| Commitments and Contingencies | Operating Leases The Company leases office and warehouse facilities under operating
leases, which expire at various dates through 2022. The amounts reflected in the table below are for the aggregate future minimum
lease payments under non-cancelable facility operating leases for properties that have not been abandoned as part of the restructuring
plan. See Note 4 for additional details regarding the restructured leases. Under lease agreements that contain escalating rent
provisions, lease expense is recorded on a straight-line basis over the lease term. During the three months ended September 30,
2018 and 2017, rent expense was $0.2 million and $0.1 million, respectively. During the nine months ended September 30, 2018 and
2017, rent expense was $0.7 million and $0.3 million, respectively. As of September 30, 2018, future minimum lease payments are as follows
(in thousands):
For the Year Ending December 31,
Remainder of 2018 $ 217
2019 674
2020 649
2021 481
2022 369
Thereafter —
Total minimum lease payments $ 2,390 The Company has subleased its Denver office space and anticipates
receiving approximately $330,000 in sublease payments. These sublease payments are not reflected in the above table. Capital Leases As of September 30, 2018, the Company was leasing one vehicle under
a fleet leasing agreement which are included in “Property and equipment, net” in the accompanying Consolidated Balance
Sheets. The original cost of leased assets was $39,000 and the associated accumulated depreciation was $25,000 as of September
30, 2018. The Company also leases manufacturing and warehouse equipment under capital leases, which expire at various dates through
February 2020. As of September 30, 2018 and December 31, 2017, short-term capital
lease liabilities of $97,000 and $126,000, respectively, were included as a component of current accrued liabilities, and the long-term
capital lease liabilities of $74,000 and $146,000, respectively, were included as a component of long-term liabilities in the accompanying
Condensed Consolidated Balance Sheets. As of September 30, 2018, the Company’s future minimum lease
payments under capital lease agreements, are as follows (in thousands):
For the Year Ending December 31,
Remainder of 2018 $ 27
2019 101
2020 50
Total minimum lease payments 178
Less amounts representing interest (7 )
Present value of minimum lease payments $ 171 Purchase Commitment Upon the completion of the sale of BioZone, the Company entered into
a manufacturing and supply agreement whereby the Company is required to purchase a minimum of approximately $2.5 million of products
per year from BioZone annually for an initial term of three years. If the minimum order quantities of specific products are not
met, a $3.0 million minimum purchase of other products must be met in order to waive the shortfall, which is at 25% of the realized
shortfall. Due to the timing of achieving the minimum purchase quantities, we are below these targets. As a result, we have provided
for the estimated purchase commitment shortfall adjustment in the three and nine months ended September 30, 2018. Settlements Manchester City Football Group The Company was engaged in a dispute with City Football Group Limited
(“CFG”), the owner of Manchester City Football Group, concerning amounts allegedly owed by the Company under a sponsorship
agreement with CFG (the “Sponsorship Agreement”). In August 2016, CFG commenced arbitration in the United Kingdom against
the Company, seeking approximately $8.3 million for the Company’s purported breach of the Sponsorship Agreement. On July 28, 2017, the Company approved a Settlement Agreement (the
“CFG Settlement Agreement”) with CFG effective July 7, 2017. The CFG Settlement Agreement represents a full and final
settlement of all litigation between the parties. Under the terms of the agreement, we agreed to pay CFG a sum of $3 million, consisting
of a $1 million payment that was advanced by a related party on July 7, 2017, a $1 million installment paid on July 7, 2018 and
a subsequent $1 million installment payment to be paid by July 7, 2019. The 2019 payment is accrued in current liabilities. The Company recorded a charge in its Statement of Operations for
the year ended December 31, 2017 for approximately $1.5 million, representing the discounted value of the unrecorded settlement
amount. During the three and nine months ended September 30, 2018, the Company recorded a charge of $30,000 and $148,000, respectively,
representing imputed interest. Former Executive Lawsuit The Company was engaged in a dispute with Mr. Richard Estalella (“Estalella”)
concerning amounts allegedly owed by the Company under an employment agreement with Estalella. Estalella was seeking certain equitable
relief and unspecified damages. On May 7, 2018, the Court vacated the trial in contemplation of the parties’ settlement of
this matter. On June 19, 2018, the Company approved a settlement agreement (the
“Estalella Settlement Agreement”) with Estalella, concerning amounts allegedly owed by the Company under an employment
agreement with Estalella (the “Employment Litigation”). The Estalella Settlement Agreement represents a full and final
settlement of the Employment Litigation. Under the terms of the agreement, the Company has agreed to pay Estalella a sum of $925,000,
consisting of a $325,000 initial payment that was made in July 2018, and subsequent payments of $150,000 installments to be paid
within 90, 180, 270 and 360 days of the initial payment, respectively. The payments are accrued in current liabilities. Additionally,
Estalella retained ownership of 350,000 shares of restricted stock that were in dispute, of which only 17,000 have been reflected
in our total shares outstanding. As such the Company has increased the total amount of share outstanding by 333,000 shares for
the period ended September 30, 2018. The Company recorded a settlement recovery in its Statement of Operations
for the nine months ended September 30, 2018 for approximately $2.7 million, representing the reversal of accrued payroll the Company
previously recorded for compensation related to the Estalella employment agreement. Insurance Carrier Lawsuit The Company was engaged in litigation with an insurance carrier,
Liberty Insurance Underwriters, Inc. (“Liberty”), arising out of Liberty’s denial of coverage. In 2014, the Company
sought coverage under an insurance policy with Liberty for claims against our directors and officers arising out of an investigation
by the Securities and Exchange Commission (“SEC”). Liberty disputed the extent to which those expenses are covered
under its policy, and the Company commenced a coverage action against Liberty for those expenses in the United States District
Court for the Southern District of New York. This matter was settled on September 21, 2018. Contingencies In the normal course of business or otherwise, the Company may become
involved in legal proceedings. The Company will accrue a liability for such matters when it is probable that a liability has been
incurred and the amount can be reasonably estimated. When only a range of possible loss can be established, the most probable amount
in the range is accrued. If no amount within this range is a better estimate than any other amount within the range, the minimum
amount in the range is accrued. The accrual for a litigation loss contingency might include, for example, estimates of potential
damages, outside legal fees and other directly related costs expected to be incurred. As of September 30, 2018, the Company was
involved in the following material legal proceedings described below. ThermoLife In January 2016, ThermoLife International LLC (“ThermoLife”),
a supplier of nitrates to MusclePharm, filed a complaint against the Company in Arizona state court. In its complaint, ThermoLife
alleges that the Company failed to meet minimum purchase requirements contained in the parties’ supply agreement and seeks
monetary damages for the deficiency in purchase amounts. In March 2016, the Company filed an answer denying the allegations
contained in the complaint and a counterclaim alleging that ThermoLife’s products were defective. On September 26, 2018,
the Court granted summary judgment to ThermoLife on MusclePharm’s claims. On November 1, 2018, the Court granted partial
summary judgment for ThermoLife on its own breach of contract claim, finding that MusclePharm is liable to ThermoLife for failing
to meet its minimum purchase requirements. MusclePharm intends to seek reconsideration of the Court’s ruling. United World Wrestling Arbitration In November 2017, United World Wrestling (“UWW”), an
amateur wrestling governing body, initiated arbitration against MusclePharm before the Court of Arbitration for Sport in Lausanne,
Switzerland (“CAS”), alleging that MusclePharm owed it $663,750, comprised of a $425,000 sponsorship fee plus accrued
interest, under the terms of a 2015 sponsorship agreement. In September 2018, the sole arbitrator issued an order and decision
in UWW’s favor for $425,000, plus interest at 12% per annum, as well as attorney’s fees in the amount of 5,000 Swiss
Francs. The Company is in ongoing discussions with UWW to resolve the matter. White Winston Lawsuit In August 2018, White Winston Select Asset Fund Series MP-18, LLC
and White Winston Select Asset Fund, LLC (together “White Winston”) initiated a derivative action against MusclePharm
and all of its directors in the First Judicial District Court of the State of Nevada. White Winston alleges that MusclePharm’s
directors breached their fiduciary duties when they approved the November 2017 refinancing of Drexler’s $18 million
Refinanced Convertible Note (discussed further below). In its Complaint, White Winston sought a permanent injunction against the
exercise of Mr. Drexler’s conversion rights, the appointment of a receiver, and unspecified monetary damages. On August
23, 2018, the Nevada district court issued an ex parte IRS Audit On April 6, 2016, the Internal Revenue Service (“IRS”)
selected the Company’s 2014 Federal Income Tax Return for audit. As a result of the audit, the IRS proposed certain adjustments
with respect to the tax reporting of the Company’s former executives’ 2014 restricted stock grants. Due to the Company’s
current and historical loss position, the proposed adjustments would have no material impact on its Federal income tax. On October
5, 2016, the IRS commenced an audit of the Company’s employment and withholding tax liability for 2014. The IRS is contending
that the Company inaccurately reported the value of the restricted stock grants and improperly failed to provide for employment
taxes and federal tax withholding on these grants. In addition, the IRS is proposing certain penalties associated with the Company’s
filings. On April 4, 2017, the Company received a “30-day letter” from the IRS asserting back taxes and penalties of
approximately $5.3 million, of which $0.4 million related to employment taxes and $4.9 million related to federal tax withholding
and penalties. Additionally, the IRS is asserting that the Company owes information reporting penalties of approximately $2.0 million.
The Company’s counsel has submitted a formal protest to the IRS disputing on several grounds all of the proposed adjustments
and penalties on the Company’s behalf, and the Company is pursuing this matter vigorously through the IRS appeal process.
Due to the uncertainty associated with determining the Company’s liability for the asserted taxes and penalties, if any,
and to the Company’s inability to ascertain with any reasonable degree of likelihood, as of the date of this report, the
outcome of the IRS appeals process, the Company has recorded an estimate for its potential liability, if any, associated with these
taxes. On August 22, 2018, Richard Estalella filed an action against
the Company and two other defendants in the Colorado District Court for the County of Denver, seeking damages arising out of the
IRS’s assertion of tax liability and penalties relating to the Company’s 2014 restricted stock grants. The Company
has answered Estalella’s complaint, asserted counterclaims against Estalella for his failure to ensure that all withholding
taxes were paid in connection with the 2014 restricted stock grants, and filed cross-claims against a valuation firm named in the
action for failing to properly value the 2014 restricted stock grants for tax purposes. The Company will continue to vigorously
litigate the matter. Durnford Matter On July 28, 2015, Plaintiff, Tucker Durnford, filed a First Amended
Class Action Complaint which alleged that MusclePharm’s Arnold Iron Mass product violates consumer protection laws by misleading
consumers about the amount and sources of protein in the product. The product has been discontinued. The last shipments were in
March of 2016. Plaintiff’s counsel alleged that results of laboratory testing
demonstrate the actual total protein content per serving to be approximately 19.4 grams, once the free-form amino acids are excluded
from the calculation. Plaintiff’s counsel attached to the First Amended Class Action Complaint what purport to be test results
supporting that allegation. We moved to dismiss the First Amended Class Action Complaint, arguing
that plaintiff’s claims are preempted by the Federal Food, Drug, and Cosmetic Act and its implementing regulations. The Court
granted MusclePharm’s motion to dismiss the case on December 18, 2015. Plaintiff was given leave to file an amended complaint,
but instead chose to appeal the order granting MusclePharm’s motion to dismiss. On December 31, 2015, plaintiff’s counsel
made a settlement demand, in an amount of $100,000, which demand was rejected. On February 10, 2016, the court entered judgment
and dismissed the case with prejudice. Plaintiff appealed to the Ninth Circuit Court of Appeals, which heard arguments on November
15, 2017. On October 12, 2018, the Ninth Circuit issued its opinion reversing
the dismissal and remanding the case to the Northern District of California. The Ninth Circuit found that plaintiff’s misbranding
theory premised on alleged “nitogen-spiking” or “protein-spiking” was preempted by federal law, but that
plaintiff could attempt to prove his allegation that the protein in the product does not come entirely from hydrolyzed beef and
lacoterferrin, and his allegation that the label misleads consumers into believing that that protein does come entirely from hydrolyzed
beef and lacoterferrin. The Company intends to vigorously defend this action and is awaiting next steps from the District court. Sponsorship and Endorsement Contract Liabilities The Company has various non-cancelable endorsement and sponsorship
agreements with terms expiring through 2019. The total value of future contractual payments as of September 30, 2018 are as follows
(in thousands):
For the Years Ending December 31,
Remainder of 2018 2019 Total
Outstanding Payments
Endorsement $ 102 $ 140 $ 242
Sponsorship 31 55 86
Total future payments $ 133 $ 195 $ 328 |
