Musclepharm Earnings 2019-12-31
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
☒
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2019
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from to
Commission File Number – 000-53166
MusclePharm Corporation
(Exact name of registrant as specified in its charter)
| Nevada | | 77-0664193 |
| (State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
| 4400 Vanowen St. Burbank, CA | | 91505 |
| (Address of principal executive offices) | | (Zip code) |
(800) 292-3909
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
| N/A | | |
Securities registered pursuant to Section 12(g) of the Act:
Title of each class
Common Stock, Par Value $0.001 Per Share
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ☐ Yes ☒ No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. ☐ Yes ☒ No
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 ☐ 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 (Section 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 ☐ No ☒
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company, 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 has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes ☒ No
Aggregate market value of the common equity held by non-affiliates of the registrants as of June 30, 2020, the last business day of the most recently completed second fiscal quarter: $1.9 million.
Number of shares of the registrant’s common stock outstanding at August 18, 2020: 33,101,866 (excludes 875,621 shares of common stock held in treasury).
MusclePharm Corporation
Form 10-K
For the Year Ended December 31, 2019
TABLE OF CONTENTS
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| PART II | |
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About this Report
This Annual Report on Form 10-K relates to the Company’s (as defined below) fiscal year ended December 31, 2019. 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 delinquent filings on Form 10-Q for the quarterly periods ended March 31, 2019, June 30, 2019 and September 30, 2019.
Forward-Looking Statements
This Annual Report on Form 10-K contains forward-looking statements. All statements contained in this Annual Report on Form 10-K other than statements of historical fact, including statements regarding our future results of operations and financial position, our business strategy and plans, and our objectives for future operations, are forward-looking statements. The words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect,” and similar expressions are intended to identify forward-looking statements. We base these forward-looking statements largely on our current expectations and projections about future events and trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives, and financial needs.
These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in Part I, Item 1A, “Risk Factors” in this Annual Report on Form 10-K. 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 Annual Report on Form 10-K 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 Annual Report on Form 10-K. Nevertheless, all rights to such trademarks are reserved. These and other trademarks referenced in this Annual Report on Form 10-K are the property of their respective owners.
PART I
Item 1. Business
MusclePharm Corporation was incorporated in Nevada in 2006. Except as otherwise indicated herein or the context requires otherwise, the terms “MusclePharm,” the “Company,” “we,” “our” and “us” refer to MusclePharm Corporation and its subsidiaries. The Company is a scientifically-driven, performance lifestyle company that develops, manufactures, markets and distributes branded sports nutrition products and nutritional supplements. Our portfolio of recognized brands, including MusclePharm® and FitMiss®, is marketed and sold in more than 100 countries globally. The Company is headquartered in Burbank, California and, as of December 31, 2019, had the following wholly-owned operating subsidiaries: MusclePharm Canada Enterprises Corp., MusclePharm Ireland Limited and MusclePharm Australia Pty Limited.
1
Products
The MusclePharm brand product portfolio is designed for athletes of all levels and anyone who pursues an active lifestyle. We offer a broad range of performance powders, capsules, tablets and gels that satisfy the needs of enthusiasts and professionals alike. Our products are marketed in multiple performance and active lifestyle distribution channels that reach athletes of all types and demographics. Our goal is to serve the needs of our customers, while fueling the engine of sport for all ages and genders. Our portfolio of products targets every type of fitness enthusiast and professional, from combat sport, weight training, bodybuilding, running, and all team and individual sports, as well as individuals who lead an active lifestyle.
We place considerable emphasis on transparency, high-quality ingredients, innovation and science. Products are placed through rigorous third-party independent testing to ensure safe, quality ingredients to support all levels of athletic ability. Tests performed on products include banned substance testing and protein verification, among others.
Sport Series - Scientifically-advanced, performance-driven sports nutrition items that cover the needs of athletes. This line of award-winning, independently-tested products helps to fuel athletes safely by increasing strength, energy, endurance, recovery and overall athletic performance. Sport Series’ lineup includes products like Combat Protein Powder, a top selling five-protein blend on the market, and the award winning Combat Crunch Protein Bars.
Essentials Series - To meet the day-in and day-out demands of fitness and sport, the Essentials Series (formerly known as the Core Series) line of supplements exists for athletes to take daily. These products include daily staples for a healthy body, such as BCAA, creatine, glutamine, carnitine, CLA, fish oil, a multi-vitamin and more.
Natural Series - A natural, non-genetically modified organism (“non-GMO”) sports performance line, made for a growing consumer base that seeks organic, vegan and plant-based nutritional product and supplement options. We created the Natural Series with USDA-certified organic ingredients, plant-based protein and natural caffeine sources, in clean and delicious formats, to power all stages of the workout.
FitMiss® - Designed and formulated specifically for the female body, FitMiss sports nutrition products are complementary to any active female’s diet. In seeking a stronger, more balanced foundation, FitMiss ingredients support women in areas of weight management, lean muscle mass, body composition, and general health and wellness.
On-the-Go – As more and more consumers are seeking healthier and convenient snacking options, retailers across multiple channels are capitalizing on this emerging trend by aggressively expanding their assortments to accommodate this demand. The On-the-Go portfolio of ready to eat products includes the award winning Combat Crunch, Protein Crisp, Organic Protein and Protein Cookie.
Sales and Marketing
Our goal is to position MusclePharm as the “must have” brand for elite athletes and fitness enthusiasts, alike, who are on a journey to holistically better themselves and achieve their maximum potential. Our marketing is focused on our most prominent products and includes brand partnerships, focusing on grass-roots marketing and advertising efforts with athletes and retail outlets close to our core audience. Our marketing includes digital marketing, sampling, public relations, athlete/influencer marketing, event marketing, trade activity, paid media, advertising, SEO/SEM, and affiliate marketing. Our roster of elite athletes, influencers and brand ambassadors play a role in our marketing. New product innovation is also a key component of driving incremental sales.
Distribution Channels
MusclePharm brands are marketed across major global retail distribution channels – Specialty, International and Food, Drug, and Mass (“FDM”). Our largest customers, Costco Wholesale Corporation (“Costco”), Amazon.com, Inc. (“Amazon”), and iHerb, LLC (“iHerb”) accounted for approximately 33%, 13% and 17% of our 2019 net revenue, respectively. Costco, Amazon and iHerb accounted for approximately 29%, 13% and 13% of our 2018 net revenue, respectively. For further information concerning our customer concentration, see Note 2 to the accompanying Consolidated Financial Statements.
Specialty: This channel is comprised of brick-and-mortar sales and e-commerce. Due to high competition within this market, we continually seek to respond to customer trends and shifts by adjusting the mix of existing product offerings, developing new innovative products and influencing preferences through our marketing. We experienced significant growth in online sales in 2019, primarily through our Amazon and iHerb distribution channels.
2
International: Our international reach touches every relevant market in the world. We seek to further grow our international sales by continuing to offer new products in key markets as well as opening new distribution channels in select regions of the world. We also are evaluating the benefits of developing expanded manufacturing partnerships outside of North America to take advantage of local opportunities.
FDM: This channel is primarily served by our direct sales force, as well as our network of brokers. We believe direct relationships with retail partners provide us an opportunity to expand our distribution into additional discount warehouses and national retailers.
Below is a table of net revenue by our major distribution channel:
| | For the Years Ended December 31, | |||
| | 2019 | % of Total | 2018 | % of Total |
| Distribution Channel | | | | |
| Specialty | $35,812 | 45% | $35,690 | 41% |
| International | 22,691 | 28% | 32,143 | 36% |
| FDM | 21,164 | 27% | 20,280 | 23% |
| Total | $79,667 | 100% | $88,113 | 100% |
Product Research, Development and Quality Control
Customers’ belief in the safety and efficacy of our products is critical. Continued innovation in delivery techniques and ingredients, new product line extensions, and new product offerings are important in order to sustain existing and create new market opportunities, meet consumer demand, and strengthen consumer relationships. To support our research and development efforts, we invest in formulation, processing and packaging development, perform product quality and stability studies, and conduct consumer market research to sample consumer opinions on product concepts, design, packaging, advertising, and marketing campaigns.
We are committed to science and sport being equal in our product development. We believe real-world applications are essential. Our state-of-the-art, 20,000 square-foot professional training and performance facility in Burbank, California is dedicated to optimizing the performance of our products for all ranges of athletes. Collecting feedback from athletes in our facility helps our team strive to improve our products and to continue to be innovative. Our product lines have been developed through a stringent protocol to ensure that all formulations promote quality and safety for our customers. Our quality control team follows detailed supplier selection and certification processes, validation of raw material verification processes, analytical testing, process audits, and other quality control procedures. Our products are also subject to extensive shelf life stability testing. We also engage third-party laboratories to routinely evaluate and validate our internal testing processes on every MusclePharm product.
We qualify ingredients, suppliers, and facilities by performing site assessments and conducting on-going performance and process reviews. Dedicated quality teams regularly audit and assess manufacturing facilities for compliance with Good Manufacturing Practices (“GMPs”), as regulated by the United States Food and Drug Administration (“FDA”), to ensure our compliance with all MusclePharm, regulatory, and certification standards and requirements. To ensure overall consistency, our quality assurance team adheres to strict written procedures. From the raw ingredient stage to the finished product stage, we monitor and perform quality control checks. Before distributing our products, we place our products under quarantine to test for environmental contaminants and verify that the finished product meets label claims. Once a product has successfully passed quality assurance testing and conforms to specifications for identity, purity, strength, and composition, we then conduct testing with third-party laboratories for added label claim verification. Multi-level practices are part of our product development process to ensure athletes and our consumers receive what we believe to be the most scientifically innovative and safest products on the market. Post-distribution, we have standard operating procedures in place for investigating and documenting any adverse events or product quality complaints. We are committed to the process of having all of our products certified to be banned-substance-free before they are available to consumers. Informed Choice, a globally recognized leader in sports testing, conducts all of our third-party banned substance testing, ensuring that all MusclePharm products are free of banned substances.
Manufacturing and Distribution
We have relationships with multiple third-party manufacturers. Certain of our vendors supply in excess of 10% of our products. Once a product is manufactured, it is sent to our distribution center in Spring Hill, Tennessee, or shipped directly to the customer. All of the third-party manufacturing facilities that we source from and distribution facilities are designed and operated to meet current GMP standards as promulgated by the FDA.
The manufacturing process performed by our third-party manufacturers generally consists of the following operations: (i) qualifying ingredients for products; (ii) testing of all raw ingredients; (iii) measuring ingredients for inclusion in production; (iv) granulating, blending and grinding ingredients into a mixture with a homogeneous consistency; (v) encapsulating or filling the blended mixture into the appropriate dosage form using either automatic or semiautomatic equipment; and (vi) testing finished products prior to distribution.
3
We maintain and operate a system that integrates distribution, warehousing, and quality control. This provides real-time lot and quality tracking of raw materials, work in progress and finished goods. We employ a supply chain staff that works with sales, marketing, product development, and quality control personnel to ensure that only products that meet all specifications are produced and released to customers.
Our Competitors
The sports nutrition market is very competitive, and the range of products is diverse and subject to rapid and frequent changes in consumer demand. Competitors use price, shelf space and store placement, brand and product recognition, new product introductions, and raw materials to capture market share. We believe that retailers look to partner with suppliers who demonstrate brand development, market intelligence, customer service, and produce high quality products with proven science. We believe we are competitive in all of these areas.
Our competitors include numerous nutritional companies that are highly fragmented in terms of geographic market coverage, distribution channels, and product categories. In addition, we compete with large pharmaceutical companies and packaged food and beverage companies. Many of these competitors have greater financial and distribution resources available to them than us and some compete through vertical integration. Private label entities have gained a foothold in many nutrition categories and also are direct competitors. Our principal competitors are: Glanbia Performance Nutrition (Optimum Nutrition), Nutrabolt, (Cellucor C4), Dymatize Enterprises LLC, and Iovate Health Sciences International Inc. As many of our competitors are either privately held or divisions within larger organizations, it is difficult to fully gauge their size and relative ranking.
Government Regulation
The formulation, manufacturing, packaging, labeling, advertising, distribution, storage, and sale of each of our product groups are subject to regulation by one or more governmental agencies. The most active of these is the FDA, which regulates our products under the Federal Food, Drug and Cosmetic Act (“FDCA”) and regulations promulgated thereunder. The FDCA defines the terms “food” and “dietary supplement” and sets forth various requirements that, unless complied with, may constitute adulteration or misbranding of such products. The FDCA has been amended several times with respect to dietary supplements, most recently by the Nutrition Labeling and Education Act of 1990 (the “NLEA”) and the Dietary Supplement Health and Education Act of 1994.
FDA regulations relating specifically to foods and dietary supplements for human use are set forth in Title 21 of the Code of Federal Regulations. These regulations include basic labeling requirements for both foods and dietary supplements. Additionally, FDA regulations require us and our third-party manufacturers to meet relevant good manufacturing practice regulations for the preparation, packaging and storage of our food and dietary supplements.
Our business practices and products are also regulated by the Federal Trade Commission (“FTC”), the Consumer Product Safety Commission, the United States Department of Agriculture (“USDA”) and the Environmental Protection Agency. Our activities, including our direct selling distribution activities, are also regulated by various agencies of the states, localities and foreign countries in which our products are sold.
In foreign markets, prior to commencing operations and initiating or permitting sales of our products in the market, we may be required to obtain an approval, license or certification from the country’s ministry of health or comparable agency. Prior to entering a new market in which a formal approval, license or certificate is required, we work extensively with local consultants and authorities in order to obtain the requisite approvals. We must also comply with product labeling and packaging regulations that vary from country to country. Our failure to comply with these regulations can result in a product being removed from sale in a particular market, either temporarily or permanently.
Intellectual Property
We regard our trademarks and other proprietary rights as valuable assets and believe that protecting our intellectual property is crucial to the continued successful implementation of our business strategy. Since we regard our intellectual property as a crucial element of our business with significant value in the marketing of our products, our policy is to rigorously pursue registrations for all trademarks associated with our products.
We have over 55 trademark applications in the United States, 53 of which are currently registered with the United States Patent and Trademark Office. Our registered trademarks include registrations of our house marks, as well as marks associated with our core product lines.
We also have filed for protection of various marks throughout the world and are committed to a significant long-term strategy to build and protect the MusclePharm brand globally. We have applied for the “MusclePharm” mark effective in 37 countries, including the United States. The mark has been granted final trademark registration effective in all 37 of those countries.
4
Seasonality
Our business does not typically experience seasonal variations, but revenue may fluctuate based upon promotions.
Employees
As of December 31, 2019, we had 45 total employees, all of whom were full time. None of the employees are represented by a union. Management considers its relations with our employees to be good and to have been maintained in a normal and customary manner.
Corporate Information
Our principal executive offices are located at 4400 Vanowen St., Burbank, CA 91505 and our telephone number is (800) 292-3909. We were incorporated in the State of Nevada in 2006. Our Internet addresses are www.musclepharm.com and www.musclepharmcorp.com. The information contained on our websites is not incorporated herein.
Available Information
Our corporate website is www.musclepharmcorp.com. We post the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the SEC: our Annual Report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as amended. All such filings are available free of charge on the Investor Relations section of our website, or from the SEC’s website at www.sec.gov. Information on our website does not constitute part of this report. Also available on the Investor Relations section of our website are the charters of the committees of our Board, as well as our corporate governance guidelines and code of ethics.
Item 1A. Risk Factors
Certain factors may have a material adverse effect on our business, financial condition and results of operations. You should consider carefully the risks and uncertainties described below, in addition to other information contained in this Annual Report on Form 10-K, including our consolidated financial statements and related notes. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business. If any of the following risks actually occurs, our business, financial condition, results of operations and future prospects could be materially and adversely affected. In that event, the trading price of our common stock could decline, and you could lose part or all of your investment.
Risks Related to Our Business and Industry
We have a history of losses from operations, there is uncertainty as to when we may become profitable, and our current indebtedness may limit our operating flexibility, which raise substantial doubt about the Company’s ability to continue as a going concern.
The Company has incurred significant losses and experienced negative cash flows since inception. As of December 31, 2019, we had a working capital deficit of $29.4 million, a stockholders’ deficit of $28.0 million and recurring losses from operations including an accumulated deficit of $195.9 million resulting from losses from operations. During 2019, we incurred an additional substantial loss. As a result of our history of losses and financial condition, there is substantial doubt about our ability to continue as a going concern.
As of December 31, 2019, we had outstanding indebtedness of $10.2 million. For a description of our indebtedness, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources.”
The ability to continue as a going concern is dependent upon us achieving profitable operations in the future and/or obtaining the necessary financing to meet our obligations and repay our liabilities when they come due. Management is on an ongoing basis evaluating strategies to obtain financing to fund our expenses and achieve a level of revenue adequate to support our current cost structure. There is no assurance that we will be able to obtain additional financing on acceptable terms or at all or to generate an adequate level of revenues.
5
Our indebtedness, and history of losses, could have important consequences to us. For example, it could:
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make us more vulnerable to general adverse economic and industry conditions, including effects of the ongoing COVID-19 pandemic;
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limit our ability to obtain additional financing for working capital, capital expenditures, acquisitions and other general corporate requirements; and
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limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate.
In addition, our ability to pay or refinance our debt depends on our successful financial and operating performance, cash flows and capital resources, which in turn depend upon prevailing economic conditions and certain financial, business and other factors, many of which are beyond our control. These factors include, among others:
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economic and demand factors affecting our industry;
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pricing pressures;
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increased operating costs;
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competitive conditions; and
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other operating difficulties.
If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay operating or capital expenditures, sell material assets or operations, seek to obtain additional capital, or restructure our debt.
We may incur additional indebtedness in the future. Our incurrence of additional indebtedness would intensify the risks described above.
Our operating results may fluctuate, which makes them difficult to predict and they may fall short of expectations.
Our operating results may fluctuate due to a number of factors, many of which are outside of our control. As a result, comparing our operating results on a period-to-period basis may not be meaningful, and you should not rely on our past results as an indication of our future performance. Our quarterly, year-to-date, and annual expenses as a percentage of our revenues may differ significantly from our historical or projected rates. Our operating results in future quarters may not meet expectations.
Each of the following factors, as well as others, may affect our operating results:
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our loss of one or more significant customers;
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the introduction of successful new products by our competitors;
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the effects of the ongoing COVID-19 pandemic; and
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adverse media reports on the use or efficacy of nutritional supplements.
Because our business is changing and evolving, our historical operating results may not be useful to you in predicting our future operating results.
We will likely be required to raise additional financing to fund our operations.
We will likely be faced with the need to raise additional funds in the future. There can be no assurance that we will be able to obtain debt or equity financing on acceptable terms, or at all.
6
Mr. Drexler’s stock ownership gives him the ability to substantially influence the strategic direction of the Company and to direct the outcome of matters requiring stockholder approval.
Mr. Ryan Drexler, our Chairman of the Board, Chief Executive Officer and President, owns approximately 55.7% of our outstanding shares of common stock. As a result, Mr. Drexler is able to substantially influence the strategic direction of the Company and the outcome of matters requiring approval by our stockholders. Mr. Drexler’s interests may not be, at all times, the same as those of our other stockholders, and his control may delay, deter or prevent acts that may be favored by our other stockholders.
We rely on a limited number of customers for a substantial portion of our sales, and the loss of or material reduction in purchase volume by any of these customers would adversely affect our sales and operating results.
During 2019, our largest customers, Costco, Amazon, and iHerb individually accounted for approximately 33%, 13% and 17%, respectively, of our net revenue. Net revenue is equal to our gross revenue less product discounts, customer rebates and incentives. The loss of any of our major customers, a significant reduction in purchases by any major customer, price pressure from any of our major customers or any serious financial difficulty of a major customer may have a material adverse effect on our sales and operating results.
The Company’s retail customers have been and may continue to be affected by outbreaks of disease, such as epidemics or pandemics, including the ongoing COVID-19 pandemic.
The Company’s retail customers have been and continue to be affected by the ongoing global COVID-19 pandemic and the resulting volatility and uncertainty it has caused in the U.S. and international markets. Store closures and social distancing have adversely impacted the Company’s sales to retailers. The COVID-19 pandemic also has the potential to significantly impact our supply chain if the facilities of our third- party manufacturers, the distribution centers where our inventory is managed or the operations of our logistics and other service providers are disrupted, temporarily closed or experience worker shortages. We may also see disruptions or delays in shipments of certain materials or products.
As a result of the ongoing COVID-19 outbreak, the Company has transitioned the majority of its workforce to a temporary remote working model, which may result in the Company experiencing lower work efficiency and productivity, which in turn may adversely affect the Company’s business. As Company employees work from home and access the Company’s system remotely, the Company may be subject to heightened security risks, including the risks of cyberattacks. Additionally, if any of the Company’s key management or other employees are unable to perform his or her duties for a period of time, including as the result of illness, the Company’s results of operations or financial condition could be adversely affected.
The Company cannot reasonably estimate the length or severity of the COVID-19 pandemic or the related responses, or the extent to which the disruption may materially impact the Company’s business, consolidated financial position, consolidated results of operations or consolidated cash flows.
Our failure to respond appropriately to competitive challenges, changing consumer preferences and demand for new products could significantly harm our customer relationships and product sales.
The sports nutrition market is very competitive, and the range of products is diverse and subject to rapid and frequent changes in consumer demand. Our failure to accurately predict product trends could negatively impact our results and cause our revenues to decline. Our success with any product offering (whether new or existing) depends upon a number of factors, including our ability to:
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deliver quality products in a timely manner in sufficient volumes;
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accurately anticipate customer needs and forecast accurately to our manufacturers;
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differentiate our product offerings from those of our competitors;
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competitively price our products; and
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develop new products.
Furthermore, products often have to be promoted heavily in stores or in the media to obtain visibility and consumer acceptance. Acquiring distribution for products is difficult and often expensive due to slotting and other promotional charges mandated by retailers. Products can take substantial periods of time to develop consumer awareness, consumer acceptance and sales volume. Accordingly, some products may fail to gain or maintain sufficient sales volume and as a result may have to be discontinued. In a highly competitive marketplace, it may be difficult to have retailer’s open SKU’s for new products.
7
Our industry is highly competitive, and our failure to compete effectively could adversely affect our market share, financial condition, and future growth.
The sports nutrition market is highly competitive with respect to:
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price;
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shelf space and store placement;
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brand and product recognition;
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new product introductions; and
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raw materials.
Many of our competitors are larger, more established companies and possess greater financial strength and other resources than we have. We face competition in the supplement market from a number of large nationally known manufacturers, private label brands and many smaller manufacturers.
Our industry is highly regulated. We may in the future incur increased compliance costs and/or incur substantial judgments, fines, legal fees, and other costs.
The manufacturing, packaging, labeling, advertising, distribution, storage and sale of our products are regulated by various federal, state, and local agencies as well as those of each foreign country to which we distribute. Our compliance costs may increase in the future, and those increases could be material. In addition, governmental authorities may commence regulatory or legal proceedings, which could restrict the permissible scope of our product claims or the ability to manufacture and sell our products in the future. For example, the FDA regulates our products to ensure that the products are not adulterated or misbranded. Failure to comply with FDA requirements may result in, among other things, warning or untitled letters, injunctions, product withdrawals, recalls, product seizures, fines, and criminal proceedings.
Our advertising is subject to regulation by the FTC under the Federal Trade Commission Act. In recent years, the FTC has initiated numerous investigations of dietary supplement and weight loss products and companies. Additionally, some states also permit advertising and labeling laws to be enforced by private attorney generals, who may seek relief for consumers, seek class action certifications, seek class wide damages, and product recalls. Any of these types of actions could have a material adverse effect on our business, financial condition, and results of operations.
Adverse publicity or consumer perception of our products and any similar products distributed by others could harm our reputation and adversely affect our sales.
We are highly dependent upon positive consumer perceptions of the safety and quality of our products as well as similar products distributed by other sports nutrition supplement companies. Consumer perception of sports nutrition supplements and our products in particular can be substantially influenced by scientific research or findings, national media attention and other publicity about product use.
Adverse publicity from these sources regarding the safety, quality, or efficacy of our products or nutritional supplements could seriously harm our reputation and results of operations. The mere publication of news articles or reports asserting that such products may be harmful or questioning their efficacy could have a material adverse effect on our business, financial condition, and results of operations, regardless of whether such news articles or reports are scientifically supported or whether the claimed harmful effects would be present at the dosages recommended for such products.
We may be exposed to material product liability claims, which could increase our costs and adversely affect our reputation and business.
As a marketer and distributor of products designed for human consumption, we could be subject to product liability claims if the use of our products is alleged to have resulted in injury or undesired results. Our products consist of vitamins, minerals, herbs, and other ingredients that are classified as dietary supplements and in most cases are not subject to pre-market regulatory approval in the United States or internationally. Previously unknown adverse reactions resulting from human consumption of these ingredients could occur.
We have not had any significant product liability claims filed against us but, in the future, we may be subject to various product liability claims, including due to tampering by unauthorized third parties, product contamination, and claims that our products had inadequate instructions for use, or inadequate warnings concerning possible side effects and interactions with other substances. The cost of defense can be substantially higher than the cost of settlement even when claims are without merit. The high cost to defend or settle product liability claims could have a material adverse effect on our business, financial condition and results of operations, and our insurance, if any, may not be adequate.
In addition, the perception of our products resulting from a product liability claim also could have a material adverse effect on our business, financial condition and results of operations.
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Our insurance coverage or third-party indemnification rights may not be sufficient to cover our legal claims or other losses that we may incur in the future.
We maintain insurance at what we believe are adequate levels for property, general product liability, product recall, director’s and officer’s liability, and workers’ compensation to protect ourselves against potential loss exposures. In the future, insurance coverage may not be available at adequate levels or on adequate terms to cover potential losses, including on terms that meet our customer’s or manufacturer’s requirements. If insurance coverage is inadequate or unavailable, we may face claims that exceed coverage limits or that are not covered, which could increase our costs and adversely affect our operating results.
If we are unable to retain key management personnel or hire qualified personnel, our ability to manage our business effectively and grow could be negatively impacted.
Over the last few years, the Company has had significant management turnover. Our future success depends in part on our ability to identify, hire, develop, motivate and retain key skilled management personnel and employees for all areas of our organization, particularly sales and marketing. Competition in our industry for qualified employees has been intense. The loss or limitation of the services of any of our key management employees, including as a result of illness, or our inability to hire qualified employees could have a material adverse effect on our business, financial condition and results of operations.
Changes in the economies of the markets in which we do business may affect consumer demand for our products.
Consumer spending habits, including spending for our products, are affected by, among other things, prevailing economic conditions, levels of employment, fuel prices, changes in exchange rates, salaries and wages, the availability of consumer credit, consumer confidence and consumer perception of economic conditions. Economic slowdowns in the markets in which we do business and an uncertain economic outlook may adversely affect consumer spending habits, which may result in lower sales of our products in future periods.
Beginning in April 2020, we began experiencing a slowdown in sales to our retail customers, including our largest customer. However, we are experiencing growth in our largest online customer, which has offset this decline, although there can be no assurances that such growth will continue, or that we will have the financial resources to produce the additional quantities required by this customer. A prolonged global or regional economic downturn could have a material negative impact on our business, financial condition, results of operations and cash flows.
If we fail to effectively manage our growth, our business and operating results could be harmed.
Growth in our business will place significant demands on our management, and our operational and financial infrastructure. To effectively manage growth, we expect that we will need to continue to improve our operational, financial and management controls and our reporting systems and procedures. To accomplish these objectives, we may need to hire additional employees, make certain enhancements to our technology systems, make capital expenditures, and utilize management resources. Failure to implement these measures could have a material adverse effect on our business, financial condition and results of operations.
Our intellectual property rights are valuable, and any inability to protect them could reduce the value of our products and brand.
We have invested significant resources to protect our brands and trademarks. However, we may be unable or unwilling to strictly enforce our intellectual property rights, including our brands and trademarks, from infringement. Our failure to enforce our intellectual property rights could diminish the value of our brands and product offerings and harm our business and future growth prospects.
We may be subject to intellectual property rights claims, which are costly to defend, could require us to pay damages and could limit our ability to sell some of our products.
Our industry is characterized by vigorous pursuit and protection of intellectual property rights, which has resulted in protracted and expensive litigation for several companies. Third parties may assert claims of misappropriation of trade secrets or infringement of intellectual property rights against us or against our end customers or partners for which we may be liable. Intellectual property lawsuits are subject to inherent uncertainties due to the complexity of the technical issues involved, and we cannot be certain that we would be successful in defending ourselves against intellectual property claims.
Further, many potential litigants have the capability to dedicate substantially greater resources than we can to enforce their intellectual property rights and to defend claims that may be brought against them. Furthermore, a successful claimant could secure a judgment that requires us to pay substantial damages or prevents us from distributing products or performing certain services.
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Product returns could negatively impact our operating results and profitability.
We permit the return of damaged or defective products and accept limited amounts of product returns in certain instances. While such returns from established customers have historically been nominal and within management’s expectations and the provisions established, future return rates may differ from those experienced in the past. Any significant increase in damaged or defective products or accepted returns could have a material adverse effect on our operating results for the period or periods in which such returns materialize.
We rely on third-party manufacturers for the production of our products.
We rely on third-party manufacturers to produce products required to meet our quality and market needs, and plan to continue to do so. If our contract manufacturers fail to maintain high manufacturing standards and processes, it could harm our business. In the event of a natural disaster or business failure, including due to bankruptcy of a contract manufacturer, we may not be able to secure a replacement of our products on a timely or cost-effective basis, which could result in delays, additional costs and reduced revenues. Additionally, our third-party manufacturers have been and may continue to be negatively affected by the ongoing COVID-19 pandemic.
A shortage in the supply of key raw materials or price increases could increase our costs or adversely affect our sales.
All of our raw materials for our products are obtained from third-party suppliers. Since all of the ingredients in our products are commonly used, we have not experienced shortages or delays in obtaining raw materials. If circumstances change, shortages could result in materially higher raw material prices or adversely affect our ability to have a product manufactured. Prices for our raw materials can and do fluctuate. Price increases from a supplier would directly affect our profitability if we are not able to pass price increases on to customers. Our inability to obtain adequate supplies of raw materials in a timely manner or a material increase in the price of our raw materials could have a material adverse effect on our business, financial condition and results of operations. Additionally, our third-party suppliers have been and may continue to be negatively affected by the ongoing COVID-19 pandemic.
Our share price has been and may continue to be volatile.
The market price of our common shares is subject to significant fluctuations in response to a multitude of factors, including variations in our quarterly operating results and financial condition. Factors other than our financial results that may affect our share price include, but are not limited to, market expectations of our performance, market perception or our industry, the activities of our managers, customers, and investors, and the level of perceived growth in the industry in which we participate, general trends in the markets for our products, general economic business and political conditions in the countries and regions in which we conduct our business, and changes in government regulation affecting our business, many of which are not within our control. In addition, like many companies of our size with low trading volume, our stock price may fluctuate significantly for reasons unrelated to our business.
We may, in the future, issue additional shares of common stock and/or preferred stock, which would reduce investors’ percent of ownership and may dilute our share value.
Our articles of incorporation, as amended, authorize the issuance of 100,000,000 shares of common stock and 10,000,000 shares of preferred stock. As of December 31, 2019, 33,000,412 shares of our common stock were outstanding, and we did not have any outstanding shares of preferred stock. As of August 18, 2020, 33,101,866 shares of our common stock were outstanding. The future issuance of common stock and preferred stock may result in substantial dilution in the percentage of our common stock held by our then existing stockholders. The issuance of common stock for future services or acquisitions or other corporate actions may have the effect of diluting the value of the shares held by our investors and might have an adverse effect on any trading market for our common stock.
We may issue shares of preferred stock in the future that may adversely impact your rights as holders of our common stock.
Our Board has the authority to fix and determine the relative rights and preferences of our authorized but undesignated preferred stock, as well as the authority to issue shares of such preferred stock, without further stockholder approval. As a result, our Board could authorize the issuance of a series of preferred stock that would grant to holders preferred rights to our assets upon liquidation, the right to receive dividends before dividends are declared to holders of our common stock, and the right to the redemption of such preferred stock, together with a premium, prior to the redemption of the common stock.
To the extent that we do issue such additional shares of preferred stock, your rights as holders of common stock could be impaired thereby, including, without limitation, dilution of your ownership interests in us. In addition, shares of preferred stock could be issued with terms calculated to delay or prevent a change in control or make removal of management more difficult, which may not be in your interest as a holder of common stock.
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Our inventory financing and convertible promissory note agreements contain covenants that limit our ability to incur additional debt and grant liens on assets.
Our convertible promissory note agreement that we have entered into with Mr. Drexler and our inventory financing contain restrictive covenants that limit our ability to, among other things, incur additional debt and grant liens on assets. If we fail to comply with the restrictions in this debt instruments, a default may allow the debtor to accelerate the related debt and to exercise his remedies under the agreement, which includes the right to declare the principal amount of that debt, together with accrued and unpaid interest and other related amounts, immediately due and payable, and to exercise any remedies he may have to foreclose on assets that are subject to liens securing that debt.
For additional details regarding our indebtedness, see Note 8 to the accompanying Consolidated Financial Statements.
Our common stock is quoted on the OTCQB, which may have an unfavorable impact on our stock price and liquidity.
Our common stock is quoted on the OTCQB Marketplace (“OTCQB”). The OTCQB is an automated quotation service operated by OTC Markets, LLC. The quotation of our shares on the OTCQB may result in a less liquid market available for existing and potential stockholders to trade shares of our common stock, in part because of the inability or unwillingness of certain investors to acquire shares of common stock not traded on a national securities exchange, and could depress the trading price of our common stock and have a long-term adverse impact on our ability to raise capital in the future.
Nevada corporation laws limit the personal liability of corporate directors and officers and require indemnification under certain circumstances.
Section 78.138(7) of the Nevada Revised Statutes provides that, subject to certain very limited statutory exceptions or unless the articles of incorporation provide for greater individual liability, a director or officer of a Nevada corporation is not individually liable to the corporation or its stockholders for any damages as a result of any act or failure to act in his or her capacity as a director or officer, unless it is proven that the act or failure to act constituted a breach of his or her fiduciary duties as a director or officer and such breach involved intentional misconduct, fraud or a knowing violation of law. We have not included in our articles of incorporation any provision intended to provide for greater liability as contemplated by this statutory provision.
In addition, Section 78.7502(3) of the Nevada Revised Statutes provides that to the extent a director or officer of a Nevada corporation has been successful on the merits or otherwise in the defense of certain actions, suits or proceedings (which may include certain stockholder derivative actions), the corporation shall indemnify such director or officer against expenses (including attorneys’ fees) actually and reasonably incurred by such director or officer in connection therewith.
We have ongoing material weaknesses and may in the future fail to maintain effective systems of internal control over financial reporting and disclosure controls and procedures, any of which could, among other things, result in significant additional costs being incurred, cause a loss of confidence in our financial reporting, and adversely affect the trading price of our common stock.
We have concluded that our internal controls over financial reporting were not effective as of December 31, 2018 due to the existence of material weaknesses in such controls, and we have also concluded that our disclosure controls and procedures were not effective as of December 31, 2019, all as described in Item 9A, “Controls and Procedures,” of this Annual Report on Form 10-K. Remediation efforts to address the identified weaknesses are just beginning. Continuing costs to remedy these material weaknesses and to address inquiries from regulators may be significant and may require significant time from our management and other personnel, and we cannot assure you that we will be able to remedy the material weaknesses.
The incurrence of significant additional expense, or the requirement that management and other personnel devote significant time to these matters could reduce the time available to execute on our business strategies and could have a material adverse effect on our business, financial condition and results of operations. We also cannot assure you that additional material weaknesses in our internal control over financial reporting will not arise or be identified in the future. If our remediation measures are insufficient to address the identified deficiencies, or if additional deficiencies in our internal control over financial reporting are discovered or occur in the future, our consolidated financial statements may contain material misstatements and we could be required to restate our financial results and may be unable to make our filings with the SEC on a timely basis. Moreover, because of the inherent limitations of any control system, material misstatements due to error or fraud may not be prevented or detected on a timely basis, or at all.
If we are unable to provide reliable and timely financial reports in the future, our business and reputation may be further harmed. Failures in internal controls may negatively affect investor confidence in our management and the accuracy of our financial statements and disclosures, or result in adverse publicity and concerns from investors and commercial customers, any of which could have a negative effect on the price of our shares, subject us to regulatory investigations and penalties and/or shareholder litigation, and materially adversely impact our business and financial condition.
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Item 1B. Unresolved Staff comments
None.
Item 2. Properties
As of December 31, 2019, we operated in leased office and warehouse facilities across the United States totaling approximately 53,000 square feet, including approximately 27,000 square feet for our corporate headquarters and MP Sports Science Center in Burbank, California. We do not own any real property.
Our current office space and locations can be seen in the below table.
| Location | | Function | | Approximate Square Feet | Expiration Date of Lease | Monthly Rent |
| Burbank, CA | | Company Headquarters, MP Sports Science Center | | 27,226 | September 30, 2022 | $38,620 |
| Spring Hill, TN | | Warehouse and distribution | | 52,740 | June 30, 2020* | $24,176 |
| Denver, CO | | Former Company Headquarters | | 30,302 | December 31,2020 | $11,616 |
| Centennial, CO | | Denver Administrative Office | | 10,289 | July 30, 2020 | $8,318 |
The Company subleased the properties in Denver, CO and Centennial, CO (through July 30, 2020). The Company does not intend to extend the lease terms expiring in 2020.
*MusclePharm made additional month-to-month lease payments on the Tennessee warehouse for the months of July and August, 2020.
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Item 3. Legal Proceedings
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.
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 December 31, 2019, we were involved in the following material legal proceedings described below. These are not 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 nitrates to MusclePharm, filed a complaint against us in Arizona state court. ThermoLife alleged that we failed to meet minimum purchase requirements contained in the parties’ supply agreement. In March 2016, we filed counterclaims alleging that ThermoLife’s products were defective. Through orders issued in September and November 2018, the court dismissed MusclePharm’s counterclaims and found that the Company was liable to ThermoLife for failing to meet its minimum purchase requirements.
The court held a bench trial on the issue of damages in October 2019, and on December 4, 2019, the court entered judgment in favor of ThermoLife and against the Company in the amount of $1.6 million, comprised of $0.9 million in damages, interest in the amount of $0.3 million and attorneys’ fees and costs in the amount of $0.4 million. The Company recorded $1.6 million in accrued expenses as of December 31, 2018. In the interim, the Company filed an appeal, which is in the process of being briefed, and has posted bonds in the total amount of $0.6 million in order to stay execution on the judgment pending appeal. Of the $0.6 million, $0.25 million (including fees) was paid by Mr. Drexler on behalf of the Company. See “Note 8. Debt” for additional information. The balance of $0.35 million was secured by a personal guaranty from Mr. Drexler, while the associated fees of $12,500 was paid by the Company.
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 that this refinancing improperly diluted their economic and voting power and constituted an improper distribution in violation of Nevada law. In its complaint, White Winston sought the appointment of a receiver over MusclePharm, a permanent injunction against the exercise of Drexler’s conversion right under the Amended Note, and other unspecified monetary damages. On September 13, 2018, White Winston filed an amended complaint, which added a former MusclePharm executive, as a plaintiff (together with White Winston, the “White Winston Plaintiffs”). On December 9, 2019, the White Winston Plaintiffs filed a Second Amended Complaint, in which they added allegations relating to the resignation of MusclePharm’s auditor, Plante & Moran PLLC (“Plante Moran”). MusclePharm has moved to dismiss the Second Amended Complaint. That motion has not yet been fully briefed.
Along with its complaint, the White Winston Plaintiffs also filed a motion for a temporary restraining order (“TRO”) and preliminary injunction enjoining the exercise of Drexler’s conversion right under the Amended Note. On August 23, 2018, the Nevada district court issued an ex parte TRO. On September 14, 2018, the court let the TRO expire and denied the White Winston Plaintiffs’ request for a preliminary injunction, finding, among other things, that the White Winston Plaintiffs did not show a likelihood of success on the merits of the underlying action and failed to establish irreparable harm. Following the court’s decision, MusclePharm filed a motion seeking to recoup the legal fees and costs it incurred in responding to the preliminary injunction motion. On October 31, 2019, the court awarded MusclePharm $56,000 in fees and costs. The White Winston Plaintiffs have appealed that award.
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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 our current and historical loss position, the proposed adjustments would have no material impact on our 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 we 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 our filings. On April 4, 2017, we 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 we owe information reporting penalties of approximately $2.0 million.
Our counsel has submitted a formal protest to the IRS disputing on several grounds all of the proposed adjustments and penalties on our behalf, and we have 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 of its former officers (the “Former Officers”) 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, we have not recorded an estimate for its potential liability, if any, associated with these taxes.
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On August 22, 2018, Richard Estalella filed an action against us and two other defendants in the Colorado District Court for the County of Denver, seeking damages arising out of the IRS’s assertion of tax liability and penalties relating to the 2014 restricted stock grants. We have answered Estalella’s complaint, asserted counterclaims against Estalella for his failure to ensure that all withholding taxes were paid in connection with the 2014 restricted stock grants, and filed cross-claims against a valuation firm named in the action for failing to properly value the 2014 restricted stock grants for tax purposes. The Company is waiting on 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 recognized a liability of $5.3 million (past due invoices plus interest) as of December 31, 2019. Trial has not yet been set, although a Trial Setting Conference has been set for September 21, 2020.
The Company intends to vigorously defend this action.
Nutrablend Matter
On February 27, 2020, Nutrablend, a manufacturer of MusclePharm products, filed an action against MusclePharm in the United States District Court for the Eastern District of California, claiming approximately $3.1 million in allegedly unpaid invoices. The amount is currently recorded as a liability as of December 31, 2019. Trial has been set for November 17, 2020. The Company intends to vigorously defend this action.
Item 4. Mine Safety Disclosures
None.
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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is quoted on the OTCQB, which is operated by the OTC Markets Group, under the symbol “MSLP.” Our transfer agent is Corporate Stock Transfer, Inc., which is located at 3200 Cherry Creek Drive South, Suite 430, Denver, Colorado 80209.
Holders of Record
As of August 18, 2020, the closing price of our common stock was $0.18, as provided by the OTCQB, and we had 33,101,866 shares of common stock outstanding, held by approximately 295 holders of record of our common stock. The number of holders does not include individuals or entities who beneficially own shares but whose shares are held of record by a broker or clearing agency, but does include each such broker or clearing agency as one record holder.
Unregistered Sale of Securities
During the fiscal year ended December 31, 2019, the Company issued 1,014,021 shares of restricted stock to purchase 1,014,021 shares of common stock, with $0 exercise price per share, to members of its Board. The issuances of such securities were not registered under the Securities Act of 1933, as amended (the “Securities Act”), because the securities were offered and sold in transactions not involving a public offering, exempt from registration under the Securities Act pursuant to Section 4(a)(2).
The Securities Enforcement and Penny Stock Reform Act of 1990
The Securities Enforcement and Penny Stock Reform Act of 1990 requires additional disclosure and documentation related to the market for penny stock and for trades in any stock defined as a penny stock. Unless we can trade at over $5.00 per share on the bid, it is more likely than not that our securities, for some period of time, would be defined under that Act as a “penny stock.” As a result, those who trade in our securities may be required to provide additional information related to their eligibility to trade our shares. These requirements present a substantial burden on any person or brokerage firm that plans to trade our securities and could thereby make it unlikely that any liquid trading market would ever result in our securities so long as the provisions of this Act are applicable to our securities.
Any broker-dealer engaged by the purchaser for the purpose of selling his or her shares in us will be subject to Rules 15g-1 through 15g-10 of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Rather than creating a need to comply with those rules, some broker-dealers will refuse to attempt to sell penny stock.
The penny stock rules require a broker-dealer, prior to a transaction in a penny stock not otherwise exempt from those rules, to deliver a standardized risk disclosure document prepared by the SEC, which:
●
contains a description of the nature and level of risk in the market for penny stocks in both public offerings and secondary trading; contains a description of the broker’s or dealer’s duties to the customer and of the rights and remedies available to the customer with respect to a violation to such duties or other requirements of the Exchange Act;
●
contains a brief, clear, narrative description of a dealer market, including “bid” and “ask” prices for penny stocks and the significance of the spread between the bid and ask price;
●
contains a toll-free telephone number for inquiries on disciplinary actions;
●
defines significant terms in the disclosure document or in the conduct of trading penny stocks; and
●
contains such other information and is in such form (including language, type, size and format) as the SEC shall require by rule or regulation.
The broker-dealer also must provide, prior to effecting any transaction in a penny stock, to the customer:
●
the bid and offer quotations for the penny stock;
●
the compensation of the broker-dealer and its salesperson in the transaction;
●
the number of shares to which such bid and ask prices apply, or other comparable information relating to the depth and liquidity of the market for such stock; and
●
monthly account statements showing the market value of each penny stock held in the customer’s account.
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In addition, the penny stock rules require that prior to a transaction in a penny stock not otherwise exempt from those rules; the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser’s written acknowledgment of the receipt of a risk disclosure statement, a written agreement to transactions involving penny stocks, and a signed and dated copy of a written suitability statement. These disclosure requirements will have the effect of reducing the trading activity in the secondary market for our stock because it will be subject to these penny stock rules. Therefore, stockholders may have difficulty selling their securities.
Dividend Policy
We have never declared dividends on our common stock, and currently do not plan to declare dividends on shares of our common stock in the foreseeable future. We expect to retain our future earnings, if any, for use in the operation and expansion of our business. Subject to the foregoing, the payment of cash dividends in the future, if any, will be at the discretion of our Board and will depend upon such factors as restrictions in debt agreements, earnings levels, capital requirements, our overall financial condition and any other factors deemed relevant by our Board.
ITEM 6. SELECTED FINANCIAL DATA
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 7. 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 Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. See “Forward Looking Statements” and “Item 1A. Risk Factors.” Except as otherwise indicated herein, the terms “MusclePharm,” “Company,” “we,” “our” and “us” refer to MusclePharm Corporation and its subsidiaries.
Overview
MusclePharm is a scientifically-driven, performance lifestyle company that develops, manufactures, markets and distributes branded sports nutrition products and nutritional supplements. We offer a broad range of performance powders, capsules, tablets, gels and on-the-go ready to eat snacks that satisfy the needs of enthusiasts and professionals alike. Our portfolio of recognized brands, MusclePharm® and FitMiss®, is marketed and sold in more than 100 countries globally. The Company is headquartered in Burbank, California and, as of December 31, 2019, had the following wholly-owned operating subsidiaries: MusclePharm Canada Enterprises Corp., MusclePharm Ireland Limited and MusclePharm Australia Pty Limited.
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, including Amazon, Costco, Kroger, Walgreens, 7-Eleven, and many others. Our primary distribution channels are Specialty, International and FDM.
Our consolidated financial statements are prepared using the accrual method of accounting in accordance with generally accepted accounting principles in the United States (“GAAP”) and have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities in the normal course of business. The Company has incurred significant losses and experienced negative cash flows since inception. In response to the Company’s continued losses, in 2018, management implemented the following plans to improve the Company’s operating costs:
1)
reduced our workforce;
2)
renegotiated or terminated a number of contracts with endorsers in a strategic shift away from such arrangements and toward more cost-effective marketing and advertising efforts; and
3)
discontinued a number of stock keeping units (“SKUs”) and wrote down inventory to net realizable value, or to zero in cases where the product was discontinued.
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In addition, during the fourth quarter of 2019, management implemented the following additional measures to improve gross margin:
1)
reduced or eliminate sales to low or negative margin customers;
2)
reduced product discounts and promotional activity;
3)
implemented a more aggressive SKU reduction; and
4)
formed a pricing committee to review all orders to better align gross margin expectations with product availability.
As a result of these measures, as well as a reduction in protein prices, the Company realized increased gross margins in the fourth quarter of 2019, a trend which continued through the first and second quarters of 2020. Beginning in April 2020, the Company began to experience a slowdown in sales from its retail customers, including its largest customer. This decline has been offset by a growth in sales to our online customers, including 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. Management believes reductions in operating costs, and continued focus on gross margin, primarily pricing controls and a reduction in product discounts and promotional activity with the Company’s customers, will allow us to ultimately achieve profitability, however, we can give no assurances that this will occur.
See “Liquidity and Capital Resources” for a further discussion of management’s plans.
COVID-19
Our results of operations are affected by economic conditions, including macroeconomic conditions and levels of business confidence. There continues to be significant volatility and economic uncertainty in many markets and the ongoing COVID-19 pandemic has increased that level of volatility and uncertainty and has created economic disruption. 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 we expect our revenue for 2020 to be down compared to 2019, there are multiple factors contributing to this decline. While revenue for April 2020 was lower due to COVID-19, as evidenced by a decline in the Company’s FDM sales, sales in other months were in line with the Company’s expectations. 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.
Outlook
As we continue to execute our growth strategy and focus on our core products, we believe that we can, over time, continue to improve our operating margins and expense structure. In addition, we have implemented plans focused on cost containment, customer profitability, product and pricing controls that we believe will improve our gross margin and reduce our losses.
We expect that our advertising and promotion expense will continue to decrease as we focus on reducing our
expenses and shifting our promotional costs, in part, from general branding and product awareness to acquiring
customers and driving sales from existing customers. We expect that our discounts and allowances will continue to decrease, both overall and as a percentage of revenue, as we further reduce certain discretionary promotional activity that does not result in a commensurate increase in revenues. In addition, we expect our gross margin to increase in future periods due to a decrease in protein prices which began in the fourth quarter of 2019, although protein prices will continue to fluctuate.
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Results of Operations
Comparison of the Year Ended December 31, 2019 to the Year Ended December 31, 2018
| ($ in thousands) | For the Years Ended December 31, | | | |
| | 2019 | 2018 | $ Change | % Change |
| Revenue, net | $79,667 | $88,113 | $(8,446) | (10)% |
| Cost of revenue | 70,979 | 69,719 | 1,260 | 2 |
| Gross profit | 8,688 | 18,394 | (9,706) | (53) |
| Operating expenses: | | | | |
| Advertising and promotion | 2,487 | 2,939 | (452) | (15) |
| Salaries and benefits | 7,910 | 8,328 | (418) | (5) |
| Selling, general and administrative | 8,899 | 11,610 | (2,711) | (23) |
| Research and development | 893 | 751 | 142 | 19 |
| Professional fees | 3,606 | 2,598 | 1,008 | 39 |
| Total operating expenses | 23,795 | 26,226 | (2,431) | (9) |
| Loss from operations | (15,107) | (7,832) | 7,275 | 93 |
| Other (expense) income: | | | | |
| (Loss) gain on settlement of obligations | (125) | 1,074 | (1,199) | (112) |
| Interest and other expense, net | (3,609) | (3,897) | (288) | (7) |
| Loss before provision for income taxes | (18,841) | (10,655) | 8,186 | 77 |
| Provision for income taxes | 86 | 100 | (14) | (14) |
| Net loss | $(18,927) | $(10,755) | $8,171 | 76% |
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The following table presents our operating results as a percentage of revenue, net for the periods presented:
| | For the Years Ended December 31, | |
| | 2019 | 2018 |
| Revenue, net | 100% | 100% |
| Cost of revenue | 89 | 79 |
| Gross profit | 11 | 21 |
| Operating expenses: | | |
| Advertising and promotion | 3 | 3 |
| Salaries and benefits | 10 | 9 |
| Selling, general and administrative | 11 | 13 |
| Research and development | 1 | 1 |
| Professional fees | 5 | 3 |
| Total operating expenses | 30 | 29 |
| Loss from operations | (19) | (8) |
| Other (expense) income: | | |
| (Loss) gain on settlement obligations | — | 1 |
| Interest and other expense, net | (5) | (4) |
| Loss before provision for income taxes | (24) | (11) |
| Provision for income taxes | — | — |
| Net loss | (24)% | (11)% |
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Revenue, net
We derive our revenue through the sales of our various branded sports nutrition products and nutritional supplements. Revenue is recognized when control of a promised good is transferred to a customer in an amount that reflects the consideration the Company expects to be entitled to in exchange for the 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.
Net revenue reflects the transaction prices for contracts, which includes goods 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 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.
MusclePharm brands are marketed across major global retail distribution channels – Specialty, International, and Food, Drug, and Mass (“FDM”). Below is a table of net revenue by our major distribution channel:
| | For the Years Ended December 31, | |||
| | 2019 | % of Total | 2018 | % of Total |
| Distribution Channel | | | | |
| Specialty | $35,812 | 45% | $35,690 | 41% |
| International | 22,691 | 28% | 32,143 | 36% |
| FDM | 21,164 | 27% | 20,280 | 23% |
| Total | $79,667 | 100% | $88,113 | 100% |
Net revenue decreased $8.4 million, or 10%, to $79.7 million for the year ended December 31, 2019, compared to $88.1 million for the year ended December 31, 2018. Net revenue from our international customers decreased by $9.5 million, or 29%, year over year. The decrease in international sales related primarily to a general shift to domestic and online marketing. Net revenue from FDM increased $0.9 million, or 4%, and net revenue from Specialty lines increased $0.1 million, or 0.3%, year over year. The increase in Specialty was due to increased promotional activity with iHerb and Amazon, resulting in higher revenues. The increase in FDM was due to an increase in Costco domestic sales, the result of an additional promotional event in 2019 as compared to 2018. During 2019, we lowered our sales price to select customers, including certain large customer, contributing to the revenue decline. The Company significantly increased expenditures on partnerships advertising, online impressions and click advertising with its online customers, while reducing end-aisle and front of the store promotions with its retail customers. Despite these measures, gross revenues declined as the Company did not realize a significant increase in its online revenues. Finally, we continue to monitor the profitability of each customer, and in the event that customers have negative or low margins, sales activities with such customers are reduced.
Discounts and sales allowances decreased to 25% of gross revenue, or $26.9 million, for the year ended December 31, 2019 from 28% of gross revenue, or $33.5 million for 2018. Discounts and sales allowance fluctuate based on customer mix and changes in discretionary promotional activity. Further, we will continue to monitor our discounts and reduce where practical to ensure we continue to meet our gross margin expectations.
During the year ended December 31, 2019, our largest customers, Costco, Amazon, and iHerb, accounted for approximately 33%, 13%, and 17%, respectively, of our net revenue. During the year ended December 31, 2018, our largest customers, Costco, Amazon, and iHerb accounted for approximately 29%, 13%, and 13% respectively, of our net revenue.
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Cost of Revenue and Gross Margin
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 mainly ship customer orders from our distribution center in Spring Hill Tennessee. The facility is operated with our equipment and employees, and we own the related inventory. We also use contract manufacturers to drop ship products directly to our customers.
Our gross profit fluctuates due to several factors, including sales incentives, new product introductions and upgrades to existing product lines, changes in customer and product mixes, the mix of product demand, shipment volumes, our product costs, pricing, and inventory write-downs. Cost of revenue will continue to fluctuate, primarily due to changes in protein prices, which prices are impacted, in part, by our ability to negotiate better pricing with our manufacturers. Protein prices increased for most of 2019, only declining at the end of the year.
Costs of revenue increased 2% to $71.0 million for the year ended December 31, 2019, compared to $69.7 million for 2018. Accordingly, gross profit for the year ended December 31, 2019 decreased $9.7 million to $8.7 million compared to $18.4 million for 2018. Gross profit margin was 11% and 21% for the years ended December 31, 2019 and 2018, respectively. Our gross margin decreased for the year ended December 31, 2019, compared to 2018 due to a significant increase in protein prices, lower sales prices, partially offset by a decrease in discounts and allowances as a percentage of revenues.
Operating Expenses
Operating expenses for the year ended December 31, 2019 were $23.8 million, compared to $26.2 million 2018. Our operating expenses were 30% and 29% of net revenue for the years ended December 31, 2019 and 2018, respectively. We continue to focus on reducing our operating expenses in response to our continued losses, including as discussed in “--Outlook.” Changes to operating expenses in 2019 were as follows:
Advertising and Promotion
Our advertising and promotion expense consists primarily of digital, print and media advertising, athletic endorsements and sponsorships, promotional giveaways, trade show events and various partnering activities with our trading partners. Historically, advertising and promotions were a large part of both our growth strategy and brand awareness, in particular strategic partnerships with sports athletes and fitness enthusiasts through endorsements, licensing, and co-branding agreements. Additionally, we co-developed products with sports athletes and teams. In connection with our restructuring plan, we terminated the majority of these contracts in a strategic shift away from such costly arrangements, and moved toward more cost-effective brand partnerships as well as grass-roots marketing and advertising efforts. We expect our advertising and promotion expenses to remain relatively constant in future periods as we continue to leverage existing brand recognition and move towards lower cost advertising outlets including social media and trade advertising.
Advertising and promotion expense decreased $0.5 million or 15% to $2.5 million for the year ended December 31, 2019, or 3.0% of net revenue, compared to $2.9 million, or 3% of net revenue, for 2018. Advertising and promotion expense for the years ended December 30, 2019 and 2018 included expenses related primarily to advertising, sponsorships and endorsements and trade shows. The decrease in spending for the year ended December 31, 2019 primarily included decreases to trade shows and events of $0.6 million, decreases to sponsorship fees of $0.3 million, decreases to other advertising of $0.2 million, offset by increased print advertising of $0.6 million.
Salaries and Benefits
Salaries and benefits consist primarily of salaries, bonuses, benefits and stock-based compensation paid or provided to our employees.
Salaries and benefits continued to decrease due to additional headcount reductions and limited headcount additions, as well as a reduction of restricted stock awards and a reduction in amortization of existing stock-based grants through the end of 2019.
Salaries and benefits decreased by $0.4 million or 5% to $7.9 million, or 9% of net revenue, for the year ended December 31, 2019 compared to $8.3 million, or 10% of revenue, for 2018. Stock-based compensation expense decreased $0.2 million and bonuses and commissions decreased by $0.6 million, partially offset by increased severance costs of $0.4 million. Bonus expense decreased compared to the year ended December 31, 2018, as we eliminated most discretionary bonuses due to our continued losses.
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Selling, General and Administrative
Our selling, general and administrative expenses consist primarily of depreciation and amortization, information technology equipment and network costs, facilities related expenses, director’s fees, which include both cash and stock-based compensation, insurance, rental expenses related to equipment leases, supplies, legal settlement costs, broker fees and other corporate expenses.
Selling, general and administrative expenses decreased by 23% to $8.9 million, or 11% of net revenue, for the year ended December 31, 2019 compared to $11.6 million, or 13% of net revenue, for the same period in 2018. The decrease was primarily due to lower provisions for bad debts of $1.8 million, lower freight expense of $0.4 million, lower travel expenses of $0.2 million and lower depreciation of $0.2 million. These expenses were partially offset by an increase of $0.2 million in rent expense.
Research and Development
Research and development expenses consist primarily of R&D personnel salaries, bonuses, benefits, and stock-based compensation, product quality control, which includes third-party testing, and research fees related to the development of new products. We expense research and development costs as incurred.
Research and development expenses increased 19% to $0.9 million, or 1% of net revenue, for the year ended December 31, 2019 compared to $0.8 million, also 1% of net revenue, for 2018. The increase was primarily due to an increase in R&D related salaries and benefits.
Professional Fees
Professional fees consist primarily of legal fees, accounting and audit fees, consulting fees, which include both cash and stock-based compensation, and investor relations costs.
Professional fees increased 39% to $3.6 million, or 5% of net revenue, for the year ended December 31, 2019, compared to $2.6 million, or 3% of net revenue, for the same period in 2018. The increase was primarily due to an increase in legal fees of $0.8 million and an increase in accounting fees of $0.2 million. The significant increase in legal fees is as a result of increased litigation and costs related to the restatement of our 2017 and 2018 financial results.
To the extent our ongoing legal matters are reduced, in addition to this resulting in a reduction in professional fees, we expect to see a further decline in legal costs for specific settlement activities. We intend to continue to invest in strengthening our governance, internal controls, and process improvements, which is expected to require support from third-party service providers.
Settlement of obligations
For the year ended December 31, 2019, we recorded settlement expenses of $0.1 million compared to a gain of $1.1 million for the year ended December 31, 2018.
Interest and other expense, net
For the years ended December 31, 2019 and 2018, “Interest and other expense, net” consisted of the following (in thousands):
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| | For the Year Ended December 31, | |
| | 2019 | 2018 |
| | | |
| Interest expense, related party | $(1,597) | $(2,160) |
| Interest expense, related party debt discount | (60) | (60) |
| Interest expense, other | (894) | (486) |
| Interest expense, secured borrowing arrangement | (1,205) | (1,094) |
| Foreign currency transaction loss | (236) | (115) |
| Other | 383 | 18 |
| Total interest and other expense, net | $(3,609) | $(3,897) |
“Other” for 2019 includes sublease income and interest income.
Interest and other expense, net for the year ended December 31, 2019 decreased 7%, or $0.3 million, compared to 2018. The decrease in interest and other expense, net was primarily related to reduced interest on a related party note together with an increase in other income, primarily due to sublease income, partially offset by increased other interest.
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 carryforwards, 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 December 31, 2019, we had cash of $1.5 million, a decline of $0.8 million from the December 31, 2018 balance of $2.3 million. This decline is due to a net loss of $18.9 million, offset by non-cash adjustments of $2.0 million, cash provided by a change in operating assets and liabilities of $10.4 million and cash provided by financing activities of $5.7 million. As of December 31, 2019, we had a working capital deficit of $29.4 million, a stockholders’ deficit of $28.0 million and an accumulated deficit of $195.9 million resulting from losses from operations. During 2019, we incurred an additional substantial loss. As a result of our history of losses and financial condition, there is substantial doubt about our ability to continue as a going concern.
The ability to continue as a going concern is dependent upon us achieving profitable operations in the future and/or obtaining the necessary financing to meet our obligations and repay our liabilities when they come due. Management is on an ongoing basis evaluating 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. There is no assurance that we will be able to obtain additional financing on acceptable terms or at all or to generate an adequate level of revenues.
In response to the Company’s continued losses, in 2018, management implemented the following plans to improve the Company’s operating costs:
1)
reduced our workforce;
2)
renegotiated or terminated a number of contracts with endorsers in a strategic shift away from such arrangements and toward more cost-effective marketing and advertising efforts; and
3)
discontinued a number of stock keeping units (“SKUs”) and wrote down inventory to net realizable value, or to zero in cases where the product was discontinued.
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Despite these measures, during 2019, the Company continued to incur substantial losses.
In addition, during the fourth quarter of 2019, management implemented the following additional measures to improve gross margin:
1)
reduced or eliminate sales to low or negative margin customers;
2)
reduced product discounts and promotional activity;
3)
implemented a more aggressive SKU reduction; and
4)
formed a pricing committee to review all orders to better align gross margin expectations with product availability.
As a result of these measures, as well as a reduction in protein prices, the Company realized increased gross margins in the fourth quarter of 2019, a trend which continued through the first and second quarters of 2020. 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 offset by growth in online customers, including 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.
Management believes reductions in operating costs, and continued focus on gross margin, primarily pricing controls and a reduction in product discounts and promotional activity with the Company’s customers, will allow us to ultimately achieve profitability, however, we can give no assurances that this will occur.
Cash Flows
Our net consolidated cash flows are as follows (in thousands):
| | For the Years Ended December 31, | |
| | 2019 | 2018 |
| Consolidated Statements of Cash Flows Data: | | |
| Net cash (used in) provided by operating activities | $(6,524) | $1,981 |
| Net cash used in investing activities | (13) | (132) |
| Net cash provided by (used in) financing activities | 5,742 | (5,726) |
| Effect of exchange rate changes on cash | 10 | (34) |
| Net change in cash | $(785) | $(3,911) |
Operating Activities
Our cash (used in) provided by operating activities is driven primarily by sales of our products and vendor-provided credit limits. Our primary uses of cash from operating activities have been for inventory purchases, advertising and promotion expenses, personnel-related expenditures, manufacturing costs, professional fees (including legal fees), and costs related to our facilities. Our cash flows from operating activities is expected to continue to be affected principally by results of operations and the extent to which we increase spending on personnel expenditures, sales and marketing activities, and our working capital requirements.
Our operating cash outflows were $8.5 million higher for the year ended December 31, 2019, due to net cash used in operating activities of $6.5 million for the year ended December 31, 2019, compared to a net cash provided of $2.0 million for 2018. The variance primarily relates to net loss of $18.9 million, adjusted for non-cash charges, which resulted in a use of cash of $16.9 million for the year ended December 31, 2019 compared to a use of cash of $7.7 million for the same period in 2018. This variance also includes a net change in net operating assets and liabilities, which resulted in a source of cash of $10.4 million for the year ended December 31, 2019 compared to a source of cash of $9.7 million for 2018.
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The source of cash of $10.4 million provided by net operating assets and liabilities was the result of a decrease in our inventory balance of $8.9 million, a decrease in our accounts receivable balance of $1.4 million, and a decrease in prepaid expenses and other assets of $0.2 million, which together provided a source of cash, partially offset by a decrease in our accounts payable and accrued liabilities balance of $0.1 million, which reduced cash flows. During the year ended December 31, 2018, the source of cash of $9.7 million provided by net operating assets and liabilities included a decrease in accounts receivable of $1.9 million, a decrease in prepaid expenses and other assets of $0.4 million, and an increase in accounts payable and accrued liabilities of $11.5 million, resulting in a source of cash, offset in part by an increase in our inventory balance, which decreased cash flows by $3.9 million. For the year ended December 31, 2018, our accounts payable provided a use of cash due to an increase in our past due accounts payable
Investing Activities
Cash used in investing activities was $13,000 for the year ended December 31, 2019 for the purchases of property and equipment.
Cash used in investing activities was $0.1 million for the year ended December 31, 2018 for the purchases of property and equipment.
Financing Activities
Cash provided by financing activities was $5.7 million for the year ended December 31, 2019, primarily due to net borrowings from our line of credit of $2.7 million, net borrowings from our secured borrowing arrangement of $3.2 million less repayments on equipment financing of $0.1 million.
Cash used in financing activities was $5.7 million for the year ended December 31, 2018, primarily due to repayments of $1.5 million on our line of credit, $4.1 million in net repayments on our secured borrowing arrangement, and repayments on equipment financing of $0.1 million.
To manage cash flow, we have entered into numerous financing arrangement 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 $18,000,000, 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 $6,000,000 with an interest rate of 8% prior to the amendment and 10% following the amendment (the “2015 Convertible Note”), (ii) a convertible secured promissory note dated as of November 8, 2016, in the original principal amount of $11,000,000 with an interest rate of 10% (the “2016 Convertible Note”) , and (iii) a secured demand promissory note dated as of July 27, 2017, in the original principal amount of $1,000,000 with an interest rate of 15% (the “2017 Note”, and together with the 2015 Convertible Note and the 2016 Convertible Note, collectively, the “Prior Notes”). The due date of the 2015 Convertible Note and the 2016 Convertible Note was November 8, 2017. The 2017 Note was due on demand.
The $18.0 million Refinanced Convertible Note bears interest at the rate of 12% per annum. Interest payments are due on the last day of each quarter. At the Company’s option (as determined by its independent directors), the Company may repay up to one-sixth of any interest payment by either adding such amount to the principal amount of the note or by converting such interest amount into an equivalent amount of the Company’s common stock. Any interest not paid when due shall be capitalized and added to the principal amount of the Refinanced Convertible Note and bear interest on the applicable interest payment date along with all other unpaid principal, capitalized interest, and other capitalized obligations. Both the principal and the interest under the Refinanced Convertible Note were due on December 31, 2019, unless converted earlier. Mr. Drexler may convert the outstanding principal and accrued interest into shares of the Company’s common stock at a conversion price of $1.11 per share at any time. The Company may prepay the Refinanced Convertible Note by giving Mr. Drexler between 15 and 60 days’ notice depending upon the specific circumstances, subject to Mr. Drexler’s conversion right.
The Refinanced Convertible Note contains customary events of default, including, among others, the failure by the Company to make a payment of principal or interest when due. Following an event of default, interest will accrue at the rate of 14% per annum. In addition, following an event of default, any conversion, redemption, payment or prepayment of the Refinanced Convertible Note will be at a premium of 105%. The Refinanced Convertible Note also contains customary restrictions on the ability of the Company to, among other things, grant liens or incur indebtedness other than certain obligations incurred in the ordinary course of business. The restrictions are also subject to certain additional qualifications and carveouts, as set forth in the Refinanced Convertible Note. The Refinanced Convertible Note is subordinated to certain other indebtedness of the Company.
As part of the Refinancing, the Company and Mr. Drexler entered into a restructuring agreement (the “Restructuring Agreement”) pursuant to which the parties agreed to 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.
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On September 16, 2019, Mr. Ryan Drexler, the Chief Executive Officer, President and Chairman of the Board of Directors of MusclePharm Corporation, a Nevada corporation (the “Company”), delivered a notice to the Company and its independent directors of his election to convert, effective as of September 16, 2019 (the “Notice Date”), $18,000,000 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 $19,262,910. Pursuant to the terms of the Note, the Company instructed the transfer agent for its shares to issue to Mr. Drexler 16,216,216 shares (the “Shares”) of its Common Stock in respect of the Partial Conversion.
The outstanding principal and the interest, due on December 31, 2019, were refinanced under a new agreement on July 1, 2020. See additional information in “Note 17. Subsequent Events.”
For the years ended December 31, 2019 and 2018, interest expense, including the amortization of debt discount, related to the related party convertible secured promissory notes was $1.7 million and $2.2 million, respectively. During the years ended December 31, 2019 and 2018, $0.8 million and $1.9 million, respectively, in interest was paid in cash to Mr. Drexler.
Related-Party Revolving Note
On October 4, 2019, we entered into a secured revolving promissory note (the “Revolving Note”) with Mr. Drexler. Under the terms of the Revolving Note, we 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. We may repay 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. The Revolving Note is subordinated to certain other indebtedness of the Company held by Crossroads.
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. As of December 31, 2019, the outstanding balance on the revolving note was $1.2 million. Both the outstanding principal and all accrued interest, which became due on March 31, 2020, were refinanced under a new agreement on July 1, 2020. The revolving note is included in “Line of credit” in the consolidated balance sheets. See additional information in “Note 17. Subsequent Events.”
Related-Party Note Payable
The Company entered into a collateral receipt and security agreement with Mr. Drexler, dated December 27, 2019 pursuant to which Mr. Drexler agreed to post bond relating to the judgment ruled on the ThermoLife case, pending the appeal. The amount paid by Mr. Drexler on behalf of the Company, including fees, was $0.3 million. The amount, which was outstanding as of December 31, 2019, was refinanced under a new agreement on July 1, 2020. The note payable is included in “Convertible note with a related party, net of discount” in the consolidated balance sheets. See additional information in “Note 17. Subsequent Events.”
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. The Security Agreement contains customary events of default, including, among others, the failure to make payments on amounts owed when due, default under any other material agreement or the departure of Mr. Drexler. The Security Agreement also contains customary restrictions on the ability of the Company to, among other things, grant liens, incur debt and transfer assets.
Under the Security Agreement, the Company has agreed to grant Crossroads a security interest in all our present and future accounts, chattel paper, goods (including inventory and equipment), instruments, investment property, documents, general intangibles, intangibles, letter of credit rights, commercial tort claims, deposit accounts, supporting obligations, documents, records and the proceeds thereof. As of December 31, 2019 and 2018, we owed Crossroads $3.0 million and $1.5 million, respectively, and the amount is included in “Line of credit” in the consolidated balance sheets.
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 the amount the Company can borrow was increased from $3.0 million to $4.0 million.
On February 26, 2020, the Company and Crossroads further 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.
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Secured Borrowing Arrangement
In January 2016, we entered into the Purchase and Sale Agreement with Prestige Capital Corporation (“Prestige”) pursuant to which we agreed to sell and assign and Prestige agreed to buy and accept, certain accounts receivable owed to us (“Accounts”). Under the terms of the Purchase and Sale Agreement, upon the receipt and acceptance of each assignment of Accounts, Prestige will pay us 80% of the net face amount of the assigned Accounts, up to a maximum total borrowings of $12.5 million subject to sufficient amounts of accounts receivable to secure the loan. The remaining 20% will be paid to us upon collection of the assigned Accounts, less any 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 us 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, we granted Prestige a continuing security interest in and 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. The Purchase and Sale Agreement’s term previously was extended to April 1, 2020 and renews automatically for successive one-year periods unless either party receives written notice of cancellation from the other, at minimum, thirty-days prior to the expiration date. At December 31, 2019 and 2018, we had outstanding borrowings of approximately $4.4 million and $1.3 million, respectively.
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. The new agreement also modified certain rates and allows for increased borrowing on foreign borrowings.
For the years ended December 31, 2019 and 2018, the Company assigned to Prestige, accounts with an aggregate face amount of approximately $55.1 million and $46.2 million, respectively, for which Prestige paid to the Company approximately $44.1 million and $36.9 million, respectively, in cash. During the years ended December 31, 2019 and 2018, $40.9 million and $41.0 million, respectively, was repaid to Prestige, including fees and interest.
HSBF Note
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. No payments are due on the Note until November 16, 2020 (the “Deferment Period”). However, interest will continue to accrue during the Deferment Period. The Note will mature on May 16, 2022. The Note includes forgiveness provisions in accordance with the requirements of the Paycheck Protection Program, Section 1106 of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”). The Company has not determined the amount of forgiveness in connection with the loan, partly due to the ongoing routine changes in the method of calculating the amount.
Off-Balance Sheet Arrangements
We did not have any off-balance sheet arrangements as of December 31, 2019.
Non-GAAP Adjusted EBITDA
In addition to disclosing financial results calculated in accordance with GAAP, this Form 10-K discloses Adjusted EBITDA, which is net loss adjusted for stock-based compensation, gain on settlement of accounts payable, loss on disposal of property and equipment, amortization of prepaid sponsorship fees, interest and other expense, net, depreciation of property and equipment, amortization of intangible assets, provision for doubtful accounts, settlement related charges (including legal) and taxes.
Management uses Adjusted EBITDA as a supplement to GAAP measures to further evaluate period-to-period operating performance, as well as the Company’s ability to meet future working capital requirements. The exclusion of non-cash charges, including stock-based compensation and depreciation and amortization, is useful in measuring the Company’s cash available for operations and performance of the Company. Management believes these non-GAAP measures will provide investors with important additional perspectives in evaluating the Company’s ongoing business performance.
The GAAP measure most directly comparable to Adjusted EBITDA is net loss. The non-GAAP financial measure of Adjusted EBITDA should not be considered as an alternative to net loss. Adjusted EBITDA is not a presentation made in accordance with GAAP and has important limitations as an analytical tool and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. Because Adjusted EBITDA excludes some, but not all, items that affect net loss and is defined differently by different companies, our definition of Adjusted EBITDA may not be comparable to similarly titled measures of other companies.
Set forth below are reconciliations of our reported GAAP net loss to Adjusted EBITDA (in thousands):
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| | Year ended | Year ended |
| | Dec. 31, 2019 | Dec. 31, 2018 |
| Net loss | $(18,927) | $(10,755) |
| | | |
| Non-GAAP adjustments: | | |
| Stock-based compensation | 284 | 496 |
| Loss on disposal of property and equipment | 5 | — |
| Interest and other expense, net | 3,609 | 3,897 |
| Depreciation and amortization of property and equipment | 339 | 529 |
| Amortization of intangible assets | 320 | 320 |
| Bad debt expense | 21 | 1,848 |
| Income taxes | 86 | 100 |
| | | |
| Adjusted EBITDA | $(14,263) | $(3,565) |
Critical Accounting Policies and Estimates
Our consolidated financial statements have been prepared in accordance with GAAP and form the basis for the following discussion and analysis on critical accounting policies and estimates. The preparation of the consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates and assumptions on a regular basis. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from these estimates and those differences could have a material effect on our business, financial condition and results of operations.
Inventory
MusclePharm products are produced through third party manufacturers, and the cost of product inventory is recorded using a standard cost methodology. This standard cost methodology closely approximates actual cost. Inventory is valued at the lower of cost or net realizable value. Adjustments to reduce the cost of inventory to its net realizable value are made, if required, and estimates are made for obsolescence, excess or slow-moving inventories, non-conforming inventories and expired inventory. These estimates are based on management’s assessment of current future product demand, production plan, and market conditions.
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Revenue Recognition
Our revenue represents sales of finished goods inventory and is recognized when control of the promised goods 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 reserves for trade promotions and product discounts, including sales incentives, are established based on our best estimate of the amounts necessary to settle future and existing credits for product sold as of the balance sheet date.
All such costs are netted against sales. These costs include end-aisle or other in-store displays, contractual advertising fees and product discounts, and other customer specific promotional activity. We provide reimbursement to our customers for such amounts as credits against amounts owed. 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.
For the years ended December 31, 2019 and 2018, our revenue is recorded net of discounts, and to a lesser degree, sales returns, where discounts for each year total $26.9 million and $33.5 million, respectively. Total discounts accounted for 25% and 28% of gross revenue in each period, respectively.
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 awards’ grant date, based on the estimated number of shares 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 also 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 our 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. We recognize 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.
Intangible Assets
Acquired intangible assets are recorded at estimated fair value, net of accumulated amortization, and costs incurred in obtaining certain trademarks are capitalized, and are amortized over their related useful lives, using a straight-line basis consistent with the underlying expected future cash flows related to the specific intangible asset. Expected future cash flows are subject to management estimation. Costs to renew or extend the life of intangible assets are capitalized and amortized over the remaining useful life of the asset. Amortization expenses are included as a component of “Selling, general and administrative” expenses in the consolidated statements of operations.
Leases
A lease is defined as a contract, or part of a contract, that conveys the right to control the use of identified assets for a period of time in exchange for consideration. An entity controls the use when it has a right to obtain substantially all of the benefits from the use of the identified asset and has the right to direct the use of the asset. The Company determines if an arrangement is a lease at contract inception. For all classes of underlying assets, the Company includes both the lease and non-lease components as a single component and accounts for it as a lease. Lease liabilities are recognized based on the present value of the lease payments over the lease term at the commencement date.
MusclePharm calculates and uses the rate implicit in the lease if the information is readily available, or if not available, the Company uses its incremental borrowing rate in determining the present value of lease payments. Lease right-of-use ("ROU") assets are based on the lease liability, subject to adjustments, such as lease incentives. The ROU assets also include any lease payments made at or before the commencement date. MusclePharm excludes variable lease payments in measuring lease assets and lease liabilities, other than those that depend on an index or a rate or are in substance fixed payments.
MusclePharm’s lease terms include options to extend or terminate the lease when it is reasonably certain that such options will be exercised. Operating leases are included in "Operating lease right-of-use assets", "Operating lease liability, current" and "Operating lease liability, long-term" on the consolidated balance sheets. Finance leases are included in "Property and equipment, net", "Accrued and other liabilities" and "Other long-term liabilities” on the consolidated balance sheets.
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Advertising and Promotion
Our advertising and promotion expenses consist primarily of digital, print and media advertising, athletic endorsements and sponsorships, promotional giveaways, trade show events and various partnering activities with our trading partners, and are expensed as incurred. For major trade shows, the expenses are recognized within a calendar year over the period in which we recognize revenue associated with sales generated at the trade show. Some of the contracts provide for contingent payments to endorsers or athletes based upon specific achievement in their sports, such as winning a championship. We record expense for these payments if and when the endorser achieves the specific achievement.
Contingencies
The Company records loss contingencies when management determines that the outcome of future events is probable of occurring and when the amount of the loss can be reasonably estimated. Gain contingencies are recognized in the consolidated financial statements when they are realized. The determination of an accrual for a loss contingency is based on management’s judgment and estimates with respect to the likely outcome of the matter. Liabilities are recorded or adjusted when events or circumstances cause these judgments or estimates to change.
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.
See additional information in “Note 9. Commitment and Contingencies.”
Recently Issued Accounting Pronouncements
See Note 2 to the to the accompanying Consolidated Financial Statements for a discussion of recent accounting pronouncements or changes in accounting pronouncements that are of significance, or potential significance, to us.
ITEM 7A. 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 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See the Consolidated Financial Statements set forth on the “Index to Financial Statements” on Page 54 of this Form 10-K, which Consolidated Financial Statements are incorporated by reference into this Item 8.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
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ITEM 9A. CONTROLS AND PROCEDURES
Background.
Prior to filing this Form 10-K, we have not issued audited financial statements or filed Annual Reports on Form 10-K or Quarterly Reports on Form 10-Q, since our Quarterly Report on Form 10-Q for the quarter ended September 30, 2018. As disclosed in our Current Report on Form 8-K filed on March 14, 2019, our previously filed Quarterly Report on Form 10-Q as of and for the three and nine months ended September 30, 2018 should no longer be relied upon.
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 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 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 this Form 10-K.
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;
●
Improper recording of a debt discount in connection with the 2017 Refinanced Convertible Note; and
●
Other period end expense cutoff.
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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.
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 December 31, 2019. 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. Remediation efforts to address the identified weaknesses are ongoing and we were not able to remediate our material weaknesses in internal controls as of December 31, 2018, and as our remediation efforts are ongoing, we are not be able to conclude that such controls are effective as of December 31, 2019.
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 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. 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, 2019 was not effective due to the existence of the material weaknesses in internal control over financial reporting described below.
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 “tone at the top” 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. |
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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 this Form 10-K.
Material Weaknesses
We have identified the following material weaknesses in connection with these issues:
Control Environment and Control Activities
●
Management did not maintain an effective control environment, including ensuring that required accounting methodologies, policies, and technical accounting personnel were in place. This control deficiency led to a series of corrections related to the years 2018 and 2017 and resulted in a restatement to the respective previously issued financial statements.
●
The Company did not properly classify payments to customers, primarily for promotional activity, as a reduction in the transaction price with its customers, instead treating such payments as an advertising and promotions activity, a component of operating expense.
●
The Company reported certain sales transactions prior to transfer of control of goods, inconsistent with customer sales agreements and the Company’s customary practices.
●
The Company did not properly estimate the expected value of customer payments, in the form of credits, at each quarter period end in 2018. In addition, the Company understated its accrual for customers credits for the year ended December 31, 2017.
●
The Company did not adjust the estimated useful life of its leasehold improvements nor an asset retirement obligation in the proper period for its former headquarters.
●
The Company improperly recorded debt discount in connection with the 2017 Refinanced Convertible Note.
●
The Company did not properly record accruals for expenses at the end of 2017.
The Company Does Not Maintain Adequate Internal Control Documentation 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 December 31, 2019, are described below.
●
Terminations and reprimands
The Company terminated certain employees directly responsible in the deliberate inappropriate conduct and other employees received written reprimands as a result of their behavior.
●
Implementation of enhanced quarterly sales cut-off procedures
The Company has implemented internal controls and procedures to conduct enhanced revenue recognition cutoff testing on a quarterly basis.
●
Mandatory training for the sales and operations department.
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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 commenced 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, the Company retained an experienced Chief Financial Officer with public company reporting expertise, hired a controller with fifteen years 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.
●
Establishment of a disclosure committee
The Company has implemented a disclosure committee to assist the Chief Executive Officer and Chief Financial Officer in preparing the disclosures required under the Securities Exchange Committee (SEC) rules and to help ensure that the Company’s disclosure controls and procedures are properly implemented.
●
Enhancing the internal compliance and legal functions, and authorizing management to retain the appropriate individual or individuals.
As part of the senior leadership reorganization referred to above, the Company engaged an outside firm which is in the process of revamping our internal control documentation and testing. In addition, the Company will continue to review the qualifications of our internal financial organization to ensure our personnel have the appropriate technical and SOX related expertise.
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 2020, with the goal to fully remediate all remaining material weaknesses by year-end.
Other than the ongoing remediation efforts described above, there have been no changes during the year ended December 31, 2019 in the Company’s internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, internal controls over financial reporting.
Notwithstanding the material weaknesses described in this Item 9A, our management has concluded that the consolidated financial statements and related financial information included in this Form 10-K presents fairly, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with GAAP. Management’s position is based on a number of factors, including, but not limited to:
●
The completion of the Audit Committee’s investigation and the substantial resources expended (including the use of external consultants) and the resulting adjustments we made to our previously issued financial statements, including the restatement of our 2017 audited financial statements and our unaudited quarterly financial statements for the periods ended September 30, 2018, June 30, 2018 and March 31, 2018;
●
The reconsideration of significant accounting policies and accounting practices previously employed by the Company, resulting in other adjustments to previously issued consolidated financial statements; and
●
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.
None.
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PART III
Item 10. Directors, Executive Officers and Corporate Governance
EXECUTIVE OFFICERS AND DIRECTORS
The names of our directors and executive officers, their ages and certain other information about them are set forth below. There are no family relationships among any of our directors or executive officers.
| Name | | Age | | Position |
| Ryan Drexler | | 49 | | Chief Executive Officer, President and Chairman of the Board of Directors |
| Allen Sciarillo | | 55 | | Chief Financial Officer |
| William Bush | | 55 | | Director |
| John J. Desmond | | 70 | | Director |
RYAN DREXLER – CHIEF EXECUTIVE OFFICER, PRESIDENT AND CHAIRMAN OF THE BOARD OF DIRECTORS
Ryan Drexler was appointed to serve as our Chief Executive Officer and President on November 18, 2016. Prior to that, Mr. Drexler served as our Interim Chief Executive Officer, President and Chairman of the Board of Directors since March 15, 2016. Mr. Drexler has served as Chairman of our Board of Directors since August 26, 2015. Mr. Drexler is currently the Chief Executive Officer of Consac, LLC (“Consac”), a privately-held firm that invests in the securities of publicly-traded and venture-stage companies. Previously, Mr. Drexler served as President of Country Life Vitamins, a family-owned nutritional supplements and natural products company that he joined in 1993. In addition to developing strategic objectives and overseeing acquisitions for Country Life, Mr. Drexler created new brands that include the BioChem family of sports and fitness nutrition products. Mr. Drexler negotiated and led the process which resulted in the sale of Country Life in 2007 to the Japanese conglomerate Kikkoman Corp. Mr. Drexler graduated from Northeastern University, where he earned a B.A. in political science. Because of his experience in running and developing nutritional supplement companies, we believe that Mr. Drexler is well qualified to serve on our Board of Directors.
ALLEN SCIARILLO – CHIEF FINANCIAL OFFICIER
Allen Sciarillo was appointed to serve as Chief Financial Officer on April 20, 2020. Before joining the Company, Mr. Sciarillo served as Director of Finance of The Crypto Company, a public company in the blockchain sector, from July 2018 to December 2019. Before that, he served as Regional Chief Financial Officer of Electro Rent Corporation, a provider of rental, leasing and sales of electronic test and measurement equipment, from February 2015 to March 2018. He previously served as Controller of Electro Rent from April 2006 to February 2015. Mr. Sciarillo earned his Bachelor of Science in Accounting from California State University, Northridge. In connection with his appointment, it is expected that Mr. Sciarillo will enter into the Company’s standard form of indemnification agreement, the form of which has been filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on August 27, 2012. The Company expects that it will enter into an employment agreement with Mr. Sciarillo. The Company will file an amendment to its Form 8-K disclosing the terms of any such employment agreement within four business days after it has been finalized. Because of his extensive financial reporting and operational accounting experience in various senior management positions at public and private companies, we believe that Mr. Sciarillo is well qualified to serve on our Board of Directors.
WILLIAM BUSH – DIRECTOR
William Bush joined our Board of Directors as an independent director in May 2015 and serves as lead director, as chair of the Compensation Committee, as a member of the Audit Committee and as Chair of the Nominating & Corporate Governance Committee. Since November 2016, Mr. Bush serves as chief financial officer of Stem, Inc., a leading software-driven energy storage provider. From January 2010 to November 2016, Mr. Bush served as the chief financial officer of Borrego Solar Systems, Inc., which is one of the nation’s leading financiers, designers and installers of commercial and industrial grid-connected solar systems. From October 2008 to December 2009, Mr. Bush served as the chief financial officer of Solar Semiconductor, Ltd., a private vertically integrated manufacturer and distributor of photovoltaic modules and systems targeted for use in industrial, commercial and residential applications, with operations in India, helping it reach $100 million in sales in its first 15 months of operation. Prior to that, Mr. Bush served as chief financial officer and corporate controller for a number of high growth software and online media companies as well as being one of the founding members of Buzzsaw.com, Inc., a spinoff of Autodesk, Inc. Prior to his work at Buzzsaw.com, Mr. Bush served as corporate controller for Autodesk, Inc. (NasdaqGM: ADSK), the fourth largest software applications company in the world. Because of his significant experience in finance, we believe that Mr. Bush is well qualified to serve on our Board of Directors.
JOHN J. DESMOND –DIRECTOR
John J. Desmond joined our Board of Directors as an independent director in July 2017 and serves as chair of the Audit Committee, a member of the Nominating & Corporate Governance Committee, and a member of the Compensation Committee. Previously, Mr. Desmond was Partner-in-Charge of the Long Island (New York) office of Grant Thornton LLP from 1988 through his retirement from the firm in 2015, having served over 40 years in the public accounting profession. At Grant Thornton LLP, Mr. Desmond's experience included among other things, serving as lead audit partner for many public and privately-held global companies. Mr. Desmond was elected by the U.S. Partners of Grant Thornton LLP to their Partnership Board from 2001 through 2013. The Partnership Board was responsible for oversight of many of the firm's activities including strategic planning, the performance of the senior leadership team and financial performance. Mr. Desmond currently serves on the Board of Directors of The First of Long Island (Nasdaq: FLIC) and its wholly owned bank subsidiary, The First National Bank of Long Island, and has been a director since October 2016. Mr. Desmond also serves or has served as a Board member of a number of not-for-profit entities. Mr. Desmond holds a B.S. degree in Accounting from St. John's University and is a Certified Public Accountant. Because of his significant experience in corporate governance, banking, strategic planning, business leadership, organizational management and business operations, accounting and financial reporting, finance, mergers and acquisitions, legal and regulatory, we believe that Mr. Desmond is well qualified to serve on our Board of Directors.
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DELINQUENT SECTION 16(a) REPORTS
Section 16(a) of the Exchange Act, requires our directors and named executive officers, and persons who beneficially own more than 10% of our common stock, to file initial reports of ownership and reports of changes in ownership of our common stock and our other equity securities with the SEC. As a practical matter, we assist our directors and officers by monitoring transactions and completing and filing Section 16 reports on their behalf. Based solely on a review of the copies of such forms in our possession and on written representations from reporting persons, we believe that during 2019, all of our named executive officers and directors filed the required reports on a timely basis under Section 16(a) of the Exchange Act, except for as follows:
| Name | | Date of Award | | Date Filed | | StockAwards |
| William J. Bush | | 7/1/2019 | | 9/16/2019 | | 238,095 |
| | | | | | | |
| John J. Desmond | | 7/1/2019 | | 9/16/2019 | | 357,143 |
CODE OF CONDUCT
Our Board of Directors established a Code of Conduct applicable to our officers and employees. The Code of Conduct is accessible on our website at www.musclepharmcorp.com. If we make any substantive amendments to the Code of Conduct or grant any waiver, including any implicit waiver, from a provision of the Code of Conduct to our officers, we will disclose the nature of such amendment or waiver on our website or in a current report on Form 8-K.
CORPORATE GOVERNANCE OVERVIEW
Our business, assets and operations are managed under the direction of our Board of Directors. Members of our Board of Directors are kept informed of our business through discussions with our Chief Executive Officer, our external counsel, members of management and other Company employees as well as our independent auditors, and by reviewing materials provided to them and participating in meetings of the Board of Directors and its committees.
Our corporate governance program features the following:
●
a Board of Directors that is nominated for election annually;
●
charters for each of the Boards committees, which clearly establish the roles and responsibilities of each such committee;
●
regular executive sessions among our non-employee and independent directors;
●
a Board of Directors that enjoys unrestricted access to our management, employees and professional advisers;
●
a Code of Conduct, Insider Trading Policy, Corporate Communications Policy and Corporate Governance Guidelines; and
●
no board member is serving on an excessive number of public company boards.
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BOARD COMMITTEES
Our Board of Directors has established an Audit Committee, a Compensation Committee, Nominating & Corporate Governance Committee and, each of which have the composition and responsibilities described below. Members serve on these committees until their resignations or until otherwise determined by our Board of Directors. The Board of Directors has further determined that Messrs. Desmond and Bush, chair and member, respectively, of the Audit Committee of the Board of Directors, are each an “Audit Committee Financial Expert,” as such term is defined in Item 407(d)(5) of Regulation S-K promulgated by the SEC, by virtue of their relevant experience listed in their respective biographical summaries provided above in the section entitled “Executive Officers and Directors.” Each of our committees have a written charter. Current copies of the charters of the Audit Committee, Compensation Committee, and Nominating & Corporate Governance Committee are available on our website at ir.musclepharmcorp.com/governance-documents. As necessary, the Board of Directors may establish special committees to address issues not directly under the governance of the established committees.
Audit Committee
The Audit Committee reviews the work of our internal accounting and audit processes and the Independent Registered Public Accounting Firm. The Audit Committee has sole authority for the appointment, and oversight of our Independent Registered Public Accounting Firm and to approve any significant non-audit relationship with the Independent Registered Public Accounting Firm. The Audit Committee is also responsible for preparing the report required by the rules of the SEC to be included in our annual proxy statement. The Audit Committee is currently comprised of Mr. Desmond and Mr. Bush. The Company’s Board of Directors has determined that Mr. Desmond is an “Audit Committee financial expert” within the meaning of Item 407 of Regulation S-K. Additionally, Mr. Desmond serves as chair of the Audit Committee. Each of Messrs. Desmond and Bush are independent for Audit Committee purposes, as determined under Exchange Act rules. Mr. Bush joined the Audit Committee in May 2015; Mr. Desmond joined the Audit Committee in July 2017. During 2019, the Audit Committee held 3 meetings.
Compensation Committee
The Compensation Committee approves our goals and objectives relevant to compensation, stays informed as to market levels of compensation and, based on evaluations submitted by management, recommends to our Board of Directors compensation levels and systems for the Board of Directors and our officers that correspond to our goals and objectives. The Compensation Committee, with the assistance of Longnecker, also produces an annual report on executive compensation for inclusion in our proxy statement. The Compensation Committee is currently comprised of Mr. Bush, as chair, and Mr. Desmond, as a member. Mr. Desmond joined the Compensation Committee in July 2017 and Mr. Bush joined as a member in May 2015. During 2019, the Compensation Committee held four meetings.
Nominating & Corporate Governance Committee
The Nominating & Corporate Governance Committee is responsible for recommending to our Board of Directors individuals to be nominated as directors and committee members. This includes evaluation of new candidates as well as evaluation of current directors. In evaluating the current directors, the Nominating & Corporate Governance Committee conducted a thorough self-evaluation process, which included the use of questionnaires and a third-party expert that interviewed each of the directors and provided an analysis of the results of the interviews to the committee. This committee is also responsible for developing and recommending to the Board of Directors our corporate governance guidelines, as well as reviewing and recommending revisions to the guidelines on a regular basis. The Nominating & Corporate Governance Committee is currently comprised of Mr. Bush, as chair, and Mr. Desmond, as a member. During 2019, the Nominating & Corporate Governance Committee held no meetings.
Board of Directors Role in Risk Management
The Board of Directors oversees an enterprise-wide approach to risk management, designed to support the achievement of organizational objectives, including strategic objectives, to improve long-term organizational performance and enhance stockholder value. Risk management includes not only understanding company specific risks and the steps management implements to manage those risks, but also the level of risk acceptable and appropriate for us. Management is responsible for establishing our business strategy, identifying and assessing the related risks and implementing appropriate risk management practices. Our Board of Directors reviews our business strategy and management’s assessment of the related risk, and discusses with management the appropriate level of risk for us. For example, the Board of Directors meets with management at least quarterly to review, advise and direct management with respect to strategic business risks, risks related to our new product development and financial risks, among others. The Board of Directors also delegates oversight to Board committees to oversee selected elements of risk.
The Audit Committee oversees financial risk exposures, including monitoring the integrity of our financial statements, internal controls over financial reporting, and the independence of our Independent Registered Public Accounting Firm. The Audit Committee reviews periodic internal controls and related assessments from our finance department. The Audit Committee also assists the Board of Directors in fulfilling its oversight responsibility with respect to compliance matters and meets at least quarterly with our finance department, Independent Registered Public Accounting Firm and internal or external legal counsel to discuss risks related to our financial reporting function. In addition, the Audit Committee ensures that our business is conducted with the highest standards of ethical conduct in compliance with applicable laws and regulations by monitoring our Code of Business Conduct and our Corporate Compliance Hotline, and the Audit Committee discusses other risk assessment and our risk management policies periodically with management.
The Compensation Committee participates in the design of the compensation program and helps create incentives that do not encourage a level of risk-taking behavior that is inconsistent with our business strategy.
The Nominating & Corporate Governance Committee oversees governance-related risks by working with management to establish corporate governance guidelines applicable to us, and making recommendations regarding director nominees, the determination of director independence, Board of Directors leadership structure and membership on Board committees.
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Item 11. Executive Compensation
Overview
We are eligible to take advantage of the rules applicable to a “smaller reporting company,” as defined in the Exchange Act, for the fiscal year ended December 31, 2019. As a “smaller reporting company” we are permitted, and have opted, to comply with the scaled back executive compensation disclosure rules applicable to a “smaller reporting company” under the Exchange Act. Only two individuals served as executive officers, as defined in Rule 3b-7 under the Exchange Act, during the fiscal year ended December 31, 2019. The following discussion relates to the compensation of those executive officers, who we refer to as our “named executive officers” or “NEOs” in this Annual Report on Form 10-K. For the fiscal year ended December 31, 2019, our NEOs were:
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Ryan Drexler – Chief Executive Officer, President and Chairman of the Board of Directors; and
●
Brian Casutto – Executive Vice President of Sales and Operations.
Mr. Casutto resigned from all his current roles with the Company on May 1, 2020.
Our executive compensation program is designed to attract, motivate and retain talented executives that will drive Company growth and create long-term shareholder value. The Compensation Committee oversees and administers our executive compensation program, with input and recommendations from our Chief Executive Officer.
Elements of Executive Compensation
Our executive compensation program has three main components: base salary, cash bonuses and incentive equity awards. Our named executive officers also receive employee benefits that are made available to our salaried employees generally, are eligible to receive certain compensation and benefits in connection with a change in control or termination of employment, and receive certain perquisites, in each case, as described below.
Base Salary
The Compensation Committee determines the initial base salary for each of our named executive officers and each year determines whether to approve any base salary adjustments based upon the Company’s performance, the named executive officer’s individual performance, changes in duties and responsibilities of the named executive officer and the recommendations of our Chief Executive Officer (other than with respect to his own base salary). For 2019, our named executive officers’ base salaries were as follows:
| Name | 2019 Base Salary |
| Ryan Drexler | $700,000 |
| Brian Casutto | $400,000 |
Cash Bonuses
Pursuant to their employment agreements, each of our named executive officers was eligible to earn a cash bonus, with a target amount established by the Compensation Committee, based on the achievement of specified performance goals. For 2019, there was no target bonuses for Mr. Casutto. Mr. Drexler was eligible to receive cash bonuses of up to $250,000 based on the achievement of specified performance goals. For 2019, Messrs. Drexler and Casutto earned no cash bonuses, as set out in the amounts set forth in the “Summary Compensation Table” below.
Incentive Equity Awards
Incentive equity awards granted by the Company have historically been in the form of restricted stock awards. The Company also has granted stock options from time to time. The Compensation Committee believes that equity-based awards can be an effective retention tool that also align our executives’ interests with those of our stockholders. In 2019, none of our named executive officers were granted equity-based awards.
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Employment Agreements
We entered into employment agreements with each of Mr. Drexler and Mr. Casutto that include certain severance and change in control payments. These agreements are described under “Narrative Disclosure to Summary Compensation Table” below.
Employee Benefit Plans and Perquisites
We maintain a 401(k) Savings/Retirement Plan for eligible employees of the Company and certain affiliates, including our named executive officers. The 401(k) Plan permits eligible employees to defer up to the maximum dollar amount allowed by law. The employee’s elective deferrals are immediately vested upon contribution to the 401(k) Plan. We currently make discretionary matching contributions to the 401(k) Plan in an amount equal to 100% of each eligible employee’s deferrals up to 4% of his or her qualifying compensation, subject to a total employer contribution maximum of $19,000 and limits imposed by applicable law. We do not maintain any other defined benefit, defined contribution or deferred compensation plans for our employees.
Our named executive officers are eligible to participate in all of our employee benefit plans, such as medical, dental, vision, group life and disability insurance, in each case on the same basis as other employees, subject to applicable law. We also provide vacation and other paid holidays to all employees, including our executive officers. In addition, we provide certain highly-compensated employees, including our named executive officers, with life insurance and supplemental long-term disability coverage. We also provide certain perquisites, as described and quantified in the Summary Compensation Table below under “All Other Compensation.”
Summary Compensation Table
The following summary compensation tables sets forth all compensation awarded to, earned by, or paid to our named executive officers for 2019 and 2018, in respect of their employment with the Company.
| Name and Principal Position | Year | Salary ($) | Bonus ($) | Stock Awards($) | Option Awards($) | All Other Compensation ($) | Total($) |
| | | | | | | | |
| Ryan Drexler (1) | | | | | | | |
| Chairman of the Board, | 2019 | 700,000 | — | — | — | 600(3) | 700,600 |
| Chief Executive Officer and President | 2018 | 681,250 | 709,690 | — | — | 1,900(4) | 1,392,840 |
| | | | | | | | |
| Brian Casutto(2) | 2019 | 400,000 | — | — | — | 61,000(3) | 461,000 |
| Executive Vice President of Sales and Operations | 2018 | 400,000 | 244,542 | — | — | 71,129(4) | 715,671 |
(1)
For information regarding certain transactions between Mr. Drexler and the Company, see Note 8 to the Consolidated Financial Statements below.
(2)
On May 1, 2020, Mr. Casutto resigned from all of his current roles with the Company.
(3)
Amounts under All Other Compensation for 2019 include Company 401(k) matching contributions, insurance premiums paid by the Company on behalf of our named executive officers, perquisites and severance payments, as follows:
(4)
Amounts under All Other Compensation for 2018 include Company 401(k) matching contributions, insurance premiums paid by the Company on behalf of our named executive officers, perquisites and severance payments, as follows:
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| | Drexler | Casutto |
| Miscellaneous (a) | $— | $— |
| Automobile Expenses (b) | — | 12,000 |
| Housing Costs(c) | — | 38,500 |
| Insurance Premiums | 600 | 10,500 |
| TOTAL | $600 | $61,000 |
| | Drexler | Casutto |
| Miscellaneous (a) | $1,900 | $10,559 |
| Automobile Expenses (b) | — | 10,223 |
| Housing Costs(c) | — | 40,700 |
| Insurance Premiums | — | 9,647 |
| TOTAL | $1,900 | $71,129 |
(a)
These amounts include amounts paid by the Company for miscellaneous expenses, including Company-provided matching contributions to health savings accounts for our named executive officer and amounts paid for expenses incurred by our named executive officers that were not adequately substantiated or did not qualify as a reimbursable business expense under our expense reimbursement policy.
(b)
We provided an automobile allowance for Mr. Casutto, and the use of a Company car by Mr. Drexler and Mr. Casutto while they were in Colorado (the location of our prior headquarters). For the Company car provided to Mr. Casutto, the Company insures the car under its insurance programs, pays all registration, license, taxes and other fees on the car, pays for all repairs and reimburses for all gas and maintenance costs on the car. The amount disclosed in the table above for Mr. Cassuto represents one-half of the total annual cost to the Company for the Company car.
(c)
We paid for temporary for housing for Mr. Casutto for his apartment in California as his residency remains out of the State. The amounts disclosed in the table above represents rent and utility costs billed by the landlord for this temporary housing.
Narrative Disclosure to Summary Compensation Table
We entered into employment agreements with each of Mr. Drexler and Mr. Casutto that include certain severance and change in control payments, in each case, as described below. As used below, the terms “without cause,” “good reason,” “qualifying sale,” “aggregate purchase price,” “performance bonus,” “cash-based incentives,” and “change in control” are defined in the applicable agreements.
Mr. Drexler. Mr. Drexler is party to an employment agreement with the Company, which was entered into as of February 11, 2016 and has subsequently been amended and restated, most recently effective as of February 1, 2018. Subject to earlier termination as provided therein, the term of his agreement runs through February 1, 2021 and automatically renews for successive one-year terms thereafter, unless either party provides at least three months’ written notice of its or his intention not to renew. Under his employment agreement, Mr. Drexler was entitled to a base salary of $700,000 per year for 2018 and 2019, which was increased to $750,000 per year effective January 1, 2020, in each case, subject to increase by the board. For 2019, Mr. Drexler was eligible to receive cash-based incentives of up to $250,000 based on the achievement of specified performance goals and, under his amended and restated agreement, was eligible to receive a 2018 performance bonus equal to 75% of his annual base salary, subject to the Company’s achievement of specified performance conditions unless otherwise determined by the Board. Under his amended and restated employment agreement, Mr. Drexler is also eligible to receive additional cash-based incentives of up to $350,000 based on the achievement of specified performance goals.
Concurrently with entering into the amended and restated employment agreement in February 2018, Mr. Drexler and the Company entered into a transaction bonus agreement, which provides that, upon the occurrence of a qualifying sale, and provided that at the time of the qualifying sale Mr. Drexler is an owner of at least 20% of the shares of the Company, Mr. Drexler will be entitled to a transaction bonus equal to 10% of the aggregate purchase price, if such price is in excess of $50 million. Mr. Drexler is entitled to this transaction bonus regardless of whether the qualifying transaction occurs during his employment or at any time thereafter.
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If Mr. Drexler’s employment is terminated for any reason, each equity award granted to him will fully vest and he will be entitled to any unpaid performance bonus or cash-based incentives (as described above), to the extent earned as of the date of such termination, in addition to any amounts required by law or Company policy. In addition, if Mr. Drexler’s employment is terminated by the Company without cause or by Mr. Drexler for good reason prior to (but not in connection with) a qualifying sale, Mr. Drexler will be entitled to receive (i) 12 months’ of base salary continuation, (ii) up to 12 months’ of Company-subsidized COBRA premiums, and (iii) a lump sum payment of the performance bonus for the year his employment terminates. If Mr. Drexler’s employment is terminated by the Company without cause or by Mr. Drexler for good reason within 12 months following (or prior to, but in connection with or anticipation of) a qualifying sale, Mr. Drexler will be entitled to receive, in lieu of the amounts described in the preceding sentence, (i) a lump sum payment equal to 200% of his annual base salary, (ii) up to 18 months’ of Company-subsidized COBRA, and (iii) a lump sum payment equal to 200% of the performance bonus for the year his employment terminates. The severance payable to Mr. Drexler on a termination of his employment by the Company without cause or by Mr. Drexler for good reason is subject to his execution (and non-revocation) of a release of claims in favor of the Company.
Under the employment agreement, Mr. Drexler agreed to certain restrictions on solicitation of employees, which continue for 12 months following the termination of his employment, if his employment is terminated due to disability, by him for good reason or by the Company with or without cause, due to expiration of the employment period by notice of non-renewal or due to termination of his employment upon a notice of termination. The employment agreement also contains restrictions with respect to disclosure of the Company’s confidential information.
Mr. Casutto. Mr. Casutto is party to an employment agreement with the Company, which was entered into as of July 15, 2015 and was amended and restated as of January 1, 2018. The original term of the employment agreement ended on December 31, 2018 and was extended to December 31, 2019. Under his employment agreement, Mr. Casutto was entitled to a base salary of $400,000 per year. In addition, Mr. Casutto was eligible to receive cash bonuses based on performance criteria to be adopted by the Compensation Committee, with a potential bonus pool of up to $350,000 per year. Under his employment agreement, he was entitled to a monthly vehicle allowance of $1,000 and a miscellaneous expense allowance of up to $5,000 per year.
If Mr. Casutto’s employment is terminated without cause or he resigns for good reason, he was be entitled to receive (i) base salary continuation for the lesser of 12 months and the remainder of the term of the employment agreement, (ii) a bonus equal to the greater of 25% of his target bonus for the year (or 50%, if the termination of employment occurs between July 1 and December 31 of the year) and the bonus for the year of termination of employment, as determined by the Compensation Committee at its discretion, and (iii) reimbursement of COBRA premiums for up to 12 months. In addition, unless otherwise provided in an equity award agreement, all equity awards held by Mr. Casutto would vest in full. All severance payable to Mr. Casutto under his employment agreement is subject to his execution (and non-revocation) of a release of claims in favor of the Company.
Under the employment agreement, Mr. Casutto agreed to certain restrictions on competition and solicitation, which continue for 12 months following the termination of his employment. The employment agreement also contained restrictions with respect to disclosure of the Company’s confidential information.
On May 1, 2020, Mr. Casutto resigned from all of his current roles with the Company. In connection with Mr. Casutto’s resignation from the Company, the Company and Mr. Casutto entered into a Separation and Release Agreement (the “Separation Agreement”), dated May 1, 2020. In lieu of any severance or other amounts under his employment agreement, the Agreement provides that the Company will pay Mr. Casutto an aggregate of $100,000 (the equivalent of three months base salary), with payments of $16,666.66 made every two weeks, beginning on May 15, 2020 and ending on July 17, 2020. The Separation Agreement includes customary provisions contained in agreements of this nature including, mutual non-disparagement and a general release of any and all claims.
Outstanding Equity Awards at Year End
As of December 31, 2019, there were no outstanding equity awards made to our named executive officers.
Director Compensation
Non-Employee Director Compensation Arrangements
Mr. Bush and Mr. Desmond earn annual cash retainer fees of $140,000 and $100,000, respectively, and are granted, on an annual basis, restricted shares having a grant date fair value of $100,000 and $150,000, respectively. Our non-employee directors also receive an additional cash payment to compensate them for taxes payable in respect of their restricted share grants, described below.
All cash retainers are prorated for partial years of service. We pay annual cash retainer fees to our non-employee directors quarterly. We also reimburse our non-employee directors for their travel and out of pocket expenses. Members of the Board of Directors who also are our employees do not receive any compensation for their service as directors. Our directors do not receive Board meeting fees.
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For 2019, each of our non-employee directors received awards of restricted common stock having a grant date value as described above, which were vested in quarterly installments. The number of shares for each quarterly vesting was determined by dividing the dollar value above by the average closing price of MusclePharm’s common stock for the fifteen trading days preceding the grant date. For 2019, our non-employee directors also received additional cash payments to compensate them for taxes payable in respect of their restricted share awards.
2019 Director Compensation.
The table below sets forth the compensation paid to each non-employee member of the Board of Directors during the fiscal year ended December 31, 2019. Messrs. Drexler and Casutto received no additional compensation for their service as a director, and, consequently, are not included in this table. The compensation received by Messrs. Drexler and Casutto in respect of their employment is set forth in the “Summary Compensation Table” above.
| Name | Fees Earned or Paid in Cash ($) | Stock Awards (1) ($) | All Other Compensation (2) ($) | Total ($) |
| John J. Desmond | $100,000 | $150,000 | $91,800 | $341,800 |
| William J. Bush | 140,000 | 100,000 | 70,300 | 310,300 |
(1)
Stock awards represent restricted stock units awarded on July 1, 2019. The grant date fair value of stock awards was calculated in accordance with FASB ASC Topic 718, disregarding the effects of estimated forfeitures, based upon the closing price of a share of our common stock on the date of grant. During 2019 Mr. Desmond was awarded 357,143 restricted stock units and Mr. Bush was awarded 238,095 restricted stock units.
(2)
Amounts under “All Other Compensation” for 2019 include tax gross-up adjustments related to vested restricted stock units.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table sets forth information with respect to the beneficial ownership of shares of our common stock by (i) each current director and (ii) each named executive officer, as of August 18, 2020.
| | Shares Beneficially Owned | |
| | Common Stock (1) | |
| Name of Beneficial Owner | Shares | % (2) |
| Named Executive Officers: | | |
| Ryan Drexler (3) | 18,516,023 | 55.7% |
| Brian Casutto | 125,000 | * |
| Non-Employee Directors: | | |
| William Bush | 492,181 | 1.5% |
| John J. Desmond | 587,357 | 1.8% |
| Officers and Directors as a Group (four persons): | 19,720,561 | 59.3% |
* Represents less than 1%.
| (1) | This column lists beneficial ownership of voting securities as calculated under SEC rules which generally attribute beneficial ownership of securities to persons who possess sole or shared voting power or investment power with respect to those securities and includes shares of our common stock issuable pursuant to the exercise of stock options, warrants, preferred stock or other securities that are immediately exercisable or convertible or exercisable or convertible within 60 days of August 18, 2020. Otherwise, except to the extent noted below, each director, named executive officer or entity has sole voting and investment power over the shares reported. Standard brokerage accounts may include nonnegotiable provisions regarding set-offs or similar rights. |
| (2) | Percent of total voting power represents voting power with respect to 33,101,866 shares of common stock outstanding as of August 18, 2020, plus 137,362 options to purchase common shares as if these options were exercised (33,239,228 common shares). |
| (3) | Ryan Drexler, the Company’s Chief Executive Officer, President and Chairman of the Board of Directors is the sole member of Consac, LLC, and as such has voting and investment power over the securities owned by the stockholder. These shares are also included in the beneficial owners of more than five percent table below. |
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Beneficial Owners of More than Five Percent
The following table shows the number of shares of our common stock, as of August 18, 2020 held by persons known to us to beneficially own more than five percent of our outstanding common stock.
| | Shares Beneficially Owned | |
| | Common Stock (1) | |
| Name of Beneficial Owner | Shares | % (2) |
| Wynnefield Capital (3) | 1,931,305 | 5.8% |
| Ryan Drexler (4) | 18,516,023 | 55.7% |
| Amerop Holdings, Inc. (5) | 3,648,355 | 11.0% |
| (1) | This column lists beneficial ownership of voting securities as calculated under SEC rules which generally attribute beneficial ownership of securities to persons who possess sole or shared voting power or investment power with respect to those securities and includes shares of our common stock issuable pursuant to the exercise of stock options, warrants, preferred stock or other securities that are immediately exercisable or convertible or exercisable or convertible within 60 days of August 18, 2020. Otherwise, except to the extent noted below, each director, named executive officer or entity has sole voting and investment power over the shares reported. Standard brokerage accounts may include nonnegotiable provisions regarding set-offs or similar rights. |
| (2) | Percent of total voting power represents voting power with respect to 33,101,866 shares of common stock outstanding as of August 18, 2020. To compute the percentage of outstanding shares of common stock held by each person and unless otherwise noted, any share of common stock which such person has the right to acquire pursuant to the exercise of stock options exercisable within 60 days of August 18, 2020 or upon conversion of convertible debt is deemed to be outstanding, but is not deemed to be outstanding for the purpose of computing the percentage ownership of any other person. |
| (3) | Joshua Landes and Nelson Obus may be deemed to hold an indirect beneficial interest in these shares, which are directly beneficially owned by Wynnefield Partners Small Cap Value, L.P., Wynnefield Partners Small Cap Value, L.P. I, Wynnefield Small Cap Value Offshore Fund and Wynnefield Capital, Inc. Profit Sharing Plan because they are co-managing members of Wynnefield Capital Management, LLC and principal executive officers of Wynnefield Capital, Inc. The principal place of business for Wynnefield Capital is 450 Seventh Avenue, Suite 509, New York, New York 10123. This information is based on a Schedule 13D/A filed on August 22, 2019 with the SEC. |
| (4) | Ryan Drexler, the Company’s Chief Executive Officer, President and Chairman of the Board of Directors, and as such has voting and investment power over the securities owned by the stockholder. These shares are also included in the Named Executive Officers portion of the Management Beneficial Ownership table above. Mr. Drexler disclaims such beneficial ownership except to the extent of his pecuniary interests therein. |
| (5) | Amerop Holdings, Inc. and Leonard P. Wessell III may be deemed to hold an indirect beneficial interest to 1,463,839 of these shares. White Winston Select Asset Funds, LLC, Todd M. Enright, Mark Blundell, Donald Feagan, and Robert Mahoney may be deemed to hold an indirect beneficial interest in these shares. White Winston Select Asset Fund Series Fund MP-18, LLC reported sole voting power with respect to 3,648,355 shares. The address of White Winston Select Asset Funds Series Fund MP-18, LLC is 265 Franklin St., Suite 1702, Boston, MA 02110. This information is based on a Schedule 13D filed on November 8, 2019 with the SEC. | |
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EQUITY COMPENSATION PLAN INFORMATION
In 2015, we adopted the MusclePharm Corporation 2015 Incentive Compensation Plan (the “2015 Plan”). The 2015 Plan was approved by our stockholders. The following table sets forth the number and weighted-average exercise price of securities to be issued upon exercise of outstanding options, warrants and rights, and the number of securities remaining available for future issuance under all of our equity compensation plans, at December 31, 2019:
| PLAN CATEGORY | Number of securities to be issued upon exercise of outstanding options | Weighted average exercise price of outstanding options | Number of securities remaining available for future issuance under equity compensation plans |
| Equity compensation plans approved by security holders: | | | |
| 2015 Incentive Compensation Plan | 171,703 | $1.89 | 576,494 |
| Total | 171,703 | $1.89 | 576,494 |
Item 13. Certain Relationships and Related Transactions, and Director Independence
RELATED PARTY TRANSACTIONS
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 $18,000,000, 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 $6,000,000 with an interest rate of 8% prior to the amendment and 10% following the amendment (the “2015 Convertible Note”), (ii) a convertible secured promissory note dated as of November 8, 2016, in the original principal amount of $11,000,000 with an interest rate of 10% (the “2016 Convertible Note”) , and (iii) a secured demand promissory note dated as of July 27, 2017, in the original principal amount of $1,000,000 with an interest rate of 15% (the “2017 Note”, and together with the 2015 Convertible Note and the 2016 Convertible Note, collectively, the “Prior Notes”). The due date of the 2015 Convertible Note and the 2016 Convertible Note was November 8, 2017. The 2017 Note was due on demand.
The $18.0 million Refinanced Convertible Note bears interest at the rate of 12% per annum. Interest payments are due on the last day of each quarter. At the Company’s option (as determined by its independent directors), the Company may repay up to one-sixth of any interest payment by either adding such amount to the principal amount of the note or by converting such interest amount into an equivalent amount of the Company’s common stock. Any interest not paid when due shall be capitalized and added to the principal amount of the Refinanced Convertible Note and bear interest on the applicable interest payment date along with all other unpaid principal, capitalized interest, and other capitalized obligations. Both the principal and the interest under the Refinanced Convertible Note were due on December 31, 2019, unless converted earlier. Mr. Drexler may convert the outstanding principal and accrued interest into shares of the Company’s common stock at a conversion price of $1.11 per share at any time. The Company may prepay the Refinanced Convertible Note by giving Mr. Drexler between 15 and 60 days’ notice depending upon the specific circumstances, subject to Mr. Drexler’s conversion right.
The Refinanced Convertible Note contains customary events of default, including, among others, the failure by the Company to make a payment of principal or interest when due. Following an event of default, interest will accrue at the rate of 14% per annum. In addition, following an event of default, any conversion, redemption, payment or prepayment of the Refinanced Convertible Note will be at a premium of 105%. The Refinanced Convertible Note also contains customary restrictions on the ability of the Company to, among other things, grant liens or incur indebtedness other than certain obligations incurred in the ordinary course of business. The restrictions are also subject to certain additional qualifications and carveouts, as set forth in the Refinanced Convertible Note. The Refinanced Convertible Note is subordinated to certain other indebtedness of the Company.
As part of the Refinancing, the Company and Mr. Drexler entered into a restructuring agreement (the “Restructuring Agreement”) pursuant to which the parties agreed to 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.
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On September 16, 2019, Mr. Ryan Drexler, the Chief Executive Officer, President and Chairman of the Board of Directors of MusclePharm Corporation, a Nevada corporation (the “Company”), delivered a notice to the Company and its independent directors of his election to convert, effective as of September 16, 2019 (the “Notice Date”), $18,000,000 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 $19,262,910. Pursuant to the terms of the Note, the Company instructed the transfer agent for its shares to issue to Mr. Drexler 16,216,216 shares (the “Shares”) of its Common Stock in respect of the Partial Conversion.
The outstanding principal and the interest, due on December 31, 2019, were refinanced under a new agreement on July 1, 2020. See additional information in “Note 17. Subsequent Events.”
For the years ended December 31, 2019 and 2018, interest expense, including the amortization of debt discount, related to the related party convertible secured promissory notes was $1.7 million and $2.2 million, respectively. During the years ended December 31, 2019 and 2018, $0.8 million and $1.9 million, respectively, in interest was paid in cash to Mr. Drexler.
Revolving Note
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. The Revolving Note is subordinated to certain other indebtedness of the Company held by Crossroads.
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. As of December 31, 2019, the outstanding balance on the revolving note was $1.2 million. Both the outstanding principal and all accrued interest, which became due on March 31, 2020, were refinanced under a new agreement on July 1, 2020. The revolving note is included in “Line of credit” in the consolidated balance sheets. See additional information in “Note 17. Subsequent Events.”
Note Payable
The Company entered into a collateral receipt and security agreement with Mr. Drexler, dated December 27, 2019 pursuant to which Mr. Drexler agreed to post bond relating to the judgment ruled on the ThermoLife case, pending the appeal. The amount paid by Mr. Drexler on behalf of the Company, including fees, was $0.25 million. The amount, which was outstanding as of December 31, 2019, was refinanced under a new agreement on July 1, 2020. The note payable is included in “Convertible note with a related party, net of discount” in the consolidated balance sheets. See additional information in “Note 17. Subsequent Events.”
Review, Approval or Ratification of Transactions with Related Parties
We have a written related person transactions policy that our executive officers, directors, nominees for election as a director, beneficial owners of more than 5% of our common stock, and any members of the immediate family of and any entity affiliated with any of the foregoing persons, are not permitted to enter into a material related person transaction with us without the review and approval of our Audit Committee, or a committee composed solely of independent directors in the event it is inappropriate for our Audit Committee to review such transaction due to a conflict of interest. The policy provides that any request for us to enter into a transaction with an executive officer, director, nominee for election as a director, beneficial owner of more than 5% of our common stock or with any of their immediate family members or affiliates, in which the amount involved exceeds $120,000 will be presented to our Audit Committee for review, consideration and approval.
In approving or rejecting any such proposal, we expect that our Audit Committee will consider the relevant facts and circumstances available and deemed relevant to the Audit Committee, including, but not limited to, whether the transaction is on terms no less favorable than terms generally available to an unaffiliated third party under the same or similar circumstances and the extent of the related persons interest in the transaction.
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DIRECTOR INDEPENDENCE
The rules of NASDAQ generally require that a majority of the members of a listed company’s Board of Directors be independent. In addition, the listing rules generally require that, subject to specified exceptions, each member of a listed company’s audit, compensation, and governance committees be independent. Although we are an over-the-counter listed company, we have nevertheless opted under our Corporate Governance Guidelines to comply with certain NASDAQ c