parties’ settlement of this matter.
On June 19, 2018, the Company approved a settlement agreement (the
“Estalella Settlement Agreement”) with Estalella,
concerning amounts allegedly owed by the Company under an
employment agreement with Estalella (the “Employment
Litigation”). The Estalella Settlement Agreement represents a
full and final settlement of the Employment Litigation. Under the
terms of the agreement, the Company has agreed to pay Estalella a
sum of $925,000, consisting of a $325,000 initial payment that was
made in July 2018, and subsequent payments of $150,000 installments
to be paid within 90, 180, 270 and 360 days of the initial payment,
respectively. The payments are accrued in current liabilities.
Additionally, Estalella retained ownership of 350,000 shares of
restricted stock that were in dispute, of which only 17,000 have
been reflected in our total shares outstanding. As such the Company
has increased the total amount of share outstanding by 333,000
shares for the period ended September 30, 2018.
The Company recorded a settlement recovery in its Statement of
Operations for the nine months ended September 30, 2018 for
approximately $2.7 million, representing the reversal of accrued
payroll the Company previously recorded for compensation related to
the Estalella employment agreement.
Insurance Carrier Lawsuit
The Company was engaged in litigation with an insurance carrier,
Liberty Insurance Underwriters, Inc. (“Liberty”),
arising out of Liberty’s denial of coverage. In 2014, the
Company sought coverage under an insurance policy with Liberty
for claims against our directors and officers arising out of an
investigation by the Securities and Exchange Commission
(“SEC”). Liberty disputed the extent to which those
expenses are covered under its policy, and the Company commenced a
coverage action against Liberty for those expenses in the United
States District Court for the Southern District of New York. This
matter was settled on September 21, 2018.
Contingencies
In the normal course of business or otherwise, the Company may
become involved in legal proceedings. The Company will accrue a
liability for such matters when it is probable that a liability has
been incurred and the amount can be reasonably estimated. When only
a range of possible loss can be established, the most probable
amount in the range is accrued. If no amount within this range is a
better estimate than any other amount within the range, the minimum
amount in the range is accrued. The accrual for a litigation loss
contingency might include, for example, estimates of potential
damages, outside legal fees and other directly related costs
expected to be incurred. As of September 30, 2018, the Company was
involved in the following material legal proceedings described
below.
17
ThermoLife
In January 2016, ThermoLife International LLC
(“ThermoLife”), a supplier of nitrates to MusclePharm,
filed a complaint against the Company in Arizona state court. In
its complaint, ThermoLife alleges that the Company failed to meet
minimum purchase requirements contained in the parties’
supply agreement and seeks monetary damages for the deficiency in
purchase amounts. In March 2016, the Company filed an answer
denying the allegations contained in the complaint and a
counterclaim alleging that ThermoLife’s products were
defective. On September 26, 2018, the Court granted summary
judgment to ThermoLife on MusclePharm’s claims. On November
1, 2018, the Court granted partial summary judgment for ThermoLife
on its own breach of contract claim, finding that MusclePharm is
liable to ThermoLife for failing to meet its minimum purchase
requirements. MusclePharm intends to seek reconsideration of the
Court’s ruling.
United World Wrestling Arbitration
In
November 2017, United World Wrestling (“UWW”), an
amateur wrestling governing body, initiated arbitration against
MusclePharm before the Court of Arbitration for Sport in Lausanne,
Switzerland (“CAS”), alleging that MusclePharm owed it
$663,750, comprised of a $425,000 sponsorship fee plus accrued
interest, under the terms of a 2015 sponsorship agreement. In
September 2018, the sole arbitrator issued an order and decision in
UWW’s favor for $425,000, plus interest at 12% per annum, as
well as attorney’s fees in the amount of 5,000 Swiss Francs.
The Company is in ongoing discussions with UWW to resolve the
matter.
White Winston Lawsuit
In
August 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 all of its directors in the First Judicial District Court of
the State of Nevada. White Winston alleges that MusclePharm’s
directors breached their fiduciary duties when they approved the
November 2017 refinancing of Drexler’s $18 million Refinanced Convertible Note (discussed
further below). In its Complaint, White Winston sought a
permanent injunction against the exercise of
Mr. Drexler’s conversion rights, the appointment of a
receiver, and unspecified monetary damages. On August 23, 2018, the
Nevada district court issued an ex
parte temporary restraining order prohibiting Drexler from
exercising his conversion rights; on September 14, 2018, the court
denied White Winston’s request for a preliminary injunction
and permitted the temporary restraining order to dissolve. White
Winston has appealed the court’s decision. In the meantime,
the action remains pending in the trial court, where the Company
has moved to dismiss the Amended Complaint.
IRS Audit
On April 6, 2016, the Internal Revenue Service (“IRS”)
selected the Company’s 2014 Federal Income Tax Return for
audit. As a result of the audit, the IRS proposed certain
adjustments with respect to the tax reporting of the
Company’s former executives’ 2014 restricted stock
grants. Due to the Company’s current and historical loss
position, the proposed adjustments would have no material impact on
its Federal income tax. On October 5, 2016, the IRS commenced an
audit of the Company’s employment and withholding tax
liability for 2014. The IRS is contending that the Company
inaccurately reported the value of the restricted stock grants and
improperly failed to provide for employment taxes and federal tax
withholding on these grants. In addition, the IRS is proposing
certain penalties associated with the Company’s filings. On
April 4, 2017, the Company received a “30-day letter”
from the IRS asserting back taxes and penalties of approximately
$5.3 million, of which $0.4 million related to employment taxes and
$4.9 million related to federal tax withholding and penalties.
Additionally, the IRS is asserting that the Company owes
information reporting penalties of approximately $2.0 million. The
Company’s counsel has submitted a formal protest to the IRS
disputing on several grounds all of the proposed adjustments and
penalties on the Company’s behalf, and the Company is
pursuing this matter vigorously through the IRS appeal process. Due
to the uncertainty associated with determining the Company’s
liability for the asserted taxes and penalties, if any, and to the
Company’s inability to ascertain with any reasonable degree
of likelihood, as of the date of this report, the outcome of the
IRS appeals process, the Company has recorded an estimate for its
potential liability, if any, associated with these
taxes.
18
On August 22, 2018, Richard Estalella filed an action against
the Company and two other defendants in the Colorado District Court
for the County of Denver, seeking damages arising out of the
IRS’s assertion of tax liability and penalties relating to
the Company’s 2014 restricted stock grants. The Company has
answered Estalella’s complaint, asserted counterclaims
against Estalella for his failure to ensure that all withholding
taxes were paid in connection with the 2014 restricted stock
grants, and filed cross-claims against a valuation firm named in
the action for failing to properly value the 2014 restricted stock
grants for tax purposes. The Company will continue to vigorously
litigate the matter.
Durnford Matter
On July 28, 2015, Plaintiff, Tucker Durnford, filed a First Amended
Class Action Complaint which alleged that MusclePharm’s
Arnold Iron Mass product violates consumer protection laws by
misleading consumers about the amount and sources of protein in the
product. The product has been discontinued. The last shipments were
in March of 2016.
Plaintiff’s counsel alleged that results of laboratory
testing demonstrate the actual total protein content per serving to
be approximately 19.4 grams, once the free-form amino acids are
excluded from the calculation. Plaintiff’s counsel attached
to the First Amended Class Action Complaint what purport to be test
results supporting that allegation.
We moved to dismiss the First Amended Class Action Complaint,
arguing that plaintiff’s claims are preempted by the Federal
Food, Drug, and Cosmetic Act and its implementing regulations. The
Court granted MusclePharm’s motion to dismiss the case on
December 18, 2015. Plaintiff was given leave to file an amended
complaint, but instead chose to appeal the order granting
MusclePharm’s motion to dismiss. On December 31, 2015,
plaintiff’s counsel made a settlement demand, in an amount of
$100,000, which demand was rejected. On February 10, 2016, the
court entered judgment and dismissed the case with prejudice.
Plaintiff appealed to the Ninth Circuit Court of Appeals, which
heard arguments on November 15, 2017.
On October 12, 2018, the Ninth Circuit issued its opinion reversing
the dismissal and remanding the case to the Northern District of
California. The Ninth Circuit found that plaintiff’s
misbranding theory premised on alleged
“nitogen-spiking” or “protein-spiking” was
preempted by federal law, but that plaintiff could attempt to prove
his allegation that the protein in the product does not come
entirely from hydrolyzed beef and lacoterferrin, and his allegation
that the label misleads consumers into believing that that protein
does come entirely from hydrolyzed beef and lacoterferrin. The
Company intends to vigorously defend this action and is awaiting
next steps from the District court.
Sponsorship and Endorsement Contract Liabilities
The Company has various non-cancelable endorsement and sponsorship
agreements with terms expiring through 2019. The total value of
future contractual payments as of September 30, 2018 are as follows
(in thousands):
|
|
For the Years Ending December 31,
|
||
|
|
Remainder of 2018
|
2019
|
Total
|
|
Outstanding Payments
|
|
|
|
|
Endorsement
|
$102
|
$140
|
$242
|
|
Sponsorship
|
31
|
55
|
86
|
|
Total
future payments
|
$133
|
$195
|
$328
|
19
Note 9. Stockholders’ Deficit
Common Stock
For the nine months ended September 30, 2018, the Company had the
following transactions related to its common stock including
restricted stock awards (in thousands, except share and per share
data):
|
Transaction Type
|
Quantity (Shares)
|
Valuation
($)
|
Range of
Value per Share
|
|
Stock
issued to related party for interest
|
81,133
|
$53
|
$0.65
|
|
Total
|
81,133
|
$53
|
$0.65
|
The fair value of all stock issuances above is based upon the
quoted closing trading price on the date of issuance.
Common stock outstanding as of September 30, 2018 and December 31,
2017 includes shares legally outstanding even if subject to future
vesting.
Warrants
In November 2016, the Company issued a warrant to purchase
1,289,378 shares of its common stock to the parent company of
Capstone related to the settlement of a dispute between the Company
and Capstone. The exercise price of this warrant is $1.83 per
share, with a contractual term of four years. The Company has
valued this warrant by utilizing the Black-Scholes model at
approximately $1.8 million with the following
assumptions: contractual life of four years, risk free
interest rate of 1.27%, dividend yield of 0%, and expected
volatility of 118.4%.
In July 2014, the Company issued a warrant to purchase 100,000
shares of its common stock related to an endorsement agreement. The
exercise price of this warrant is $11.90 per share, with a
contractual term of five years.
Note 10. Stock-Based Compensation
Restricted Stock
The Company’s stock-based compensation for the three months
ended September 30, 2018 and 2017 consist primarily of restricted
stock awards. The activity of restricted stock awards granted to
employees, executives and Board members was as
follows:
|
|
Unvested Restricted Stock Awards
|
|
|
|
Number of
Shares
|
Weighted Average
Grant Date Fair
Value
|
|
Unvested
balance – December 31, 2017
|
487,267
|
$2.32
|
|
Granted
|
250,000
|
1.00
|
|
Vested
|
(460,267)
|
1.94
|
|
Cancelled
|
—
|
—
|
|
Unvested
balance – September 30, 2018
|
277,000
|
1.77
|
The Company issued 250,000 shares of restricted stock to its Board
members for each of the three and nine months ended September 30,
2018. The Company issued
168,783 and 538,945 shares of restricted stock to its Board members
for the three and nine months ended September 30, 2017,
respectively. The total fair value of restricted stock awards
granted to employees and the Board was $0.3 million for each of the
three months ended September 30, 2018 and 2017, respectively, and
$0.3 million and $1.0 million for the nine months ended September
30, 2018 and 2017, respectively. As of September 30, 2018, the
total unrecognized expense for unvested restricted stock awards,
net of expected forfeitures, was $0.3 million, which is expected to
be amortized over a weighted average period of 0.7
years.
20
Restricted Stock Awards Issued to Ryan Drexler, Chairman of the
Board, Chief Executive Officer and President
In January 2017, the Company issued Mr. Drexler 350,000 shares of
restricted stock pursuant to an Amended and Restated Executive
Employment Agreement dated November 18, 2016 with a grant date
value of $0.7 million based upon the closing price of the
Company’s common stock on the date of issuance. These shares
of restricted stock vested in full upon the first anniversary of
the grant date.
Accelerated Vesting of Restricted Stock Awards Related to
Terminations of Employment
In March 2017, Brent Baker, the Company’s former Executive
Vice President of International Business, terminated employment
with the Company. In connection with his termination of employment
in March 2017, 10,000 shares of restricted stock held by Mr. Baker
vested in full upon his termination of employment in accordance
with the original grant terms. In connection with the accelerated
vesting of these restricted stock awards, the Company recognized
stock compensation expense of $42,902, which is included in
“Salaries and Benefits” in the accompanying
Consolidated Statements of Operations for the nine months ended
September 30, 2017.
Stock Options
The Company may grant options to purchase shares of the
Company’s common stock to certain employees and directors
pursuant to the 2015 Incentive Compensation Plan (the “2015
Plan”). Under the 2015 Plan, all stock options are granted
with an exercise price equal to or greater than the fair market
value of a share of the Company’s common stock on the date of
grant. Vesting is generally determined by the Compensation
Committee of the Board within limits set forth in the 2015 Plan. No
stock option will be exercisable more than ten years after the date
it is granted.
In February 2016, the Company issued options to purchase 137,362
shares of its common stock to Mr. Drexler, the Company’s
Chairman of the Board, Chief Executive Officer and President, and
options to purchase 54,945 shares of its common stock to Michael
Doron, the former Lead Director of the Board. Upon resignation from
the Board of Directors in June 2017, Mr. Doron forfeited 20,604 of
the options issued. These stock options were granted with an
exercise price of $1.89 per share, a contractual term of 10 years
and a grant date fair value of $1.72 per share, or $0.3 million in
the aggregate, which is amortized on a straight-line basis over the
vesting period of two years. The Company determined the fair value
of the stock options using the Black-Scholes model. The table below
sets forth the assumptions used in valuing such
options.
|
|
For
the Year Ended
December 31,
2016
|
|
|
Expected term of options
|
6.5 years
|
|
|
Expected volatility-range used
|
118.4%-131.0%
|
|
|
Expected volatility-weighted average
|
125.7%
|
|
|
Risk-free interest rate-range used
|
1.27%-1.71%
|
|
For the three months ended September 30, 2017, the Company recorded
stock compensation expense related to options of $29,000. The
Company did not record stock compensation expense related to
options for the three months ended September 30, 2018. For the nine
months ended September 30, 2018 and 2017, the Company recorded
stock compensation expense related to options of $16,000 and
$112,000, respectively.
Note 11. Net Loss per Share
Basic net loss per share is computed by dividing net loss for the
period by the weighted average number of shares of common stock
outstanding during each period. There was no dilutive effect for
the outstanding potentially dilutive securities for the three or
nine months ended September 30, 2018 and 2017, respectively, as the
Company reported a net loss for both periods.
21
The following table sets forth the computation of the
Company’s basic and diluted net loss per share for the
periods presented (in thousands, except share and per share
data):
|
|
For the
Three Months
Ended
September 30,
|
For the
Nine Months
Ended
September 30,
|
||
|
|
2018
|
2017
|
2018
|
2017
|
|
Net
loss
|
$(1,978)
|
$(2,128)
|
$(5,355)
|
$(8,426)
|
|
Weighted
average common shares used in computing net loss per share, basic
and diluted
|
15,029,312
|
13,875,119
|
14,783,699
|
13,819,939
|
|
Net
loss per share, basic and diluted
|
$(0.13)
|
$(0.15)
|
$(0.36)
|
$(0.61)
|
Diluted net income per share is computed by dividing net income for
the period by the weighted average number of shares of common
stock, common stock equivalents and potentially dilutive securities
outstanding during each period. The Company uses the treasury stock
method to determine whether there is a dilutive effect of
outstanding potentially dilutive securities, and the if-converted
method to assess the dilutive effect of the convertible
notes.
There was no dilutive effect for the outstanding awards for the
three and nine months ended September 30, 2018 and 2017,
respectively, as the Company reported a net loss for all
periods.
Total outstanding potentially dilutive securities were comprised of
the following:
|
|
As of September 30,
|
|
|
|
2018
|
2017
|
|
Stock
options
|
171,703
|
171,703
|
|
Warrants
|
1,389,378
|
1,389,378
|
|
Unvested
restricted stock
|
277,000
|
737,690
|
|
Convertible
notes
|
16,216,216
|
8,619,624
|
|
Total
common stock equivalents
|
18,054,297
|
10,918,395
|
Note 12. Income Taxes
The Company recorded a reversal of tax expense of $3,000 and a tax
expense of $14,000 for the three months ended September 30, 2018
and 2017, respectively, and a tax expense of $100,000 and $118,000
for the nine months ended September 30, 2018 and 2017,
respectively.
Income taxes are provided for the tax effects of transactions
reported in the Condensed Consolidated Financial Statements and
consist of taxes currently due. Deferred taxes relate to
differences between the basis of assets and liabilities for
financial and income tax reporting which will be either taxable or
deductible when the assets or liabilities are recovered or settled.
In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or
all of the deferred income tax assets will not be realized. The
ultimate realization of deferred income tax assets is dependent
upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Management
considers the scheduled reversal of deferred income tax
liabilities, projected future taxable income, and tax planning
strategies in making this assessment. Based on consideration of
these items, management has established a full valuation allowance
as it is more likely than not that the tax benefits will not be
realized as of September 30, 2018.
22
Note 13. Segments, Geographical Information
The Company’s chief operating decision maker reviews
financial information presented on a consolidated basis for
purposes of allocating resources and evaluating financial
performance. As such, the Company currently has a single reporting
segment and operating unit structure. In addition, substantially
all long-lived assets are attributable to operations in the U.S.
for both periods presented.
Revenue, net by geography is based on the Company addresses of the
customers. The following table sets forth revenue, net by
geographic area (in thousands):
|
|
For the Three Months
Ended September 30,
|
For the Nine Months
Ended September 30,
|
||
|
|
2018
|
2017
|
2018
|
2017
|
|
Revenue,
net:
|
|
|
|
|
|
United
States
|
$20,841
|
$14,502
|
$53,543
|
$46,769
|
|
International
|
6,547
|
9,894
|
27,496
|
29,828
|
|
Total
revenue, net
|
$27,388
|
$24,396
|
$81,039
|
$76,597
|
Note 14. Subsequent Events
GAAP requires an entity to disclose events that occur after the
balance sheet date but before financial statements are issued or
are available to be issued (“subsequent events”) as
well as the date through which an entity has evaluated subsequent
events. There are two types of subsequent events. The first type
consists of events or transactions that provide additional evidence
about conditions that existed at the date of the balance sheet,
including the estimates inherent in the process of preparing
financial statements, (“recognized subsequent events”).
The second type consists of events that provide evidence about
conditions that did not exist at the date of the balance sheet but
arose subsequent to that date (“non-recognized subsequent
events”).
Recognized Subsequent Events
None.
Unrecognized Subsequent Events
Effective October 1, 2018, EKS&H LLLP
(“EKS&H”), the independent registered public
accounting firm for MusclePharm Corporation (the
“Company”), combined with Plante & Moran PLLC
(“Plante Moran”). As a result of this transaction, on
October 1, 2018, EKS&H resigned as the independent registered
public accounting firm for the Company. Concurrent with such
resignation, the Company’s audit committee approved the
engagement of Plante Moran as the new independent registered public
accounting firm for the Company. For additional information see the
Company’s Current Report on Form 8-K filed with the SEC on
October 4, 2018.
23
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
Condensed 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, 2017, as filed with the Securities and
Exchange Commission on April 2, 2018, or the 2017 Form 10-K. 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 “Company,”
“we,” “our” and “us” refer to
MusclePharm Corporation and its subsidiaries.
Overview
We are 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, bars and capsules, which seek to help
athletes of all types achieve a heightened level of performance and
satisfaction. Our portfolio consists of sports nutrition staples,
such as protein powders and bars, and preworkout powders, as well
as well-known supplements like creatine, BCAA, fish oil, a
multi-vitamin and more. These products fall under
globally-recognized brands, MusclePharm® and FitMiss®,
which are marketed and sold in more than 100 countries globally.
Our corporate headquarters is located in Burbank, CA.
Our products 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, and Club retail channels, including Amazon, Costco,
iHerb, Kroger, Walgreens and 7-Eleven. Our sales in the e-commerce
space grew approximately 250% in 2017 compared to 2016 and we have
continued to see growth in 2018. Additionally, BodyBuilding.com
named our Combat Crunch Bar as Protein Bar of the Year in each of
2015, 2016 and 2017.
Outlook
As we continue to execute our growth strategy and focus on our core
operations, we anticipate both continued improvement in our
operating margins and expense structure, as well as topline sales
advancement. The termination of the Arnold Schwarzenegger
product-line licensing agreement, discontinuance of unprofitable
SKUs and product families, as well as the migration to new product
suppliers have impacted revenue growth for the short-term. However,
we anticipate revenues and growth margin to strengthen as we
increase focus on our core MusclePharm products. In addition, the
sale of our wholly-owned subsidiary, BioZone, in May 2016, enabled
us to further narrow our focus on core products, and further
innovate and develop new products. We also anticipate improved
results from advertising and promotions expenses as we focus on
effective marketing and advertising strategies, having moved away
from costly celebrity endorsements.
Management’s Plans with Respect to Liquidity and Capital
Resources
Management believes the restructuring plan, the continued reduction
in ongoing operating costs and expense controls, and the
aforementioned growth strategy, will enable us to ultimately
achieve profitability. We have reduced our operating expenses
sufficiently and believe that our ongoing sources of revenue
together with our access to capital will be sufficient to cover
these expenses for the foreseeable future.
24
As of September 30, 2018, we had a stockholders’ deficit of
$17.5 million and recurring losses from operations. To manage cash
flow, we entered into a secured borrowing arrangement, pursuant to
which we have the ability to borrow up to $12.5 million subject to
sufficient amounts of accounts receivable to secure the loan. The
Agreement’s term has been extended to November 30, 2018, at
which point the term now renews automatically for successive
four-month periods unless either party receives written notice of
cancellation from the other, at a minimum thirty days prior to the
expiration date. In October 2017, we also entered into a loan and
security agreement to borrow against our inventory up to a maximum
of $3.0 million for an initial six-month term which was
automatically extended for six additional months. As of September
30, 2018, we owed $1.5 million on this credit line.
On November 3, 2017, we entered into a refinancing transaction with
Mr. Ryan Drexler, our Chairman of the Board, Chief Executive
Officer and President, to restructure all of the $18.0 million in
notes payable to him, which are now due on December 31, 2019.
Accordingly, such debt is classified as a long-term liability at
September 30, 2018.
As of September 30, 2018, we had approximately $1.7 million in cash
and a $2.0 million working capital deficit.
Our Condensed Consolidated Financial Statements as of and for the
three and nine months ended September 30, 2018 were prepared on the
basis of a going concern, which contemplates, among other things,
the realization of assets and satisfaction of liabilities in the
ordinary course of business. Accordingly, they do not give effect
to adjustments that could be necessary should we be required to
liquidate our assets.
Our ability to continue as a going concern and raise capital for
specific strategic initiatives could also depend on obtaining
adequate capital to fund operating losses until it becomes
profitable. We can give no assurances that any additional capital
that it is able to obtain, if any, will be sufficient to meet our
needs, or that any such financing will be obtainable on acceptable
terms.
Mr. Drexler has verbally both stated his intent and ability to put
more capital into the business if necessary. However, Mr. Drexler
is under no obligation to us to do so, and we can give no
assurances that Mr. Drexler will be willing or able to do so at a
future date and/or that he will not demand payment of his
refinanced convertible note on December 31, 2019.
We believe that our capital resources as of September 30, 2018,
available borrowing capacity and current operating plans will be
sufficient to fund our planned operations for at least twelve
months from the date of filing this report.
25
Results of Operations
Comparison of the Three Months Ended September 30, 2018 to the
Three Months Ended September 30, 2017
|
|
For the Three
Months Ended
September 30,
|
|
|
|
|
|
2018
|
2017
|
$ Change
|
% Change
|
|
|
($ in thousands)
|
|
|
|
|
Revenue,
net
|
$27,388
|
$24,396
|
$2,992
|
12.3%
|
|
Cost
of revenue
|
18,595
|
16,359
|
2,236
|
13.7
|
|
Gross
profit
|
8,793
|
8,037
|
756
|
9.4
|
|
Operating
expenses:
|
|
|
|
|
|
Advertising
and promotion
|
3,589
|
1,952
|
1,637
|
83.9
|
|
Salaries
and benefits
|
1,856
|
2,640
|
(784)
|
(29.7)
|
|
Selling,
general and administrative
|
2,975
|
3,468
|
(493)
|
(14.2)
|
|
Research
and development
|
185
|
199
|
(14)
|
(7.0)
|
|
Professional
fees
|
436
|
1,034
|
(598)
|
(57.8)
|
|
Impairment
of assets
|
743
|
—
|
743
|
—
|
|
Total
operating expenses
|
9,784
|
9,293
|
491
|
5.3
|
|
Loss
from operations
|
(991)
|
(1,256)
|
265
|
(21.1)
|
|
Interest
and other expense, net
|
(990)
|
(858)
|
(132)
|
15.4
|
|
Loss
before income taxes
|
(1,981)
|
(2,114)
|
133
|
(6.3)
|
|
Income
taxes
|
(3)
|
14
|
(17)
|
(121.4)
|
|
Net
loss
|
$(1,978)
|
$(2,128)
|
$150
|
(7.0)%
|
26
Comparison of the Nine Months Ended September 30, 2018 to the
Nine Months Ended September 30, 2017
|
|
For the Nine
Months Ended
September 30,
|
|
|
|
|
|
2018
|
2017
|
$ Change
|
% Change
|
|
|
($ in
thousands)
|
|
|
|
|
Revenue,
net
|
$81,039
|
$76,597
|
$4,442
|
5.8%
|
|
Cost
of revenue
|
55,875
|
54,474
|
1,401
|
2.6
|
|
Gross
profit
|
25,164
|
22,123
|
3,041
|
13.7
|
|
Operating
expenses:
|
|
|
|
|
|
Advertising
and promotion
|
12,241
|
6,079
|
6,162
|
101.4
|
|
Salaries
and benefits
|
6,305
|
8,530
|
(2,225)
|
(26.1)
|
|
Selling,
general and administrative
|
8,175
|
9,183
|
(1,008)
|
(11.0)
|
|
Research
and development
|
605
|
488
|
117
|
24.0
|
|
Professional
fees
|
1,634
|
2,643
|
(1,009)
|
(38.2)
|
|
Impairment
of assets
|
743
|
|
743
|
100.0
|
|
Settlement
of obligation
|
(2,747)
|
1,453
|
(4,200)
|
(289.1)
|
|
Total
operating expenses
|
26,956
|
28,376
|
(1,420)
|
(5.0)
|
|
Loss
from operations
|
(1,792)
|
(6,253)
|
4,461
|
(71.3)
|
|
Gain
on settlement of accounts payable
|
—
|
471
|
(471)
|
(100.0)
|
|
Interest
and other expense, net
|
(3,463)
|
(2,526)
|
(937)
|
37.1
|
|
Loss
before income taxes
|
(5,255)
|
(8,308)
|
3,053
|
(36.7)
|
|
Income
taxes
|
100
|
118
|
(18)
|
(15.3)
|
|
Net
loss
|
$(5,355)
|
$(8,426)
|
$3,071
|
(36.4)%
|
27
The following table presents our operating results as a percentage
of revenue, net for the periods presented:
|
|
For the Three Months
Ended September 30,
|
For the Nine Months
Ended September 30,
|
||
|
|
2018
|
2017
|
2018
|
2017
|
|
Revenue,
net
|
100%
|
100%
|
100%
|
100%
|
|
Cost
of revenue
|
68
|
67
|
69
|
71
|
|
Gross
profit
|
32
|
33
|
31
|
29
|
|
Operating
expenses:
|
|
|
|
|
|
Advertising
and promotion
|
13
|
8
|
15
|
8
|
|
Salaries
and benefits
|
7
|
11
|
8
|
11
|
|
Selling,
general and administrative
|
11
|
14
|
10
|
12
|
|
Research
and development
|
1
|
1
|
1
|
1
|
|
Professional
fees
|
1
|
4
|
2
|
3
|
|
Impairment
of assets
|
3
|
—
|
1
|
—
|
|
Settlement
|
—
|
—
|
(4)
|
2
|
|
Total
operating expenses
|
36
|
38
|
33
|
37
|
|
Loss
from operations
|
(4)
|
(4)
|
(2)
|
(8)
|
|
Gain
on settlement of accounts payable
|
—
|
—
|
—
|
1
|
|
Interest
and other expense, net
|
(3)
|
(4)
|
(4)
|
(3)
|
|
Loss
before income taxes
|
(7)
|
(8)
|
(6)
|
(11)
|
|
Income
taxes
|
—
|
—
|
—
|
—
|
|
Net
loss
|
(7)%
|
(8)%
|
(6)%
|
(11)%
|
Revenue, net
Specialty Website Sales
We generate specialty revenues from the sale of nutritional
supplements to customers in the United States through our website.
For sales made through our website, we recognize revenue upon
shipment to the customer as that is when the customer obtains
control of the promised good. We require cash or credit card
payment at the point of sale or when the order is placed on our
website. Accounts receivable from Specialty Website Sales represent
amounts due from credit card companies and are generally collected
within a few days of the purchase. As such, we have determined that
no allowance for doubtful accounts is necessary.
Wholesale (Specialty, International and FDM)
For our distribution sales, we recognize revenue at the point of
sale. We generate wholesale revenues primarily from the sale of
nutritional supplements to retailers and distributors in the United
States and Canada. Our revenue contracts are identified when
purchase orders are received and accepted from customers and
represent a single performance obligation to sell our products to a
customer. We recognize revenue upon shipment to the customer as
that is when the customer obtains control of the promised goods. We
typically extend credit terms to our wholesale customers based on
their creditworthiness and generally do not receive advance
payments. As such, we record accounts receivable at the time of
shipment, when the Company’s right to the consideration
becomes unconditional. Accounts receivable from our wholesale
customers are typically due within 30 days of invoicing. An
allowance for doubtful accounts is provided based on a periodic
analysis of individual account balances, including an evaluation of
days outstanding, payment history, recent payment trends, and the
Company’s assessment of its customers’
creditworthiness.
28
Net revenues reflect the transaction prices for contracts, which
include 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.
For the three and nine months ended September 30, 2018, net revenue
increased 12.3% to $27.4 million and 5.8% to $81.0 million,
respectively, compared to the three and nine months ended September
30, 2017 when net revenues were $24.4 million and $76.6 million,
respectively. Net revenue for the three months ended September
30, 2018 increased due to growth in our domestic sales of $6.4
million, which was partially offset by reduced international sales
of $3.4 million. Net revenue for the nine months ended September
30, 2018 increased due to growth in our domestic sales of $6.7
million, which was partially offset by reduced international sales
of $2.3 million. For the three months ended September 30, 2018
discounts and sales allowances increased to 19% of gross revenue,
or $6.4 million compared to the three months ended September 30,
2017 when discounts and allowances were 8%, or $2.1 million. For
the nine months ended September 30, 2018 discounts and sales
allowances increased to 17% of gross revenues, or $16.5 million
compared to the nine months ended September 30, 2017 when discounts
and allowances were 16% or $13.8 million. The changes in discounts
and allowances is primarily relate to discounts and allowances on
existing products with key customers.
During the three and nine months ended September 30, 2018, our
largest customer, Costco Wholesale Corporation, or Costco,
accounted for approximately 38% and 25% of our net revenue,
respectively. During each of the three and nine months ended
September 30, 2018, Amazon accounted for approximately 15% of our
net revenue, respectively. During the three and nine months ended
September 30, 2018, iHerb accounted for approximately 18% and 12%
of our net revenues, respectively.
During both the three and nine months ended September 30, 2017, our
largest customer, Costco Wholesale Corporation, or Costco,
accounted for approximately 26% of our net revenue. During the
three and nine months ended September 30, 2017, Amazon accounted
for approximately 16% and 11% of our net revenues,
respectively.
Cost of Revenue and Gross Margin
Cost of revenue for our products is directly related to the
production, manufacturing, and freight-in of the related products
purchased from third party contract manufacturers. We mainly ship
customer orders from our distribution center in Spring Hill,
Tennessee. This facility is operated with our equipment and
employees, and we own the related inventory. We also use contract
manufacturers to drop ship products directly to our
customers.
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 and nine
months ended September 30, 2018 increased from the same periods in
2017 primarily as a result of
increased sales.
For the three and nine months ended September 30, 2018, costs of
revenue increased 13.7% to $19.0 million and 2.6% to $55.9 million,
respectively, compared to the three and nine months ended September
30, 2017, when costs of revenues were $16.4 million and $54.5
million, respectively. Accordingly, gross profit for three and nine
months increased 9.4% to $8.8 million and 13.7% to $25.2 million,
respectively, compared to three and nine months ended September 30,
2017, when gross profit was $8.0 million and $22.1 million,
respectively. Positively impacting this gross profit percentage is
our ability to offset our inflationary cost increase in our protein
products that negatively impacted our costs in 2017.
Operating Expenses
Operating expenses for the each of the three and nine months ended
September 30, 2018 were $9.8 million and $27.0 million,
respectively, compared to $9.3 million and $28.4 million for the
three and nine months ended September 30, 2017, respectively. For
the three months ended September 30, 2018, our operating expenses
overall were 36% of net revenue compared to 38% for the same period
in 2017. For the nine months ended September 30, 2018, our
operating expenses overall were 33% of net revenue compared to 37%
for the same period in 2017. We have been focused on instituting
new strategies focusing on new advertising and promotions, while at
the same time reducing other operating expenses.
29
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. Prior to our
restructuring which began during the third quarter of 2015,
advertising and promotions were a large part of both our growth
strategy and brand awareness. We built 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 have terminated the majority of
these contracts in a strategic shift away from such costly
arrangements and moved toward more ROI driven brand partnerships as
well as grass-roots marketing and advertising efforts that leverage
existing brand recognition and more effective advertising outlets
including social media and trade advertising.
For the three and nine months ended September 30, 2018, advertising
and promotion expense increased 83.9% to $3.6 million and 101.4% to
$12.2 million, respectively, compared to the three and nine months
ended September 30, 2017, when advertising and promotion expense
were $2.0 million and $6.1 million, respectively. Advertising and
promotion expense for the three and nine months ended September 30,
2018 and 2017 included expenses related to strategic partnerships,
advertising, and store support. The increase in spending for the
three months ended September 30, 2018 primarily included increases
to strategic partnership advertising of $1.1 million and store
support of $0.4 million. The increase in spending for the nine
months ended September 30, 2018 primarily included increases to
strategic partnership advertising of $3.0 million, store support of
$2.3 million, and print advertising of $0.2 million.
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.
For the three and nine months ended September 30, 2018, salaries
and benefits expense decreased 29.7% to $1.9 million and 26.1% to
$6.3 million, respectively, compared to the three and nine months
ended September 30, 2017, when salaries and benefits expenses were
$2.6 million and $8.5 million, respectively. For the three and nine
months ended September 30, 2018, stock-based compensation expense
decreased $0.3 million and $0.9 million, respectively. For the nine
months ended September 30, 2018, other compensation expense
decreased by $1.3 million compared to the nine months ended
September 30, 2017, which was related to the reduction in
headcount.
Selling, General and Administrative
Our selling, general and administrative expenses consist primarily
of depreciation and amortization, 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.
For the three and nine months ended September 30, 2018, selling,
general and administrative expenses decreased 14.2% to $3.0 million
and 11.0% to $8.2 million, respectively, compared to the three and
nine months ended September 30, 2017, when selling, general and
administrative expenses were $3.5 million and $9.2 million,
respectively. The decreases during the three months ended September
30, 2018 compared to the three months ended September 30, 2017 were
primarily due to lower depreciation of $0.1 million, lower bad debt
of $0.6 million, and lower board costs of $0.1 million. These
reductions were partially offset by increased freight expense of
$0.3. The decreases during the nine months ended September 30, 2018
compared to the nine months ended September 30, 2017 were primarily
due to lower office expenses and other miscellaneous cost savings
of $0.4 million, lower board costs of $0.4 million, lower insurance
expense of $0.1 million, lower bad debt expense of $0.4 million,
lower depreciation and amortization of $0.3 million, and a decrease
of $0.2 million related to information technology.
30
These reductions were partially offset by increases due to higher
freight expense of $0.5 million, and higher rent expense of $0.3
million.
Research and Development
Research and development expenses consist primarily of R&D
personnel salaries, bonuses, benefits, and stock-based
compensation, product quality control, which includes third-party
testing, and research fees related to the development of new
products. We expense research and development costs as
incurred.
For the three and nine months ended September 30, 2018, research
and development expenses decreased 7.0% to $0.2 million and
increased 24.0% to $0.6 million, respectively, compared to three
and nine months ended September 30, 2017, when research and
development expenses were $0.2 million and $0.5 million,
respectively. primarily due to increased quality control testing
fees.
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. We expect
our professional fees to decrease slightly as we continue to
rationalize our professional service providers and focus on key
initiatives. Also, as our ongoing legal matters are reduced, we
expect to see a further decline in legal costs for specific
settlement activities. We intend to continue to invest in
strengthening our governance, internal controls, and process
improvements which may require some support from third-party
service providers.
For the three and nine months ended September 30, 2018,
professional fees expenses decreased 57.8% to $0.4 million and
38.2% to $1.6 million, respectively, compared to the three and nine
months ended September 30, 2017, when professional fees expenses
were $1.0 million and $2.6 million, respectively. The decrease
during the three months ended September 30, 2018 compared to the
three months ended September 30, 2017 was primarily due to lower
accounting fees of $0.1 million, reduced consulting fees of $0.1
million, reduced legal fees of $0.3 million due to reduced
litigation, and $0.1 million due to reduced regulatory related
fees. The decrease during the nine months ended September 30, 2018
compared to the nine months ended September 30, 2017 was primarily
due to lower accounting fees of $0.2 million, lower legal fees of
$0.7 million due to reduced litigation, and reduced consulting and
regulatory related fees of $0.1 million.
Impairment of assets
During the three months ended September 30, 2018, we subleased our
former headquarters in Denver, CO. As a result, we determined that
the leasehold improvements had become fully impaired. We recorded
an impairment charge of $0.7 million during the
period.
31
Interest and other Expense, net
For the three and nine months ended September 30, 2018 and 2017,
“Interest and other expense, net” consisted of the
following (in thousands):
|
|
For the
Three Months
Ended September 30,
|
For the
Nine Months
Ended September 30,
|
||
|
|
2018
|
2017
|
2018
|
2017
|
|
Interest
and other expense, net:
|
|
|
|
|
|
Interest
expense, related party
|
$(559)
|
$(523)
|
$(1,652)
|
$(1,379)
|
|
Interest
expense, related party debt discount
|
(155)
|
(153)
|
(557)
|
(460)
|
|
Interest
expense, other
|
(28)
|
(6)
|
(160)
|
(14)
|
|
Interest
expense, secured borrowing arrangements
|
(251)
|
(172)
|
(906)
|
(397)
|
|
Foreign
currency transaction (loss) gain
|
(4)
|
16
|
(197)
|
49
|
|
Other
|
7
|
(20)
|
9
|
(325)
|
|
Total
interest and other expense, net
|
$(990)
|
$(858)
|
$(3,463)
|
$(2,526)
|
Net interest and other expense for the three and nine months ended
September 30, 2018 increased 15.4%, or $0.1 million and 37.1%, or
$0.9 million, compared to the same periods in 2017, primarily
related to interest expense with a related party and increased
interest on secured borrowings.
Income Taxes
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.
Liquidity and Capital Resources
Management believes the restructuring plan, the continued reduction
in ongoing operating costs and expense controls, and the
aforementioned growth strategy, will enable us to ultimately
achieve profitability. We have reduced our operating expenses
sufficiently and believe that our ongoing sources of revenue
together with our access to capital will be sufficient to cover
these expenses for the foreseeable future, however, we can give no
assurances that this will occur.
As of September 30, 2018, we had a stockholders’ deficit of
$17.5 million and recurring losses from operations. To manage cash
flow, we entered into a secured borrowing arrangement, pursuant to
which we have the ability to borrow up to $12.5 million subject to
sufficient amounts of accounts receivable to secure the loan. The
agreement’s term has been extended to November 30, 2018,
which renews automatically for successive four-month periods unless
either party receives written notice of cancellation from the
other, at a minimum thirty days prior to the expiration date. In
October 2017, we also entered into a loan and security agreement to
borrow against our inventory up to a maximum of $3.0 million for an
initial six-month term which automatically extends for six
additional months. As of September 30, 2018, we owed $1.5 million
on this credit line.
On November 3, 2017, we entered into a refinancing transaction with
Mr. Ryan Drexler, our Chairman of the Board, Chief Executive
Officer and President, to restructure all of the $18.0 million in
notes payable to him, which are now due on December 31, 2019.
Accordingly, such debt is classified as a long-term liability at
September 30, 2018.
As of September 30, 2018, we had approximately $1.7 million in cash
and a $2.0 million working capital deficit.
32
Our Condensed Consolidated Financial Statements as of and for the
three months ended September 30, 2018 were prepared on the basis of
a going concern, which contemplates, among other things, the
realization of assets and satisfaction of liabilities in the
ordinary course of business. Accordingly, they do not give effect
to adjustments that could be necessary should we be required to
liquidate our assets.
Our ability to continue as a going concern and raise capital for
specific strategic initiatives could also depend on obtaining
adequate capital to fund operating losses until it becomes
profitable. We can give no assurances that any additional capital
that it is able to obtain, if any, will be sufficient to meet our
needs, or that any such financing will be obtainable on acceptable
terms.
Mr. Drexler has verbally both stated his intent and ability to put
more capital into the business if necessary. However, Mr. Drexler
is under no obligation to us to do so, and we can give no
assurances that Mr. Drexler will be willing or able to do so at a
future date and/or that he will not demand payment of his
refinanced convertible note on December 31, 2019.
We believe that our capital resources as of September 30, 2018,
available borrowing capacity and current operating plans will be
sufficient to fund our planned operations for at least twelve
months from the date of filing this report.
Our net consolidated cash flows are as follows (in
thousands):
|
|
For the Nine Months
Ended September 30,
|
|
|
|
2018
|
2017
|
|
Consolidated Statements of Cash Flows Data:
|
|
|
|
Net
cash provided by/(used in) operating activities
|
$2,023
|
$(2,337)
|
|
Net
cash used in investing activities
|
(86)
|
(27)
|
|
Net
cash (used in)/provided by financing activities
|
(6,393)
|
2,140
|
|
Effect
of exchange rate changes on cash
|
(23)
|
159
|
|
Net
change in cash
|
$(4,479)
|
$(65)
|
Operating Activities
Our cash provided by/used in operating activities is driven
primarily by sales of our products and vendor provided credit as a
result of improved payment terms with vendors offset in 2018 by an
increase in accounts payable. 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 from 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.
Our operating cash flows were $4.4 million higher for the nine
months ended September 30, 2018 compared to the same period in
2017. The variance primarily relates to net loss adjusted for
non-cash charges, which resulted in a use of cash of $4.8 for the
nine months ended September 30, 2018, compared to a use of cash of
$4.1 million for the same period in 2017. This increase also
included a net change in net operating assets and liabilities,
which resulted in a source of cash of $6.8 million for the nine
months ended September 30, 2018 compared to a source of cash of
$1.7 million for the same period in 2017. During the nine months ended September 30, 2018,
an increase in accounts payable and accrued liabilities resulted in
a $8.4 million cash flow from working capital. This increase was
offset by an increase in our accounts receivable, an increase in
inventory, prepaid and other, and a decrease in accrued
restructuring, in the amounts of $0.5 million, $0.8 million, $0.1
million, and $0.2 million, respectively. During the nine months
ended September 30, 2017, a decrease in inventory and an increase
in accounts payable and accrued liabilities, in the amounts of $2.4
million and $0.4 million, respectively, resulted in cash flow from
working capital. This increase in cash flow from working capital
was offset by an increase in our accounts receivable balance, a net
increase in our prepaid accounts, and decreases in accrued
restructuring, in the amounts of $0.8 million, $0.2 million, and
$0.1 million, respectively.
33
Investing Activities
During the nine months ended September 30, 2018 and 2017, we used
$86,000 and $27,000, respectively, for the purchase of
equipment.
Financing Activities
Cash used in financing activities was $6.4 million for the
nine months ended September 30, 2018, compared to cash provided by
financing activities of $2.1 provided during the nine months ended
September 30, 2017. Cash provided from the secured borrowing
arrangement in both periods was offset by repayments of outstanding
debt.
Indebtedness Agreements
Related-Party Notes Payable
On November 3, 2017, we entered into the “Refinancing”
with Mr. Ryan Drexler, our Chairman of the Board of Directors,
Chief Executive Officer and President. As part of the Refinancing,
we issued to Mr. Drexler the Refinanced Convertible Note in the
original principal amount of $18,000,000, which amends and restates
(i) the 2015 Convertible Note dated as of December 7, 2015, and
amended as of January 14, 2017, in the original principal amount of
$6,000,000 with an interest rate of 8% prior to the amendment and
10% following the amendment, (ii) the 2016 Convertible Note dated
as of November 8, 2016, in the original principal amount of
$11,000,000 with an interest rate of 10%, and (iii) the 2017 Note
dated as of July 27, 2017, in the original principal amount of
$1,000,000 with an interest rate of 15%. The due date of the 2015
Convertible Note and the 2016 Convertible Note was November 8,
2017. The 2017 Note was due on demand.
2017 Refinanced Convertible Note
The $18 million Refinanced Convertible Note bears interest at the
rate of 12% per annum. Interest payments are due on the last day of
each quarter. At our option (as determined by its independent
directors), we may repay up to one sixth of any interest payment by
either adding such amount to the principal amount of the note or by
converting such interest amount into an equivalent amount of our
common stock. Any interest not paid when due shall be capitalized
and added to the principal amount of the Refinanced Convertible
Note and bear interest on the applicable interest payment date
along with all other unpaid principal, capitalized interest, and
other capitalized obligations.
Both the principal and the interest under the Refinanced
Convertible Note are due on December 31, 2019, unless converted
earlier.
Mr. Drexler may convert the outstanding principal and accrued
interest into shares of our common stock at a conversion price of
$1.11 per share at any time. We may prepay the Refinanced
Convertible Note by giving Mr. Drexler between 15 and 60
days’ notice depending upon the specific circumstances,
subject to Mr. Drexler’s conversion right.
The Refinanced Convertible Note contains customary events of
default, including, among others, the failure by us to make a
payment of principal or interest when due. Following an event of
default, interest will accrue at the rate of 14% per annum. In
addition, following an event of default, any conversion,
redemption, payment or prepayment of the Refinanced Convertible
Note will be at a premium of 105%. The Refinanced Convertible Note
also contains customary restrictions on the ability of us to, among
other things, grant liens or incur indebtedness other than certain
obligations incurred in the ordinary course of business. The
restrictions are also subject to certain additional qualifications
and carveouts, as set forth in the Refinanced Convertible Note. The
Refinanced Convertible Note is subordinated to certain other
indebtedness of the Company.
As part of the Refinancing, we and Mr. Drexler entered into the
Restructuring Agreement pursuant to which the parties agreed to
enter into the Refinanced Convertible Note and to amend and restate
the security agreement pursuant to which the Prior Notes were
secured by all of the assets and properties of us and our
subsidiaries whether tangible or intangible, by entering into the
Amended Security Agreement. Pursuant to the Restructuring
Agreement, we agreed to pay, on the effective date of the
Refinancing, all outstanding interest on the Prior Notes through
November 8, 2017 and certain fees and expenses incurred by Mr.
Drexler in connection with the Restructuring.
34
In connection with the refinancing, we recorded a debt discount of
$1.2 million. The debt discount is equal to the change in the fair
value of the conversion option between the Refinanced Convertible
Note and the Prior Notes. The fair value of the conversion option
was determined using a Monte Carlo simulation and the model of
stock price behavior known as GBM which simulates a future period
as a random step from a previous period.
In addition, the Refinanced Convertible Note contains two embedded
derivatives for default interest and an event of default put. Due
to the unlikely event of default, the embedded derivatives have a
de minimis value as of September 30, 2018.
For the nine months ended September 30, 2018 and 2017, interest
expense related to the related party convertible secured promissory
notes was $2.2 million and $1.8 million, respectively. During the
nine months ended September 30, 2018 and 2017, $1.4 million and
$1.8 million, respectively, in interest was paid in cash to Mr.
Drexler.
Inventory Financing
On October 6, 2017, the Company entered into a Security Agreement
with Crossroads. Pursuant to the Security Agreement, Borrower may
borrow up to 70% of its Inventory Cost or up to 75% of Net Orderly
Liquidation Value (each as defined in the Security Agreement), up
to a maximum amount of $3.0 million at an interest rate of 1.5% per
month, subject to a minimum monthly fee of $22,500. The initial
term of the Security Agreement was six months from the date of
execution, and such initial term is extended automatically in
six-month increments, unless earlier terminated pursuant to the
terms of the Security Agreement. The Security Agreement contains
customary events of default, including, among others, the failure
to make payments on amounts owed when due, default under any other
material agreement or the departure of Mr. Drexler. The Security
Agreement also contains customary restrictions on the ability of
Borrower to, among other things, grant liens, incur debt and
transfer assets. Under the Security Agreement, Borrower has agreed
to grant Crossroads a security interest in all our present and
future accounts, chattel paper, goods (including inventory and
equipment), instruments, investment property, documents, general
intangibles, intangibles, letter of credit rights, commercial tort
claims, deposit accounts, supporting obligations, documents,
records and the proceeds thereof. As of September 30, 2018, we owed
$1.5 million to Crossroads.
Secured Borrowing Arrangement
In January 2016, we entered into the Purchase and Sale Agreement
with Prestige pursuant to which we agreed to sell and assign and
Prestige agreed to buy and accept, certain accounts receivable owed
to us (“Accounts”). Under the terms of the Purchase and
Sale Agreement, upon the receipt and acceptance of each assignment
of Accounts, Prestige will pay us 80% of the net face amount
of the assigned Accounts, up to a maximum total borrowings of $12.5
million subject to sufficient amounts of accounts receivable to
secure the loan. The remaining 20% will be paid to us upon
collection of the assigned Accounts, less any chargeback, disputes,
or other amounts due to Prestige. Prestige’s purchase of the
assigned Accounts from us will be at a discount fee which varies
based on the number of days outstanding from the assignment of
Accounts to collection of the assigned Accounts. In addition, we
granted Prestige a continuing security interest in and lien upon
all accounts receivable, inventory, fixed assets, general
intangibles and other assets. The Purchase and Sale Agreement’s term has
been extended to November 30, 2018, which renews automatically for
successive four-month periods unless either party receives written
notice of cancellation from the other, at minimum, thirty-days
prior to the expiration date. At September 30, 2018, we had
approximately $0.6 million of outstanding
borrowings.
During the three months ended September 30, 2018, we assigned to
Prestige accounts with an aggregate face amount of approximately
$9.9 million, for which Prestige paid us approximately $7.9 million
in cash. During the three months ended September 30, 2018, $10.7
million we repaid to Prestige, including fees and interest. During
the nine months ended September 30, 2018, we assigned to Prestige
accounts with an aggregate face amount of approximately $39.6
million, for which Prestige paid us approximately $31.7 million in
cash. During the nine months ended September 30, 2018, $37.1
million we repaid to Prestige, including fees and
interest.
35
During the three months ended September 30, 2017, we assigned to
Prestige accounts with an aggregate face amount of approximately
$13.3 million, for which Prestige paid us approximately $10.6
million in cash. During the three months ended September 30, 2017,
$9.8 million we subsequently repaid to Prestige, including
fees and interest. During the nine months ended September 30, 2017,
we sold to Prestige accounts with an aggregate face amount of
approximately $27.9 million, for which Prestige paid us
approximately $22.3 million in cash. During the nine months ended
September 30, 2017, $21.4 million we repaid to Prestige,
including fees and interest.
Contractual Obligations
Our principal commitments consist of obligations under operating
leases for office and warehouse facilities, capital leases for
manufacturing and warehouse equipment, debt, restructuring
liability and non-cancelable endorsement and sponsorship
agreements. The following table summarizes our commitments to
settle contractual obligations in cash as of September 30,
2018:
|
|
Payments Due by Period
|
||||
|
|
1 Year
|
2 to 3 Years
|
Thereafter
|
Total
|
|
|
|
(in
thousands)
|
||||
|
Operating lease obligations(1)
|
$723
|
$1,178
|
$489
|
$—
|
$2,390
|
|
Capital
lease obligations
|
102
|
76
|
—
|
—
|
178
|
|
Secured
borrowing arrangements
|
2,094
|
—
|
—
|
—
|
2,094
|
|
Convertible notes with a related
party(2)
|
2,719
|
18,540
|
—
|
—
|
21,259
|
|
Restructuring
liability
|
463
|
58
|
—
|
—
|
521
|
|
Settlement
agreements
|
1,600
|
—
|
—
|
—
|
1,600
|
|
Other contractual obligations(3)
|
963
|
161
|
—
|
—
|
1,124
|
|
Total
|
$8,664
|
$20,013
|
$489
|
$—
|
$29,166
|
|
(1)
|
The amounts in the table above excluded operating lease expenses
which were abandoned in conjunction with our restructuring plans
and is included within the caption Restructuring
liability.
|
|
(2)
|
See “Indebtedness Agreement” above. Amount includes
interest.
|
|
(3)
|
Other contractual obligations consist of non-cancelable endorsement
and sponsorship agreements and the minimum purchase requirement
with BioZone. See Note 8 to the accompanying Condensed Consolidated
Financial Statements for further information.
|
Off-Balance Sheet Arrangements
We did not have any off-balance sheet arrangements as of September
30, 2018.
Critical Accounting Policies and Estimates
The preparation of the accompanying Condensed Consolidated
Financial Statements and related disclosures in conformity with
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
Condensed 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.
Note 2, “Summary of Significant Accounting Policies” in
Part I, Item 1 of this Form 10-Q and in the Notes to Consolidated
Financial Statements in Part II, Item 8 of the 2017 Form 10-K, and
“Critical Accounting Policies and Estimates” in Part I,
Item 7 of the 2017 Form 10-K describe the significant accounting
policies and methods used in the preparation of our Condensed
Consolidated Financial Statements. There have been no material
changes to our critical accounting policies and estimates since the
2017 Form 10-K, other than the adoption of the new revenue
recognition standards as of January 1, 2018.
36
Non-GAAP Adjusted EBITDA
In addition to disclosing financial results calculated in
accordance with U.S. Generally Accepted Accounting Principles
(GAAP), this Form 10-Q discloses Adjusted EBITDA, which is net loss
adjusted for stock-based compensation, restructuring and asset
impairment charges, gain/(loss) on settlement of accounts payable,
loss on sale of subsidiary, amortization of prepaid sponsorship
fees, other expense, net, amortization of prepaid stock
compensation, depreciation and amortization of property and
equipment, amortization of intangible assets, (recovery)/provision
for doubtful accounts, issuance of common stock warrants,
settlement related, including legal and income taxes. In addition,
we provide Adjusted EBITDA excluding one-time events, which
excludes charges related to executive severance, discontinued
business/product lines, unusual credits against revenue and unusual
spikes in whey protein costs. Management believes that these
non-GAAP measures provide investors with important additional
perspectives into our ongoing business performance.
The GAAP measure most directly comparable to Adjusted EBITDA is net
loss. The non-GAAP financial measure of Adjusted EBITDA and
Adjusted EBITDA excluding one-time events should not be considered
as an alternative to net loss. Adjusted EBITDA and Adjusted EBITDA
excluding one-time events is not a presentation made in accordance
with 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 GAAP. Because Adjusted
EBITDA and Adjusted EBITDA excluding one-time events excludes some,
but not all, items that affect net loss and is defined differently
by different companies, our definition of Adjusted EBITDA and
Adjusted EBITDA excluding one-time events may not be comparable to
similarly titled measures of other companies.
Set forth below are reconciliations of our reported GAAP net loss
to Adjusted EBITDA (in thousands):
37
|
|
|
Three Months Ended
|
|
Three Months Ended
|
|||||
|
|
Nine Months Ended September 30, 2018
|
Sept. 30, 2018
|
June 30,
2018
|
Mar. 31, 2018
|
Year Ended Dec. 31, 2017
|
Dec. 31, 2017
|
Sept. 30, 2017
|
June 30, 2017
|
Mar. 31, 2017
|
|
Net loss
|
$(5,355)
|
$(1,978)
|
$(1,074)
|
$(2,303)
|
$(10,973)
|
$(2,547)
|
$(2,128)
|
$(3,149)
|
$(3,149)
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-GAAP
adjustments:
|
|
|
|
|
|
|
|
|
|
|
Stock-based
compensation
|
377
|
120
|
120
|
137
|
2,096
|
408
|
540
|
541
|
607
|
|
Restructuring
and asset impairment charges
|
—
|
—
|
—
|
—
|
180
|
180
|
—
|
—
|
—
|
|
Gain on
settlement of accounts payable
|
—
|
—
|
—
|
—
|
(430)
|
41
|
—
|
(22)
|
(449)
|
|
Amortization
of prepaid sponsorship fees
|
384
|
168
|
125
|
91
|
461
|
86
|
120
|
110
|
145
|
|
Interest and
other expense, net
|
3,463
|
990
|
1,165
|
1,308
|
4,072
|
1,546
|
858
|
690
|
978
|
|
Depreciation
and amortization of property and equipment
|
582
|
184
|
191
|
207
|
1,139
|
230
|
279
|
290
|
340
|
|
Impairment of
assets
|
743
|
743
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
|
Amortization
of intangible assets
|
240
|
80
|
80
|
80
|
320
|
80
|
80
|
80
|
80
|
|
Provision for
doubtful accounts
|
822
|
408
|
250
|
164
|
1,524
|
310
|
990
|
144
|
80
|
|
Settlement,
including legal
|
1,162
|
266
|
564
|
332
|
3,643
|
866
|
532
|
1,942
|
303
|
|
Income
taxes
|
100
|
(3)
|
34
|
69
|
142
|
24
|
14
|
76
|
28
|
|
Adjusted
EBITDA
|
$2,518
|
$978
|
$1,455
|
$85
|
$2,174
|
$1,224
|
$1,285
|
$702
|
$(1,037)
|
|
|
|
|
|
|
|
|
|
|
|
|
One-time events:
|
|
|
|
|
|
|
|
|
|
|
Executive
Severance
|
(2,685
|
—
|
(2,740)
|
55
|
831
|
109
|
66
|
134
|
522
|
|
Discontinued
business/product lines
|
—
|
—
|
—
|
—
|
272
|
—
|
—
|
132
|
140
|
|
Unusual
credits against revenue
|
—
|
—
|
—
|
—
|
1,141
|
—
|
—
|
—
|
1,141
|
|
Whey protein
costs
|
—
|
—
|
—
|
—
|
1,322
|
—
|
—
|
296
|
1,026
|
|
Total one-time
adjustments
|
(2,685)
|
—
|
(2,740)
|
55
|
3,566
|
109
|
66
|
562
|
2,829
|
|
Adjusted
EBITDA excluding one-time events
|
$(167)
|
$978
|
$(1,285)
|
$140
|
$5,740
|
$1,333
|
$1,351
|
$1,264
|
$1,792
|
38
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
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive
Officer (“CEO”) who is our principal executive officer
and principal financial officer, have evaluated the effectiveness
of our disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934,
as amended (“Exchange Act”)), as of the end of the
period covered by this Quarterly Report on Form 10-Q. Based on such
evaluation, our CEO has concluded that as of September 30,
2018, our disclosure controls and procedures are designed at a
reasonable assurance level and are effective to provide reasonable
assurance that information we are required to disclose in reports
that we file or submit under the Exchange Act is recorded,
processed, summarized, and reported within the time periods
specified in the rules and forms of the Securities and Exchange
Commission (“SEC”), and that such information is
accumulated and communicated to our management, including our CEO,
as appropriate, to allow timely decisions regarding required
disclosure.
Changes in Internal Control
There were no changes in our internal control over financial
reporting identified in management’s evaluation pursuant to
Rules 13a-15(d) or 15d-15(d) of the Exchange Act during the third
quarter of 2018 that materially affected, or are reasonably likely
to materially affect, our internal control over financial
reporting.
Limitations on Effectiveness of Controls and
Procedures
In designing and evaluating the disclosure controls and procedures,
management recognizes that any controls and procedures, no matter
how well designed and operated, can provide only reasonable
assurance of achieving the desired control objectives. In addition,
the design of disclosure controls and procedures must reflect the
fact that there are resource constraints and that management is
required to apply judgment in evaluating the benefits of possible
controls and procedures relative to their costs.
39
PART II—OTHER INFORMATION
Item 1. Legal Proceedings
Contingencies
Except for the updates set forth below, there have been no material
changes to the information set forth under the heading “Legal
Proceedings” in our Annual Report on Form 10-K for the year
ended December 31, 2017. Additionally, see Note 8, Commitments and
Contingencies, to our Condensed Consolidated Financial Statements
in this Quarterly Report on Form 10-Q.
In addition, we are currently involved in various claims and legal
actions that arise in the ordinary course of business. We do not
believe that the ultimate resolution of these actions will have a
material adverse effect on our business, financial condition or
results of operations. However, a significant increase in the
number of these claims, unanticipated damages owed under successful
claims and multiple significant unrelated judgments against us
could have a material adverse effect on our business, financial
condition or results of operations.
Supplier Complaint
In January 2016, ThermoLife International LLC
(“ThermoLife”), a supplier of nitrates to MusclePharm,
filed a complaint against the Company in Arizona state court. In
its complaint, ThermoLife alleges that the Company failed to meet
minimum purchase requirements contained in the parties’
supply agreement and seeks monetary damages for the deficiency in
purchase amounts. In March 2016, the Company filed an answer
denying the allegations contained in the complaint and a
counterclaim alleging that ThermoLife’s products were
defective. On September 26, 2018, the Court granted summary
judgment to ThermoLife on MusclePharm’s claims. On November
1, 2018, the Court granted partial summary judgment for ThermoLife
on its own breach of contract claim, finding that MusclePharm is
liable to ThermoLife for failing to meet its minimum purchase
requirements. MusclePharm intends to seek reconsideration of the
Court’s ruling.
Former Executive Lawsuit
We were engaged in a dispute with Mr. Richard Estalella
(“Estalella”) concerning amounts allegedly owed by us
under an employment agreement with Estalella. Estalella was seeking
certain equitable relief and unspecified damages. On May 7, 2018,
the Court vacated the trial in contemplation of the parties’
settlement of this matter.
On September 19, 2018, we approved a settlement agreement (the
“Estalella Settlement Agreement”) with Estalella,
concerning amounts allegedly owed by us under an employment
agreement with Estalella. The Estalella Settlement Agreement
represents a full and final settlement of all litigation between
the parties. Under the terms of the agreement, we agreed to pay
Estalella a sum of $925,000, consisting of a $325,000 payment that
was paid in July 2018, and subsequent payments of $150,000
installments to be paid by October 2018, January 2019, April 2019,
and July 2019, respectively. The payments are accrued in current
liabilities. Additionally, Estalella retained ownership of 350,000
shares of restricted stock that were in dispute.
Insurance Carrier Lawsuit
We were engaged in litigation with an insurance carrier, Liberty
Insurance Underwriters, Inc. (“Liberty”), arising out
of Liberty’s denial of coverage. In 2014, we sought coverage
under an insurance policy with Liberty for claims against our
directors and officers arising out of an investigation by the
Securities and Exchange Commission (“SEC”). Liberty
disputed the extent to which those expenses are covered under its
policy, and we commenced a coverage action against Liberty for
those expenses in the United States District Court for the Southern
District of New York. This matter was settled on September 21,
2018.
Manchester City Football Group
We were engaged in a dispute with City Football Group Limited
(“CFG”), the owner of Manchester City Football Group,
concerning amounts allegedly owed by us under a Sponsorship
Agreement with CFG (the “Sponsorship Agreement”). In
August 2016, CFG commenced arbitration in the United Kingdom
against us, seeking approximately $8.3 million for our purported
breach of the Sponsorship Agreement.
40
On July 28, 2017, we 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, we agreed to pay CFG a sum of $3 million,
consisting of a $1 million payment that was advanced by a related
party on July 7, 2017, a $1 million installment paid on July 7,
2018 and a subsequent $1 million installment payment to be paid by
July 7, 2019.
United World Wrestling Arbitration
In November 2017, United World Wrestling (“UWW”), an
amateur wrestling governing body, initiated arbitration against
MusclePharm before the Court of Arbitration for Sport in Lausanne,
Switzerland (“CAS”), alleging that MusclePharm owed it
$663,750, comprised of a $425,000 sponsorship fee plus accrued
interest, under the terms of a 2015 sponsorship agreement. In
September 2018, the sole arbitrator issued an order and decision in
UWW’s favor for $425,000, plus interest at 12% per annum, as
well as attorney’s fees in the amount of 5,000 Swiss Francs.
The Company is in ongoing discussions with UWW to resolve the
matter.
White Winston Lawsuit
In August 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 all of its directors in the First Judicial District Court of
the State of Nevada. White Winston alleges that MusclePharm’s
directors breached their fiduciary duties when they approved the
November 2017 refinancing of Drexler’s $18 million Refinanced
Convertible Note (discussed further below). In its Complaint, White
Winston sought a permanent injunction against the exercise of Mr.
Drexler’s conversion rights, the appointment of a receiver,
and unspecified monetary damages. On August 23, 2018, the Nevada
district court issued an ex parte temporary restraining order
prohibiting Drexler from exercising his conversion rights; on
September 14, 2018, the court denied White Winston’s request
for a preliminary injunction and permitted the temporary
restraining order to dissolve. White Winston has appealed the
court’s decision. In the meantime, the action remains pending
in the trial court, where the Company has moved to dismiss the
Amended Complaint.
Durnford Matter
On July 28, 2015, Plaintiff, Tucker Durnford, filed a First Amended
Class Action Complaint which alleged that MusclePharm’s
Arnold Iron Mass product violates consumer protection laws by
misleading consumers about the amount and sources of protein in the
product. The product has been discontinued. The last shipments were
in March of 2016.
Plaintiff’s counsel alleged that results of laboratory
testing demonstrate the actual total protein content per serving to
be approximately 19.4 grams, once the free-form amino acids are
excluded from the calculation. Plaintiff’s counsel attached
to the First Amended Class Action Complaint what purport to be test
results supporting that allegation.
We moved to dismiss the First Amended Class Action Complaint,
arguing that plaintiff’s claims are preempted by the Federal
Food, Drug, and Cosmetic Act and its implementing regulations. The
Court granted MusclePharm’s motion to dismiss the case on
December 18, 2015. Plaintiff was given leave to file an amended
complaint, but instead chose to appeal the order granting
MusclePharm’s motion to dismiss. On December 31, 2015,
plaintiff’s counsel made a settlement demand, in an amount of
$100,000, which demand was rejected. On February 10, 2016, the
court entered judgment and dismissed the case with prejudice.
Plaintiff appealed to the Ninth Circuit Court of Appeals, which
heard arguments on November 15, 2017.
On October 12, 2018, the Ninth Circuit issued its opinion reversing
the dismissal and remanding the case to the Northern District of
California. The Ninth Circuit found that plaintiff’s
misbranding theory premised on alleged
“nitogen-spiking” or “protein-spiking” was
preempted by federal law, but that plaintiff could attempt to prove
his allegation that the protein in the product does not come
entirely from hydrolyzed beef and lacoterferrin, and his allegation
that the label misleads consumers into believing that that protein
does come entirely from hydrolyzed beef and lacoterferrin. The
Company intends to vigorously defend this action and is awaiting
next steps from the District court.
Item 1A. Risk Factors
There have been no material changes to the Risk Factors as
disclosed in our 2017 Form 10-K for the year ended December 31,
2017 filed with the Securities and Exchange Commission on April 2,
2018.
Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds
None.
41
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Mine Safety Disclosures
None.
Item 5. Other Information.
Item 6. Exhibit Index
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Incorporated by Reference
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Exhibit No.
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Description
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Form
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SEC File
Number
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Exhibit
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Filing Date
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31.1**
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Certification
of the Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
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31.2**
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Certification
of the Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
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32.1***
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Certification
of the Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
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32.2***
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Certification
of the Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
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101**
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The following materials from MusclePharm Corporation’s
quarterly report on Form 10-Q for the three and nine months ended
September 30, 2018 formatted in XBRL (eXtensible Business Reporting
Language): (i) the Condensed Consolidated Balance Sheets; (ii) the
Condensed Consolidated Statements of Operations; (iii) the
Condensed Consolidated Statements of Comprehensive Income; (iii)
the Condensed Consolidated Statement of Changes in
Stockholders’ Deficit; (iv) the Condensed Consolidated
Statements of Cash Flows; and (v) related notes to these financial
statements.
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*
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Indicates management contract or compensatory plan or
arrangement.
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**
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Filed herewith
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***
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Furnished herewith
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42
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.
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MUSCLEPHARM CORPORATION
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Date: November 13, 2018
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By:
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/s/ Ryan Drexler
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Name:
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Ryan Drexler
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Title:
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Chief Executive Officer, President and Chairman
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(Principal Executive Officer)
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(Interim Principal Financial Officer)
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(Interim Principal Accounting Officer)
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43