UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form FORM 10-Q
(Mark one)
For the quarterly period ended: SeptemberJune 30, 20202021 or
For the transition period from _______________ to ______________
Commission file number: 000-53166
MusclePharm Corporation
(Exact name of registrant as specified in its charter)
| Nevada | 77-0664193 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
3753 Howard Hughes Parkway Suite 200-849 Las Vegas, NV | 89169 | |
| ||
| (Address of principal executive offices) | (Zip code) | |
(800) (800) 292-3909
(Registrant’s telephone number, including area code)
4500 Park Granada, Suite 202
Calabasas, CA91302
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered | ||
| N/A |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [ ]☐ Yes [X] ☒ No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). [ ]☐ Yes [X] ☒ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | ☐ | Accelerated filer | ☐ | |||
| Non-accelerated filer | ☒ | Smaller reporting company | ☒ | |||
| Emerging growth company | ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). [ ]☐ Yes [X] ☒ No
Number of shares of the registrant’s common stock outstanding at November 16, 2020: 33,130,039August 11, 2021: (excludes 875,621 shares of common stock held in treasury).
MusclePharm Corporation
Form 10-Q
TABLE OF CONTENTS
This Form 10-Q relates to the Company’s (as defined below) quarterly period ended September 30, 2020. As previously indicated by the Company, it has been delinquent in its filings with the Securities and Exchange Commission (the “SEC”) and is making this filing after its due date. Simultaneously with making this filing, the Company also is filing its Form 10-Q for the quarterly period ended March 31, 2020 and June 30, 2020.
Forward-Looking Statements
Except as otherwise indicated herein, the terms “MusclePharm,” “Company,” “we,” “our” and “us” refer to MusclePharm Corporation and its subsidiaries. This Quarterly Report on Form 10-Q contains forward-looking statements.statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (“the Exchange Act”), and Section 27A of the Securities Act of 1933, as amended. All statements contained in this Quarterly Report on Form 10-Q other than statements of historical fact, including statements regarding our future results of operations and financial position, including our future profits, financing sources and our ability to satisfy our liabilities, our business strategy and plans, and our objectives for future operations, are forward-looking statements. The words “believe,”In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “estimate,“should,” “continue,“expects,” “anticipate,“plans,” “intend,“anticipates,” “expect,“believes,” and similar expressions are intended to identify forward-looking statements.“estimates,” “projects,” “intends,” “predicts,” “potential,” or “continue” or other comparable terminology. We have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives, and financial needs.
These forward-looking statements are not guarantees of future performance and involve risks, uncertainties, estimates and assumptions that are difficult to predict and are subject to a number of risks, uncertainties and assumptions, including those described in Item 1A, “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019,2020, filed with the SEC on August 25, 2020.March 29, 2021. Moreover, we operate in a very competitive and rapidly changing environment. In particular, we have experienced a slowdown in sales from our retail customers due to the ongoing COVID-19 pandemic, and we cannot predict the ultimate impact of the COVID-19 pandemic on our business. New risks may emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the future events and trends discussed in this Quarterly Report on Form 10-Q may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.
We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements, except as required by law. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.
Note Regarding Trademarks
We have proprietary rights to a number of registered and unregistered trademarks worldwide that we believe are important to our business, including, but not limited to: “MusclePharm” and “FitMiss”. We have, in certain cases, omitted the ®, © and ™ designations for these and other trademarks used in this Form 10-Q. Nevertheless, all rights to such trademarks are reserved. These and other trademarks referenced in this Form 10-Q are the property of their respective owners.owners and they will assert, to the fullest extent under applicable law, their rights thereto.
| 1 |
MusclePharm Corporation
(In thousands, except share and per share data)
June 30, 2021 | December 31, 2020 | |||||||
| (Unaudited) | ||||||||
| ASSETS | ||||||||
| Current assets: | ||||||||
| Cash | $ | 1,016 | $ | 2,003 | ||||
| Accounts receivable, net of allowances of $1,033 and $3,407 at June 30, 2021 and December 31, 2020, respectively | 5,564 | 7,488 | ||||||
| Inventory | 1,561 | 1,032 | ||||||
| Prepaid expenses and other current assets | 2,182 | 1,341 | ||||||
| Total current assets | 10,323 | 11,864 | ||||||
| Property and equipment, net | 9 | 13 | ||||||
| Intangible assets, net | 195 | 356 | ||||||
| Operating lease right-of-use assets | 338 | 474 | ||||||
| Other assets | 75 | 295 | ||||||
| TOTAL ASSETS | $ | 10,940 | $ | 13,002 | ||||
| LIABILITIES AND STOCKHOLDERS’ DEFICIT | ||||||||
| Current liabilities: | ||||||||
| Obligation under secured borrowing arrangement | $ | 5,297 | $ | 7,098 | ||||
| Line of credit | 2,458 | 743 | ||||||
| Operating lease liability, current | 424 | 381 | ||||||
| Convertible note with a related party, net of discount | 2,872 | 2,872 | ||||||
| Accounts payable | 15,218 | 13,989 | ||||||
| Accrued and other liabilities | 6,806 | 6,924 | ||||||
| Total current liabilities | 33,075 | 32,007 | ||||||
| Operating lease liability, long-term | 119 | 343 | ||||||
| Other long-term liabilities | 4,012 | 5,071 | ||||||
| Total liabilities | 37,206 | 37,421 | ||||||
| Commitments and contingencies (Note 9) | ||||||||
| Stockholders’ deficit: | ||||||||
| Common stock, par value of $ per share; shares authorized, and shares issued as of June 30, 2021 and December 31, 2020, respectively; and shares outstanding as of June 30, 2021 and December 31, 2020, respectively | 32 | 32 | ||||||
| Additional paid-in capital | 178,569 | 178,261 | ||||||
| Treasury stock, at cost; shares | (10,039 | ) | (10,039 | ) | ||||
| Accumulated deficit | (194,828 | ) | (192,673 | ) | ||||
| TOTAL STOCKHOLDERS’ DEFICIT | (26,266 | ) | (24,419 | ) | ||||
| TOTAL LIABILITIES AND STOCKHOLDERS’ DEFICIT | $ | 10,940 | $ | 13,002 | ||||
| September 30, 2020 | December 31, 2019 | |||||||
| (Unaudited) | ||||||||
| ASSETS | ||||||||
| Current assets: | ||||||||
| Cash | $ | 1,085 | $ | 1,532 | ||||
| Accounts receivable, net | 5,205 | 4,807 | ||||||
| Inventory | 1,487 | 4,720 | ||||||
| Prepaid expenses and other current assets | 1,070 | 1,104 | ||||||
| Total current assets | 8,847 | 12,163 | ||||||
| Property and equipment, net | 46 | 216 | ||||||
| Intangible assets, net | 436 | 676 | ||||||
| Operating lease right-of-use assets | 541 | 1,175 | ||||||
| Other assets | 347 | 310 | ||||||
| TOTAL ASSETS | $ | 10,217 | $ | 14,540 | ||||
| LIABILITIES AND STOCKHOLDERS’ DEFICIT | ||||||||
| Current liabilities: | ||||||||
| Obligation under secured borrowing arrangement | $ | 2,916 | $ | 4,443 | ||||
| Line of credit | 514 | 4,204 | ||||||
| Operating lease liability, current | 395 | 624 | ||||||
| Convertible note with a related party, net of discount | 2,735 | 1,034 | ||||||
| Accounts payable | 21,343 | 26,178 | ||||||
| Accrued and other liabilities | 6,391 | 5,058 | ||||||
| Total current liabilities | 34,294 | 41,541 | ||||||
| Operating lease liability, long-term | 447 | 723 | ||||||
| Other long-term liabilities | 2,741 | 228 | ||||||
| Total liabilities | 37,482 | 42,492 | ||||||
| Commitments and contingencies (Note 8) | ||||||||
| Stockholders’ deficit: | ||||||||
| Common stock, par value of $0.001 per share; 100,000,000 shares authorized, 34,005,660 and 33,876,033 shares issued as of September 30, 2020 and December 31, 2019, respectively; 33,130,039 and 33,000,412 shares outstanding as of September 30, 2020 and December 31, 2019, respectively. | 31 | 31 | ||||||
| Additional paid-in capital | 178,236 | 177,914 | ||||||
| Treasury stock, at cost; 875,621 shares | (10,039 | ) | (10,039 | ) | ||||
| Accumulated deficit | (195,493 | ) | (195,858 | ) | ||||
| TOTAL STOCKHOLDERS’ DEFICIT | (27,265 | ) | (27,952 | ) | ||||
| TOTAL LIABILITIES AND STOCKHOLDERS’ DEFICIT | $ | 10,217 | $ | 14,540 | ||||
The accompanying notes are an integral part of these Consolidated Financial Statements.
| 2 |
MusclePharm Corporation
Consolidated Statements of Operations
(In thousands, except share and per share data)
(Unaudited)
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
| 2021 | 2020 | 2021 | 2020 | |||||||||||||
| Revenue, net | $ | 14,908 | $ | 16,993 | $ | 28,029 | $ | 33,224 | ||||||||
| Cost of revenue | 12,728 | 12,009 | 22,160 | 23,431 | ||||||||||||
| Gross profit | 2,180 | 4,984 | 5,869 | 9,793 | ||||||||||||
| Operating expenses: | ||||||||||||||||
| Advertising and promotion | 145 | 188 | 489 | 313 | ||||||||||||
| Salaries and benefits | 1,181 | 1,774 | 2,229 | 3,455 | ||||||||||||
| Selling, general and administrative | 2,115 | 1,807 | 3,512 | 3,718 | ||||||||||||
| Professional fees | 482 | 865 | 1,109 | 1,406 | ||||||||||||
| Total operating expenses | 3,923 | 4,634 | 7,339 | 8,892 | ||||||||||||
| Loss from operations | (1,743 | ) | 350 | (1,470 | ) | 901 | ||||||||||
| Other (expense) income: | ||||||||||||||||
| Loss on settlement obligation | — | (37 | ) | — | (87 | ) | ||||||||||
| Interest and other expense, net | (501 | ) | (544 | ) | (680 | ) | (1,083 | ) | ||||||||
| Loss before provision for income taxes | (2,244 | ) | (231 | ) | (2,150 | ) | (269 | ) | ||||||||
| Provision for income taxes | 7 | 22 | 7 | 44 | ||||||||||||
| Net loss | $ | (2,251 | ) | $ | (253 | ) | $ | (2,157 | ) | $ | (313 | ) | ||||
| Net loss per share, basic and diluted | $ | (0.07 | ) | $ | (0.01 | ) | $ | (0.07 | ) | $ | (0.01 | ) | ||||
| Weighted average shares used to compute net loss per share, basic and diluted | 33,386,200 | 32,764,553 | 33,131,087 | 32,612,956 | ||||||||||||
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| 2020 | 2019 | 2020 | 2019 | |||||||||||||
| Revenue, net | $ | 16,085 | $ | 21,175 | $ | 49,309 | $ | 62,249 | ||||||||
| Cost of revenue | 11,073 | 19,649 | 34,504 | 56,077 | ||||||||||||
| Gross profit | 5,012 | 1,526 | 14,805 | 6,172 | ||||||||||||
| Operating expenses: | ||||||||||||||||
| Advertising and promotion | 49 | 574 | 362 | 2,134 | ||||||||||||
| Salaries and benefits | 1,538 | 2,070 | 4,993 | 5,844 | ||||||||||||
| Selling, general and administrative | 1,737 | 2,127 | 5,455 | 7,658 | ||||||||||||
| Professional fees | 885 | 842 | 2,291 | 2,783 | ||||||||||||
| Impairment of operating lease right-of-use asset | 167 | — | 167 | — | ||||||||||||
| Total operating expenses | 4,376 | 5,613 | 13,268 | 18,419 | ||||||||||||
| Income (loss) from operations | 636 | (4,087 | ) | 1,537 | (12,247 | ) | ||||||||||
| Other income (expense): | ||||||||||||||||
| Loss on settlement obligation | — | (16 | ) | (87 | ) | (125 | ) | |||||||||
| Gain on settlement of payables | 518 | — | 518 | — | ||||||||||||
| Interest and other expense, net | (456 | ) | (923 | ) | (1,539 | ) | (3,007 | ) | ||||||||
| Income (loss) before provision for income taxes | 698 | (5,026 | ) | 429 | (15,379 | ) | ||||||||||
| Provision for income taxes | 20 | 53 | 64 | 89 | ||||||||||||
| Net income (loss) | $ | 678 | $ | (5,079 | ) | $ | 365 | $ | (15,468 | ) | ||||||
| Net income (loss) per share, basic | $ | 0.02 | $ | (0.27 | ) | $ | 0.01 | $ | (0.94 | ) | ||||||
| Net income (loss) per share, diluted | $ | 0.01 | $ | (0.27 | ) | $ | 0.01 | $ | (0.94 | ) | ||||||
| Weighted average shares used to compute net income (loss) per share, basic | 33,008,189 | 18,527,438 | 32,746,147 | 16,443,945 | ||||||||||||
| Weighted average shares used to compute net income (loss) per share, diluted | 49,097,595 | 18,527,438 | 48,835,553 | 16,443,945 | ||||||||||||
The accompanying notes are an integral part of these Consolidated Financial Statements.
| 3 |
MusclePharm Corporation
Consolidated Statements of Comprehensive LossChanges in Stockholders’ Deficit
(In thousands)thousands, except share data)
(Unaudited)
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| 2020 | 2019 | 2020 | 2019 | |||||||||||||
| Net income (loss) | $ | 678 | $ | (5,079 | ) | $ | 365 | $ | (15,468 | ) | ||||||
| Other comprehensive income (loss): | ||||||||||||||||
| Change in foreign currency translation adjustment | — | (3 | ) | — | 180 | |||||||||||
| Comprehensive income (loss) | $ | 678 | $ | (5,082 | ) | $ | 365 | $ | (15,288 | ) | ||||||
| Additional | Total | |||||||||||||||||||||||
| Common Stock | Paid-in | Treasury | Accumulated | Stockholders’ | ||||||||||||||||||||
| Shares | Amount | Capital | Stock | Deficit | Deficit | |||||||||||||||||||
| Balance - December 31, 2019 | 33,000,412 | $ | 31 | $ | 177,914 | $ | (10,039 | ) | $ | (195,858 | ) | $ | (27,952 | ) | ||||||||||
| Stock-based compensation | — | — | 100 | — | — | 100 | ||||||||||||||||||
| Stock-based compensation, shares | ||||||||||||||||||||||||
| Issuance of shares of common stock related to the payment of advertising services | 101,454 | — | 47 | — | — | 47 | ||||||||||||||||||
| Net loss | — | — | — | — | (60 | ) | (60 | ) | ||||||||||||||||
| Balance - March 31, 2020 | 33,101,866 | $ | 31 | $ | 178,061 | $ | (10,039 | ) | $ | (195,918 | ) | $ | (27,865 | ) | ||||||||||
| Stock-based compensation | — | — | 79 | — | — | 79 | ||||||||||||||||||
| Issuance of shares of common stock related to the payment of advertising services | 28,173 | — | 69 | — | — | 69 | ||||||||||||||||||
| Net loss | — | — | — | — | (253 | ) | (253 | ) | ||||||||||||||||
| Balance – June 30, 2020 | 33,130,039 | $ | 31 | $ | 178,209 | $ | (10,039 | ) | $ | (196,171 | ) | $ | (27,970 | ) | ||||||||||
The accompanying notes are an integral part of these Consolidated Financial Statements.
| 4 |
MusclePharm Corporation
Consolidated Statements of Changes in Stockholders’ Deficit
(In thousands, except share data)
(Unaudited)
| Accumulated | ||||||||||||||||||||||||||||
| Additional | Other | Total | ||||||||||||||||||||||||||
| Common Stock | Paid-in | Treasury | Comprehensive | Accumulated | Stockholders’ | |||||||||||||||||||||||
| Shares | Amount | Capital | Stock | Loss | Deficit | Deficit | ||||||||||||||||||||||
| Balance—December 31, 2018 | 15,314,667 | $ | 15 | $ | 158,944 | $ | (10,039 | ) | $ | (238 | ) | $ | (176,877 | ) | $ | (28,195 | ) | |||||||||||
| Stock-based compensation for issuance and amortization of restricted stock awards to employees, executives, and directors | — | — | 65 | — | — | — | 65 | |||||||||||||||||||||
| Issuance of shares of common stock related to the payment of advertising services | 336,113 | — | 96 | — | — | — | 96 | |||||||||||||||||||||
| Change in foreign currency translation adjustment | — | — | — | — | 233 | (54 | ) | 179 | ||||||||||||||||||||
| Net loss | — | — | — | — | — | (4,505 | ) | (4,505 | ) | |||||||||||||||||||
| Balance—March 31, 2019 | 15,650,780 | $ | 15 | $ | 159,105 | $ | (10,039 | ) | $ | (5 | ) | $ | (181,436 | ) | $ | (32,360 | ) | |||||||||||
| Stock-based compensation for issuance and amortization of restricted stock awards to employees, executives, and directors | — | — | 63 | — | — | — | 63 | |||||||||||||||||||||
| Issuance of shares of common stock related to the payment of advertising services | 153,147 | — | 344 | — | — | — | 344 | |||||||||||||||||||||
| Change in foreign currency translation adjustment | — | — | — | — | 4 | — | 4 | |||||||||||||||||||||
| Net loss | — | — | — | — | — | (5,884 | ) | (5,884 | ) | |||||||||||||||||||
| Balance—June 30, 2019 | 15,803,927 | $ | 15 | $ | 159,512 | $ | (10,039 | ) | $ | (1 | ) | $ | (187,320 | ) | $ | (37,883 | ) | |||||||||||
| Stock-based compensation for issuance and amortization of restricted stock awards to employees, executives, and directors | 595,238 | — | 62 | — | — | — | 62 | |||||||||||||||||||||
| Issuance of shares of common stock related to the payment of advertising services | 180,919 | — | 153 | — | — | — | 153 | |||||||||||||||||||||
| Shares issued upon conversion of note payable | 16,216,216 | 16 | 17,984 | — | — | — | 18,000 | |||||||||||||||||||||
| Issuance of shares of common stock related to the settlement of litigation | 150,000 | — | 60 | — | — | — | 60 | |||||||||||||||||||||
| Change in foreign currency translation adjustment | — | — | — | — | (3 | ) | — | (3 | ) | |||||||||||||||||||
| Net loss | — | — | — | — | — | (5,079 | ) | (5,079 | ) | |||||||||||||||||||
| Balance—September 30, 2019 | 32,946,300 | $ | 31 | $ | 177,771 | $ | (10,039 | ) | $ | (4 | ) | $ | (192,399 | ) | $ | (24,640 | ) | |||||||||||
| Additional | Total | |||||||||||||||||||||||
| Common Stock | Paid-in | Treasury | Accumulated | Stockholders’ | ||||||||||||||||||||
| Shares | Amount | Capital | Stock | Deficit | Deficit | |||||||||||||||||||
| Balance - December 31, 2020 | 33,105,284 | $ | 32 | $ | 178,261 | $ | (10,039 | ) | $ | (192,673 | ) | $ | (24,419 | ) | ||||||||||
| Stock-based compensation | 280,916 | — | — | — | — | — | ||||||||||||||||||
| Net income | — | — | — | — | 94 | 94 | ||||||||||||||||||
| Balance - March 31, 2021 | 33,386,200 | $ | 32 | $ | 178,261 | $ | (10,039 | ) | $ | (192,579 | ) | $ | (24,325 | ) | ||||||||||
| Balance | 33,386,200 | $ | 32 | $ | 178,261 | $ | (10,039 | ) | $ | (192,579 | ) | $ | (24,325 | ) | ||||||||||
| Stock-based compensation | — | — | 308 | — | — | 308 | ||||||||||||||||||
| Net loss | — | — | — | — | (2,251 | ) | (2,251 | ) | ||||||||||||||||
| Balance – June 30, 2021 | 33,386,200 | $ | 32 | $ | 178,569 | $ | (10,039 | ) | $ | (194,828 | ) | $ | (26,266 | ) | ||||||||||
| Balance | 33,386,200 | $ | 32 | $ | 178,569 | $ | (10,039 | ) | $ | (194,828 | ) | $ | (26,266 | ) | ||||||||||
The accompanying notes are an integral part of these Consolidated Financial Statements.
| 5 |
MusclePharm Corporation
Consolidated Statements of ChangesCash Flows
(Unaudited, in Stockholders’ Deficitthousands)
(In thousands, except share data)
Six Months Ended Jun 30, | ||||||||
| 2021 | 2020 | |||||||
| CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||
| Net loss | $ (2,157 | ) | $ | (313 | ) | |||
| Adjustments to reconcile net loss to net cash provided by operating activities: | ||||||||
| Depreciation and amortization of property and equipment | 6 | 105 | ||||||
| Amortization of intangible assets | 160 | 160 | ||||||
| Bad debt expense | 326 | 121 | ||||||
| Gain on disposal of property and equipment | — | (11 | ) | |||||
| Inventory provision | 9 | (4 | ) | |||||
| Stock-based compensation | 308 | 179 | ||||||
| Issuance of common stock to non-employees | — | 116 | ||||||
| Changes in operating assets and liabilities: | ||||||||
| Accounts receivable, net | 564 | 7 | ||||||
| Inventory | (538 | ) | (395 | ) | ||||
| Prepaid expenses and other current assets | 192 | 21 | ||||||
| Other assets | 355 | 345 | ||||||
| Accounts payable and accrued liabilities | (124 | ) | 860 | |||||
| Net cash (used in) provided by operating activities | (899 | ) | 1,191 | |||||
| CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||
| Purchase of property and equipment | (3 | ) | — | |||||
| Proceeds from disposal of property and equipment | — | 11 | ||||||
| Net cash (used in) provided by investing activities | (3 | ) | 11 | |||||
| CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||
| Proceeds from line of credit | 2,192 | — | ||||||
| Payments on line of credit | (478 | ) | (814 | ) | ||||
| Proceeds from secured borrowing arrangement, net of reserves | 26,211 | 21,116 | ||||||
| Payments on secured borrowing arrangement | (28,011 | ) | (22,639 | ) | ||||
| Proceeds from issuance of Paycheck Protection Program Loan | — | 965 | ||||||
| Repayment of finance lease obligations | — | (52 | ) | |||||
| Proceeds of notes payable | 186 | |||||||
| Repayment of notes payable | (185 | ) | (97 | ) | ||||
| Net cash used in financing activities | (85 | ) | (1,521 | ) | ||||
| NET CHANGE IN CASH | (987 | ) | (319 | ) | ||||
| CASH — BEGINNING OF PERIOD | 2,003 | 1,532 | ||||||
| CASH — END OF PERIOD | $ 1,016 | $ | 1,213 | |||||
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: | ||||||||
| Cash paid for taxes | $ | 681 | $ | 402 | ||||
(Unaudited)
| Additional | Total | |||||||||||||||||||||||
| Common Stock | Paid-in | Treasury | Accumulated | Stockholders’ | ||||||||||||||||||||
| Shares | Amount | Capital | Stock | Deficit | Deficit | |||||||||||||||||||
| Balance—December 31, 2019 | 33,000,412 | $ | 31 | $ | 177,914 | $ | (10,039 | ) | $ | (195,858 | ) | $ | (27,952 | ) | ||||||||||
| Stock-based compensation for issuance and amortization of restricted stock awards to employees, executives, and directors | — | — | 100 | — | — | 100 | ||||||||||||||||||
| Issuance of shares of common stock related to the payment of advertising services | 101,454 | — | 47 | — | — | 47 | ||||||||||||||||||
| Net loss | — | — | — | (60 | ) | (60 | ) | |||||||||||||||||
| Balance—March 31, 2020 | 33,101,866 | $ | 31 | $ | 178,061 | $ | (10,039 | ) | $ | (195,918 | ) | $ | (27,865 | ) | ||||||||||
| Stock-based compensation for issuance and amortization of restricted stock awards to employees, executives, and directors | — | — | 79 | — | — | 79 | ||||||||||||||||||
| Issuance of shares of common stock related to the payment of advertising services | 28,173 | — | 69 | — | — | 69 | ||||||||||||||||||
| Net loss | — | — | — | — | (253 | ) | (253 | ) | ||||||||||||||||
| Balance—June 30, 2020 | 33,130,039 | $ | 31 | $ | 178,209 | $ | (10,039 | ) | $ | (196,171 | ) | $ | (27,970 | ) | ||||||||||
| Stock-based compensation for issuance and amortization of restricted stock awards to employees, executives, and directors | — | — | 27 | — | — | 27 | ||||||||||||||||||
| Net income | — | — | — | — | 678 | 678 | ||||||||||||||||||
| Balance—September 30, 2020 | 33,130,039 | $ | 31 | $ | 178,236 | $ | (10,039 | ) | $ | (195,493 | ) | $ | (27,265 | ) | ||||||||||
The accompanying notes are an integral part of these Consolidated Financial Statements.
| 6 |
MusclePharm Corporation
Consolidated Statements of Cash Flows
(Unaudited, in thousands)
Nine Months Ended September 30, | ||||||||
| 2020 | 2019 | |||||||
| CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||
| Net income (loss) | $ | 365 | $ | (15,468 | ) | |||
| Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | ||||||||
| Depreciation and amortization of property and equipment | 130 | 269 | ||||||
| Amortization of intangible assets | 240 | 240 | ||||||
| Bad debt expense | 174 | 41 | ||||||
| (Gain) loss on disposal of property and equipment | (176 | ) | 5 | |||||
| Amortization of debt discount | — | 60 | ||||||
| Gain on settlement of payables | (518 | ) | — | |||||
| Inventory provision | (115 | ) | 375 | |||||
| Stock-based compensation | 206 | 190 | ||||||
| Issuance of common stock to non-employees | 116 | 653 | ||||||
| Write off of cumulative translation adjustments | — | 175 | ||||||
| Impairment of operating lease right-of-use assets | 167 | — | ||||||
| Changes in operating assets and liabilities: | ||||||||
| Accounts receivable | (572 | ) | 1,056 | |||||
| Inventory | 3,347 | 6,197 | ||||||
| Prepaid expenses and other current assets | 36 | (236 | ) | |||||
| Other assets | 429 | 533 | ||||||
| Accounts payable and accrued liabilities | (1,259 | ) | 1,676 | |||||
| Net cash provided by (used in) operating activities | 2,570 | (4,234 | ) | |||||
| CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||
| Purchase of property and equipment | (4 | ) | (13 | ) | ||||
| Proceeds from disposal of property and equipment | 220 | — | ||||||
| Net cash provided by (used in) investing activities | 216 | (13 | ) | |||||
| CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||
| Payments on line of credit | (2,452 | ) | — | |||||
| Proceeds from line of credit | — | 1,500 | ||||||
| Proceeds from secured borrowing arrangement, net of reserves | 32,762 | 31,225 | ||||||
| Payments on secured borrowing arrangement, net of fees | (34,289 | ) | (29,171 | ) | ||||
| Repayment of finance lease obligations | (54 | ) | (88 | ) | ||||
| Repayment of notes payable | (165 | ) | — | |||||
| Proceeds from issuance of PPP loan | 965 | — | ||||||
| Net cash (used in) provided by financing activities | (3,233 | ) | 3,466 | |||||
| Effect of exchange rate changes on cash | — | 7 | ||||||
| NET CHANGE IN CASH | (447 | ) | (774 | ) | ||||
| CASH — BEGINNING OF PERIOD | 1,532 | 2,317 | ||||||
| CASH — END OF PERIOD | $ | 1,085 | $ | 1,543 | ||||
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: | ||||||||
| Cash paid for interest | $ | 522 | $ | 1,171 | ||||
| Cash paid for taxes | $ | — | $ | 73 | ||||
| SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES: | ||||||||
| Convertible secured note settled through the issuance of common stock | $ | — | $ | 16,841 | ||||
| Operating lease right-of-use assets and lease obligations (ASC 842) | $ | — | $ | 2,117 | ||||
| Property and equipment acquired in conjunction with finance leases | $ | — | $ | 29 | ||||
The accompanying notes are an integral part of these Consolidated Financial Statements.
MusclePharm Corporation
Notes to Consolidated Financial Statements
(Unaudited)
Note 1. Description of Business
Description of Business
MusclePharm Corporation, was incorporated in Nevada in 2006. Except as otherwise indicated hereintogether with its subsidiaries (the “Company” or the context requires otherwise, the terms “MusclePharm,” the “Company,” “we,” “our” and “us” refer to MusclePharm Corporation and its subsidiaries. The Company“MusclePharm”) is a scientifically-driven, performance lifestyle company that develops, markets and distributes branded sports nutrition products and nutritional supplements that are manufactured by the Company’s co-manufacturers. Our portfolio of recognized brands, including MusclePharm® and FitMiss,®, is marketed and sold globally. The Company is headquartered in Calabasas, California and, as of September 30, 2020, had the following wholly-owned operating subsidiaries: MusclePharm Canada Enterprises Corp., MusclePharm Ireland Limited and MusclePharm Australia Pty Limited.
The Company has historically incurred significant losses and experienced negative cash flows since inception. As of SeptemberJune 30, 2020,2021, the Company had cash of $1.1 $1.0million, an increase of $0.4 million from March 31, 2021 and a decline of $0.4 $1.0 million from the December 31, 20192020 balance of $1.5 $2.0 million. As of SeptemberJune 30, 2020, we2021, the Company had a working capital deficit of $25.4 $22.8 million, a stockholders’ deficit of $27.3$26.3 million and an accumulated deficit of $195.5 $194.8 million resulting from recurring losses from operations. As a result of our history of losses and financial condition, there is substantial doubt about our ability to continue as a going concern.
The Company’s ability to continue as a going concern is dependent upon usit generating profits in the future and/or obtaining the necessary financing to meet ourits obligations and repay our liabilities arising from normal business operations when they come due. ManagementThe Company is evaluating different strategies to obtain financing to fund ourits operations to cover expenses and achievefocus on achieving a level of revenue adequate to support ourits current cost structure. Financing strategies may include, but are not limited to, private placements of capital stock, debt borrowings, partnerships and/or collaborations.
The Company has been focused on cost containment and improving gross margins by focusing on customers with higher margins, reducing product discounts and promotional activity, along with reducing the number of SKU’s and negotiate pricing for raw materials. In response to the Company’s continued net loss in 2019, management implemented the following measures to improve gross profit:
As a result of these measures, as well as a reduction in protein prices,addition, the Company realized increasedhas worked to negotiate lower production costs with its co-manufacturers. Although these steps improved gross profitmargins through the first quarter of 2021, with the recent increases in commodity prices, primarily protein, the company’s gross margins have been impacted and will continue to be impacted unless commodity prices return the same levels that were seen in 2020.
In 2021, the Company announced its entrance into the functional energy space with its partnership with a former Rockstar Energy executive. The Company plans to launch 3 new energy products in the fourth quartersummer of 2019, a trend which continued into2021. The Company believes with the third quarterlaunch of 2020. Beginning in April 2020, the Company experienced a slowdown, which has continued to date, in sales from its retail customers, including its largest customer. This decline has been partially offset by a growth in sales to our largest online customers, although there can be no assurances that such growth will continue, or that the Company will have the financial resources to produce the additional quantities required by these customers. In 2020, the Company also negotiated lower costs of goods sold with our co-manufacturers. Management believesnew energy products, reductions in operating costs and continued focus on gross profit and top line sales growth will allow usit to ultimately achieve sustained profitability. However, the Company can give no assurances that this will occur, especially with the cost to launch new energy products along with the recent increase in the cost of protein, which may have a material impact on the Company’s profitability. Additionally, the Company’s profitability however,may be materially impacted by the ability of our third-party manufacturers to meet our customers’ demands. Although, the Company believes entering the functional energy space will help to increase sales and gross margin, and reduce exposure to commodity prices, the Company can give no assurances that this will occur. To manage cash flow, the Company has entered into multiple financing arrangements. See additional information in “Note 7. Debt.”
OurThe Company’s results of operations are affected by economic conditions, including macroeconomic conditions and levels of business confidence. There continues to be significant volatility and economic uncertainty in many markets and the ongoing COVID-19 pandemic has increasedcontributes to that level of volatility and uncertainty and has created economic disruption. We areThe Company is actively managing ourits business to respond to the impact. There were no adjustments recorded in the financial statements that might result from the outcome of these uncertainties.
The ultimate impact of the COVID-19 pandemic on the Company’s operations is unknown and will depend on future developments, which are highly uncertain and cannot be predicted with confidence, including the duration of the COVID-19 outbreak, new information which may emerge concerning the severity of the COVID-19 pandemic, and any additional preventative and protective actions that governments, or the Company, may direct, which may result in an extended period of continued business disruption, reduced customer traffic and reduced operations. Any resulting financial impact cannot be reasonably estimated at this time but may have a material impact on our business, financial condition and results of operations. Management continues to monitor the business environment for any significant changes that could impact the Company’s operations. The Company has taken proactive steps to manage costs and discretionary spending, such as remote working and reducing facility related expense.
Note 2. Summary of Significant Accounting Policies
Basis of Presentation and Principles of Consolidation
The accompanying unaudited interim consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X for interim financial information.S-X. Accordingly, these statements do not include all of the information and notes required by U.S. GAAP for complete financial statements. The consolidated financial statements include the accounts of MusclePharm Corporationthe Company and its wholly-ownedwholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
The Company’s management believes the unaudited interim consolidated financial statements include all adjustments of a normal recurring nature necessary for the fair presentation of the Company’s financial position as of SeptemberJune 30, 2020,2021, results of operations for the three and ninesix months ended SeptemberJune 30, 20202021 and 2019,2020, and cash flows for the ninesix months ended SeptemberJune 30, 20202021 and 2019.2020. The results of operations for the three and ninesix months ended SeptemberJune 30, 20202021 are not necessarily indicative of the results to be expected for the year ended December 31, 2020. Certain prior period amounts have been conformed to the current period’s presentation.2021.
These unaudited interim consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019,2020, filed with the SEC on August 25, 2020.March 29, 2021.
Use of Estimates
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported and disclosed in the consolidated financial statements and accompanying notes. Such estimates include, but are not limited to, allowance for doubtful accounts, revenue discounts and allowances, the valuation of inventory and deferred tax assets, the assessment of useful lives, recoverability and valuation of long-lived assets, likelihood and range of possible losses on contingencies, valuations of equity securities and intangible assets, warrants and options, present value of lease liabilities, among others. Actual results could differ from those estimates.
Revenue RecognitionShipping and handling
Revenue is recognized when control of the promised goods or services is transferred to the Company’s customers in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services.
The Company sells a variety of protein products through a broad distribution platform that includes supermarkets, mass merchandisers, wholesale clubs, drugstores, convenience stores, home stores, specialty stores and websites and other e-commerce channels, all of which sell our products to consumers.
For performance obligations related to the shipping and invoicing of products, control transfers at the point in time upon which finished goods are delivered to the Company’s customers or when finished goods are picked up by a customer or a customer’s carrier, depending on shipping terms. Once a product has been delivered or picked up by the customer, the customer is able to direct the use of, and obtain substantially all of the remaining benefits from the asset. The Company considers control to have transferred upon delivery or customer receipt because the Company has an enforceable right to payment at that time, the customer has legal title to the asset, the Company has transferred physical possession of the asset, and the customer has significant risk and rewards of ownership of the asset.
The Company conducts extensive promotional activities, primarily through the use of off-list discounts, slotting, coupons, cooperative advertising, periodic price reduction arrangements, and end-aisle and other in-store displays. The costs of such activities are netted against sales and are recorded when the related sale takes place. The reserves for sales returns and consumer and trade promotion liabilities are established based on the Company’s best estimate of the amounts necessary to settle future and existing obligations for products sold as of the balance sheet date. To determine the appropriate timing of recognition of consideration payable to a customer, all consideration payable to our customers is reflected in the transaction price at inception and reassessed routinely.
The Company expenses incremental direct costs of obtaining a contract (broker commissions) when the related sale takes place, since the amortization period of the commissions paid for the sale of products is less than a year. These costs are recorded in “Selling, general and administrative” expenses in the accompanying consolidated statements of income.
The Company accounts for shipping and handling costs as fulfillment activities, which are therefore recognized upon shipment of the goods.
For the three and ninesix months ended SeptemberJune 30, 2020,2021 the Company incurred $0.2$0.5 million and $0.9 $1.0 million, respectively, of inbound shipping and handling costs. For the three and ninesix months ended SeptemberJune 30, 2019,2020 the Company incurred $0.3 $0.4 million and $0.9 $0.8 million, respectively, of inbound shipping and handling costs. Shipping and handling costs related to inbound purchases of raw material and finished goods are included in cost of revenuesrevenue in our consolidated statements of operations.
For the three and ninesix months ended SeptemberJune 30, 2020,2021, the Company incurred $0.6$0.9 million and $1.7$1.6 million, respectively, of shipping and handling costs related to shipments to our customers. For the three and ninesix months ended SeptemberJune 30, 2019,2020, the Company incurred $0.9$0.6 million and $2.9$1.2 million, respectively, of shipping and handling costs related to shipments to our customers. Shipping and handling costs related to shipments to our customers is included in selling,“Selling, general and administrative expensesadministrative” expense in our consolidated statements of operations.
| 8 |
Sales discounts and returns
The Company excludes from its revenue any amounts collected from customers for sales (and similar) taxes. During the three months ended SeptemberJune 30, 20202021 and 2019,2020, the Company recorded discounts, and to a lesser degree, sales returns, totaling $4.1 $1.9 million and $7.0 $3.6 million, respectively, which accounted for 20% 11% and 25% 17% of gross revenue in each period, respectively. During the ninesix months ended SeptemberJune 30, 20202021 and 2019,2020, the Company recorded discounts, and to a lesser degree, sales returns, totaling $11.7 $4.4 million and $22.5 $7.6 million, respectively, which accounted for 14% and 19% and 27% of gross revenue in each period, respectively.
Concentrations
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and accounts receivable. The Company minimizes its credit risk associated with cash by periodically evaluating the credit quality of its primary financial institution. The Company maintains its cash balance at times, may exceed federallycredit-worthy financial institutions that are insured limits.by the Federal Deposit Insurance Corporation (“FDIC”) up to $250,000. There was an aggregate uninsured cash balance of $0.8 million as of June 30, 2021. Management believes the financial risk associated with these balances is minimal and has not experienced any losses to date.
Significant customers are those that represent more than 10% of the Company’s revenue, net or accounts receivable for each period presented.
For each significantthe three months ended June 30, 2021, the Company had two customers who individually accounted for 55% and 13% of net revenue. For the six months ended June 30, 2021, the Company had three customers who individually accounted for 43%, 13% and 13% of net revenue. One customer percentage accounted for 59% of revenue, net and accounts receivable, arenet as follows:of June 30, 2021.
| Percentage of Revenue, net for the Three Months Ended September 30, | Percentage of Revenue, net for the Nine Months Ended September 30, | Percentage of Net Accounts Receivable as of | ||||||||||||||||||||||
| 2020 | 2019 | 2020 | 2019 | September 30, 2020 | December 31, 2019 | |||||||||||||||||||
| Customers | ||||||||||||||||||||||||
| Costco | 46 | % | 34 | % | 37 | % | 33 | % | 37 | % | 34 | % | ||||||||||||
| Amazon | 10 | % | 16 | % | 19 | % | 13 | % | 20 | % | 20 | % | ||||||||||||
| iHerb | * | 18 | % | * | 16 | % | * | * | ||||||||||||||||
| Coupang Global, LLC | * | * | 13 | % | * | 11 | % | * | ||||||||||||||||
* Represents less than 10% For the three months ended June 30, 2020, the Company had three customers who individually accounted for 30%, 24% and 21% of net revenue orrevenue. For the six months ended June 30, 2020, the Company had three customers who individually accounted for 33%, 23% and 16% of net revenue. Three customers accounted for 31%, 18% and 16% of accounts receivable.receivable, net as of June 30, 2020.
The Company uses a limited number of non-affiliated suppliers for contract manufacturing of its products. TheFor the three months ended June 30, 2021, the Company had the following concentration three suppliers who individually accounted for approximately , and of its purchases with contract manufacturers:manufacturers and raw material providers. For the six months ended June 30, 2021, the Company had three suppliers who individually accounted for approximately , and of its purchases with contract manufacturers and raw material providers. Four customers accounted for 33%, 17%, 12% and 11% of accounts payable as of June 30, 2021.
| For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||||||
| 2020 | 2019 | 2020 | 2019 | |||||||||||||
| Vendor | ||||||||||||||||
| Nutra Blend | * | 19 | % | * | 25 | % | ||||||||||
| S.K. Laboratories | 10 | % | 26 | % | 26 | % | 36 | % | ||||||||
| Mill Haven Foods LLC | * | 11 | % | 22 | % | * | ||||||||||
| Innovations in Nutrition and Wellness | 37 | % | * | 23 | % | * | ||||||||||
| Bakery Barn | * | 10 | % | * | * | |||||||||||
| JW Nutritional | * | 12 | % | * | * | |||||||||||
For the three months ended June 30, 2020, the Company had three suppliers who individually accounted for approximately , and of its purchases with contract manufacturers and raw material providers. For the six months ended June 30, 2020, the Company had three suppliers who individually accounted for approximately , and of its purchases with contract manufacturers and raw material providers. Three customers accounted for 19%, 12% and 12% of accounts payable as of June 30, 2020.
* Represents less than 10% of total purchases.
Share-Based Payments and Stock-Based Compensation
Share-based compensation awards, including stock options and restricted stock awards, are recorded at estimated fair value on the applicable award’s grant date, based on the estimated number of awards that are expected to vest. The grant date fair value is amortized on a straight-line basis over the time in which the awards are expected to vest, or immediately if no vesting is required. Share-based compensation awards issued to non-employees for services are recorded at fair value on the grant date. The fair value of restricted stock awards is based on the fair value of the stock underlying the awards on the grant date as there is no exercise price.
The fair value of stock options is estimated using the Black-Scholes option-pricing model. The determination of the fair value of each stock award using this option-pricing model is affected by the Company’s assumptions regarding a number of complex and subjective variables. These variables include, but are not limited to, the expected stock price volatility over the term of the awards and the expected term of the awards based on an analysis of the actual and projected employee stock option exercise behaviors and the contractual term of the awards. Due to the Company’s limited experience with the expected term of options, the simplified method was utilized in determining the expected option term as prescribed in Staff Accounting Bulletin No. 110. The Company recognizes stock-based compensation expense over the requisite service period, which is generally consistent with the vesting of the awards, based on the estimated fair value of all stock-based payments issued to employees and directors that are expected to vest.
Recent Accounting Pronouncements
In July 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”), which among other things, these amendments requirerequires the measurement of all expected credit losses of financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. ASU 2016-13 is effective for periods beginning after December 15, 2022, and interim periods within those fiscal years. The Company will evaluate the impact of the pronouncement closer to the effective date.
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, expected to reduce cost and complexity related to the accounting for income taxes. The ASU removes specific exceptions to the general principles in Topic 740 in GAAP. It eliminates the need for an organization to analyze whether the following apply in a given period: exception to the incremental approach for intra-period tax allocation; exceptions to accounting for basis differences when there are ownership changes in foreign investments; and exception in interim period income tax accounting for year-to-date losses that exceed anticipated losses. The ASU also improves financial statement preparers’ application of income tax-related guidance and simplifies GAAP for: franchise taxes that are partially based on income; transactions with a government that result in a step up in the tax basis of goodwill; separate financial statements of legal entities that are not subject to tax; and enacted changes in tax laws in interim periods. This guidance is effective for fiscal years and interim periods within those years beginning after December 15, 2020 with early adoption permitted. Amendments are to be applied prospectively, except for certain amendments that are to be applied either retrospectively or with a modified retrospective approach through a cumulative effect adjustment recorded to retained earnings. The Company iscurrently evaluating the impact of the pronouncement.this ASU may have on its consolidated financial statements.
| 9 |
On
In August 5, 2020, the FASB issued ASU No. 2020-06, Debt - Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging - Contracts in Entity’s Own Equity (Subtopic 815-40). The new ASU eliminates the beneficial conversion and cash conversion accounting models for convertible instruments. It also amends the accounting for certain contracts in an entity’s own equity that are currently accounted for as derivatives because of specific settlement provisions. In addition, the new guidance modifies how particular convertible instruments and certain contracts that may be settled in cash or shares impact the diluted EPS computation. This guidance is effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted, but nonot earlier than fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. The FASB also specified that an entity should adopt the guidance as of the beginning of its annual fiscal year and is not permitted to adopt the guidance in an interim period. The Company will evaluateis currently evaluating the impact this ASU may have on its consolidated financial statements.
In May 2021, the FASB issued ASU 2021-04, Earnings Per Share (Topic 260), Debt-Modifications and Extinguishments (Subtopic 470-50), Compensation-Stock Compensation (Topic 718), and Derivatives and Hedging-Contracts in Entity’s Own Equity (Subtopic 815-40). The ASU addresses issuer’s accounting for certain modifications or exchanges of freestanding equity-classified written call options. This amendment is effective for all entities, for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the pronouncement closerimpact this ASU may have on its consolidated financial statements.
Recently Adopted Accounting Pronouncements
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, which was expected to reduce cost and complexity related to the accounting for income taxes. The ASU removes specific exceptions to the general principles in Topic 740 in U.S. GAAP. It eliminates the need for an organization to analyze whether the following apply in a given period: exception to the incremental approach for intra-period tax allocation; exceptions to accounting for basis differences when there are ownership changes in foreign investments; and exception in interim period income tax accounting for year-to-date losses that exceed anticipated losses. The ASU also simplifies U.S. GAAP for: franchise taxes that are partially based on income; transactions with a government that result in a step up in the tax basis of goodwill; separate financial statements of legal entities that are not subject to tax; and enacted changes in tax laws in interim periods. The Company adopted this ASU effective date.January 1, 2021, with certain provisions applied retrospectively and other provisions applied prospectively. Adoption of this ASU did not have a material impact to the Company’s condensed consolidated balance sheet, statements of operations, or cash flows.
Reclassifications.
Certain prior period amounts have been reclassified to conform to the current period financial statement presentations, including classification of certain labilities. These changes in presentation did not have a material impact on the Company's financial condition or results of operations.
Note 3. Fair Value of Financial InstrumentsInventory
As of September 30, 2020, and December 31, 2019, the Company held no assets or liabilities that required re-measurement at fair value on a recurring basis. Cash balances as of September 30, 2020 and December 31, 2019 were $1.1 million and $1.5 million, respectively. The carrying amounts of the cash balances reported in the consolidated balance sheets approximate the fair value.
Note 4. Balance Sheet Components
Inventory
Inventory consisted solely of finished goods and raw materials and finished goods, which were located either atused to manufacture our products by one of our co-manufacturers or our warehouse as(in thousands):
Schedule of SeptemberInventory
As of June 30, 2021 | As of December 31, 2020 | |||||||
| Raw materials | $ | 625 | $ | 332 | ||||
| Finished goods | 936 | 700 | ||||||
| Inventory | $ | 1,561 | $ | 1,032 | ||||
| 10 |
Note 4. Accrued and Other Liabilities
As of June 30, 20202021 and December 31, 2019.
The Company records charges for obsolete2020, the Company’s accrued and slow-moving inventory based on the age of the product as determined by the expiration date or otherwise determined to be obsolete. Products within one year of their expiration dates are considered for write-off purposes. Historically, the Company has had minimal returns with established customers. The Company incurred insignificant inventory write-offs during each of the nine months ended September 30, 2020 and 2019. Inventory write-downs, once established, are not reversed as they establish a new cost basis for the inventory.
Property and Equipment
Property and equipment consisted of the following as of September 30, 2020 and December 31, 2019 (in thousands):
As of September 30, 2020 | As of December 31, 2019 | |||||||
| Furniture, fixtures and equipment | $ | 1,762 | $ | 2,592 | ||||
| Leasehold improvements | 7 | 236 | ||||||
| Vehicles | 39 | 39 | ||||||
| Displays | 453 | 453 | ||||||
| Website | 497 | 497 | ||||||
| Property and equipment, gross | 2,757 | 3,817 | ||||||
| Less: accumulated depreciation and amortization | (2,711 | ) | (3,601 | ) | ||||
| Property and equipment, net | $ | 46 | $ | 216 | ||||
Depreciation and amortization expense related to property and equipment was $24,000 and $75,000 for the three months ended September 30, 2020 and 2019, respectively. Depreciation and amortization expense was $0.1 million and $0.3 million for the nine months ended September 30, 2020 and 2019, respectively. Depreciation and amortization expense is included in “Selling, general, and administrative” expense in the accompanying consolidated statements of operations.
Intangible Assets
Intangible assetsother liabilities consisted of the following (in thousands):
| As of September 30, 2020 | ||||||||||||||||
| Gross Value | Accumulated Amortization | Net Carrying Value | Remaining Weighted- Average Useful Lives (years) | |||||||||||||
| Amortized Intangible Assets | ||||||||||||||||
| Brand (apparel rights) | $ | 2,244 | $ | (1,808 | ) | $ | 436 | 1.4 | ||||||||
| Total intangible assets | $ | 2,244 | $ | (1,808 | ) | $ | 436 | |||||||||
| As of December 31, 2019 | ||||||||||||||||
Gross Value | Accumulated | Net | Remaining Weighted- | |||||||||||||
| Amortized Intangible Assets | ||||||||||||||||
| Brand (apparel rights) | $ | 2,244 | $ | (1,568 | ) | $ | 676 | 2.1 | ||||||||
| Total intangible assets | $ | 2,244 | $ | (1,568 | ) | $ | 676 | |||||||||
Intangible assets amortization expense was $0.1 million for eachSchedule of the three months ended September 30, 2020Accrued and 2019, respectively, and $0.2 million for each of the nine months ended September 30, 2020 and 2019, respectively, which is included in “Selling, general and administrative” expense in the accompanying consolidated statements of operations.Other Liabilities
As of September 30, 2020, the estimated future amortization expense of intangible assets is as follows (in thousands):
| For the Year Ending December 31, | ||||
| Remainder of 2020 | $ | 80 | ||
| 2021 | 320 | |||
| 2022 | 36 | |||
| Total amortization expense | $ | 436 | ||
As of June 30, 2021 | As of December 31, 2020 | |||||||
| Accrued professional fees | $ | 114 | $ | 242 | ||||
| Accrued interest | 748 | 644 | ||||||
| Accrued payroll and bonus | 630 | 738 | ||||||
| Settlements – short-term (Nutrablend and 4Excelsior) | 2,949 | 2,735 | ||||||
| Accrued expenses - ThermoLife | 1,364 | 1,364 | ||||||
| Accrued and other short-term liabilities | 1,001 | 1,201 | ||||||
| Accrued and other liabilities | $ | 6,806 | $ | 6,924 | ||||
Note 5. Interest and other expense, net
For the three and nine months ended SeptemberJune 30, 20202021 and 2019,2020, “Interest and other expense, net” consisted of the following (in thousands):
Schedule of Interest and Other Expense, Net
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||||||||||||||||||||||
| 2020 | 2019 | 2020 | 2019 | For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||||||||||||||
| Interest and other expense, net: | ||||||||||||||||||||||||||||||||
| 2021 | 2020 | 2021 | 2020 | |||||||||||||||||||||||||||||
| Interest expense, related party | $ | (76 | ) | $ | (458 | ) | $ | (228 | ) | $ | (1,528 | ) | $ | (147 | ) | $ | (76 | ) | $ | (282 | ) | $ | (152 | ) | ||||||||
| Interest expense, related party debt discount | — | (30 | ) | — | (60 | ) | ||||||||||||||||||||||||||
| Interest expense, other | (249 | ) | (162 | ) | (581 | ) | (619 | ) | (235 | ) | (175 | ) | (443 | ) | (332 | ) | ||||||||||||||||
| Interest expense, secured borrowing arrangement | (312 | ) | (335 | ) | (1,060 | ) | (840 | ) | (258 | ) | (383 | ) | (424 | ) | (748 | ) | ||||||||||||||||
| Foreign currency transaction loss | (2 | ) | (11 | ) | (20 | ) | (224 | ) | 34 | 16 | 32 | (18 | ) | |||||||||||||||||||
| Other | 183 | 73 | 350 | 264 | 105 | 74 | 437 | 167 | ||||||||||||||||||||||||
| Total interest and other expense, net | $ | (456 | ) | $ | (923 | ) | $ | (1,539 | ) | $ | (3,007 | ) | $ | (501 | ) | $ | (544 | ) | $ | (680 | ) | $ | (1,083 | ) | ||||||||
“Other” primarily includes sublease income and gain on disposal of fixed assets.income.
Note 6. Leases
The Company elected not to apply ASC 842 to arrangements with lease terms of 12 month or less. The Company determines if a contract contains a lease when the contract conveys the right to control the use of identified property, plant, or equipment for a period of time in exchange for consideration. Upon identification and commencement of a lease, we establish a ROU asset and a lease liability. ROU assets and lease liabilities are measured and recognized based on the present value of the future minimum lease payments over the lease term at the commencement date. At adoption, the Company reduced the ROU asset through a derecognition of the restructuring liability for its abandoned lease facilities. Subsequent to adoption, the Company no longer recognized lease expense on a straight-line basis, as the impact of the derecognition resulted in a front-loading of the lease expenses.
The Company has operating leases for warehouse facilities and office spaces across the U.S. The remaining lease terms for these leases range from 1 to 2 years. The Company also leased manufacturing and warehouse equipment under finance lease arrangements, which expired at various dates through July 2020. The Company does not intend to extend the lease terms expiring in 2020. The lease rental agreement, in which the Company leased a Tennessee warehouse, expired on June 30, 2020. Subsequent to the expiration of the lease, the Company utilized the warehouse and made payments to the landlord on a month-to-month basis between July and August 2020.
On July 24, 2020, the Company entered into a sublease agreement (“Sublease Agreement”) with a third-party to sublease the office building at Burbank. The sublease commenced on September 15, 2020 and would be in effect through the remainderA summary of the Company’s lease term (September 15, 2020 through Septemberportfolio as of June 30, 2022). Rent will be abated between November 1, 20202021 and December 31, 2020 for a totalis presented in the table below (in thousands):
Schedule of one and a half months. In September 2020, the Company assessed its existing leases for impairment as the remaining lease costs exceeded the anticipated sublease income on these leases. As a result of the impairment analysis, the Company recorded an impairment charge of $0.2 million.Supplemental Balance Sheet Information
| Balance Sheet Classification | June 30, 2021 | December 31, 2020 | ||||||||
| Assets | ||||||||||
| Operating | ROU assets, net | $ | 338 | $ | 474 | |||||
| Liabilities | ||||||||||
| Current liabilities: | ||||||||||
| Operating | Operating lease liability - current | $ | 424 | $ | 381 | |||||
| Non-current liabilities: | ||||||||||
| Operating | Operating lease liability - long term | 119 | 343 | |||||||
| Total lease liabilities | $ | 543 | $ | 724 | ||||||
Supplemental balance sheet information related to leases was as follows (in thousands):
| Balance Sheet Classification | September 30, 2020 | December 31, 2019 | ||||||||
| Assets | ||||||||||
| Operating | ROU assets, net | $ | 541 | $ | 1,175 | |||||
| Finance | Property and equipment, net | 9 | 57 | |||||||
| Total Assets | 550 | 1,232 | ||||||||
| Liabilities | ||||||||||
| Current liabilities: | ||||||||||
| Operating | Operating lease liability - current | $ | 395 | $ | 624 | |||||
| Finance | Current accrued liability | — | 54 | |||||||
| Total current liabilities | 395 | 678 | ||||||||
| Non-current liabilities: | ||||||||||
| Operating | Operating lease liability - long term | 447 | 723 | |||||||
| Total non-current liabilities | 447 | 723 | ||||||||
| Total lease liabilities | $ | 842 | $ | 1,401 | ||||||
Fixed lease costs represent the explicitly quantified lease payments prescribed by the lease agreement and are included in the measurement of the ROU asset and corresponding lease liability. Some leasing arrangements require variable payments that are dependent on usage, output, or may vary for other reasons, such as insurance and tax payments. The variable lease payments are not presented as part of the initial ROU asset or lease liability. The Company’s lease agreements do not contain any material restrictive covenants.
The components of lease cost for operating and finance leases for the three and nine months ended September 30, 2020 were as follows (in thousands):
| Income Statement Classification | Three months ended September 30, 2020 | Nine months ended September 30, 2020 | ||||||||
| Operating lease cost | Selling, general and administrative | $ | 139 | $ | 614 | |||||
| Finance lease cost: | ||||||||||
| Amortization of right-of-use asset | Selling, general and administrative | 7 | 52 | |||||||
| Interest on lease liabilities | Selling, general and administrative | — | 1 | |||||||
| Total finance lease cost | 7 | 53 | ||||||||
| Variable lease payments | Selling, general and administrative | 94 | 260 | |||||||
| Sublease income | Other income | (22 | ) | (168 | ) | |||||
| Total lease cost | $ | 218 | $ | 759 | ||||||
The components of lease cost for operating and finance leases for the three and nine months ended September 30, 2019 were as follows (in thousands):
| Income Statement Classification | Three months ended September 30, 2019 | Nine months ended September 30, 2019 | ||||||||
| Operating lease cost | Selling, general and administrative | $ | 264 | $ | 786 | |||||
| �� | ||||||||||
| Finance lease cost: | ||||||||||
| Amortization of right-of-use asset | Selling, general and administrative | 30 | 88 | |||||||
| Interest on lease liabilities | Selling, general and administrative | 1 | 5 | |||||||
| Total finance lease cost | 31 | 93 | ||||||||
| Variable lease payments | Selling, general and administrative | 55 | 169 | |||||||
| Sublease income | Other income | (72 | ) | (262 | ) | |||||
| Total lease cost | $ | 278 | $ | 786 | ||||||
The Company had no short-term leases as of September 30, 2020 and 2019. The Company’s leases do not provide an implicit rate; therefore, the Company uses its incremental borrowing rate based on the information available at the effective date in determining the present value of future payments for those leases. Supplemental cash flow information related to leases was as follows:
Schedule of Supplemental Cash Flow Information
| Nine months ended September 30, 2020 | Nine months ended September 30, 2019 | Six months ended June 30, 2021 | Six months ended June 30, 2020 | |||||||||||||
| Cash paid for amounts included in the measurement of lease liabilities (in thousands): | ||||||||||||||||
| Operating cash flows from operating leases | $ | 506 | $ | 570 | $ | 180 | $ | 397 | ||||||||
| Operating cash flows from finance leases | 1 | 5 | — | 1 | ||||||||||||
| Financing cash flows from finance leases | 54 | 88 | — | 52 | ||||||||||||
| The weighted average remaining lease term was as follows: | ||||||||||||||||
| Operating leases (in years) | 1.8 | 2.4 | 1.2 | 2.0 | ||||||||||||
| Finance leases (in years) | 0.0 | 0.7 | — | 0.1 | ||||||||||||
| The weighted average discount rate was as follows: | ||||||||||||||||
| Operating leases | 18 | % | 18 | % | ||||||||||||
| Finance leases | — | 5 | % | |||||||||||||
The weighted average discount rate was as follows:
| Operating leases | 18 | % | 18 | % | ||||
| Finance leases | 5 | % | 5 | % |
The maturities of lease liabilities at September 30, 2020 were as follows (in thousands):
| Operating | Finance | |||||||
| Remaining three months of the year ending 2020 | $ | 153 | $ | — | ||||
| 2021 | 481 | — | ||||||
| 2022 | 369 | — | ||||||
| Thereafter | — | — | ||||||
| Total future undiscounted lease payments | 1,003 | |||||||
| Less amounts representing interest | (162 | ) | — | |||||
| Present value of lease liabilities | $ | 841 | $ | — | ||||
Note 7. DebtOther Long-Term Liabilities
As of SeptemberJune 30, 2020,2021, and December 31, 2019,2020, the Company’s debtother long-term liabilities consisted of the following (in thousands):
Schedule of Other Long-Term Liabilities
| As of September 30, 2020 | As of December 31, 2019 | |||||||
| Refinanced convertible note, related party | $ | 2,735 | $ | 1,034 | ||||
| Bonds payable | — | 253 | ||||||
| Revolving line of credit, related party | — | 1,239 | ||||||
| Obligations under secured borrowing arrangement | 2,916 | 4,443 | ||||||
| Line of credit – inventory financing | 514 | 2,965 | ||||||
| Notes payable | 278 | 247 | ||||||
| Paycheck Protection Program loan | 965 | — | ||||||
| Total debt | 7,408 | 10,181 | ||||||
| Less: current portion | (6,443 | ) | (10,130 | ) | ||||
| Long term debt | $ | 965 | $ | 51 | ||||
As of June 30, 2021 | As of December 31, 2020 | |||||||
| Settlements – long-term (Nutrablend and 4Excelsior) | 3,143 | 3,906 | ||||||
| Paycheck Protection Program loan | 643 | 965 | ||||||
| Other | — | 200 | ||||||
| Other long-term debt | $ | 3,786 | $ | 5,071 | ||||
Note 8. Debt
Related-Party Refinanced Convertible Note
On November 3, 2017,29, 2020, the Company entered into thea refinancing agreement with Mr. Ryan Drexler, the Company’s Chairman of the Board of Directors and Chief Executive Officer and President (the “Refinancing”“November 2020 Refinancing”). As part of the Refinancing,, in which the Company issued to Mr. Drexler an amended and restateda convertible secured promissory note (the “Refinanced“November 2020 Convertible Note”) in the original principal amount of $18.0 million,$2,871,967, which amended and restated (i) a convertible secured promissory note dated as of December 7, 2015, amended as of January 14, 2017, inAugust 21, 2020. The $2.9 million November 2020 Convertible Note bears interest at the original principal amount of $6.0 million with an interest rate of 8% prior to12% per annum. Unless earlier converted or repaid, all outstanding principal and any accrued but unpaid interest under the amendment and 10% following the amendment (the “2015 Convertible Note”), (ii) a convertible secured promissory note dated as of November 8, 2016, in the original principal amount of $11.0 million with an interest rate of 10% (the “2016 Convertible Note”), and (iii) a secured demand promissory note dated as of July 27, 2017, in the original principal amount of $1.0 million with an interest rate of 15% (the “2017 Note”, and together with the 2015 Convertible Note and the 2016 Convertible Note, collectively, the “Prior Notes”). The due date of the 2015 Convertible Note and the 20162020 Convertible Note was November 8, 2017. The 2017 Note was due and payable on demand.
Interest rate on the $18.0 million Refinanced Convertible Note was 12% per annum, and interest payments were due on the last day of each quarter. At the Company’s option (as determined by its independent directors),July 1, 2021; however, the Company could repay upand Mr. Drexler agreed 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.extension until July 14, 2022 (see Note 14. Subsequent Events). Any interest not paid when due wouldshall be capitalized and added to the principal amount of the RefinancedNovember 2020 Convertible Note and bear interest on the applicable interest payment date along with all other unpaid principal, capitalized interest, and other capitalized obligations. Both the principal and the interest under the Refinanced Convertible Note were due on December 31, 2019, unless converted earlier.
Mr. Drexler couldmay, at any time, and from time to time, upon written notice to the Company, convert the outstanding principal and accrued interest into shares of the Company’s common stockCommon Stock, at a conversion price of $1.11$0.23 per share. At the election of the Company, one-sixth of the interest may be paid in kind (“PIK Interest”) by adding such amount to the principal amount of the note, or through the issuance of shares of the Company’s common stock to Mr. Drexler. The PIK Interest is convertible to common stock at the closing price per share at any time.on the last business day of each calendar quarter. In no event will the conversion price of such PIK Interest be less than $0.10. The Company couldmay prepay the Refinanced Convertible Note by giving Mr. Drexler between 1515- and 60 days’60-days’ notice depending upon the specific circumstances, subject to Mr. Drexler’s conversion right.
The RefinancedCompany intends to pay all interest due on the Convertible Note contained customary events of default, including, among others, the failure by the Company to make a payment of principal or interest when due. Following an event of default, interest would accrueMr. Drexler at the rateend of 14% per annum. In addition, following an event of default, any conversion, redemption, payment or prepayment of the Refinancedeach calendar quarter.
The November 2020 Convertible Note would be at a premium of 105%. The Refinanced Convertible Note also containedcontains 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 RefinancedNovember 2020 Convertible Note.
As part of The November 2020 Convertible Note is subordinated to the Refinancing,secured borrowing arrangement the Company and Mr. Drexler entered into a restructuring agreement (the “Restructuring Agreement”with Prestige Capital Corporation (“Prestige”) pursuant to which.
For the parties agreed to amendthree months ended June 30, 2021 and restate the security agreement resulting in a Third Amended and Restated Security Agreement (the “Amended Security Agreement”) in which the Prior Notes were secured by all of the assets and properties of the Company and its subsidiaries whether tangible or intangible. Pursuant2020, interest expense related to the Restructuring Agreement,related party convertible secured promissory note was $0.1 million and $0.1 million, respectively.
For the Company agreed to pay, on the effective date of the Refinancing, all outstandingsix months ended June 30, 2021 and 2020, interest on the Prior Notes through November 8, 2017 and certain fees and expenses incurred by Mr. Drexler in connection with the Restructuring.
On September 16, 2019, Mr. Ryan Drexler delivered a noticeexpense related to the Companyrelated party convertible secured promissory note was $0.2 million and its independent directors of his election to convert, effective as of September 16, 2019 (the “Notice Date”), $18.0$0.2 million, of the amount outstanding under that certain Amended and Restated Convertible respectively.
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Related-Party Secured Revolving Promissory Note dated as of November 8, 2017 (the “Note”), issued by the Company to Mr. Drexler, into shares of the Company’s common stock, par value $0.001 per share (the “Common Stock”), at a conversion price of $1.11 per share, pursuant to the terms and conditions of the Note (the “Partial Conversion”). As of the Notice Date, the total amount outstanding under the Note (including principal and accrued and unpaid interest) was equal to $19.3 million. Pursuant to the terms of the Note, the Company instructed the transfer agent to issue to Mr. Drexler 16,216,216 shares (the “Shares”) of its Common Stock in respect of the Partial Conversion.
On October 4, 2019,15, 2020, the Company entered into a secured revolving promissory note (the “Revolving Note”) with Mr.Ryan Drexler. Under the terms of the Revolving Note, the Company can borrow up to $3.0$3.0 million. The Revolving Note bears interest at the rate of 12% annually. per annum. The use of funds will be solelywere used for the purchase of whey protein and other general corporate purposes. Both the outstanding principal, if any, and all accrued interest under the Revolving Note were due on March 31, 2021; however, the Company and Mr. Drexler agreed to be used in the manufacturing of MusclePharm products.an extension until June 30, 2022 (see Note 14. Subsequent Events). The Company may prepay the Revolving Note by giving Mr. Drexler one days’ advance written notice. The Revolving Note contains customary events of default, including, among others, the failure by the Company to make a payment of principal or interest when due. Following an event of default, Mr. Drexler is entitled to accelerate the entire indebtedness under the Revolving Note. The Revolving Note also contains customary restrictions on the ability of the Company to, among other things, grant liens or incur indebtedness other than certain obligations incurred in the ordinary course of business. The restrictions are also subject to certain additional qualifications and carveouts.carveouts, as set forth in the Revolving Note. The Revolving Note is subordinated to the secured borrowing arrangement the Company entered into with Prestige. In connection with the Revolving Note, the Company and Mr. Drexler entered into a fifth amended and restated security agreement dated October 4, 2019,15, 2020 (the “Security Agreement”) pursuant to which the Revolving Note is secured by all of the assets and properties of the Company and its subsidiaries whether tangible or intangible.
On December 27, 2019,As of June 30, 2021, the Company entered into a collateral receipt and security agreement with Mr. Drexler, pursuant to which Mr. Drexler agreed to post bond relating to the judgment ruled against the Company in connection with the litigation between the Company and ThermoLife International LLC (“ThermoLife”), pending the appeal. The amount paid by Mr. Drexler on behalf of the Company, including fees, was $0.3 million.
On August 21, 2020, the Company entered into a refinancing agreement with Mr. Ryan Drexler, the Company’s Chairman of the Board of Directors, Chief Executive Officer and President (the “2020 Refinancing”), with an effective date of July 1, 2020. As part of the 2020 Refinancing, the Company issued to Mr. Drexler an amended and restated convertible secured promissory note (the 2020 “Refinanced Convertible Note”) in the original principal amount of $2,735,199, which amended and restated (i) a convertible secured promissory note dated as of November 8, 2017, $1,134,483 of which was outstanding as of July 1, 2020 (ii) a collateral receipt and security agreement with Mr. Drexler dated as of December 27, 2019, $252,500 of which was outstanding as of July 1, 2020, and (iii) a secured revolving promissory note dated as of October 4, 2019, $1,348,216 of which was outstanding as of July 1, 2020. The $2.7 million 2020 Refinanced Convertible Note bears interest at the rate of 12% per annum.
The 2020 Refinanced Convertible Note contains customary restrictionsbalance on the ability of the Company to, among other things, grant liens or incur indebtedness other than certain obligations incurred in the ordinary course of business. The restrictions are also subject to certain additional qualifications and carveouts, as set forth in the 2020 Refinanced Convertible Note. The 2020 Refinanced Convertible Note is subordinated to certain other indebtedness of the Company held by Prestige Capital Corporation (“Prestige”) and Crossroads Financial Group, LLC (“Crossroads”). The Company may prepay the 2020 Refinanced Convertible Note by giving Mr. Drexler between 15 and 60 days’ notice depending upon the specific circumstances, subject to Mr. Drexler’s conversion right. Mr. Drexler may convert the outstanding principal and accrued interest into shares of the Company’s common stock at a conversion price equal to or greater than (i) the closing price per share of the common stock on the last business day immediately preceding November 1, 2020 or (ii) $0.17.
All outstanding principal and accrued but unpaid interest under the 2020 Refinanced Convertible Note were due and payable on November 1, 2020. The Note is currently in default and the Company is in negotiations with Mr. Drexler to either convert the 2020 Refinanced Convertible Note or amend the 2020 Refinancing by the end of November 2020. Interest accrued but unpaid will be capitalized on the due date and added to the principal amount of the 2020 Refinanced Convertible Note.
For the three months ended September 30, 2020 and 2019, interest expense, related to the related party convertible notesrevolving note was $80,000 and $0.5 million, respectively.$2.5 million. During the three and six months ended SeptemberJune 30, 2020, no2021, interest was paid in cash to Mr. Drexler. During the three months ended September 30, 2019, $0.4 million in interestDrexler was paid in cash to Mr. Drexler.
For the nine months ended September 30, 2020 and 2019, interest expense, related to the related party convertible notes was $0.2$0.1 million and $1.6$0.1 million, respectively. During the nine months ended September 30, 2020, no interest was paid in cash to Mr. Drexler. During the nine months ended September 30, 2019, $0.8 million in interest was paid in cash to Mr. Drexler.
Line of Credit - Inventory Financing
On October 6, 2017, the Company entered into a Loan and Security Agreement (“Security Agreement”) with Crossroads. Pursuant to the Security Agreement, the Company may borrow up to 70% of its Inventory Cost or up to 75% of Net Orderly Liquidation Value (each as defined in the Security Agreement), up to a maximum amount of $3.0 million at an interest rate of 1.5% per month, subject to a minimum monthly fee of $22,500. Subsequent to the end of 2017, the maximum amount was increased to $4.0 million. The term of the Security Agreement automatically extends in one-year increments, unless earlier terminated pursuant to the terms of the Security Agreement. The Security Agreement contains customary events of default, including, among others, the failure to make payments on amounts owed when due, default under any other material agreement or the departure of Mr. Drexler. The Security Agreement also contains customary restrictions on the ability of the Company to, among other things, grant liens, incur debt, and transfer assets. Under the Security Agreement, the Company agreed to grant Crossroads a security interest in all of the Company’s present and future accounts, chattel paper, goods (including inventory and equipment), instruments, investment property, documents, general intangibles, intangibles, letter of credit rights, commercial tort claims, deposit accounts, supporting obligations, documents, records and the proceeds thereof. The Security Agreement has second priority lien on the Company’s assets and is subordinated to the Company’s indebtedness held by Prestige. As of September 30, 2020, and December 31, 2019, we owed Crossroads $0.5 million and $3.0 million, respectively.
On April 1, 2019, the Company and Crossroads amended the terms of the agreement. The agreement was extended until March 31, 2020, the rate was modified to 1.33% per month, and increased the amount the Company can borrow from $3.0 million to $4.0 million.
On February 26, 2020, the Company and Crossroads amended the terms of the agreement. The agreement was extended until April 1, 2021 and the amount the Company can borrow was decreased from $4.0 million to $3.0 million.
Secured Borrowing Arrangement
In January 2016, the Company entered into a Purchase and Sale Agreement (the “Purchase and Sale Agreement”) with Prestige, pursuant to which the Company agreed to sell and assign and Prestige agreed to buy and accept, certain accounts receivable owed to the Company (“Accounts”). Under the terms of the Purchase and Sale Agreement, upon the receipt and acceptance of each assignment of Accounts, Prestige will pay the Company 80% of the net face amount of the assigned Accounts, up to a maximum total borrowing of $12.5$12.5 million subject to sufficient amounts of accounts receivable to secure the loan. The remaining 20% will be paid to the Company upon collection of the assigned Accounts, less any chargebacks (including chargebacks for any customer amounts that remain outstanding for over 90 days), disputes, or other amounts due to Prestige. Prestige’s purchase of the assigned Accounts from the Company will be at a discount fee which varies from 0.7% to 4%, based on the number of days outstanding from the assignment of Accounts to collection of the assigned Accounts. In addition, the Company granted Prestige a continuing security interest in and first priority lien upon all accounts receivable, inventory, fixed assets, general intangibles, and other assets. Prestige will have no recourse against the Company if payments are not made due to the insolvency of an account debtor within 90 days of invoice date, with the exception of international and certain domestic customers. As of September 30, 2020 and December 31, 2019, the Company had outstanding borrowings of approximately $3.0 million and $4.4 million, respectively.
During the three months ended September 30, 2020 and 2019, the Company assigned to Prestige accounts with an aggregate face amount of approximately $14.6 million and $14.8 million, respectively, for which Prestige paid to the Company approximately $11.6 million and $11.9 million, respectively, in cash. During the three months ended September 30, 2020 and 2019, $11.6 million and $12.5 million was repaid to Prestige, respectively, including fees and interest.
During the nine months ended September 30, 2020 and 2019, the Company assigned to Prestige accounts with an aggregate face amount of approximately $41.0 million and $39.0 million, respectively, for which Prestige paid to the Company approximately $32.8 million and $31.2 million, respectively, in cash. During the nine months ended September 30, 2020 and 2019, $34.3 million and $29.2 million was repaid to Prestige, respectively, including fees and interest.
On April 10, 2019, the Company and Prestige amended the terms of the agreement. The agreement was extended until April 1, 2020. Thereafter the agreement shall renew itself2020 and automatically renews for one (1) year periods unless either party receives written notice of cancellation from the other, at minimum, thirty (30) days prior to the expiration date.date thereafter.
On June 14, 2021, Prestige advanced the Company $1 million with a six-month term, 15% interest rate and 2% accommodation fee.
As of June 30, 2021, and December 31, 2020, the Company had outstanding borrowings under the secured borrowing arrangement of approximately $5.3 million and $7.1 million, respectively.
During the three months ended June 30, 2021 and 2020, the Company assigned to Prestige, accounts with an aggregate face amount of approximately $18.5 million and $14.8 million, respectively, for which Prestige paid to the Company approximately $14.7 million and $11.7 million, respectively, in cash. During the three months ended June 30, 2021 and 2020, $14.2 million and $12.6 million, respectively, was repaid to Prestige, including fees and interest.
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During the six months ended June 30, 2021 and 2020, the Company assigned to Prestige, accounts with an aggregate face amount of approximately $32.8 million and $26.4 million, respectively, for which Prestige paid to the Company approximately $26.2 million and $21.1 million, respectively, in cash. During the six months ended June 30, 2021 and 2020, $28.0 million and $22.6 million, respectively, was repaid to Prestige, including fees and interest.
Paycheck Protection Program Loan
Due to economic uncertainty as a result of the ongoing pandemic (COVID-19), on May 14, 2020, the Company received an aggregate principal amount of $964,910$964,910 pursuant to the borrowing arrangement (“Note”) with Harvest Small Business Finance, LLC (“HSBF”) and agreed to pay the principal amount plus interest at a 1% fixed interest rate per year, on the unpaid principal balance. The Note includes forgiveness provisions in accordance with the requirements of the Paycheck Protection Program, Section 1106 of the CARES Act.
The Note is expected to mature on May 16, 2022.2025. Payments were due by November 16, 2020 (the “Deferment Period”) and interest was accrued during the Deferment Period. However, the Flexibility Act, which was signed into law on June 5, 2020, extended the Deferment Period to the date that the forgiven amount is remitted by the United States Small Business Administration (“SBA”) to HSBF. The Company is in the process of filling out the forgiveness application form.As of SeptemberJune 30, 2020,2021, the Company owed approximately $1.0 $1.0 million (principal plus accrued interest), which $0.1M is classified as “short-term” and the remaining amount is recorded inwithin “Other long-term liabilities” in the consolidated balance sheets.liabilities.”
Note 8. 9. Commitments and Contingencies
Settlements
Manchester City Football Group
The Company was engaged in a dispute with City Football Group Limited (“CFG”), the owner of Manchester City Football Group, concerning amounts allegedly owed by the Company under a sponsorship agreement with CFG (the “Sponsorship Agreement”). In August 2016, CFG commenced arbitration in the United Kingdom against the Company, seeking approximately $8.3$8.3 million for the Company’s purported breach of the Sponsorship Agreement.
On July 28, 2017, the Company approved a Settlement Agreement (the “CFG Settlement Agreement”) with CFG effective July 7, 2017. The CFG Settlement Agreement represents a full and final settlement of all litigation between the parties. Under the terms of the agreement, the Company agreed to pay CFG a sum of $3$3 million, which was recorded as accrued expenses in 2017. The settlement consists of a $1$1 million payment that was advanced by a related party on July 7, 2017, a $1$1 million installment paid on July 7, 2018 and a subsequent $1$1 million installment payment to be paid by July 7, 2019. Of this amount, the Company has remitted $0.3$0.3 million.
During each of the three months ended SeptemberJune 30, 20202021 and 2019,2020, the Company recorded a charge of $19,000$19,000 and $19,000, respectively and during the ninesix months ended SeptemberJune 30, 20202021 and 2019,2020, the Company recorded a charge of $56,000$38,000 and $77,000,$38,000, respectively. This charge, representing imputed interest, is included in “Interest and other expense, net” in the Company’s consolidated statements of operations.
Nutrablend Matter
On February 27, 2020, Nutrablend, a manufacturer of MusclePharm products, filed an action against MusclePharmthe Company in the United States District Court for the Eastern District of California, claiming approximately $3.1$3.1 million in allegedly unpaid invoices. These invoices relate to the third and fourth quarter of 2019, and a liability has been recorded in the books for the related periods.
On September 25, 2020, the parties successfully mediated the case to a settlement (the “Nutrablend Agreement”) and the Company agreed to (i) pay approximately $3.1$3.1 million (“Owed Amount”) in monthly payments (“Monthly Payments”) from September 1, 2020 through June 30, 2023 and (ii) issue monthly purchase orders (“Purchase Orders”) at minimum amounts accepted by Nutrablend.
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MusclePharm
The Company agreed to issue Purchase Orders in a combined total amount of at least (i) $1,500,000$1,500,000 from September 1, 2020 through November 30, 2020; (ii) $1,800,000$1,800,000 from December 1, 2020 through February 28, 2021; (iii) $2,100,000$2,100,000 from March 31, 2021 through May 31, 2021; (iv) $2,100,000$2,100,000 from June 1, 2021 through August 31, 2021; and (v) $1,400,000$1,400,000 from September 1, 2021 through October 30, 2021. Beginning on November 1, 2021, MusclePharmthe Company will be required to issue monthly Purchase Orders to Nutrablend in a minimum amount of $700,000$700,000 until the Owed Amount is paid in full to Nutrablend. In the event that MusclePharmthe Company pays the Owed Amount in full before September 1, 2021, MusclePharm isits entitled to a rebate on all completed Purchase Orders. Further, once the monthly payments, and any additional payments that MusclePharmthe Company has made on the Owed Amount, reduce the outstanding balance of the Owed Amount to below $2.0$2.0 million, MusclePharmthe Company is eligible for an extension of a line of credit from Nutrablend in an amount of up to $3.0$3.0 million.
On July 7, 2021, the Company commenced an action against Nutrablend in the Central District of California, seeking (i) a declaration that the Nutrablend Agreement purchase order provisions have been terminated due to Nutrablend’s failure to provide the Company with reasonable assurances of its ability to fulfill its purchase orders; (ii) a declaration that approximately $2.0 million in purchase orders that the Company placed in July and August 2020 were intended to and do count towards the minimums set forth in the Nutrablend Agreement; and (iii) damages based on Nutrablend’s failure to fulfill purchase orders. The case is ongoing.
The Company determined that approximately $1.0$1.1 million dollars of the Owed Amount was due within a year, and this amount was recorded in “Accrued and other liabilities” in the consolidated balance sheets. The present value of the remaining Owed Amount that was due after a year was $1.6$1.0 million, and the amount was recorded in “Other long termlong-term liabilities” in the consolidated balance sheets. The Company made the first paymentpayments of $60,000 in September 2020.$0.7 million as of June 30, 2021.
During the three and ninesix months ended SeptemberJune 30, 2021 the Company recorded interest of $0.1 million and $0.1 million, respectively. This charge, representing imputed interest, is included in “Interest and other expense, net” in the Company’s consolidated statements of operations.
4Excelsior Matter
On March 18, 2019, Excelsior Nutrition, Inc. (“4Excelsior”), a manufacturer of MusclePharm products, filed an action against the Company in the Superior Court of the State of California for the County of Los Angeles, claiming approximately $6.2 million in damages relating to allegedly unpaid invoices, as well as approximately $7.8 million in consequential damages.
On December 16, 2020, the Company and 4Excelsior entered into a Settlement Agreement and Mutual Release (“the Agreement”), pursuant to which the parties resolved and settled the civil action pending in the Superior Court of the State of California for the County of Los Angeles (the “Litigation”). The parties agreed to a mutual general release of claims and to jointly file within 10 business days of the effective date of the Agreement a stipulation and proposed order of dismissal, dismissing with prejudice all claims and counterclaims asserted in the Litigation. The Company agreed to pay $4.75 million (the “Settlement Amount”) in four monthly payments of $70,000, beginning January 5, 2021, and thereafter in monthly payments of $0.1 million until the Settlement Amount is fully paid. The Company may prepay all or any portion of the Settlement Amount at any time without penalty or premium. The Agreement provides that, in the event of a Default (as defined in the Agreement) by the Company, the entire outstanding balance of the Settlement Amount will become immediately due and payable, plus accrued interest at a rate of 18% per annum, commencing from the date of default.
The Company determined that approximately $1.1 million dollars of the Settlement Amount was due within a year, and this amount was recorded $0.5in “Accrued and other liabilities” in the consolidated balance sheets. The present value of the remaining Settlement Amount that was due after a year was $2.2 million, and the amount was recorded in “Other long-term liabilities” in the consolidated balance sheets. The Company made payments of $0.8 million as a gain onof June 30, 2021.
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During the settlement ofthree and six months ended June 30, 2021, the liability, andCompany recorded interest expense of $3,000,$0.1 million and $0.2 million, respectively, in the consolidated statements of operations.
Contingencies
In the normal course of business or otherwise, the Company may become involved in legal proceedings. The Company will accrue a liability for such matters when it is probable that a liability has been incurred and the amount can be reasonably estimated. When only a range of possible loss can be established, the most probable amount in the range is accrued. If no amount within this range is a better estimate than any other amount within the range, the minimum amount in the range is accrued. The accrual for a litigation loss contingency might include, for example, estimates of potential damages, outside legal fees and other directly related costs expected to be incurred. The Company provides disclosures for material contingencies when there is a reasonable possibility that a loss or an additional loss may be incurred. In assessing whether a loss is a reasonable possibility, the Company may consider the following factors, among others: the nature of the litigation, claim or assessment, available information, opinions or views of legal counsel and other advisors, and the experience gained from similar cases. As of SeptemberJune 30, 2020,2021, the Company was involved in the following material legal proceedings described below.
ThermoLife International
In January 2016, ThermoLife International LLC (“ThermoLife”), a supplier of nitrates to MusclePharm,the Company, filed a complaint against the Company in Arizona state court. ThermoLife alleged that the Company failed to meet minimum purchase requirements contained in the parties’ supply agreement. In March 2016, the Company filed counterclaims alleging that ThermoLife’s products were defective. Through orders issued in September and November 2018, the court dismissed MusclePharm’s counterclaims and found that the Company was liable to ThermoLife for failing to meet its minimum purchase requirements.
The court held a bench trial on the issue of damages in October 2019, and on December 4, 2019, the court entered judgment in favor of ThermoLife and against the Company in the amount of $1.6$1.6 million, comprised of $0.9$0.9 million in damages, interest in the amount of $0.3$0.3 million and attorneys’ fees and costs in the amount of $0.4$0.4 million. The Company recorded $1.6$1.6 million in accrued expenses asin 2018. As of December 31, 2018. InJune 30, 2021, the interim, thetotal amount accrued, including interest, was $1.8 million. The Company has filed an appeal which is in the process of being briefed, and has posted bonds in the total amount of $0.6$0.6 million in order to stay execution on the judgment pending appeal. Of the $0.6 million, $0.25$0.25 million (including fees) was paid by Mr. Drexler on behalf of the Company on December 31, 2019.Company. See “Note 7.8. Debt” for additional information. Subsequent to December 31, 2019, theThe balance of $0.35$0.35 million was secured by a personal guaranty from Mr. Drexler, while the associated feesannual fee of $12,500 was$12,500 has been paid by the Company. On April 27, 2021, the appellate court issued a decision largely affirming the trial court judgement, except vacating the judgement’s $0.3 million prejudgment interest award and remanding for a recalculation of prejudgment interest. On May 18, 2021, ThermoLife filed a motion asking the trial court to increase the Company’s appeal bond to the full amount of the judgment, or $1.8 million, which the Court denied on June 2, 2021.
For both the three months ended SeptemberJune 30, 20202021 and 2019,2020, interest expense recognized by the Company on the awarded damages was $22,000. For$22,000 and for both the ninesix months ended SeptemberJune 30, 20202021 and 2019,2020, interest expense recognized by the Company on the awarded damages was $66,000.$44,000.
The Company intends to continuously vigorously continue pursuing its defenses, includingdefenses. On June 25, 2021, the Company filed a petition for review in the Arizona Supreme Court requesting that the Court accept review of the appeal affirming the judgment against the Company. ThermoLife opposed the petition for review on appeal.July 26, 2021. The Arizona Supreme Court has not yet ruled on the Company’s petition for review.
White Winston Select Asset Fund Series MP-18, LLC et al., vv. MusclePharm Corp., et al., (Nev. Dist. Ct.; Cal. Superior Court; Colorado Dist. Ct.; Mass. Super. Ct.)
On August 21, 2018, White Winston Select Asset Fund Series MP-18, LLC and White Winston Select Asset Fund, LLC (together “White Winston”) initiated a derivative action against MusclePharmthe Company and its directors (collectively the(the “director defendants”). White Winston alleges that the director defendants breached their fiduciary duties by improperly approving the refinancing of three promissory notes issued by MusclePharmthe Company to Mr. Drexler (the “Amended Note”), in exchange for $18.0$18.0 million in loans. White Winston alleges that this refinancing improperly diluted their economic and voting power and constituted an improper distribution in violation of Nevada law. In its complaint, White Winston sought the appointment of a receiver over MusclePharm,the Company, a permanent injunction against the exercise of Mr. Drexler’s conversion right under the Amended Note, and other unspecified monetary damages. On September 13, 2018, White Winston filed an amended complaint, which added a former MusclePharm executive of the Company, as a plaintiff (together with White Winston, the “White Winston Plaintiffs”). On December 9, 2019, the White Winston Plaintiffs filed a Second Amended Complaint, in which they added allegations relating to the resignation of MusclePharm’sthe Company’s auditor, Plante & Moran PLLC (“Plante Moran”). MusclePharmthe Company has moved to dismiss the Second Amended Complaint. That motion has not yet been fully briefed.
Along with its complaint, the White Winston Plaintiffs also filed a motion for a temporary restraining order (“TRO”) and preliminary injunction enjoining the exercise of Mr. Drexler’s conversion right under the Amended Note. On August 23, 2018, the Nevada district court issued an ex parte TRO. On September 14, 2018, the court let the TRO expire and denied the White Winston Plaintiffs’Winston’s request for a preliminary injunction, finding, among other things, that the White Winston Plaintiffs did not show a likelihood of success on the merits of the underlying action and failed to establish irreparable harm. Following the court’s decision, MusclePharmthe Company filed a motion seeking to recoup the legal fees and costs it incurred in responding to the preliminary injunction motion. On October 31, 2019, the court awarded MusclePharm $56,000the Company $56,000 in fees and costs. The White Winston Plaintiffs have appealed that award.
Due to the uncertainty associated with determining our liability, if any, and due to our inability to ascertain with any reasonable degree of likelihood, as of the date of this report, the outcome of the trial, the Company has not recorded an estimate for its potential liability.
On June 17, 2019, the White Winston Plaintiffs moved for the appointment of a temporary receiver over MusclePharm,the Company, citing Plante Moran’s resignation. The court granted the White Winston Plaintiffs’Winston’s request to hold an evidentiary hearing on the motion, but subsequently stayed the date for that hearing wasaction pending the parties’ attempts to resolve their dispute. Although the parties have been unable to reach a resolution, the litigation has not set as of the date hereof.yet resumed. On July 30, 2019, the White Winston Plaintiffs filed an action in the Superior Court of the State of California in and for the County of Los Angeles, seeking access to MusclePharm’sthe Company’s books and records. MusclePharm has answeredrecords and requesting the petition, asserting asappointment of an independent auditor for the company. On February 25, 2021, the court ordered the Company to produce certain documents, denied White Winston’s request for an auditor, and ordered the Company to pay a defense$1,500 penalty. On July 20, 2021 the California court awarded White Winston $92,942 in attorneys’ fees and cost relating to the books-and-records action. The Company paid the amounts due on July 30, 2021, and on August 4, 2021 White Winston submitted a filing acknowledging that the request does not have a proper purpose. A trial on the petitionCalifornia court’s judgment has been set for February 25, 2021.fully satisfied.
The Company intends to vigorously defend these actions.
IRS Audit
On April 6, 2016, the Internal Revenue Service (“IRS”) selected our 2014 Federal Income Tax Return for audit. As a result of the audit, the IRS proposed certain adjustments with respect to the tax reporting of our former executives’ 2014 restricted stock grants. Due to the Company’s current and historical loss position, the proposed adjustments would have no material impact on the Company’s Federal income tax. On October 5, 2016, the IRS commenced an audit of our employment and withholding tax liability for 2014. The IRS contendscontended 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 proposingproposed 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$5.3 million, of which $4.4$4.4 million related to withholding taxes, specifically, income withholding and Social Security taxes, and $0.9$0.9 million related to penalties. Additionally, the IRS assertsasserted that the Company owes information reporting penalties of approximately $2.0$2.0 million.
The Company’s counsel has submitted a formal protest to the IRS disputing on several grounds all of the proposed adjustments and penalties on the Company’s behalf, and the Company has been pursuingpursued this matter vigorously through the IRS appeal process. An Appeals Conference was held with the IRS in Denver, Colorado on July 31, 2019. At the conference, the Company made substantial arguments challenging the IRS’s claims for employment taxes and penalties. On December 16, 2019, a further Appeals Conference was held with the IRS by telephone. At the telephone conference, the Appeals Officer confirmed that he agreed with the Company’s argument that the failure to deposit penalties should be conceded by the IRS. The failure to deposit penalties total about $2.0$2 million. Thus, with this concession, the IRS’s claims have been reduced from approximately $7.3$7.3 million to about $5.3$5.3 million.
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The remaining issue in dispute in this matter involvesinvolved the fair market value of restricted stock units in the Company granted to certain former officers (the “Former Officers”) of the Company under Internal Revenue Code § 83. The Company and the IRS disagreedisagreed as to the value of the restricted stock on the date of the grants, i.e., October 1, 2014. The Company and the IRS have exchanged expert valuation reports on the fair market value of the stock and have had extensive negotiations on this issue. The parties, however, have not been able to reach an agreement with respect to the value of the stock. The IRS has also made parallel claims regarding the restricted stock units against the Former Officers of the Company. The IRS has asserted that the Former Officers received ordinary income from the stock grants, and that they owe additional personal income taxes based on the fair market value of the stock. The Former Officers’ cases, unlike the Company’s case, are pending before the United States Tax Court. In the Tax Court litigation, the Former Officers are challenging the IRS’s determinations regarding the fair market value of the restricted stock grants on October 1, 2014. The Former Officers have separate counsel from the Company. The same IRS Appeals Officer and Revenue Agents assigned to the Company’s case are also involved in the cases for the Former Officers. Throughout the proceedings, the Company has argued to the IRS that it is the Former Officers who are directly and principally liable for the amount of any tax due, and not the Company.
The Former Officers cases were scheduled for trial in Tax Court on March 9, 2020. The trial of the cases was continued by the Court on February 4, 2020. The basis for the continuance was that the IRS and the Former Officers had made progress toward a settlement of the valuation issue involving the grants of the restricted stock. The outcome of these settlement negotiations will be relevant to the Company’s case. The Company is closely monitoring the settlement discussions between the IRS and the Former Officers. The Tax Court has ordered the Former Officers to file status reports regarding progress of their settlement negotiations with the IRS on or before October 22, 2020.February 28, 2021. The IRS and the Former Officers filed status reports with the Tax Court on February 26, 2021. After receiving the status reports, the Tax Court issued an order directing the parties to file further status reports on or before July 9, 2021. The Tax Court has not set a trial dates in the cases of the Former Officers.
Due
On June 2, 2021, the IRS confirmed to the uncertainty associated with determining our liabilityCompany that the statutes of limitations for the asserted taxesassessment and penalties, ifcollection of employment tax and corporation income tax against the Company expired on December 15, 2020, without any assessments of tax or penalties. The IRS has told the Company that the employment tax and to our inability to ascertaincorporation income tax cases against the Company have been closed with any reasonable degree of likelihood, as of the date of this report, the outcome of the IRS appeals process,finality, and that the Company has not recorded an estimateno liability for its potential liability, if any, associated with these taxes.employment tax and corporation income tax for 2014.
On August 22, 2018, Richard Estalella filed an action against the Companyus and two other defendants in the Colorado District Court for the County of Denver, seeking damages arising out of the IRS’s assertion of tax liability and penalties relating to the 2014 restricted stock grants. The Company hasWe have answered Estalella’s complaint, asserted counterclaims against Estalella for his failure to ensure that all withholding taxes were paid in connection with the 2014 restricted stock grants, and filed cross-claims against atwo valuation firmfirms named in the action (as well as their principals) for failing to properly value the 2014 restricted stock grants for tax purposes. TheTrial in the matter has been scheduled for February 7, 2022. There are no amounts accrued related to this matter and the Company on the other hand, is relying on a separate valuation report prepared by a different valuation firm in its defense to the IRS case. This new valuation firm supports the Company’s position. The Company is waiting on the next steps from the court and will continue to vigorously litigate the matter.
4Excelsior Matter
On March 18, 2019, 4Excelsior, a manufacturer of MusclePharm products, filed an action against MusclePharm in the Superior Court of the State of California for the County of Los Angeles, claiming approximately $6.2 million in damages relating to allegedly unpaid invoices, as well as approximately $7.8 million in consequential damages. On January 27, 2020, MusclePharm filed a counterclaim against 4Excelsior seeking unidentified damages relating to, among other things, 4Excelsior’s failure to fulfill a purchase order. MusclePharm also moved to strike 4Excelsior’s consequential damages on the grounds that they are unrecoverable under the Uniform Commercial Code. The court denied that motion, and the action has proceeded to discovery. The Company had a liability of $5.7 million and $5.3 million as of September 30, 2020 and December 31, 2019, respectively. This liability, which represents past due invoices (May 2018 through March 2019) plus interest, is recorded in “Accounts Payable” in the consolidated balance sheets. Trial has not yet been set, although a Trial Setting Conference was set for December 17, 2020.
On November 16, 2020, the Company and 4Excelsior entered into a stipulation of settlement that provided that the Company would pay to 4Excelsior a total of $4,750,000, in four monthly payments of $70,000, beginning January 5, 2021, and thereafter in monthly payments of $100,000. The parties have not yet entered into a settlement agreement giving effect to the stipulation of settlement.
Note 9. Stockholders’ Deficit
Common Stock
The fair value of all stock issuances is based upon the quoted closing trading price on the date of issuance. Common stock outstanding as of September 30, 2020 includes shares legally outstanding, even if subject to future vesting. For the nine months ended September 30, 2020, the Company had the following transactions related to its common stock, including restricted stock awards (in thousands, except share and per share data):
| Transaction Type | Quantity (Shares) | Valuation | Range of Value per Share | |||||||||
| Stock issued for advertising services | 129,627 | $ | 117 | $ | 0.90 | |||||||
| Total | 129,627 | $ | 117 | $ | 0.90 | |||||||
For the nine months ended September 30, 2019, the Company had the following transactions related to its common stock including restricted stock awards (in thousands, except share and per share data):
| Transaction Type | Quantity (Shares) | Valuation ($) | Range of Value per Share | |||||||||
| Stock issued for note conversion | 16,216,216 | $ | 18,000 | $ | 1.11 | |||||||
| Stock issued for consulting services | 22,222 | 10 | 0.45 | |||||||||
| Stock issued in relation to Biozone settlement | 150,000 | 60 | 0.40 | |||||||||
| Restricted stock issued to directors | 595,238 | 250 | 0.42 | |||||||||
| Stock issued for advertising services | 647,957 | 583 | 0.90 | |||||||||
| Total | 17,631,633 | $ | 18,903 | $ | 0.40 to 1.11 | |||||||
The fair value of all stock issuances above is based upon the quoted closing trading price on the date of issuance. Common stock outstanding as of September 30, 2020 and December 31, 2019 includes shares legally outstanding even if subject to future vesting.
Warrants
For the nine months ended September 30, 2020 and 2019, the Company did not issue any warrants. As of both September 30, 2020 and 2019, the Company had outstanding warrants of 1,289,378 shares.
Treasury Stock
For the nine months ended September 30, 2020 and 2019, the Company did not repurchase any shares of its common stock and held 875,621 shares in treasury as of both September 30, 2020 and 2019.
Restricted Stock
The Company’s stock-based compensation forFor the ninethree and six months ended SeptemberJune 30, 2020 and 2019 consist primarily of2021, the Company granted restricted stock awards. The activityfair value of this grant is approximately $29,000, which is being expensed on a straight-line basis over two years.
There were restricted stock awards granted to employees, executives and Board members during the ninethree months and six months ended SeptemberJune 30, 2020 was as follows:2020.
| Unvested Restricted Stock Awards | ||||||||
Number of Shares | Weighted Average Grant Date Fair Value | |||||||
| Unvested balance – December 31, 2019 | 690,132 | $ | 0.42 | |||||
| Granted | — | — | ||||||
| Vested | (568,280 | ) | 0.42 | |||||
| Forfeited | (121,852 | ) | 0.42 | |||||
| Unvested balance – September 30, 2020 | — | — | ||||||
There were no restricted stock awards granted for bothFor the three and ninesix months ended SeptemberJune 30, 2020. The2021, the Company issued 595,238 sharesrecorded $ million of stock-based compensation expense related to restricted stock to its Board members for bothstock.
For the three and ninesix months ended SeptemberJune 30, 2019.2020, the Company recorded $ and $ million, respectively, of stock-based compensation expense related to restricted stock.
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Transaction Equity Bonus
On April 5, 2021, with the appointment of the Company’s President and Chief Financial Officer, the Company granted an award where upon the occurrence of a sale of the Company, the President and Chief Financial Officer will receive 2% of the fully diluted equity of the Company. The totalgrant will vest upon the one-year anniversary and if a sale transaction has not occurred by the two-year anniversary, then the President and Chief Financial Officer shall have the option to convert the transaction equity bonus into common shares. The fair value of restricted stock awards granted to the Board for boththis grant is approximately $ million, which is being expensed on a straight-line basis over one-year.
For the three and ninesix months ended SeptemberJune 30, 2019 was $0.3 million.2021, the Company recorded $ million of stock-based compensation expense related to transaction awards.
As of SeptemberFor the three and six months ended June 30, 2020, there was no unrecognizedthe Company recorded expense for unvested restricted stockrelated to transaction awards.
Stock Options
TheOn May 12, 2021, the Company may grant optionsentered into an Agreement (the “Agreement”) with Joseph Cannata (“Cannata”), pursuant to which the Company has engaged Cannata on a non-exclusive basis to assist with the growth of the Company’s energy beverage product line.
In connection with entry into the Agreement, the Company issued to Cannata an option to purchase shares of the Company’s common stock at a price per share of $. The option has an exercise term of years (subject to potential acceleration upon a sale of the Company) and will vest in two equal tranches upon the achievement of certain employees and directors pursuantnet revenue milestones related to the 2015 Incentive Compensation Plan (the “2015 Plan”). UnderCompany’s energy beverage products with the 2015 Plan, all stock options are granted with an exercise price equaldetermination in the second quarter of 2021 that it is probable the performance criteria related to or greater than the grants will be achieved. The estimated fair market value of a share of the Company’s common stock on the date of grant. Vestingthis grant is generally$ million and was determined by using the Compensation CommitteeBlack-Scholes valuation model with a term of years; annual volatility rate of ; discount rate of ; and for dividend rate. The fair value of performance-based restricted stock awards are recognized over the Board within limits set forthderived requisite vesting period beginning in the 2015 Plan. No stock option will be exercisable more than ten years after the date it is granted.period in which they are deemed probable to vest.
Stock Options Summary Table
The following table describes the total options outstanding, granted, exercised, expired and forfeited as of and during the nine months ended September 30, 2020. Shares obtained from the exercise of our options are subject to various trading restrictions.
| Options Pursuant to the 2015 Plan | Weighted Average Exercise Price Per Share | Weighted Average Fair Value of Options | Weighted Average Remaining Contractual Life (Years) | Aggregate Intrinsic Value | ||||||||||||||||
| Issued and outstanding as of December 31, 2019 | 171,703 | $ | 1.89 | $ | 1.72 | 6.17 | — | |||||||||||||
| Granted | — | — | — | — | — | |||||||||||||||
| Exercised | — | — | — | — | — | |||||||||||||||
| Forfeited | — | — | — | — | — | |||||||||||||||
| Issued and outstanding as of September 30, 2020 | 171,703 | 1.89 | 1.72 | 5.39 | — | |||||||||||||||
| Exercisable as of September 30, 2020 | 171,703 | 1.89 | 1.72 | 5.39 | — | |||||||||||||||
For the three and ninesix months ended SeptemberJune 30, 2020 and 2019,2021, the Company recorded no stockapproximately $ of stock-based compensation expense related to stock options.
For the three and six months ended June 30, 2020, the Company recorded expense related to stock options.
Basic net income (loss)loss per share is computed by dividing net income (loss)loss for the period by the weighted average number of shares of common stock outstanding during each period.
Schedule of Basic and Diluted Net Income (loss) Per Share
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||
| 2021 | 2020 | 2021 | 2020 | |||||||||||||
| Net loss | $ | (2,251 | ) | $ | (253 | ) | $ | (2,157 | ) | $ | (313 | ) | ||||
| Weighted average common shares used in computing net loss per share, basic and diluted | 33,386,200 | 32,764,553 | 33,131,087 | 32,612,956 | ||||||||||||
| Net loss per share, basic and diluted | $ | (0.07 | ) | $ | (0.01 | ) | $ | (0.07 | ) | $ | (0.01 | ) | ||||
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For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||||||
| 2020 | 2019 | 2020 | 2019 | |||||||||||||
| Net income (loss) | $ | 678 | $ | (5,079 | ) | $ | 365 | $ | (15,468 | ) | ||||||
| Weighted average common shares used in computing net income (loss) per share, basic | 33,008,189 | 18,527,438 | 32,746,147 | 16,443,945 | ||||||||||||
| Potentially diluted securities | 16,089,406 | — | 16,089,406 | — | ||||||||||||
| Weighted average common shares used in computing net income (loss) per share, diluted | 49,097,595 | 18,527,438 | 48,835,553 | 16,443,945 | ||||||||||||
| Net income (loss) per share, basic | $ | 0.02 | $ | (0.27 | ) | $ | 0.01 | $ | (0.94 | ) | ||||||
| Net income (loss) per share, diluted | $ | 0.01 | $ | (0.27 | ) | $ | 0.01 | $ | (0.94 | ) | ||||||
Diluted net income (loss)loss per share is computed by dividing net income (loss)loss for the period by the weighted average number of shares of common stock, common stock equivalents and potentially dilutive securities outstanding during each period. The Company uses the treasury stock method to determine whether there is a dilutive effect of outstanding potentially dilutive securities, and the if-converted method to assess the dilutive effect of the convertible notes.
The Company reported a net income for the three and nine months ended September 30, 2020. The 2020 Refinanced Convertible Note issued to Mr. Drexler was assumed to have been converted on the effective date of July 1, 2020, at a conversion price of $0.17. The resulting shares of 16,089,406, which represented potentially dilutive securities was included in the computations for the diluted net income per share for the three and nine months ended September 30, 2020.
There was no dilutive effect for the outstanding awards for the three and ninesix months ended SeptemberJune 30, 2019,2021 and 2020, as the Company reported a net loss for both periods. The followingall periods presented. However, if the Company had net income for the three and six months ended June 30, 2021, the potentially dilutive securities included in earnings per share computation would have been . If the Company had net income for the three and six months ended June 30, 2020, the potentially dilutive securities included in earnings per share computation would have been .
Schedule of the securities would be anti-dilutive:Outstanding Potentially Dilutive Securities
| As of June 30, | ||||||||
| 2021 | 2020 | |||||||
| Stock options | 171,703 | 171,703 | ||||||
| Warrants | — | 1,289,378 | ||||||
| Unvested restricted stock | — | 270,660 | ||||||
| Convertible notes | 12,373,071 | 931,974 | ||||||
| Total common stock equivalents | 12,544,774 | 2,663,715 | ||||||
| As of September 30, | ||||||||
| 2020 | 2019 | |||||||
| Stock options | 171,703 | 171,703 | ||||||
| Warrants | 1,289,378 | 1,289,378 | ||||||
| Unvested restricted stock | — | 595,238 | ||||||
| 2017 Refinanced Convertible notes | — | 931,974 | ||||||
| Total common stock equivalents | 1,461,081 | 2,988,293 | ||||||
Note 12. Income Taxes
The Company recorded a tax expenseprovision of $20,000 $7,000and tax income of $53,000 $22,000 for the three months ended SeptemberJune 30, 20202021 and 2019,2020, respectively, and $64,000 $7,000and $89,000 $44,000for the ninesix months ended SeptemberJune 30, 2021 and 2020, and 2019, respectively.
Income taxes are provided for the tax effects of transactions reported in the consolidated financial statements and consist of taxes currently due. Deferred taxes relate to differences between the basis of assets and liabilities for financial and income tax reporting which will be either taxable or deductible when the assets or liabilities are recovered or settled. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred income tax assets will not be realized. The ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible.
Management considers the scheduled reversal of deferred income tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based on consideration of these items, management has establisheddetermined that enough uncertainty exists relative to the realization of the deferred income tax asset balances to warrant the application of a full valuation allowance as it is more likely than not that the tax benefits will not be realized as of SeptemberJune 30, 2020.2021.
Utilization of net operating losses and R&D credits may be limited due to potential ownership changes under Section 382 of the IRS Code. The Company will undergo a review of its net operating losses in connection with the conversion of Mr. Drexler’s convertible note in September 2019. It is anticipated that a majority of the net operating losses carry-forwards will be utilized as a result of the conversion. These net operating loss carry-forwards and federal R&D credits have expiration dates starting in 2025 through 2037.
Note 13. Segments, Geographical Information
The Company’s chief operating decision maker reviews financial information presented on a consolidated basis for purposes of allocating resources and evaluating financial performance. As such, the Company currently has a single reporting segment and operating unit structure. In addition, substantially all long-lived assets are attributable to operations in the U.S. for both periods presented.
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Revenue, net by geography is based on the Companycompany addresses of the customers. The following table sets forth revenue, net by geographic area (in thousands):
Schedule of Revenue, Net by Geographic Area
| For the Three Months Ended September 30, | For the Nine Months Ended September 30, | For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||||||||||||||||
| 2020 | 2019 | 2020 | 2019 | 2021 | 2020 | 2021 | 2020 | |||||||||||||||||||||||||
| Revenue, net: | ||||||||||||||||||||||||||||||||
| United States | $ | 10,072 | $ | 15,632 | $ | 35,433 | $ | 44,798 | $ | 9,050 | $ | 13,514 | $ | 18,562 | $ | 25,361 | ||||||||||||||||
| International | 6,013 | 5,543 | 13,876 | 17,451 | 5,858 | 3,479 | 9,467 | 7,863 | ||||||||||||||||||||||||
| Total revenue, net | $ | 16,085 | $ | 21,175 | $ | 49,309 | $ | 62,249 | $ | 14,908 | $ | 16,993 | $ | 28,029 | $ | 33,224 | ||||||||||||||||
The MusclePharm brands are marketed across major global retail distribution channels. Below is a table of revenue, net by our major distribution channel (in thousands):
Schedule of Revenue, Net by Major Distribution Channel
| For the Three Months Ended June 30, | ||||||||||||||||
| 2021 | % of Total | 2020 | % of Total | |||||||||||||
| Distribution Channel | ||||||||||||||||
| Specialty | $ | 9,983 | 67 | % | $ | 8,933 | 53 | % | ||||||||
| International | 1,775 | 12 | % | 3,479 | 20 | % | ||||||||||
| FDM | 3,150 | 21 | % | 4,581 | 27 | % | ||||||||||
| Total | $ | 14,908 | 100 | % | $ | 16,993 | 100 | % | ||||||||
| For the Six Months Ended June 30, | ||||||||||||||||
| 2021 | % of Total | 2020 | % of Total | |||||||||||||
| Distribution Channel | ||||||||||||||||
| Specialty | $ | 17,055 | 61 | % | $ | 16,969 | 51 | % | ||||||||
| International | 6,148 | 22 | % | 7,863 | 24 | % | ||||||||||
| FDM | 4,826 | 17 | % | 8,392 | 25 | % | ||||||||||
| Total | $ | 28,029 | 100 | % | $ | 33,224 | 100 | % | ||||||||
Note 14. Subsequent Events
GAAP requires an entityRelated-Party Refinanced Convertible Note
On August 13, 2021 the Company and Ryan Drexler agreed to disclose events that occur afterextend the balance sheet date but before financial statements are issued or are available to be issued (“subsequent events”) as well as the dateNovember 2020 Convertible Note through which an entity has evaluated subsequent events. There are two types of subsequent events.July 14, 2022. The first type consists of events or transactions that provide additional evidence about conditions that existed at the dateamendment did not change any terms of the balance sheet, includingagreement other than 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”).maturity date.
Related Party Secured Revolving Promissory Note
On October 15, 2020,August 13, 2021, the Company entered intoissued to Ryan Drexler (the “Holder”) a convertible secured revolving promissory note (the “Revolving“August 2021 Convertible Note”) with Ryan Drexler,in the Chief Executive Officer, President and Chairmanoriginal principal amount of the Board of Directors of the Company. Under the terms of the Revolving Note, the Company can borrow up to $3.0 million. $2,457,549.
The RevolvingAugust 2021 Convertible Note bears interest at the rate of 12% per annum. The useInterest payments are due on the last day of fundseach calendar 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 August 2021 Convertible Note or by converting such interest amount into an equivalent amount of the Company’s common stock, $ par value per share (the “Common Stock”). Any interest not paid when due shall be capitalized and added to the principal amount of the August 2021 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 any accrued but unpaid interest under the August 2021 Convertible Note will be used fordue on July 14, 2022, unless converted or repaid earlier.
The Holder may, at any time, and from time to time, upon written notice to the purchase of whey protein and other general corporate purposes. BothCompany, convert the outstanding principal if any, and all accrued interest underinto shares of Common Stock, at a conversion price equal to the Revolving Note are dueclosing price of the common stock on March 31,October 15, 2021. The Company may prepay the RevolvingAugust 2021 Convertible Note by giving Mr. Drexler one the Holder between 15 and 60 days’ advance written notice. notice depending upon the specific circumstances, subject to the Holder’s conversion right.
The RevolvingAugust 2021 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, Mr. Drexler is entitledat the option of the Holder and upon written notice to accelerate the entire indebtednessCompany, or automatically under the Revolving Note.certain circumstances, all outstanding principal and accrued interest will become due and payable. The RevolvingAugust 2021 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 RevolvingAugust 2021 Convertible Note. The RevolvingAugust 2021 Convertible Note is subordinated to certain other indebtedness of the Company held byCompany.
Secured Borrowing Arrangement
On July 26, 2021, Prestige and Crossroads. In connection with the Revolving Note,advanced the Company $1 million with a six month term and Mr. Drexler entered into a fifth amended and restated security agreement dated October 15, 2020 (the “Security Agreement”) pursuant15% interest rate. In addition, there was an accommodation fee equal to which the Revolving Note is secured by all1% of the assets and properties of the Company and its subsidiaries whether tangible or intangible.amount advanced plus stock options.
There are no events subsequent to September 30, 2020 that have not been described in the accompanying footnotes.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q (the “Form 10-Q”), and with our audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 20192020 (the “2019“2020 Form 10-K”), as filed with the Securities and Exchange Commission on August 25, 2020.March 29, 2021. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below and those discussed in the section entitled “Risk Factors” included elsewhere in this Form 10-Q. Except as otherwise indicated herein, the terms “MusclePharm,” “Company,” “we,” “our” and “us” refer to MusclePharm Corporation and its subsidiaries.
Overview
The CompanyMusclePharm is a scientifically-driven, performance lifestyle company that develops, manufactures, markets and distributes branded sports nutrition products and nutritional supplements that are manufactured by the Company’s co-manufacturers. The Company offerssupplements. We offer a broad range of performance powders, barscapsules, tablets, gels and capsules, which seekon-the-go ready to help athleteseat snacks that satisfy the needs of all types achieve a heightened level of performanceenthusiasts and satisfaction.professionals alike. Our portfolio consists of sports nutrition staples, such as protein powdersrecognized brands, MusclePharm and bars, and pre-workout powders, as well as well-known supplements like creatine, BCAA, fish oil, a multi-vitamin and more. These products fall under the globally-recognized brands, MusclePharm® and FitMiss®, which areFitMiss, is marketed and sold globally. Our corporate headquarters are located in Calabasas, CA.more than 100 countries globally.
Our offerings are clinically developed through a six-stage research process, and all of our manufactured products are rigorously vetted for banned substances by the leading quality assurance program, Informed-Choice. While we initially drove growth in the Specialty retail channel, in recent years we have expanded our focus to drive sales and retailer growth across leading e-commerce, Food Drug & Mass (“FDM”), and Club retail channels. Our primary distribution channels including Amazon, Costco, Kroger, Walgreens, 7-Eleven,are Specialty, International and many others.FDM.
COVID-19
Our results of operations arehave been affected by economic conditions, including macroeconomic conditions and levels of business confidence. There continues to be significant volatility and economic uncertainty in many markets and the ongoing COVID-19 pandemic has increased that level of volatility and uncertainty and has created economic disruption. Beginning in April 2020, the Company began to experience a slowdown, which has continued to date, in sales from its retail customers, including its largest customer. This decline has been partially offset by a growth in sales to our largest online customer, although there can be no assurances that such growth will continue, or that the Company will have the financial resources to produce the additional quantities required by this customer. We are actively managing our business to respond to the impact.
As COVID-19 infections have been reported throughout the United States, certain federal, state and local governmental authorities have issued stay-at-home orders, proclamations and/or directives aimed at minimizing the spread of the infection. Additionally, more restrictive proclamations and/or directives may be issued in the future.
The ultimate impact of the COVID-19 pandemic on the Company’s operations is unknown and will depend on future developments, which are highly uncertain and cannot be predicted with confidence, including the duration of the COVID-19 outbreak, new information which may emerge concerning the severity of the COVID-19 pandemic, and any additional preventative and protective actions that governments, or the Company, may direct, which may result in an extended period of continued business disruption, reduced customer traffic and reduced operations. Any resulting financial impact cannot be reasonably estimated at this time but may have a material impact on our business, financial condition and results of operations.
While revenue, net is down for 2020 compared to 2019, there are multiple factors contributing to this decline. Our revenue for 2020 is down primarily as a result of a reduction in promotional discounts, resulting in lower sales volume with certain customers, and to a lesser degree, due to the impact of COVID-19, resulting in a decline in our Specialty, International, and Food, Drug, and Mass (“FDM”) sales. Management continues to monitor the business environment for any significant changes that could impact the Company’s operations. The Company has taken proactive steps to manage costs and discretionary spending, such as remote working and reducing facility related expense.
Results of Operations
Comparison of the Three Months Ended SeptemberJune 30, 20202021 to the Three Months Ended SeptemberJune 30, 20192020 ($ in thousands):
| ($ in thousands) | Three Months Ended September 30 | |||||||||||||||||||||||||||||||
| 2020 | 2019 | $ Change | % Change | For the Three Months Ended June 30, | ||||||||||||||||||||||||||||
| 2021 | 2020 | $ Change | % Change | |||||||||||||||||||||||||||||
| Revenue, net | $ | 16,085 | $ | 21,175 | $ | (5,090 | ) | (24 | )% | $ | 14,908 | $ | 16,993 | $ | (2,085 | ) | (12 | )% | ||||||||||||||
| Cost of revenue | 11,073 | 19,649 | (8,576 | ) | (44 | ) | 12,728 | 12,009 | 719 | 6 | ||||||||||||||||||||||
| Gross profit | 5,012 | 1,526 | 3,486 | 228 | 2,180 | 4,984 | (2,804 | ) | (56 | ) | ||||||||||||||||||||||
| Operating expenses: | ||||||||||||||||||||||||||||||||
| Advertising and promotion | 49 | 574 | (525 | ) | (91 | ) | 145 | 188 | (43 | ) | (23 | ) | ||||||||||||||||||||
| Salaries and benefits | 1,538 | 2,070 | (532 | ) | (26 | ) | 1,181 | 1,774 | (593 | ) | (33 | ) | ||||||||||||||||||||
| Selling, general and administrative | 1,737 | 2,127 | (390 | ) | (18 | ) | 2,115 | 1,807 | 306 | 17 | ||||||||||||||||||||||
| Professional fees | 885 | 842 | 43 | 5 | 482 | 865 | (383 | ) | (44 | ) | ||||||||||||||||||||||
| Impairment of operating lease right-of-use assets | 167 | — | 167 | 100 | ||||||||||||||||||||||||||||
| Total operating expenses | 4,376 | 5,613 | (1,237 | ) | (22 | ) | 3,923 | 4,634 | (713 | ) | (15 | ) | ||||||||||||||||||||
| Income (loss) from operations | 636 | (4,087 | ) | 4,723 | (116 | ) | ||||||||||||||||||||||||||
| Other income (expense): | ||||||||||||||||||||||||||||||||
| Loss on settlement obligation | — | (16 | ) | 16 | (100 | ) | ||||||||||||||||||||||||||
| Gain on settlement of payables | 518 | — | 518 | 100 | ||||||||||||||||||||||||||||
| Income from operations | (1,743 | ) | 350 | (2,091 | ) | (597 | ) | |||||||||||||||||||||||||
| Other expense: | ||||||||||||||||||||||||||||||||
| Interest and other expense, net | (456 | ) | (923 | ) | 467 | (51 | ) | (501 | ) | (581 | ) | 80 | (14 | ) | ||||||||||||||||||
| Income (loss) before provision for income taxes | 698 | (5,026 | ) | 5,723 | (114 | ) | (2,244 | ) | (231 | ) | (2,011 | ) | (871 | ) | ||||||||||||||||||
| Provision for income taxes | 20 | 53 | (33 | ) | (62 | ) | 7 | 22 | (15 | ) | (68 | ) | ||||||||||||||||||||
| Net income (loss) | $ | 678 | $ | (5,079 | ) | $ | 5,757 | (113 | )% | $ | (2,251 | ) | $ | (253 | ) | $ | (1,996 | ) | (789 | )% | ||||||||||||
Comparison of the NineSix Months Ended SeptemberJune 30, 2021 to the Six Months Ended June 30, 2020 to the Nine Months Ended September 30, 2019($ in thousands):
Nine Months Ended September 30 | For the Six Months Ended June 30, | |||||||||||||||||||||||||||||||
| ($ in thousands) | 2020 | 2019 | $ Change | % Change | ||||||||||||||||||||||||||||
| 2021 | 2020 | $ Change | % Change | |||||||||||||||||||||||||||||
| Revenue, net | $ | 49,309 | $ | 62,249 | $ | (12,940 | ) | (21 | )% | $ | 28,029 | $ | 33,224 | $ | (5,195 | ) | (16 | )% | ||||||||||||||
| Cost of revenue | 34,504 | 56,077 | (21,573 | ) | (38 | ) | 22,160 | 23,431 | (1,271 | ) | (5 | ) | ||||||||||||||||||||
| Gross profit | 14,805 | 6,172 | 8,633 | 140 | 5,869 | 9,793 | (3,924 | ) | (40 | ) | ||||||||||||||||||||||
| Operating expenses: | ||||||||||||||||||||||||||||||||
| Advertising and promotion | 362 | 2,134 | (1,772 | ) | (83 | ) | 489 | 313 | 176 | 56 | ||||||||||||||||||||||
| Salaries and benefits | 4,993 | 5,844 | (851 | ) | (15 | ) | 2,229 | 3,455 | (1,226 | ) | (35 | ) | ||||||||||||||||||||
| Selling, general and administrative | 5,455 | 7,658 | (2,203 | ) | (29 | ) | 3,512 | 3,718 | (208) | (6 | ) | |||||||||||||||||||||
| Professional fees | 2,291 | 2,783 | (492 | ) | (18 | ) | 1,109 | 1,406 | (297 | ) | (21 | ) | ||||||||||||||||||||
| Impairment of operating lease right-of-use asset | 167 | — | 167 | 100 | ||||||||||||||||||||||||||||
| Total operating expenses | 13,268 | 18,419 | (5,151 | ) | (28 | ) | 7,339 | 8,892 | (1,555 | ) | (21 | ) | ||||||||||||||||||||
| Income (loss) from operations | 1,537 | (12,247 | ) | 13,784 | (113 | ) | ||||||||||||||||||||||||||
| Other income (expense): | ||||||||||||||||||||||||||||||||
| Loss on settlement obligation | (87 | ) | (125 | ) | 38 | (30 | ) | |||||||||||||||||||||||||
| Gain on settlement of payables | 518 | — | 518 | 100 | ||||||||||||||||||||||||||||
| Income from operations | (1,470 | ) | 901 | (2,369 | ) | (263 | ) | |||||||||||||||||||||||||
| Other expense: | ||||||||||||||||||||||||||||||||
| Interest and other expense, net | (1,539 | ) | (3,007 | ) | 1,468 | (49 | ) | (680 | ) | (1,170 | ) | 490 | (42 | ) | ||||||||||||||||||
| Income (loss) before provision for income taxes | 429 | (15,379 | ) | 15,808 | (103 | ) | (2,148 | ) | (269 | ) | (1,879 | ) | (699 | ) | ||||||||||||||||||
| Provision for income taxes | 64 | 89 | (25 | ) | (28 | ) | 7 | 44 | (37 | ) | (84 | ) | ||||||||||||||||||||
| Net income (loss) | $ | 365 | $ | (15,468 | ) | $ | 15,833 | (102 | )% | $ | (2,157 | ) | $ | (313 | ) | $ | (1,842 | ) | (588 | )% | ||||||||||||
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, | For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||||||||||||||||
| 2020 | 2019 | 2020 | 2019 | 2021 | 2020 | 2021 | 2020 | |||||||||||||||||||||||||
| Revenue, net | 100 | % | 100 | % | 100 | % | 100 | % | 100 | % | 100 | % | 100 | % | 100 | % | ||||||||||||||||
| Cost of revenue | 69 | 93 | 70 | 90 | 85 | 71 | 79 | 71 | ||||||||||||||||||||||||
| Gross profit | 31 | 7 | 30 | 10 | 15 | 29 | 21 | 29 | ||||||||||||||||||||||||
| Operating expenses: | ||||||||||||||||||||||||||||||||
| Advertising and promotion | — | 3 | 1 | 3 | 1 | 1 | 2 | 1 | ||||||||||||||||||||||||
| Salaries and benefits | 10 | 10 | 10 | 9 | 8 | 10 | 8 | 10 | ||||||||||||||||||||||||
| Selling, general and administrative | 11 | 10 | 11 | 12 | 14 | 11 | 13 | 11 | ||||||||||||||||||||||||
| Professional fees | 5 | 4 | 5 | 4 | 3 | 5 | 4 | 4 | ||||||||||||||||||||||||
| Impairment of operating lease right-of-use asset | 1 | — | — | — | ||||||||||||||||||||||||||||
| Total operating expenses | 27 | 27 | 27 | 28 | 26 | 27 | 26 | 26 | ||||||||||||||||||||||||
| Income (loss) from operations | 4 | (20 | ) | 3 | (18 | ) | ||||||||||||||||||||||||||
| Gain (loss) from operations | (12 | ) | 2 | (5 | ) | 3 | ||||||||||||||||||||||||||
| Other income (expense): | ||||||||||||||||||||||||||||||||
| Loss on settlement obligation | — | (1 | ) | — | — | |||||||||||||||||||||||||||
| Gain on settlement of payables | 3 | — | 1 | — | ||||||||||||||||||||||||||||
| Interest and other expense, net | (3 | ) | (2 | ) | (3 | ) | (5 | ) | (3 | ) | (3 | ) | (2 | ) | (4 | ) | ||||||||||||||||
| Income (loss) before provision for income taxes | 4 | (23 | ) | 1 | (23 | ) | ||||||||||||||||||||||||||
| Loss before provision for income taxes | (15 | ) | (1 | ) | (8 | ) | (1 | ) | ||||||||||||||||||||||||
| Provision for income taxes | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||
| Net income (loss) | 4 | (23 | )% | 1 | (23 | )% | ||||||||||||||||||||||||||
| Net loss | (15 | )% | (1 | )% | (8 | )% | (1 | )% | ||||||||||||||||||||||||
Revenue, net
We derive our revenue through the sales of our various branded nutritional supplements. Revenue is recognized when control of a promised good is transferred to a customer in an amount that reflects the consideration that the Company expects to be entitled to in exchange for that good. This usually occurs when finished goods are delivered to the Company’s customers or when finished goods are picked up by a customer or a customer’s carrier.
The MusclePharm brands are marketed across major global retail distribution channels. Below is a table of revenue, net by our major distribution channel:channel (in thousands):
| For the Three Months Ended September 30, | For the Three Months Ended June 30, | |||||||||||||||||||||||||||||||
| 2020 | % of Total | 2019 | % of Total | 2021 | % of Total | 2020 | % of Total | |||||||||||||||||||||||||
| Distribution Channel | ||||||||||||||||||||||||||||||||
| Specialty | $ | 4,770 | 30 | % | $ | 9,655 | 45 | % | $ | 9,983 | 67 | % | $ | 8,933 | 53 | % | ||||||||||||||||
| International | 6,013 | 37 | % | 5,543 | 27 | % | 1,775 | 12 | % | 3,479 | 20 | % | ||||||||||||||||||||
| FDM | 5,302 | 33 | % | 5,925 | 28 | % | 3,150 | 21 | % | 4,581 | 27 | % | ||||||||||||||||||||
| Total | $ | 16,085 | 100 | % | $ | 21,175 | 100 | % | $ | 14,908 | 100 | % | $ | 16,993 | 100 | % | ||||||||||||||||
| For the Six Months Ended June 30, | ||||||||||||||||
| 2021 | % of Total | 2020 | % of Total | |||||||||||||
| Distribution Channel | ||||||||||||||||
| Specialty | $ | 17,055 | 61 | % | $ | 16,969 | 51 | % | ||||||||
| International | 6,148 | 22 | % | 7,863 | 24 | % | ||||||||||
| FDM | 4,826 | 17 | % | 8,392 | 25 | % | ||||||||||
| Total | $ | 28,029 | 100 | % | $ | 33,224 | 100 | % | ||||||||
| For the Nine Months Ended September 30, | ||||||||||||||||
| 2020 | % of Total | 2019 | % of Total | |||||||||||||
| Distribution Channel | ||||||||||||||||
| Specialty | $ | 21,739 | 44 | % | $ | 27,966 | 45 | % | ||||||||
| International | 13,876 | 28 | % | 17,451 | 28 | % | ||||||||||
| FDM | 13,694 | 28 | % | 16,832 | 27 | % | ||||||||||
| Total | $ | 49,309 | 100 | % | $ | 62,249 | 100 | % | ||||||||
Revenue, net reflects the transaction prices for contracts, which includes products shipped at selling list prices reduced by variable consideration. We record sales incentives as a direct reduction of revenue for various discounts provided to our customers consisting primarily of volume incentive rebates and promotional related credits. We accrue for sales discounts over the period they are earned. Sales discounts are a significant part of our marketing plan to our customers as they help drive increased sales and brand awareness with end users through promotions that we support through our distributors and re-sellers.
| 24 |
ForRevenue, net decreased $2.1 million, or 12%, to $14.9 million for the three months ended SeptemberJune 30, 2020,2021, compared to $17.0 million for the increase in international sales is primarily due to notable sales with Coupang Direct Import (approximately 5% of revenue, net), a customer since March of 2020, which has been experiencing substantial organic growth. For the ninethree months ended SeptemberJune 30, 2020, the reductions in sales from international customers related primarily to lower sales volumes due to a reduction in discounts offered to these customers.
For the three and nine months ended September 30, 2020, the decrease in Specialty is primarily due to lower sales volumes due to a reduction in discounts offered to these customers, in particular iHerb, who represented 18% and 16% of revenue,2020. Revenue, net for the three and nine months ended SeptemberJune 30, 2019, respectively,2021 decreased primarily due to industry wide supply shortages on components and less than 10%protein, which delayed production of our products.
Discounts and sales allowances decreased to 11% of gross revenue, netor $1.9 million, for the same periods in 2020.
For the three months ended SeptemberJune 30, 2020,2021, from 17% of gross revenue, or $3.6 million for the decreasesame period in FDM is primarily2020. The reduction in discounts as a percent of gross revenue was due to a decreasechanges in sales to BJ’s Wholesale Club. During the nine months ended September 30, 2020, the decrease in FDM is primarily due to a decrease in domestic sales to Costco, the result of a reduction incustomer mix and discretionary promotional sales in 2020 as compared to 2019, and the impact of Covid-19, which impacted several Brick-and-Mortar stores. During the nine months ended September 30, 2020, Costco’s net domestic sales decreased $2.1 million, the result of a reduction in promotional discounts of 36% in 2020 as compared to 2019, and the impact of Covid-19. activity.
During the three months ended SeptemberJune 30, 2021 and 2020, and 2019, Costcoour largest customer accounted for approximately 46%55% and 34%43% of our revenue, net, respectively.
Revenue, net decreased $5.2 million, or 16%, to $28.0 million for the six months ended June 30, 2021, compared to $33.2 million for the six months ended June 30, 2020. Revenue, net for the six months ended June 30, 2021 decreased primarily due to industry wide supply shortages on components and protein, which delayed production of our products.
Discounts and sales allowances decreased to 11% of gross revenue, or $4.3 million, for the six months ended June 30, 2021, from 27% of gross revenue, or $7.6 million for the same period in 2020. The reduction in discounts as a percent of gross revenue was due to changes in customer mix and discretionary promotional activity.
During the ninesix months ended SeptemberJune 30, 2021 and 2020, and 2019, Costcoour largest customer accounted for approximately 37%43% and 33% of our revenue, net, respectively.
Revenue, net decreased $5.1 million, or 24%, to $16.1 million for the three months ended September 30, 2020, compared to $21.2 million for the same period in 2019. Revenue, net for the three months ended September 30, 2020 decreased primarily due to reduced domestic sales of $5.6 million, which was partially offset by increased international sales of $0.5 million. Discounts and sales allowances decreased to 20% of gross revenue, or $4.1 million, for the three months ended September 30, 2020 from 25% of gross revenue, or $7.0 million for the same period in 2019. Discounts and sales allowance will fluctuate based on customer mix and changes in discretionary promotional activity.
Revenue, net decreased $12.9 million, or 21%, to $49.3 million for the nine months ended September 30, 2020, compared to $62.2 million for the same period in 2019. Revenue, net for the nine months ended September 30, 2020 decreased due to reduction in our international sales of $3.6 million, together with reduced domestic sales of $9.3 million. Discounts and sales allowances decreased to 19% of gross revenue, or $11.7 million, for the nine months ended September 30, 2020 from 27% of gross revenue, or $22.5 million for the same period in 2019. Discounts and sales allowance will fluctuate based on customer mix and changes in discretionary promotional activity.
We expect that our discounts and allowances will continue to decrease, overall and as a percentage of revenue as we reduce certain discretionary promotional activity. We have not experienced a commensurate increase in revenues as a result of higher discretionary promotional activity.
Cost of Revenue and Gross Profit
Cost of revenue for MusclePharm products is directly related to the production, manufacturing, and freight-in of the related products purchased from third party contract manufacturers. We primarily use contract manufacturers to drop ship products directly to our customers, as well as ship product to our warehouse in Tennessee. The Tennessee warehouse is operated with our equipment and employees, and we own the related inventory.customers.
Our gross profit fluctuates primarily 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.pricing.
Costs of revenue decreased 44%increased 6%, despite the decrease in sales volume, to $11.1$12.7 million for the three months ended SeptemberJune 30, 2020,2021, compared to $19.6$12.0 million for the same period in 2019.2020. This decreaseincrease was due in part, to lower revenues,increased commodity costs, specifically protein, the prices of which have risen significantly year over year, along with gross revenue for the three months ended September 30, 2020 decreasing 28% compared to the same period in 2019. In addition, during the three months ended September 30, 2020, there was a significant decrease in protein prices compared to the prior year period, further contributing to lower costs of revenue.increased freight costs. Gross profit for the three months ended SeptemberJune 30, 2020 increased $3.5 million2021 decreased 15% to $5.0$2.2 million, compared to $1.5$5.0 million for the same period in 2019.2020. Gross profit was 31%15% of revenue, net for the three months ended SeptemberJune 30, 20202021 compared to 7%29% of revenue, net for the same period in 2019. Positively2020. Negatively impacting the gross profit percentage was a decrease of 5% in promotional discounts, as a percentage of revenue, net,were higher commodity prices, specifically for protein and a decrease in protein prices for the three months ended September 30, 2020 compared to the three months ended September 30, 2019, further contributing to the gross profit percentage increase.freight costs.
Costs of revenue decreased 38%5% to $34.5$22.2 million for the ninesix months ended SeptemberJune 30, 2020,2021, compared to $56.1$23.4 million for the same period in 2019.2020. This decrease was due in part, to lower revenues,sales volume along with gross revenue for the nine months ended September 30, 2020 decreasing 28% compared to the same period in 2019. In addition, during the nine months ended September 30, 2020, there was a significant decrease inincreased commodity costs, specifically protein, prices compared to the priorof which have risen significantly year period, further contributing to lower costs of revenue.over year, along with increased freight costs. Gross profit for the ninesix months ended SeptemberJune 30, 2020 increased $8.6 million2021 decreased 21% to $14.8$5.9 million, compared to $6.2$9.8 million for the same period in 2019.2020. Gross profit was 30%21% of revenue, net for the ninesix months ended SeptemberJune 30, 20202021 compared to 10%29% of revenue, net for the same period in 2019. Positively2020. Negatively impacting the gross profit percentage was a decrease of 8% in promotional discounts, as a percentage of revenue, net,were higher commodity, specifically for protein and a decrease in protein prices for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019, further contributing to the gross profit percentage increase.freight costs.
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Operating Expenses
Advertising and Promotion
Our advertising and promotion expenses consistexpense consists primarily of digital,expenses related to club demonstrations, print and mediaonline advertising, athletictrade shows and strategic partnerships with athletes and sports teams. Historically, advertising and promotions were a large part of both our growth strategy and brand awareness, in particular strategic partnerships with sports athletes and fitness enthusiasts through endorsements, licensing, and sponsorships, co-branding agreements. Additionally, we co-developed products with sports athletes and teams. In connection with our restructuring plan, we terminated the majority of these contracts in a strategic shift away from such costly arrangements and moved toward more cost-effective programs, including digital advertising, ambassador programs and sampling/promotional giveaways, in store product demonstrations, broker fees, in store product displays and trade show events.materials.
Advertising and promotion expense decreased 91%23% to $0.05$0.1 million for the three months ended SeptemberJune 30, 2020,2021, or 1% of revenue, net compared to $0.2 million, or 1% of revenue, net for the same period in 2019, when advertising and promotion expense was $0.57 million.2020. The decrease was primarily duefor 2021 is related to reduced other advertising (including reduced club demonstrations and sports marketing), reduced print advertising and reduced giveaways of $0.1 million.decreased marketing expenses.
Advertising and promotion expense decreased 83%increased 56% to $0.4$0.5 million for the ninesix months ended SeptemberJune 30, 2020,2021, or 2% of revenue, net compared to $0.3 million, or 1% of revenue, net for the same period in 2019, when advertising2020. The increase for 2021 is related to increased demonstrations and promotion expense was $2.1 million. The decreasesampling due to the launch of a new flavor for our performance powders with one of our largest customers during the nine months ended September 30, 2019 primarily included a reduction in giveaways, sponsorships, trade shows, print advertising and club demonstrations.first quarter of 2021.
The reductions in both comparative periods were all made in an effort to reduce overall spending as we shift our promotional costs, in part, from general branding and product awareness to acquiring customers and driving sales from existing customers.
Salaries and Benefits
Salaries and benefits consist primarily of salaries, bonuses, benefits, and stock-based compensation. Personnel costs are a significant component of our operating expenses.
ForSalaries and benefits decreased 16% to $1.2 million, or 7% of revenue, net for the three months ended SeptemberJune 30, 2020, salaries and benefits expense decreased 26% to $1.5 million,2021 compared to $2.1$1.8 million, or 10% of revenue, net for the same period in 2019.2020 primarily due to a reduction in headcount as we have focused on reducing operating costs.
ForSalaries and benefits decreased 37% to $2.2 million, or 7% of revenue, net for the ninesix months ended SeptemberJune 30, 2020, salaries and benefits expense decreased 15% to $5.0 million,2021 compared to $5.8$3.5 million, or 10% of revenue, net for the same period in 2019.
For the three and nine months ended September 30, 2020 the reductions were primarily due to a reduction in headcount reductions and termination of higher income employees, such as Mr. Casutto, a former executive.we have focused on reducing operating costs.
Selling, General and Administrative
Our selling, general and administrative expenses consist primarily of freight costs,depreciation and amortization, research and development, 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 theSelling, general and administrative expenses increased 17% to $2.1 million, or 14% of revenue, net for three months ended SeptemberJune 30, 2021, compared to $1.8 million, or 11% of revenue, net for the same period in 2020 selling,primarily due to an increase in bad debt reserves, partially offset by reduction in board member compensation and office expenses associated with closure of headquarters and warehouses.
Selling, general and administrative expenses decreased 18%5% to $1.7$3.5 million, or 13% of revenue, net for six months ended June 30, 2021, compared to $3.7 million, or 11% of revenue, net for the same period in 2019, when selling, general and administrative expenses were $2.1 million. The decrease during the three months ended September 30, 2020 compared to the same period in 2019 were primarily due to lower freight expenses of $0.3 million (due to changesa reduction in carrierboard member compensation and shipping locations and lower revenues), together with lower travel expenses, depreciation, research and development, office expenses associated with closure of headquarters and other general expenses,warehouses, partially offset by increased bad debts, with a combined reduction of $0.1 million. These reductions arean increase in line with the Company’s cost reduction strategy.
For the nine months ended September 30, 2020, selling, general and administrative expenses decreased 29% to $5.5 million, compared to the same period in 2019, when selling, general and administrative expenses were $7.7 million. The decrease during the nine months ended September 30, 2019 compared to the nine months ended September 30, 2019 were primarily due to lower freight expenses of $1.2 million (due to changes in carrier and shipping locations and lower revenues), together with reduced travel expenses, depreciation, research and development, office expenses and other general expenses, offset by increased bad debt with a combined reduction of $1.0 million. These reductions are in line with the Company’s cost reduction strategy.reserves.
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.
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Professional fees decreased 44% to $0.5 million, or 3% of revenue, net for the three months ended June 30, 2021, compared to $0.9 million, or 5% of revenue, net for the same period in 2020 primarily due to the deceased costs in consulting fees.
Professional fees decreased 21% to $1.1 million, or 4% of revenue, net for the six months ended June 30, 2021, compared to $1.4 million, or 4% of revenue, net for the same period in 2020 primarily due to decreased consulting fees.
Interest and other expense, net
For the three months ended SeptemberJune 30, 2021 and 2020, “Interest and 2019, professional fees were relatively flat at $0.9 million and $0.8 million, respectively.other expense, net” consisted of the following (in thousands):
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||
| 2021 | 2020 | 2021 | 2020 | |||||||||||||
| Interest expense, related party | $ | (147 | ) | $ | (76 | ) | $ | (282 | ) | $ | (152 | ) | ||||
| Interest expense, other | (235 | ) | (175 | ) | (443 | ) | (332 | ) | ||||||||
| Interest expense, secured borrowing arrangement | (258 | ) | (383 | ) | (424 | ) | (748 | ) | ||||||||
| Foreign currency transaction loss | 34 | 16 | 32 | (18 | ) | |||||||||||
| Other | 105 | 74 | 438 | 167 | ||||||||||||
| Total interest and other expense, net | $ | (501 | ) | $ | (544 | ) | $ | (679 | ) | $ | (1,083 | ) | ||||
For“Other” includes sublease income.
Net interest and other expense for the ninethree months ended SeptemberJune 30, 2020, professional fees2021 decreased 18% to $2.314%, or $0.1 million, compared to the same period in 2019 when professional fees were $2.8 million.2020. The decrease is primarily related to reduced interest expense for secured borrowing arrangements, partially offset by an increase in interest expense for related party and other debt.
Net interest and other expense for the six months ended June 30, 2021 decreased 42%, or $0.4 million, compared to the same period in 2020. The decrease is primarily due to reduced legal fees of $1.1 million as the Company has made progress on winding down various legal matters. These reduced legal fees have been offset in part by increased accounting fees, resulting from the additional audit and accounting work performed which relate to the restated financial statements filed with the SEC on August 25, 2020.
Interest and other income (expense), net
For the three and nine months ended September 30, 2020 and 2019, “Interest and other income (expense), net” consisted of the following (in thousands):
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||||||
| 2020 | 2019 | 2020 | 2019 | |||||||||||||
| Interest and other expense, net: | ||||||||||||||||
| Interest expense, related party | $ | (76 | ) | $ | (458 | ) | $ | (228 | ) | $ | (1,528 | ) | ||||
| Interest expense, related party debt discount | — | (30 | ) | — | (60 | ) | ||||||||||
| Interest expense, other | (249 | ) | (162 | ) | (581 | ) | (619 | ) | ||||||||
| Interest expense, secured borrowing arrangement | (312 | ) | (335 | ) | (1,060 | ) | (840 | ) | ||||||||
| Foreign currency transaction loss | (2 | ) | (11 | ) | (20 | ) | (224 | ) | ||||||||
| Other | 183 | 73 | 350 | 264 | ||||||||||||
| Total interest and other expense, net | $ | (456 | ) | $ | (923 | ) | $ | (1,539 | ) | $ | (3,007 | ) | ||||
“Other” primarily includes sublease income and gain on disposal of fixed assets.
Net interest and other expense net for the three months ended September 30, 2020 decreased 51%, or $0.5 million, compared to the same period in 2019. The decrease is primarily related to increased other income due to a gain on disposal of fixed assets of $0.1 million, together with lower interest of $0.4 million related to the Refinanced Convertible Note, of which the principal balance of $18.0 million was converted to common stock in September 2019. This decrease wassecured borrowing arrangements, partially offset by increased settlementan increase in interest and factoring and financing fees on the secured borrowing arrangement.
Net interestexpense for related party and other expense, net for the nine months ended September 30, 2020 decreased 49%, or $1.5 million, compared to the same period in 2019. The decrease is primarily related to increased other income due to a gain on disposal of fixed assets of $0.1 million, a decreased foreign currency transaction loss of $0.2 million, and lower interest of $1.2 million related to the Refinanced Convertible Note, of which the principal balance of $18.0 million was converted to common stock in September 2019. This decrease was partially offset by increased factoring and financing fees on the secured borrowing arrangement.debt.
Provision for Income Taxes
Provision for income taxes consists primarily of federal and state income taxes in the U.S. and income taxes in foreign jurisdictions in which we conduct business. Due to uncertainty as to the realization of benefits from our deferred tax assets, including net operating loss carry-forwards, research and development and other tax credits, we have a full valuation allowance reserved against such assets. We expect to maintain this full valuation allowance at least in the near term.
Liquidity and Capital Resources
The Company has incurred significant losses and experienced negative cash flows since inception. As of SeptemberJune 30, 2020,2021, the Company had cash of $1.1$1.0 million, a decline of $0.4$1.0 million from the December 31, 20192020 balance of $1.5$2.0 million. As of SeptemberJune 30, 2020,2021, we had a working capital deficit of $25.4$22.8 million, a stockholders’ deficit of $27.3$26.3 million and an accumulated deficit of $195.5$194.8 million resulting from recurring losses from operations. As a result of our history of losses and financial condition, there is substantial doubt about our ability to continue as a going concern. For financial information concerning more recent periods, see our reports for such periods filed with the SEC.
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The ability to continue as a going concern is dependent upon us generating profitable operations in the future and/or obtaining the necessary financing to meet our obligations and repay our liabilities arising from normal business operations when they come due. Management is evaluating different strategies to obtain financing to fund our expenses and achieve a level of revenue adequate to support our current cost structure. Financing strategies may include, but are not limited to, private placements of capital stock, debt borrowings, partnerships and/or collaborations.
In response toDuring the Company’s continued net loss infourth quarter of 2019, management implemented the following measures to improve gross profit:
formed a pricing committee to review all orders to better align gross profit expectations with product availability.
As a result of these measures, as well as a reduction in protein prices, the Company realized increasedfocused on cost containment and improving gross profitmargins by focusing on customers with higher margins, reducing product discounts and promotional activity, along with reducing the number of SKU’s and negotiate pricing for raw materials. These steps improved gross margins in the fourth quarter of 2019 aand this trend whichhas continued intothrough June 30, 2021. However, with the third quarter ofrecent increases in commodity prices, the company’s gross margins have been impacted and will continue to be impacted unless commodity prices return the same levels that were seen in 2020. Beginning in April
During 2020, the Company experienced a slowdown which has continued to date, in sales from its retail customers, including itsour largest customer. This decline has beencustomer, which was partially offset by a growthan increase in sales tofrom our largest online customers, although therecustomer. In addition, the Company negotiated lower cost of sold with its co-manufactures.
In 2021, the Company announced its entrance into the functional energy space with its partnership with a former Rockstar Energy executive. The Company plans to launch 3 new energy products in the summer of 2021.
The Company believes with the launch of its new energy products, reductions in operating costs and continued focus on gross profit and top line sales growth will allow it to ultimately achieve sustained profitability, however, the Company can begive no assurances that such growththis will continue, or thatoccur. In addition, the cost to launch new energy products along with the recent increase in the cost of protein may have a material impact on the Company’s profitability, as well as the ability of our third-party manufacturers to meet our customers’ demands. Although, the Company believes entering the functional energy space will have the financial resourceshelp to produce the additional quantities required by these customers. In 2020,increase sales and gross margin, and reduce exposure to commodity prices, the Company also negotiated lower costs of goods sold with our co-manufacturers. can give no assurances that this will occur.
Management believes reductions in operating costs and continued focus on gross profit primarily pricing controls and a reduction in product discounts and promotional activity with the Company’s customers, will allow us to ultimately achieve profitability;profitability, however, the Company can give no assurances that this will occur. To manage cash flow, we have entered into numerous financing arrangements outlined in “Note 8. Debt” to the Notes to Consolidated Financial Statements (unaudited) contained herein.
Our net consolidated cash flows are as follows (in thousands):
For the Nine Months Ended September 30, | ||||||||
| 2020 | 2019 | |||||||
| Consolidated Statements of Cash Flows Data: | ||||||||
| Net cash provided by (used in) operating activities | $ | 2,570 | $ | (4,234 | ) | |||
| Net cash provided by (used in) investing activities | 216 | (13 | ) | |||||
| Net cash (used in) provided by financing activities | (3,233 | ) | 3,466 | |||||
| Effect of exchange rate changes on cash | — | 7 | ||||||
| Net change in cash | $ | (447 | ) | $ | (774 | ) | ||
For the Six Months Ended June 30, | ||||||||
| 2021 | 2020 | |||||||
| Consolidated Statements of Cash Flows Data: | ||||||||
| Net cash (used in) provided by operating activities | $ | (899 | ) | $ | 1,191 | |||
| Net cash (used in) provided by investing activities | (3 | ) | 11 | |||||
| Net cash used in financing activities | (85 | ) | (1,521 | ) | ||||
| Net change in cash | $ | (987 | ) | $ | (319 | ) | ||
Operating Activities
Our cash used inprovided by operating activities is driven primarily by sales of our products and vendor provided credit. Our primary uses of cash from operating activities have been for inventory purchases, advertising and promotion expenses, personnel-related expenditures, manufacturing costs, professional fees, costs related to our facilities, and legal fees. Our cash flows fromprovided by operating activities will continue to be affected principally by the results of operations and the extent to which we increase spending on personnel expenditures, sales and marketing activities, and our working capital requirements.
OurCash used in operating cash inflows were $6.8activities decreased by $2.1 million higher for the nine monthsperiod ended SeptemberJune 30, 20202021 to $0.9 million compared to the same period in 2019. The variance includes a source of cash provided by a current period net income, which reducedoperations of $1.2 million for 2020.
During the prior year net loss by $15.8 million, offset by a use of cash due to a change in non-cash adjustments of $1.8 million. This variance finally includes a use of cash due to asix months ended June 30, 2021, the primary change in net operating assets and liabilities of $7.2 million. The change in net operating assets and liabilities in the current period iswas primarily the result of an increasea net loss of $2.2 million, partially offset by non-cash items of amortization, bad debt expense and stock-based compensation, along with decreases in our accounts receivable balance of $0.6 million, a decrease in our inventory balance of $3.3 million, a decrease inprepaid and other assets of $0.4 million and a decreaseincreases in our accounts payable and accrued liabilities balance of $1.3 million, due to the paydown of vendor invoices. liabilities.
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During the ninesix months ended SeptemberJune 30, 2019,2020, the change in net cash provided by operating assets and liabilities included a decrease in our accounts receivable balanceactivities of $1.1$1.2 million a decrease in our inventory balance of $6.2 million, an increase in our accounts payable and accrued liabilities balance of $1.7 million, and a decrease in prepaid expenses and other assetsprimarily relates to net loss of $0.3 million, which together provided a sourceoffset by non-cash items of cash flow.amortization, bad debt expense, and stock-based compensation, along with decreases in prepaid and other assets.
Investing Activities
During the ninesix months ended SeptemberJune 30, 2021, cash used was for the purchase of computer equipment. During the six months ended June 30, 2020, we received $0.2 million$11,000 of proceeds from the disposal of assets held at our Tennessee warehouseproperty and Burbank locations. During the nine months ended September 30, 2019, we used $13,000 for the purchase of equipment.
Financing Activities
Cash used in financing activities for the six months ended June 30, 2021 was $0.1 million. During the six months ended June 30, 2021 cash used in financing activities was $3.2 million for the nine months ended September 30, 2020 and cash provided by financing activities was $3.5 million for the nine months ended September 30, 2019. During the nine months ended September 30, 2020, we used $2.5 million to repay the line of credit and received $1.0 million as part of the Paycheck Protection Program. Cash provided from therepayments on secured borrowing arrangement, was offset by repaymentsproceeds from line of outstanding debt, resultingcredit.
Cash used in a net cash used offinancing activities for the six months ended June 30, 2020 was $1.5 million. During the ninesix months ended SeptemberJune 30, 2019, we received $1.5 million proceeds from the line2020 cash used in financing activities was for repayment of credit; further, cash provided from the secured borrowing arrangement was offset by repayments of outstanding debt, resulting in net proceeds of $2.1 million.arrangements.
To manage cash flow, we have entered into numerous financing arrangements outlined below.
Indebtedness Agreements
Related-Party Refinanced Convertible Note
On November 3, 2017, the Company entered into the refinancing with Mr. Ryan Drexler, the Company’s Chairman of the Board of Directors, Chief Executive Officer and President (the “Refinancing”). As part of the Refinancing, the Company issued to Mr. Drexler an amended and restated convertible secured promissory note (the “Refinanced Convertible Note”) in the original principal amount of $18.0 million, which amended and restated (i) a convertible secured promissory note dated as of December 7, 2015, amended as of January 14, 2017, in the original principal amount of $6.0 million with an interest rate of 8% priorFor information regarding our indebtedness agreements, see “Note 8. Debt” to the amendmentNotes to Consolidated Financial Statements (unaudited) contained herein.
Contingencies
For information regarding contingencies, see “Note 9. Commitments and 10% following the amendment (the “2015 Convertible Note”), (ii) a convertible secured promissory note dated as of November 8, 2016, in the original principal amount of $11.0 million with an interest rate of 10% (the “2016 Convertible Note”), and (iii) a secured demand promissory note dated as of July 27, 2017, in the original principal amount of $1.0 million with an interest rate of 15% (the “2017 Note”, and together with the 2015 Convertible Note and the 2016 Convertible Note, collectively, the “Prior Notes”). The due date of the 2015 Convertible Note and the 2016 Convertible Note was November 8, 2017. The 2017 Note was due on demand.
The interest rate on the $18.0 million Refinanced Convertible Note was 12% per annum, and interest payments were due on the last day of each quarter. At the Company’s option (as determined by its independent directors), the Company could repay up to one-sixth of any interest payment by either adding such amountContingencies” to the principal amount of the note or by converting such interest amount into an equivalent amount of the Company’s common stock. Any interest not paid when due would be capitalized and addedNotes to the principal amount of the Refinanced Convertible Note and bear interest on the applicable interest payment date along with all other unpaid principal, capitalized interest, and other capitalized obligations. Both the principal and the interest under the Refinanced Convertible Note were due on December 31, 2019, unless converted earlier. Mr. Drexler could convert the outstanding principal and accrued interest into shares of the Company’s common stock at a conversion price of $1.11 per share at any time. The Company could prepay the Refinanced Convertible Note by giving Mr. Drexler between 15 and 60 days’ notice depending upon the specific circumstances, subject to Mr. Drexler’s conversion right.Consolidated Financial Statements (unaudited) contained herein.
The Refinanced Convertible Note contained customary events of default, including, among others, the failure by the Company to make a payment of principal or interest when due. Following an event of default, interest would accrue at the rate of 14% per annum. In addition, following an event of default, any conversion, redemption, payment or prepayment of the Refinanced Convertible Note would be at a premium of 105%. The Refinanced Convertible Note also contained customary restrictions on the ability of the Company to, among other things, grant liens or incur indebtedness other than certain obligations incurred in the ordinary course of business. The restrictions are also subject to certain additional qualifications and carveouts, as set forth in the Refinanced Convertible Note.
As part of the Refinancing, the Company and Mr. Drexler entered into a restructuring agreement (the “Restructuring Agreement”) pursuant to which the parties agreed to amend and restate the security agreement resulting in a Third Amended and Restated Security Agreement (the “Amended Security Agreement”) in which the Prior Notes were secured by all of the assets and properties of the Company and its subsidiaries whether tangible or intangible. Pursuant to the Restructuring Agreement, the Company agreed to pay, on the effective date of the Refinancing, all outstanding interest on the Prior Notes through November 8, 2017 and certain fees and expenses incurred by Mr. Drexler in connection with the Restructuring.
On September 16, 2019, Mr. Ryan Drexler delivered a notice to the Company and its independent directors of his election to convert, effective as of September 16, 2019 (the “Notice Date”), $18.0 million of the amount outstanding under that certain Amended and Restated Convertible Secured Promissory Note, dated as of November 8, 2017 (the “Note”), issued by the Company to Mr. Drexler, into shares of the Company’s common stock, par value $0.001 per share (the “Common Stock”), at a conversion price of $1.11 per share, pursuant to the terms and conditions of the Note (the “Partial Conversion”). As of the Notice Date, the total amount outstanding under the Note (including principal and accrued and unpaid interest) was equal to $19.3 million. Pursuant to the terms of the Note, the Company instructed the transfer agent to issue to Mr. Drexler 16,216,216 shares (the “Shares”) of its Common Stock in respect of the Partial Conversion.
On October 4, 2019, the Company entered into a secured revolving promissory note (the “Revolving Note”) with Mr. Drexler. Under the terms of the Revolving Note, the Company can borrow up to $3.0 million. The Revolving Note bears interest at the rate of 12% annually. The use of funds will be solely for the purchase of whey protein to be used in the manufacturing of MusclePharm products. The Company may prepay the Revolving Note by giving Mr. Drexler one days’ written notice. The Revolving Note contains customary events of default, including, among others, the failure by the Company to make a payment of principal or interest when due. Following an event of default, Mr. Drexler is entitled to accelerate the entire indebtedness under the Revolving Note. The Revolving Note also contains customary restrictions on the ability of the Company to, among other things, grant liens or incur indebtedness other than certain obligations incurred in the ordinary course of business. The restrictions are also subject to certain additional qualifications and carveouts. In connection with the Revolving Note, the Company and Mr. Drexler entered into a security agreement dated October 4, 2019 pursuant to which the Revolving Note is secured by all of the assets and properties of the Company and its subsidiaries whether tangible or intangible.
On December 27, 2019, the Company entered into a collateral receipt and security agreement with Mr. Drexler, pursuant to which Mr. Drexler agreed to post bond relating to the judgment ruled against the Company in connection with the litigation between the Company and ThermoLife, pending the appeal. The amount paid by Mr. Drexler on behalf of the Company, including fees, was $0.3 million.
On August 21, 2020, the Company entered into a refinancing agreement with Mr. Ryan Drexler, the Company’s Chairman of the Board of Directors, Chief Executive Officer and President (the “2020 Refinancing”), with an effective date of July 1, 2020. As part of the 2020 Refinancing, the Company issued to Mr. Drexler an amended and restated convertible secured promissory note (the 2020 “Refinanced Convertible Note”) in the original principal amount of $2,735,199, which amended and restated (i) a convertible secured promissory note dated as of November 8, 2017, $1,134,483 of which was outstanding as of July 1, 2020 (ii) a collateral receipt and security agreement with Mr. Drexler dated as of December 27, 2019, $252,500 of which was outstanding as of July 1, 2020, and (iii) a secured revolving promissory note dated as of October 4, 2019, $1,348,216 of which was outstanding as of July 1, 2020. The $2.7 million 2020 Refinanced Convertible Note bears interest at the rate of 12% per annum.
The 2020 Refinanced Convertible Note contains customary restrictions on the ability of the Company to, among other things, grant liens or incur indebtedness other than certain obligations incurred in the ordinary course of business. The restrictions are also subject to certain additional qualifications and carveouts, as set forth in the 2020 Refinanced Convertible Note. The 2020 Refinanced Convertible Note is subordinated to certain other indebtedness of the Company held by Prestige and Crossroads. The Company may prepay the 2020 Refinanced Convertible Note by giving Mr. Drexler between 15 and 60 days’ notice depending upon the specific circumstances, subject to Mr. Drexler’s conversion right. Mr. Drexler may convert the outstanding principal and accrued interest into shares of the Company’s common stock at a conversion price equal to or greater than (i) the closing price per share of the common stock on the last business day immediately preceding November 1, 2020 or (ii) $0.17.
All outstanding principal and accrued but unpaid interest under the 2020 Refinanced Convertible Note were due and payable on November 1, 2020. The Note is currently in default and the Company is in negotiations with Mr. Drexler to either convert the 2020 Refinanced Convertible Note or amend the 2020 Refinancing by the end of November 2020. Interest accrued but unpaid will be capitalized on the due date and added to the principal amount of the 2020 Refinanced Convertible Note.
For the three months ended September 30, 2020 and 2019, interest expense, including the amortization of debt discount, related to the related party convertible notes was $80,000 and $0.5 million, respectively. During the three months ended September 30, 2020, no interest was paid in cash to Mr. Drexler. During the three months ended September 30, 2019, $0.4 million in interest was paid in cash to Mr. Drexler.
For the nine months ended September 30, 2020 and 2019, interest expense, including the amortization of debt discount, related to the related party convertible notes was $0.2 million and $1.6 million, respectively. During the nine months ended September 30, 2020, no interest was paid in cash to Mr. Drexler. During the nine months ended September 30, 2019, $0.8 million in interest was paid in cash to Mr. Drexler.
Line of Credit - Inventory Financing
On October 6, 2017, the Company entered into a Security Agreement with Crossroads. Pursuant to the Security Agreement, the Company may borrow up to 70% of its Inventory Cost or up to 75% of Net Orderly Liquidation Value (each as defined in the Security Agreement), up to a maximum amount of $3.0 million at an interest rate of 1.5% per month, subject to a minimum monthly fee of $22,500. Subsequent to the end of 2017, the maximum amount was increased to $4.0 million. The term is extended automatically in one-year increments, unless earlier terminated pursuant to the terms of the Security Agreement. The Security Agreement contains customary events of default, including, among others, the failure to make payments on amounts owed when due, default under any other material agreement or the departure of Mr. Drexler. The Security Agreement also contains customary restrictions on the ability of the Company to, among other things, grant liens, incur debt and transfer assets. Under the Security Agreement, the Company agreed to grant Crossroads a security interest in all 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. The Security Agreement has second priority lien on the Company’s assets and is subordinated to the Company’s indebtedness held by Prestige. As of September 30, 2020, and December 31, 2019, we owed Crossroads $0.5 million and $3.0 million, respectively.
On April 1, 2019, the Company and Crossroads amended the terms of the agreement. The agreement was extended until March 31, 2020, the rate was modified to 1.33% per month, and increased the amount the Company can borrow from $3.0 million to $4.0 million.
On February 26, 2020, the Company and Crossroads amended the terms of the agreement. The agreement was extended until April 1, 2021 and the amount the Company can borrow was decreased from $4.0 million to $3.0 million
Secured Borrowing Arrangement
In January 2016, the Company entered into a Purchase and Sale Agreement (the “Purchase and Sale Agreement”) with Prestige, pursuant to which the Company agreed to sell and assign and Prestige agreed to buy and accept, certain accounts receivable owed to the Company (“Accounts”). Under the terms of the Purchase and Sale Agreement, upon the receipt and acceptance of each assignment of Accounts, Prestige will pay the Company 80% of the net face amount of the assigned Accounts, up to a maximum total borrowing of $12.5 million subject to sufficient amounts of accounts receivable to secure the loan. The remaining 20% will be paid to the Company upon collection of the assigned Accounts, less any chargebacks (including chargebacks for any customer amounts that remain outstanding for over 90 days), disputes, or other amounts due to Prestige. Prestige’s purchase of the assigned Accounts from the Company will be at a discount fee which varies based on the number of days outstanding from the assignment of Accounts to collection of the assigned Accounts. In addition, the Company granted Prestige a continuing security interest in and first priority lien upon all accounts receivable, inventory, fixed assets, general intangibles, and other assets. Prestige will have no recourse against the Company if payments are not made due to the insolvency of an account debtor within 90 days of invoice date, with the exception of international and certain domestic customers. As of September 30, 2020 and December 31, 2019, the Company had outstanding borrowings of approximately $3.0 million and $4.4 million, respectively.
During the three months ended September 30, 2020 and 2019, the Company assigned to Prestige accounts with an aggregate face amount of approximately $14.6 million and $14.8 million, respectively, for which Prestige paid to the Company approximately $11.6 million and $11.9 million, respectively, in cash. During the three months ended September 30, 2020 and 2019, $11.6 million and $12.5 million was repaid to Prestige, respectively, including fees and interest.
During the nine months ended September 30, 2020 and 2019, the Company assigned to Prestige accounts with an aggregate face amount of approximately $41.0 million and $39.0 million, respectively, for which Prestige paid to the Company approximately $32.8 million and $31.2 million, respectively, in cash. During the nine months ended September 30, 2020 and 2019, $34.3 million and $29.2 million was repaid to Prestige, respectively, including fees and interest.
On April 10, 2019, the Company and Prestige amended the terms of the agreement. The agreement was extended until April 1, 2020. Thereafter the agreement shall renew itself automatically for one (1) year periods unless either party receives written notice of cancellation from the other, at minimum, thirty (30) days prior to the expiration date.
Paycheck Protection Program Loan
Due to economic uncertainty as a result of the ongoing pandemic (COVID-19), on May 14, 2020, the Company received an aggregate principal amount of $964,910 pursuant to the borrowing arrangement (“Note”) with Harvest Small Business Finance, LLC (“HSBF”) and agreed to pay the principal amount plus interest at a 1% fixed interest rate per year, on the unpaid principal balance. The Note includes forgiveness provisions in accordance with the requirements of the Paycheck Protection Program, Section 1106 of the CARES Act.
The Note is expected to mature on May 16, 2022. Payments were due by November 16, 2020 (the “Deferment Period”) and interest was accrued during the Deferment Period. However, the Flexibility Act, which was signed into law on June 5, 2020, extended the Deferment Period to the date that the forgiven amount is remitted by the United States Small Business Administration (“SBA”) to HSBF. The Company is in the process of filling out the forgiveness application form. As of September 30, 2020, the Company owed approximately $1.0 million (principal plus accrued interest).
Off-Balance Sheet Arrangements
We did not have any off-balance sheet arrangements as of SeptemberJune 30, 2020.2021.
Non-GAAP Adjusted EBITDA
In addition to disclosing financial results calculated in accordance with U.S. GAAP, this Quarterly Report on Form 10-Q discloses Adjusted EBITDA, which is net loss adjusted for items such as stock-based compensation, gain or loss on disposal of property and equipment, (gain) loss on settlements, interest and other expense, net, depreciation of property and equipment, amortization of intangible assets, provision for doubtful accounts impairment of intangible assets and provision for income taxes.
Management uses Adjusted EBITDA as a supplement to U.S. GAAP measures to further evaluate period-to-period operating performance, as well as the Company’s ability to meet future working capital requirements. The exclusion of non-cash charges, including stock-based compensation gain on disposal of property and equipment, depreciation of property and equipment, amortization of intangible assets, provision for doubtful accounts and provision for income taxes, is useful in measuring the Company’s cash available for operations and performance of the Company. Management believes these non-GAAPnon-U.S. GAAP measures will provide investors with important additional perspectives in evaluating the Company’s ongoing business performance.
The U.S. GAAP measure most directly comparable to Adjusted EBITDA is net loss.income (loss). The non-GAAP financial measure of Adjusted EBITDA should not be considered as an alternative to net loss.income (loss). Adjusted EBITDA is not a presentation made in accordance with U.S. GAAP and has important limitations as an analytical tool and should not be considered in isolation or as a substitute for analysis of our results as reported under U.S. GAAP. Because Adjusted EBITDA excludes some, but not all, items that affect net lossincome (loss) and is defined differently by different companies, our definition of Adjusted EBITDA may not be comparable to similarly titled measures of other companies.
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For the Nine Months | For the Three Months ended | For the Nine Months | For the Three Months ended | |||||||||||||
| September 30, 2020 | September 30, 2020 | September 30, 2019 | September 30, 2019 | |||||||||||||
| Net Loss | $ | 365 | 678 | (15,468 | ) | (5,079 | ) | |||||||||
| Non-GAAP adjustments: | ||||||||||||||||
| Stock-based compensation | 206 | 27 | 191 | 63 | ||||||||||||
| (Gain) loss on disposal of property and equipment | (176 | ) | (165 | ) | 5 | — | ||||||||||
| Gain on settlement of payables | (518 | ) | (518 | ) | — | — | ||||||||||
| Interest and other expense, net | 1,715 | 632 | 3,007 | 923 | ||||||||||||
| Depreciation and amortization of property and equipment | 130 | 24 | 269 | 75 | ||||||||||||
| Amortization of intangible assets | 240 | 80 | 240 | 80 | ||||||||||||
| Impairment of operating lease right-of-use asset | 167 | 167 | — | — | ||||||||||||
| Provision for doubtful accounts | 174 | 53 | 41 | (232 | ) | |||||||||||
| Provision for income taxes | 64 | 20 | 88 | 53 | ||||||||||||
| Adjusted EBITDA | $ | 2,367 | 998 | (11,627 | ) | (4,117 | ) | |||||||||
Set forth below are reconciliations of our reported U.S. GAAP net loss to Adjusted EBITDA (in thousands):
For the Three Months ended | For the Three Months ended | For the Six Months ended | For the Six Months ended | |||||||||||||
| June 30, 2021 | June 30, 2020 | June 30, 2021 | June 30, 2020 | |||||||||||||
| Net Loss | $ | (2,251 | ) | $ | (253 | ) | $ | (2,157 | ) | $ | (313 | ) | ||||
| Non-GAAP adjustments: | ||||||||||||||||
| Stock-based compensation | 308 | 79 | 308 | 179 | ||||||||||||
| Gain on disposal of property and equipment | — | — | — | (11 | ) | |||||||||||
| (Gain) loss on settlements | 29 | — | (171 | ) | — | |||||||||||
| Interest and other expense, net | 606 | 618 | 1,118 | 1,248 | ||||||||||||
| Depreciation and amortization of property and equipment | 3 | 42 | 6 | 105 | ||||||||||||
| Amortization of intangible assets | 80 | 80 | 160 | 160 | ||||||||||||
| Provision for doubtful accounts | 338 | 110 | 327 | 121 | ||||||||||||
| Provision for income taxes | 7 | 22 | 7 | 44 | ||||||||||||
| Adjusted EBITDA | $ | (880 | ) | $ | 698 | $ | (402 | ) | $ | 1,533 | ||||||
Critical Accounting Policies and Estimates
The preparation of the accompanying consolidated financial statements and related disclosures in conformity with U.S. GAAP and our discussion and analysis of our financial condition and operating results require our management to make judgments, assumptions and estimates that affect the amounts reported in these consolidated financial statements and accompanying notes. Management bases its estimates on historical experience and on various other assumptions we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates, and such differences may be material.
Note 2, “Summary of Significant Accounting Policies” in Part I, Item 1 of this Form 10-Q; Notes to Consolidated Financial Statements in Part II, Item 8 of the 2019 Form 10-K; and “Critical Accounting Policies and Estimates”Our critical accounting estimates are detailed in Part I, Item 7 of the 2019our Annual Report on Form 10-K describefor the significant accounting policies and methods used in the preparation of our consolidated financial statements.year ended December 31, 2020.
There have been no material changes to our critical accounting policies and estimates, sinceexcept for the 2019 Form 10-K.following:
Stock-based compensation
Determining the appropriate fair value model and calculating the fair value of stock-based awards requires estimates and judgments. Our stock-based compensation is a “critical accounting estimate” because changes in the assumptions used to develop estimates of fair value or the requisite service period could materially affect key financial measures, including income (loss) from operations and net income (loss).
We use the Black-Scholes valuation model to calculate the fair value of performance-based stock options. The value is recognized as expense over the derived requisite service period beginning in the period in which they are deemed probable to vest. Vesting probability is assessed based upon certain factors and requires significant judgment.
The expected term of options granted is estimated based on a number of factors, including the vesting and expiration terms of the award and the historical volatility of our common stock. The risk-free interest rate is determined based upon a constant U.S. Treasury security rate with a contractual life that approximates the expected term of the option award.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company qualifies as a smaller reporting company as defined in Item 10(f)(1) of SEC Regulation S-K and is not required to provide the information required by this Item.
Item 4. Controls and Procedures
i) Background.
In February 2019, management was made aware, as part of the year-end sales cut-off testing procedures performed during the Company’s 2018 annual audit, by its then independent auditors, Plante & Moran, PLLC, that sales transactions may have been recognized as revenue prematurely which could have a material impact on revenue recognition for the year ended December 31, 2018. Upon such notification, management reviewed the Company’s revenue recognition reporting system, practices and underlying documents supporting the appropriateness of revenue under the Company’s previously established accounting policies for each quarterly period in the year ended December 31, 2018. In addition to the 2018 year-end period, management initially concluded that a potential material misstatement in revenue recognition was isolated to the previously issued quarterly financial statements for the three and nine months ended September 30, 2018.
Audit Committee Investigation
In March 2019, following management’s presentation of their initial assessment of the revenue recognition issue, the Audit Committee of the Board of Directors engaged independent legal counsel and a forensic accountant to conduct an investigation and to work with management to determine the potential impact on accounting for revenues. The investigation included the review of management’s initial assessment, interviews with key personnel, correspondence, and document review, among other procedures. In April 2019, as a result of the findings of the Audit Committee’s investigation to date, the Company determined that certain of its employees had engaged in deliberate inappropriate conduct, which resulted in revenue being intentionally recorded in periods prior to the criteria for revenue recognition under U.S. GAAP being satisfied. Further, the investigation discovered that revenue had been prematurely recorded in prior periods as well as the periods initially identified by management.
The investigation revealed that certain customer orders had been invoiced, triggering revenue recognition, prior to the actual shipment leaving the Company’s control. Such orders from customers had been marked as fulfilled in the Company’s enterprise reporting platform (“ERP”), thereby triggering the generation of an invoice and the recognition of revenue, in advance of shipments from both the Company’s distribution center in Tennessee and for orders that were drop-shipped directly to key customers from certain contract manufacturers. In addition, it was discovered during the investigation that certain orders had been moved to third-party locations at the respective cut-off periods and not actually shipped to the end customer until after the cut-off period resulting in the premature issuance of invoices to customers and recognition of revenue.
As a result of the Audit Committee’s investigation, certain employees were terminated, and others received written reprimands related to their conduct as a result of their behavior. In connection with the improprieties identified during the investigation resulting in the restatement of previously reported financial statements, the Company identified control deficiencies in its internal control over financial reporting that constitute material weaknesses.
The investigatory adjustments are further described in Note 16, “Changes and Correction of Errors in Previously Reported Consolidated Financial Statements” located in Item 8 of the 2019 Annual Report on Form 10-K.
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Other Adjustments Resulting from Reconsidering Previously Issued Financial Statements
As a result of issues identified during the Audit Committee investigation, management reconsidered the Company’s previously issued consolidated financial statements and as a result, additional corrections to the Company’s previously issued consolidated financial statements for each of the quarterly reporting periods ended September 30, 2018 and for the year ended December 31, 2017 were identified. These errors, for each period presented below, were primarily due to the following:
| ● | Improper classification of trade promotions, payable to the Company’s customers, as operating expenses instead of a reduction in revenue; |
| ● | Improper cut-off related to sales transactions recorded prior to transfer of control to customers in 2018 and risk of loss transferred to the customer in 2017; |
| ● | |
| Corrections of estimates of the expected value of customer payments, in the form of credits, issued to customers; | |
| ● | |
| Untimely recording of the change in the estimated useful life of leasehold improvements and an asset retirement obligation related to a modification to the lease of the Company’s former headquarters; | |
| ● | |
| Incorrect treatment of debt discounts related to the related-party convertible note; and | |
| ● | |
| Other period-end expense |
Other adjustments include, but are not limited to the following; purchase price variances, accrual for legal fees, payroll tax adjustment on restricted stock, rebate receivable and recognizing revenue on a net versus gross basis. Accumulated deficit has been adjusted to reflect changes to net loss, for each period restated.
(ii) Evaluation of disclosure controls and procedures.
The principal executive officer and principal financial officer have evaluated the Company’s disclosure controls and procedures as of SeptemberJune 30, 2020.2021. Based on this evaluation, they concluded that because of the material weaknesses in our internal control over financial reporting discussed below, the disclosure controls and procedures were not effective as required under Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
Disclosure controls and procedures are designed to ensure that the information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms and to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
(iii) Management’s report on internal control over financial reporting.
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Exchange Act Rule 13a-15(f). The Company’s internal control over financial reporting is a process affected by the Company’s management to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external purposes in accordance with U.S. GAAP.
In designing and evaluating our internal controls and procedures, our management recognized that internal controls and procedures, no matter how well conceived and operated, can provide only a reasonable, not absolute, assurance that the objectives of the internal controls and procedures are met. In addition, any evaluation of the effectiveness of internal controls over financial reporting in future periods is subject to risk that those internal controls may become inadequate because of changes in conditions or the degree of compliance with the policies or procedures may deteriorate.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.
The Company’s management assessed the effectiveness of its internal control over financial reporting as of December 31, 2019.2020. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission’s 2013 Internal Control-Integrated Framework. Based on its assessment, as well as factors identified during the Audit Committee investigation and subsequent audit process, management has concluded that the Company’s internal control over financial reporting as of December 31, 20192020 was not effective due to the existence of the material weaknesses in internal control over financial reporting described below.
(iv) Material Weaknesses Identified in connection with the Audit Committee Investigation.
Based on the principal findings of the investigation conducted by the Audit Committee, management has concluded that it did not maintain an appropriate control environment, inclusive of structure and responsibility including proper segregation of duties, and risk assessment and monitoring activities which led to revenue recognition and tonal concerns and which constituted the following material weaknesses:
| A. | Pressure to achieve sales targets gave rise to the premature and/or inappropriate recognition of revenues, typically occurring at or near the end of financial reporting periods; |
| B. | The Company’s internal controls failed and/or were not adequate to ensure that there was effective testing of period end sales cutoff, including a proper review and comparison of invoice dates and related proof of delivery; and |
| C. | Inadequate segregation of duties, allowing for an improper alignment of sales and operations under common leadership. |
(v) Material Weaknesses Resulting from Reconsidering Previously Issued Financial Statements.
As described above, management reconsidered the Company’s previously issued financial statements resulting in corrections to our unaudited consolidated financial statements for each of the quarterly periods ended September 30, 2018 and our audited consolidated financial statements as of and for the year ended December 31, 2017, which are contained in Note 16, “Changes and Correction of Errors in Previously Reported Consolidated Financial Statements” located in Item 8 of the 2019 Annual Report on Form 10-K filed with the SEC on August 25, 2020.
We have identified the following material weaknesses in connection with these issues:
CONTROL ENVIRONMENT AND CONTROL ACTIVITIES
| ● | Management did not maintain an effective control environment, including ensuring that required accounting methodologies, policies, and technical accounting personnel were in place. This control deficiency led to a series of corrections related to the years 2018 and 2017 and resulted in a restatement to the respective previously issued financial statements. |
| ● | |
| The Company did not properly classify payments to customers, primarily for promotional activity, as a reduction in the transaction price with its customers, instead treating such payments as an advertising and promotions activity, a component of operating expense. | |
| ● | |
| The Company reported certain sales transactions prior to transfer of control of goods, inconsistent with customer sales agreements and the Company’s customary practices. | |
| ● | |
| The Company did not properly estimate the expected value of customer payments, in the form of credits, at each quarter period end in 2018. In addition, the Company understated its accrual for | |
| ● | |
| The Company did not adjust the estimated useful life of its leasehold improvements nor an asset retirement obligation in the proper period for its former headquarters. |
THE COMPANY DOES NOT MAINTAIN ADEQUATE INTERNAL CONTROL DOCUMENATIONDOCUMENTATION AND TESTING PROCEDURES
| ● | The Company lacks the proper internal control documentation and testing, and therefore internal controls were not consistently performed. Management has concluded that the foregoing was attributable to several factors including the lack of finance leadership, not retaining a third-party professional Sarbanes-Oxley (“SOX”) testing consultant, and significant management turnover. Therefore, management has not documented and enforced an appropriate level of review and controls, including properly documented entity level, information technology general controls including appropriate user access controls, and business process controls. |
Remediation
Our remedial actions to date and remediation plans to be undertaken in response to the findings of the Audit Committee’s investigation and the material weaknesses on internal control over financial reporting and our conclusions reached in evaluating the effectiveness of our disclosure controls and procedures and internal controls over financial reporting as of SeptemberJune 30, 2020,2021, are described below.
| ● | Terminations and reprimands |
The Company terminated certain employees directly responsible in the deliberate inappropriate conduct and other employees received written reprimands as a result of their behavior.
| ● | Implementation of enhanced quarterly |
The Company has implemented internal controls and procedures to conduct enhanced revenue recognition cutoffcut-off testing on a quarterly basis.
The Company also improved cut-off in regard to the Company’s inventory as inventory is currently maintained and controlled either by third-part manufacturers, or in a Company warehouse operated by a third-party logistics provider. This allows the Company to use inventory counts provided by independent third parties.
| ● | Mandatory training for the sales and operations department. |
The Company has commenced a series of compliance outreach and training for its sales and operations departments relating to potential improper customer transactions identified by the internal investigation. These trainings will also include a review of the Company’s Code of Business Conduct and Ethics (the “Code of Conduct”) and the Employee Complaints & Whistleblower Policy (the “Whistleblower Policy”).
| ● | Company-wide training about compliance matters, including with respect to employee complaints and concerns and enhancement of the customer contracting process. |
The Company has commencedis implementing Company-wide training sessions. These sessions will focus on a number of areas related to sensitivity training/tonal concerns, including increased promotion and training around the Code of Conduct and the Whistleblower Policy. The Company will design and implement a more formalized compliance program with the goal of sustaining a culture of compliance.
| ● | Consider appropriate employment actions relating to certain employees |
The Company implemented a senior leadership reorganization pursuant to which, among other things,strengthen the Company’s leadership team and set the company up for long term profitable growth. During 2021, the Company retainedhired an experienced President and Chief Financial Officer with a Fortune 500 c-suite background and an experienced VP, Controller with public company reporting expertise hired a controller with fifteen yearsand experience remediating material weaknesses. In addition, the Company promoted from within an SVP of assurance experience as a member of two Big 4 multinational accounting firms, as well as engaging third-party accounting personnel with the requisite skill set to strengthen the financial reporting structure and internal control over financial reporting. The Company is conducting a search for an industry knowledgeable operating officer to work closely with the Company’s Chief Executive Officer and Chief Financial Officer.sales.
| ● | Establishment of a disclosure committee |
The Company has implementedis currently implementing a disclosure committee, which it expects to put in place during the third quarter of 2021, to assist the Chief Executive Officer and Chief Financial Officer in preparing the disclosures required under the SECby U.S. GAAP and U.S. Securities and Exchange Committee (SEC) rules and to help ensure that the Company’s disclosure controls and procedures are properly implemented.
| ● | Enhancing the internal compliance |
As part of the senior leadership reorganization referred to above, the Company engaged anis evaluating outside firm which isfirms to assist in the process of revamping ourits internal control documentation and testing. In addition, the Company will continue to review the qualifications of our internal financial organization to ensure our personnel have the appropriate technical and SOX related expertise.
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The Company has enhanced its Whistleblower Policy by including our Audit Committee Chair in the investigation, documentation, and resolution process.
We are committed to continuing to improve our internal control processes related to these matters and will continue to review our financial reporting controls and procedures. As we continue to evaluate and work to improve our internal control over financial reporting, we may take additional measures to address deficiencies or modify certain of the remediation measures described above.
We expect that our remediation efforts, including design and implementation, will continue through fiscal year 2021. In particular, as noted above, the Company has implemented enhanced controls regarding sales cut-off, as well as customer discounts.
Due to the considerable time and effort management of the Company undertook in order to bring its delinquent filings current, which was completed on November 24, 2020, along with turnover within the goalfinance department and despite ongoing remediation efforts through the second quarter of 2021, the Company was not able to fully remediate all remaining material weaknesses by year-end.complete a majority of its remediation efforts during the period ended June 30, 2021.
Other than the ongoing remediation efforts described above, there have been no changes during the quarter ended SeptemberJune 30, 20202021 in the Company’s internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, internal controls over financial reporting.
Notwithstanding the material weaknesses described in this Item 9A,4, our management has concluded that the consolidated financial statements and related financial information included in this Quarterly Report on Form 10-Q presents fairly, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with U.S. GAAP. Management’s position is based on a number of factors, including, but not limited to:
| ● | The completion of the Audit Committee’s investigation and the substantial resources expended (including the use of external consultants) and the resulting adjustments we made to our previously issued financial statements, including the restatement of our 2017 audited financial statements and our unaudited quarterly financial statements for the periods ended September 30, 2018, June 30, 2018 and March 31, 2018; |
| ● | The reconsideration of significant accounting policies and accounting practices previously employed by the Company, resulting in other adjustments to previously issued consolidated financial |
Based on the actions described above, we have updated, and in some cases corrected, our accounting policies and have applied those to our consolidated financial statements for all periods presented.
In the normal course of business or otherwise, we may become involved in legal proceedings. We 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, 2020, we were involved in the following materialFor information regarding legal proceedings, described below. These are notsee Note 9 to the only legal proceedings in which we are involved. We are involved in additional legal proceedings in the ordinary course of our business and otherwise.
ThermoLife International
In January 2016, ThermoLife International LLC (“ThermoLife”), a supplier of nitratesNotes to MusclePharm, filed a complaint against us in Arizona state court. ThermoLife alleged that we failed to meet minimum purchase requirementsConsolidated Financial Statements (unaudited) contained in the parties’ supply agreement. In March 2016, we filed counterclaims alleging that ThermoLife’s products were defective. Through orders issued in September and November 2018, the court dismissed MusclePharm’s counterclaims and found that the Company was liable to ThermoLife for failing to meet its minimum purchase requirements.
The court held a bench trial on the issue of damages in October 2019, and on December 4, 2019, the court entered judgment in favor of ThermoLife and against the Company in the amount of $1.6 million, comprised of $0.9 million in damages, interest in the amount of $0.3 million and attorneys’ fees and costs in the amount of $0.4 million. The Company recorded $1.6 million in accrued expenses as of December 31, 2018. In the interim, the Company filed an appeal,herein, which is in the process of being briefed, and has posted bonds in the total amount of $0.6 million in order to stay execution on the judgment pending appeal. Of the $0.6 million, $0.25 million (including fees) was paidincorporated by Mr. Drexler on behalf of the Company on December 31, 2019. See “Note 7. Debt” for additional information. Subsequent to December 31, 2019, the balance of $0.35 million was secured by a personal guaranty from Mr. Drexler, while the associated fees of $12,500 was paid by the Company.
For both the three months ended September 30, 2020 and 2019, interest expense recognized on the awarded damages was $22,000. For both the nine months ended September 30, 2020 and 2019, interest expense recognized on the awarded damages was $66,000.
The Company intends to continue to vigorously pursue its defenses on appeal.
White Winston Select Asset Fund Series MP-18, LLC et al., v MusclePharm Corp., et al., (Nev. Dist. Ct.; Cal. Superior Court; Colorado Dist. Ct.; Mass. Super. Ct.)
On August 21, 2018, White Winston Select Asset Fund Series MP-18, LLC and White Winston Select Asset Fund, LLC (together “White Winston”) initiated a derivative action against MusclePharm and its directors (collectively the “director defendants”). White Winston alleges that the director defendants breached their fiduciary duties by improperly approving the refinancing of three promissory notes issued by MusclePharm to Drexler (the “Amended Note”), in exchange for $18.0 million in loans. White Winston alleges thatreference into this refinancing improperly diluted their economic and voting power and constituted an improper distribution in violation of Nevada law. In its complaint, White Winston sought the appointment of a receiver over MusclePharm, a permanent injunction against the exercise of Drexler’s conversion right under the Amended Note, and other unspecified monetary damages. On September 13, 2018, White Winston filed an amended complaint, which added a former MusclePharm executive, as a plaintiff (together with White Winston, the “White Winston Plaintiffs”). On December 9, 2019, the White Winston Plaintiffs filed a Second Amended Complaint, in which they added allegations relating to the resignation of MusclePharm’s auditor, Plante & Moran PLLC (“Plante Moran”). MusclePharm has moved to dismiss the Second Amended Complaint. That motion has not yet been fully briefed.part II, Item 1.
Along with its complaint, the White Winston Plaintiffs also filed a motion for a temporary restraining order (“TRO”) and preliminary injunction enjoining the exercise of Drexler’s conversion right under the Amended Note. On August 23, 2018, the Nevada district court issued an ex parte TRO. On September 14, 2018, the court let the TRO expire and denied the White Winston Plaintiffs’ request for a preliminary injunction, finding, among other things, that the White Winston Plaintiffs did not show a likelihood of success on the merits of the underlying action and failed to establish irreparable harm. Following the court’s decision, MusclePharm filed a motion seeking to recoup the legal fees and costs it incurred in responding to the preliminary injunction motion. On October 31, 2019, the court awarded MusclePharm $56,000 in fees and costs. The White Winston Plaintiffs have appealed that award.
Due to the uncertainty associated with determining our liability, if any, and due to our inability to ascertain with any reasonable degree of likelihood, as of the date of this report, the outcome of the trial, the Company has not recorded an estimate for its potential liability.
On June 17, 2019, the White Winston Plaintiffs moved for the appointment of a temporary receiver over MusclePharm, citing Plante Moran’s resignation. The court granted the White Winston Plaintiffs’ request to hold an evidentiary hearing on the motion, but the date for that hearing was not set as of the date hereof. On July 30, 2019, the White Winston Plaintiffs filed an action in the Superior Court of the State of California in and for the County of Los Angeles, seeking access to MusclePharm’s books and records. MusclePharm has answered the petition, asserting as a defense that the request does not have a proper purpose. A trial on the petition has been set for February 25, 2021.
The Company intends to vigorously defend these actions.
IRS Audit
On April 6, 2016, the Internal Revenue Service (“IRS”) selected our 2014 Federal Income Tax Return for audit. As a result of the audit, the IRS proposed certain adjustments with respect to the tax reporting of our former executives’ 2014 restricted stock grants. Due to the Company’s current and historical loss position, the proposed adjustments would have no material impact on the Company’s Federal income tax. On October 5, 2016, the IRS commenced an audit of our employment and withholding tax liability for 2014. The IRS contends that the Company inaccurately reported the value of the restricted stock grants and improperly failed to provide for employment taxes and Federal tax withholding on these grants. In addition, the IRS is proposing certain penalties associated with the Company’s filings. On April 4, 2017, the Company received a “30-day letter” from the IRS asserting back taxes and penalties of approximately $5.3 million, of which $4.4 million related to withholding taxes, specifically, income withholding and Social Security taxes, and $0.9 million related to penalties. Additionally, the IRS asserts that the Company owes information reporting penalties of approximately $2.0 million.
The Company’s counsel has submitted a formal protest to the IRS disputing on several grounds all of the proposed adjustments and penalties on the Company’s behalf, and the Company has been pursuing this matter vigorously through the IRS appeal process. An Appeals Conference was held with the IRS in Denver, Colorado on July 31, 2019. At the conference, the Company made substantial arguments challenging the IRS’s claims for employment taxes and penalties. On December 16, 2019, a further Appeals Conference was held with the IRS by telephone. At the telephone conference, the Appeals Officer confirmed that he agreed with the Company’s argument that the failure to deposit penalties should be conceded by the IRS. The failure to deposit penalties total about $2.0 million. Thus, with this concession, the IRS’s claims have been reduced from approximately $7.3 million to about $5.3 million.
The remaining issue in dispute in this matter involves the fair market value of restricted stock units in the Company granted to certain former officers (the “Former Officers”) of the Company under Internal Revenue Code § 83. The Company and the IRS disagree as to the value of the restricted stock on the date of the grants, i.e., October 1, 2014. The Company and the IRS have exchanged expert valuation reports on the fair market value of the stock and have had extensive negotiations on this issue. The parties, however, have not been able to reach an agreement with respect to the value of the stock. The IRS has also made parallel claims regarding the restricted stock units against the Former Officers of the Company. The IRS has asserted that the Former Officers received ordinary income from the stock grants, and that they owe additional personal income taxes based on the fair market value of the stock. The Former Officers’ cases, unlike the Company’s case, are pending before the United States Tax Court. In the Tax Court litigation, the Former Officers are challenging the IRS’s determinations regarding the fair market value of the restricted stock grants on October 1, 2014. The Former Officers have separate counsel from the Company. The same IRS Appeals Officer and Revenue Agents assigned to the Company’s case are also involved in the cases for the Former Officers. Throughout the proceedings, the Company has argued to the IRS that it is the Former Officers who are directly and principally liable for the amount of any tax due, and not the Company.
The Former Officers cases were scheduled for trial in Tax Court on March 9, 2020. The trial of the cases was continued by the Court on February 4, 2020. The basis for the continuance was that the IRS and the Former Officers had made progress toward a settlement of the valuation issue involving the grants of the restricted stock. The outcome of these settlement negotiations will be relevant to the Company’s case. The Company is closely monitoring the settlement discussions between the IRS and the Former Officers. The Tax Court has ordered the Former Officers to file status reports regarding progress of their settlement negotiations with the IRS on or before October 22, 2020.
Due to the uncertainty associated with determining our liability for the asserted taxes and penalties, if any, and to our inability to ascertain with any reasonable degree of likelihood, as of the date of this report, the outcome of the IRS appeals process, the Company has not recorded an estimate for its potential liability, if any, associated with these taxes.
On August 22, 2018, Richard Estalella filed an action against the Company and two other defendants in the Colorado District Court for the County of Denver, seeking damages arising out of the IRS’s assertion of tax liability and penalties relating to the 2014 restricted stock grants. The Company has answered Estalella’s complaint, asserted counterclaims against Estalella for his failure to ensure that all withholding taxes were paid in connection with the 2014 restricted stock grants, and filed cross-claims against a valuation firm named in the action for failing to properly value the 2014 restricted stock grants for tax purposes. The Company, on the other hand, is relying on a separate valuation report prepared by a different valuation firm in its defense to the IRS case. This new valuation firm supports the Company’s position. The Company is waiting on the next steps from the court and will continue to vigorously litigate the matter.
4Excelsior Matter
On March 18, 2019, 4Excelsior, a manufacturer of MusclePharm products, filed an action against MusclePharm in the Superior Court of the State of California for the County of Los Angeles, claiming approximately $6.2 million in damages relating to allegedly unpaid invoices, as well as approximately $7.8 million in consequential damages. On January 27, 2020, MusclePharm filed a counterclaim against 4Excelsior seeking unidentified damages relating to, among other things, 4Excelsior’s failure to fulfill a purchase order. MusclePharm also moved to strike 4Excelsior’s consequential damages on the grounds that they are unrecoverable under the Uniform Commercial Code. The court denied that motion, and the action has proceeded to discovery. The Company had a liability of $5.7 million and $5.3 million as of September 30, 2020 and December 31, 2019, respectively. This liability, which represents past due invoices (May 2018 through March 2019) plus interest, is recorded in “Accounts Payable” in the consolidated balance sheets. Trial has not yet been set, although a Trial Setting Conference was set for December 17, 2020.
On November 16, 2020, the Company and 4Excelsior entered into a stipulation of settlement that provided that the Company would pay to 4Excelsior a total of $4,750,000, in four monthly payments of $70,000, beginning January 5, 2021, and thereafter in monthly payments of $100,000. The parties have not yet entered into a settlement agreement giving effect to the stipulation of settlement.
The information to be reported under this Item is not required for smaller reporting companies.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.We have not made any repurchases of our common stock during the second quarter of 2021.
| 35 |
Item 3. Defaults Upon Senior Securities.Securities
None.
Item 4. Mine Safety Disclosures
None.
Item 5. Other Information.Information
None
| Incorporated by Reference | ||||||||||
Exhibit No. | Description | Form | SEC File Number | Exhibit | Filing Date | |||||
| 10.1** | Letter agreement, dated May 12, 2021 between the Company and Joseph Cannata. | |||||||||
| 31.1** | Certification of the Chief Executive Officer pursuant to | |||||||||
| 31.2** | Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |||||||||
| 32.1*** | Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |||||||||
| 32.2*** | Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |||||||||
| 101** | The following materials from MusclePharm Corporation’s quarterly report on Form 10-Q for the three months ended March 31, 2021 formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets; (ii) the Consolidated Statements of Operations; (iii) the Consolidated Statements of Comprehensive Income; (iv) the Consolidated Statement of Changes in Stockholders’ Deficit; (v) the Consolidated Statements of Cash Flows; and | |||||||||
| ** | Filed herewith |
| *** | Furnished herewith |
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| MUSCLEPHARM CORPORATION | ||
| Date: | By: | /s/ |
| Name: | ||
| Title: | Chief Financial Officer | |
(Principal Financial Officer and Principal Accounting Officer) | ||