MusclePharm Corp - Quarter Report: 2015 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended: September 30, 2015

OR

For the transition period from                      to                     

Commission File Number: 000-53166

MusclePharm Corporation

(Exact name of registrant as specified in its charter)

(303) 396-6100

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months, and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.    Yes  x    No  ¨

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

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

Number of shares of the registrant’s common stock outstanding at October 30, 2015: 13,731,929 excludes 875,621 common shares held in treasury.

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MusclePharm Corporation

Form 10-Q

TABLE OF CONTENTS

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NOTE ABOUT FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements contained in this Quarterly Report on Form 10-Q other than statements of historical fact, including statements regarding our future results of operations and financial position, our business strategy and plans, and our objectives for future operations, are forward-looking statements. The words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect,” and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives, and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in Part II, Item 1A, “Risk Factors” in this Quarterly Report on Form 10-Q and contained in our other filings and reports made with the Securities and Exchange Commission. Moreover, we operate in a very competitive and rapidly changing environment which is subject to various federal and state regulations. New risks and uncertainties emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the future events and trends discussed in this Quarterly Report on Form 10-Q may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.

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

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PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

MusclePharm Corporation

Consolidated Balance Sheets

(In thousands, except share and per share data)

The accompanying notes are an integral part of these consolidated financial statements.

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MusclePharm Corporation

Consolidated Statements of Operations

(In thousands, except share and per share data)

(Unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

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MusclePharm Corporation

Consolidated Statements of Comprehensive (Loss) Income

(In thousands)

(Unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

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MusclePharm Corporation

Consolidated Statement of Stockholders’ (Deficit) Equity

(In thousands, except share data)

(Unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

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MusclePharm Corporation

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

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MusclePharm Corporation

Consolidated Statements of Cash Flows (Continued)

(In thousands)

(Unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

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MusclePharm Corporation

Notes to Consolidated Financial Statements

(Unaudited)

Note 1: Description of Business and Basis of Presentation

Description of Business

MusclePharm Corporation, or the Company, was incorporated in Nevada in 2006. The Company is a scientifically driven, performance lifestyle company that develops, manufactures, markets and distributes branded nutritional supplements. The Company is headquartered in Denver, Colorado and has the following wholly-owned operating subsidiaries: MusclePharm Canada Enterprises Corp (“MusclePharm Canada”), BioZone Laboratories, Inc. (“BioZone Labs”) and MusclePharm Ireland Limited (“MusclePharm Ireland”).

On August 24, 2015, the board of directors approved a restructuring plan for the Company. The approved restructuring plan was designed to reduce costs and to better align the Company’s resources for profitable growth. Specifically, during the quarter ended September 30, 2015, the restructuring plan resulted in: 1) a reduction in the Company’s workforce; 2) the Company abandoning certain leased facilities; and 3) the Company renegotiating or terminating a number of contracts with endorsers in a strategic shift away from such arrangements and towards more grass-roots marketing and advertising efforts. Management is continuing to execute on the approved restructuring plan, and as such, additional restructuring charges may be necessary in the fourth quarter of 2015. See Note 8 to the consolidated financial statements for further detail.

Basis of Presentation

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).

Reclassifications

Certain amounts in the consolidated statement of cash flows for the nine months ended September 30, 2014 were revised to conform to the consolidated statement of cash flows for the year ended December 31, 2014 and the current period presentation. These adjustments resulted in an increase in net cash used in operating activities of $335,000, a decrease in net cash used in investing activities of $2.9 million, and a decrease in net cash provided by financing activities of $2.6 million.

Note 2: Summary of Significant Accounting Policies

Principles of Consolidation

The consolidated financial statements include the accounts of MusclePharm Corporation and its wholly-owned subsidiaries. Acquisitions are included in the consolidated financial statements from the date of the acquisition. All significant intercompany balances and transactions have been eliminated in consolidation.

Unaudited Interim Financial Information

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with GAAP. In our opinion, the unaudited interim consolidated financial statements include all adjustments of a normal recurring nature necessary for the fair presentation of our financial position as of September 30, 2015, our results of operations for the three and nine months ended September 30, 2015 and 2014, and our cash flows for the nine months ended September 30, 2015 and 2014. The results of operations for the three and nine months ended September 30, 2015 are not necessarily indicative of the results to be expected for the year ending December 31, 2015.

These unaudited interim consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2014, filed with the SEC on March 16, 2015.

Use of Estimates

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported and disclosed in the consolidated financial statements and accompanying notes. Such estimates include, but are not limited to, allowance for doubtful accounts, revenue discounts and allowances, the valuation of inventory, the assessment of useful lives and recoverability of long-lived assets, valuations of equity securities and intangible assets, fair value of derivatives, warrants and options, among others. Actual results could differ from those estimates.

Recent Accounting Pronouncements

In April 2015, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2015-03, Interest — Imputation of Interest (Subtopic 835-30) — Simplifying the Presentation of Debt Issuance Costs, which provides guidance on simplifying the presentation of debt issuance costs, requiring that debt issuance costs related to a recognized debt liability be presented in the consolidated balance sheets as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. In August 2015, the FASB issued ASU No, 2015-15, Interest – Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements — Amendments to SEC Paragraphs Pursuant to Staff Announcement at June 18, 2015 EITF Meeting (“ASU 2015-15”), which further clarifies ASU 2015-03 as it relates to presentation and subsequent measurement of debt issuance costs related to line-of-credit arrangements. ASU 2015-15 allows an entity deferring and presenting debt issuance costs related to line-of-credit arrangements as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. Both ASU 2015-03 and ASU 2015-15 require retrospective adoption and will be effective for financial statement periods beginning after December 15, 2015, and interim periods within those fiscal years, with early adoption permitted. The Company has not early adopted ASU 2015-03 or ASU 2015-15 and the adoption of these standards is not expected to have a material effect on its consolidated financial statements or disclosures.

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In August 2014, the FASB issued ASU No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). ASU 2014-15 explicitly requires management to assess an entity’s ability to continue as a going concern, and to provide related footnote disclosure in certain circumstances. The new standard will be effective for all entities in the first annual period ending after December 15, 2016. Earlier adoption is permitted. The Company is currently evaluating the impact of the adoption of ASU 2014-15.

In June 2014, the FASB issued ASU No. 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (“ASU 2014-12”). The amendments in ASU 2014-12 require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance in Accounting Standards Codification Topic No. 718, “Compensation – Stock Compensation”, as it relates to awards with performance conditions that affect vesting to account for such awards. The amendments in ASU 2014-12 are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Early adoption is permitted. Entities may apply the amendments in ASU 2014-12 either: (a) prospectively to all awards granted or modified after the effective date; or (b) retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the consolidated financial statements and to all new or modified awards thereafter. The adoption of ASU 2014-12 is not expected to have a material effect on the Company’s consolidated financial statements or disclosures.

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”), which provides guidance for revenue recognition. ASU 2014-09 affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets and supersedes the revenue recognition requirements in Topic 605, “Revenue Recognition,” and most industry-specific guidance. This ASU also supersedes some cost guidance included in Subtopic 605-35, “Revenue Recognition- Construction-Type and Production-Type Contracts.” ASU 2014-09’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which a company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under today’s guidance, including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. ASU 2014-09 is effective for the Company beginning January 1, 2018 and, at that time, the Company may adopt the new standard under the full retrospective approach or the modified retrospective approach. Early adoption is permitted beginning January 1, 2017. The Company has not yet selected a transition method nor determined the effect of ASU 2014-09 on its ongoing financial reporting.

Note 3: Fair Value of Financial Instruments

Management believes the fair value of the line-of-credit and term loan approximates carrying value because the debt carries market rates of interest. The Company’s remaining financial instruments consisted primarily of accounts receivable, accounts payable, accrued liabilities, and accrued restructuring charges, all of which are short-term in nature with fair values approximating carrying value.

Note 4: Capstone Nutrition Agreements

The Company entered into a series of agreements with Capstone Nutrition (“F.H.G. Corporation”) effective March 2, 2015, including an amendment (the “Amendment”) to a Manufacturing Agreement dated November 27, 2013 (the “Manufacturing Agreement”). Pursuant to the Amendment, Capstone shall be the Company’s nonexclusive manufacturer of dietary supplements and food products sold or intended to be sold by the Company. The Amendment includes various agreements including amended pricing terms. The initial term ends January 1, 2022, and may be extended for three successive twenty-four month terms and includes renewal options.

Contribution toward Capstone Facility Build-Out. The Company agreed to pay to Capstone a non-refundable sum of $2.5 million to be used by Capstone solely in connection with the expansion of its facility necessary to fulfill anticipated Company requirements under the Manufacturing Agreement and Amendment. The Company has paid Capstone $2.5 million as of September 30, 2015.

The Company and Capstone entered into a Class B Common Stock Warrant Purchase Agreement (“Warrant Agreement”) whereby the Company may purchase approximately 19.9% of Capstone’s parent company, INI Parent, Inc. (“INI”), on a fully-diluted basis as of March 2, 2015. Pursuant to the Warrant Agreement, INI issued to the Company a warrant (the “Warrant”) to purchase shares of INI’s Class B common stock, par value $0.001 per share at an exercise price of $0.01 per share (the “Warrant Shares”). The warrant may be exercised if the Company is in compliance with the terms and conditions of the Amendment.

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The Company determined the value of the warrants and recorded an asset of $977,000, which is included in the caption long-term investments on the consolidated balance sheet as of September 30, 2015. The Company also recorded $1.5 million of prepaid expenses and other assets on the consolidated balance sheet as of September 30, 2015 which will be amortized over the remaining life of the Manufacturing Agreement of 6.5 years.

The Company and INI also entered into an option agreement (the “Option Agreement”). Subject to additional provisions and conditions set forth in the Option Agreement, at any time on or prior to June 30, 2016, the Company shall have the right to purchase for cash all of the remaining outstanding shares of INI’s common stock not already owned by the Company after giving effect to the exercise of the Warrant, based on an aggregate enterprise value, equal to $200 million. The fair value of the option was deemed de minimus as of the transaction date.

Note 5: Balance Sheet Components

Inventory

Inventory consisted of the following as of September 30, 2015 and December 31, 2014 (in thousands):

The Company writes down inventory for obsolete and slow moving inventory based on the age of the product as determined by the expiration date. Products within one year of their expiration dates are considered for write-off purposes. Historically, the Company has had minimal returns with established customers, and any damaged packaging is sent back to the manufacturer for replacement. Other than write-down of inventory during restructuring activities, the Company incurred insignificant inventory write-offs during the three and nine months ended September 30, 2015 and 2014.

As disclosed further in Note 8, the Company executed a restructuring plan in August 2015 and recorded a write-down of inventory related to discontinued products of $1.3 million. Inventory write downs are included as a component of cost of revenue in the accompanying consolidated statements of operations. Inventory write-downs, once established, are not reversed as they establish a new cost basis for the inventory.

Property and Equipment

Property and equipment consisted of the following as of September 30, 2015 and December 31, 2014 (in thousands):

Depreciation and amortization expense related to property and equipment was $492,000 and $303,000 for the three months ended September 30, 2015 and 2014, respectively, and $1.3 million and $950,000 for the nine months ended September 30, 2015 and 2014, respectively. These expenses are included in the selling, general and administrative expenses in the consolidated statements of operations.

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As disclosed further in Note 8, the Company executed a restructuring plan in August 2015 and wrote-off certain long-lived assets, primarily leasehold improvements, related to the abandonment of certain leased facilities. The write-off of long-lived assets of $380,000 is included as a component of restructuring and other charges in the accompanying consolidated statements of operations for the three and nine months ended September 30, 2015.

Intangible Assets

Intangible assets consist of the following (in thousands) and include the BioZone asset acquisition and MusclePharm’s apparel rights reacquired from Worldwide Apparel disclosed further in Note 11:

Intangible assets amortization expense was $278,000 for the three months ended September 30, 2015. During the three months ended September 30, 2014, the Company completed the final valuation of assets acquired from BioZone including the estimated useful lives. As a result, the Company realized a credit of $156,000 in intangible assets amortization based upon the final estimated useful life and true up of amortization expense from the acquisition date to September 30, 2014. Intangible assets amortization expense was $776,000 and $422,000 for the nine months ended September 30, 2015 and 2014, respectively. These expenses are included in selling, general and administrative expenses in the consolidated statements of operations.

As of September 30, 2015, the estimated future amortization expense of intangible assets is as follows (in thousands):

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Note 6: Other (Expense) Income, net

During the three and nine months ended September 30, 2015 and 2014, other (expense) income, net consisted of the following (in thousands):

Note 7: Debt

The Company’s debt obligations consist of the following (in thousands):

In September 2014, the Company entered into a line of credit facility with a banking institution for up to $8.0 million of borrowings. The line of credit renews annually and matures in September 2017 and accrues interest at the prime rate plus 2%, currently 5.25%. The line of credit is secured by the Company’s inventory, accounts receivable, intangible assets and equipment. As of September 30, 2015, the outstanding borrowings under the line of credit were $2.6 million. The Company was not in compliance with certain financial covenants under the line of credit as of September 30, 2015 a result of which limits further borrowings, and received various waivers from the lender during the period.

In February 2015, the Company entered into a term loan agreement with the same banking institution for a principal amount of $4.0 million. The term loan carries a fixed interest rate of 5.25% per annum, is repayable in 36 equal monthly installments of principal and interest, and matures in February 2018. Outstanding borrowings are subject to prepayment penalties of 1.0% of the prepayment amount. The Company also paid debt issuance costs of $40,000 which were recorded in prepaid expenses and other current assets in the consolidated balance sheets. As of September 30, 2015, the outstanding borrowings under the term loan were $3.3 million. The term loan contains various events which could require repayment, including in connection with the line of credit.

Borrowings on the term loan are secured by the Company’s assets and 860,900 shares of its common stock which are reported as treasury shares. The Company is also required to comply with certain negative covenants under the term loan, including restrictions on indebtedness, investments, asset dispositions, mergers or consolidations and other corporate activities. The Company was not in compliance with certain financial covenants under the term loan as of September 30, 2015 and received various waivers from the lender during the period.

On October 9, 2015, the Company entered into loan modification agreements with the banking institution under its line of credit and term loan to: (i) change the maturity date of the loans to January 15, 2016, (ii) prohibit the loans to be declared in default prior to December 10, 2015, except for defaults resulting from failure to make timely payments, and (iii) delete certain financial covenants from the line of credit. In consideration for these modifications, the Company’s chairman of the board of directors and a family member provided their individual guaranty for the remaining balance of the loans ($6.2 million). In consideration for executing his guaranty, the Company issued chairman of the board of directors 28,571 shares of its common stock with a grant date fair value of $80,000 (based upon the closing price of common stock on the date of issuance).

Note 8: Restructuring

As part of an effort to better focus and align the Company’s resources toward profitable growth, on August 24, 2015, the board of directors authorized the Company to undertake steps to commence a restructuring of the business and operations. The Company closed certain facilities, reduced headcount, discontinued products, and renegotiated certain contracts resulting in a restructuring and other charges of $17.9 million, of which $1.3 million related to inventory was included in cost of revenue and $16.6 million was included in operating expenses in the accompanying consolidated statements of operations.

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For the three and nine months ended September 30, 2015, restructuring charges of $8.2 million, to be paid in cash, were comprised primarily of: (i) $1.2 million related to severance and termination benefit costs related to the terminated employees; (ii) $6.6 million related to cancellation of certain contracts and sponsorship agreements, which are payable through December 2016; and (iii) $454,000 for costs associated with permanently vacating certain leased facilities.

The following table illustrates the provision of the restructuring charges and the accrued restructuring charges balance as of September 30, 2015 (in thousands):

As a result of the reduction in force, 325,421 shares of restricted common stock vested in accordance with the original stock grant terms and condition and resulted in the recognition of employee stock based compensation of $1.7 million. During the three months ended September 30, 2015, in association with the restructuring, the Company recorded the following charges totaling $8.4 million (in thousands):

The Company expects to complete further restructuring activities during the fourth quarter of 2015.

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The total future payments under the restructuring plan as of September 30, 2015 are as follows (in thousands):

Note 9: Commitments and Contingencies

Operating Leases and Capital Leases

The Company leases office and warehouse facilities under operating leases which expire at various dates through 2029. For lease agreements that contain escalating rent provisions, lease expense is recorded on a straight-line basis over the lease term. Rent expense was $422,000 and $356,000 for the three months ended September 30, 2015 and 2014, respectively, and $1.2 million and $989,000 for the nine months ended September 30, 2015 and 2014, respectively.

In December 2014, the Company entered into a capital lease agreement providing for approximately $1.8 million in credit to lease up to 50 vehicles as part of a fleet lease program. As of September 30, 2015, the Company acquired 19 vehicles under the capital lease, which are included in the caption property and equipment, net in the accompanying consolidated balance sheets.

The Company also leases manufacturing and warehouse equipment under capital leases, which expire at various dates through May 2019. As of September 30, 2015 and December 31, 2014, the Company had outstanding balances on capital leases of $519,000 and $265,000, respectively, which were included as a component of accrued liabilities and other long-term liabilities in the consolidated balance sheets. As of September 30, 2015, the Company’s future minimum lease payments are as follows (in thousands):

Contingencies

In the normal course of business, the Company may become involved in legal proceedings. The Company will accrue a liability for such matters when it is probable that a liability has been incurred and the amount can be reasonably estimated. When only a range of possible losses can be established, the most probable amount in the range is accrued. If no amount within this range is a better estimate than any other amount within the range, the minimum amount in the range is accrued. The accrual for a litigation loss contingency might include, for example, estimates of potential damages, outside legal fees and other directly related costs expected to be incurred. As of September 30, 2015 and December 31, 2014, the Company was not involved in any material legal proceedings, except for the SEC investigation discussed below and routine litigation and claims (primarily trademark disputes) experienced in the ordinary course of its business and as otherwise described in this Quarterly Report under Item II, Legal Proceedings.

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SEC Settlement

In September 2015, the Company’s proposal regarding final settlement of an SEC ongoing investigation was accepted and all aspects of the investigation related to the Company were terminated. The Company, without admitting or denying the SEC claims, agreed to payment of $700,000 which was previously accrued for and $400,000 had already been paid into escrow. The Company also agreed to appointment of an independent consultant mutually acceptable to the Company for a 12-month period to monitor the Company’s reporting practices in several regards and appointed Chord Advisors, LLC, a New York consulting firm.

Insurance Carrier Lawsuit

On February 12, 2015, the Company filed a complaint in the District Court, City and County of Denver, Colorado against Liberty Insurance Underwriters, Inc. (“Liberty”) claiming wrongful and unreasonable denial of coverage for the cost and expenses that the Company has incurred and continued to incur in connection with SEC investigation and related matters under the Company’s Directors and Officers Insurance policies.

Product Liability

Additionally, as a manufacturer of nutritional supplements and other consumer products for ingestion, the Company is subject to various claims in the ordinary course of its business related to labeling (including trademarks), content, packaging, and regulatory requirements. The Company currently maintains product liability insurance with a deductible/retention of $10,000 per claim with an aggregate cap on retained loss of $20.0 million, however the nature of such claims may not be covered by such insurance. The Company does not maintain any insurance related to recalls or “advertising injury” type of claims. As of September 30, 2015 and December 31, 2014, the Company had not recorded an accrual for product liability or related claims although claims of this nature are routinely asserted against the Company. There can be no assurance that insurance coverage will be available for such claims or similar claims experienced in the ordinary course of the Company’s business.

Sponsorship and Endorsement Contract Liabilities

The Company has various non-cancelable endorsement and sponsorship agreements with terms expiring through 2022. The total future contractual payments as of September 30, 2015 are as follows (in thousands), although the Company is seeking to terminate or amend certain significant agreements for endorsement or sponsorship, which adjusted terms are not reflected in the below as of September 30, 2015:

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Note 10: Stockholders’ (Deficit) Equity

Common Stock

For the nine months ended September 30, 2015, the Company issued common stock including restricted stock awards, as follows (in thousands, except share and per share data):

For the nine months ended September 30, 2014, the Company issued common stock including restricted stock awards, as follows (in thousands, except share and per share data):

The fair value of all stock issuances above is based upon either the quoted closing trading price on the date of issuance or the value of derivative instruments at the date of conversion.

Treasury Stock

For the nine months ended September 30, 2015, the Company did not repurchase any shares of its common stock and held 875,621 shares in treasury as of September 30, 2015 (of which 860,900 shares are subject to a pledge with a lender).

For the nine months ended September 30, 2014, the Company’s treasury stock transactions are as follows:

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Note 11: Stock-Based Compensation

The Company’s stock-based compensation for the nine months ended September 30, 2015 consists primarily of restricted stock awards. The activity of restricted stock awards granted to employees, executives, and board members was as follows:

The total fair value of restricted stock awards granted to employees and board members was $184,000 for the three months ended September 30, 2015. No restricted stock awards were granted to employees and board members for the three months ended September 30, 2014. The total fair value of restricted stock awards granted to employees and board members was $1.1 million and $1.5 million for the nine months ended September 30, 2015 and 2014, respectively. As of September 30, 2015 and December 31, 2014, the total unrecognized expense for unvested restricted stock awards, net of expected forfeitures, was $11.3 million and $20.7 million, respectively, which are expected to be amortized over a weighted-average period of 3.0 and 2.6 years, respectively.

Restricted Stock Awards Related to Energy Drink Agreement

In January 2015, the Company entered into an energy drink agreement with Langer Juice and Creative Flavor Concepts to expand into a new product line. In connection with the agreement, the Company issued a total of 150,000 shares of its restricted common stock with trade restrictions for a period of three years. The restricted stock awards issued had a grant date fair value of approximately $1.2 million, which were initially included as a component of prepaid stock compensation and additional paid-in capital in the consolidated balance sheets upon issuance. The prepaid stock compensation was originally amortized over the performance period of ten years. In connection with the restructuring event disclosed further in Note 8, the Company discontinued this product and wrote-off the unamortized prepaid stock compensation of $1.1 million in August 2015.

Agreements with Worldwide Apparel, LLC – Muscle Pharm Apparel Rights

In February 2015, the Company entered into an agreement with Worldwide Apparel, LLC (“Worldwide”) to terminate Worldwide’s right to use MusclePharm’s brand images in apparel effective March 28, 2015. The brand rights were originally licensed in May 2011, and amended in March 2014 prior to the termination. The consideration related to the acquisition of the MusclePharm Apparel from Worldwide consists of cash consideration of $850,000 and 170,000 shares of MusclePharm common stock with an aggregated fair value of $1.4 million. The total cost of the MusclePharm apparel acquisition of $2.2 million is included in the caption brand within intangible assets, net, in the accompanying consolidated balance sheet, and is subject to amortization over a period of seven years.

Restricted Stock Awards Issued Related to Attempted Financing Agreement

In May 2015, the Company negotiated the termination of an attempted financing agreement with a lending institution and issued 50,000 shares of its common stock. The fair value of the common stock was $325,000 based upon the closing price of common stock on the date of issuance, and was recorded in selling, general and administrative expense in the accompanying consolidated statement of operations.

Restricted Stock Awards Issued Related to Consulting/Endorsement Agreement

In May 2015, the Company entered into consulting and endorsement agreements with William Phillips. In connection with the endorsement agreements, the Company agreed to issue a total of 50,000 shares of its restricted common stock. The restricted common stock issued had a grant date fair value of $292,000, which was included as a component of prepaid stock compensation and additional paid-in capital in the consolidated balance sheets upon issuance. The prepaid stock compensation was originally amortized over the performance period of three years. In connection with the restructuring disclosed in Note 8, the Company terminated the consulting and endorsement agreements with William Phillips and wrote-off the unamortized prepaid stock compensation of $268,000.

In connection with the consulting agreement, the Company also agreed to issue restricted shares worth $25,000 (based upon the weighted average stock price during the 15-day-period prior to issuance) within 10 days after each subsequent three-month period term. In July 2015, the Company issued 5,189 shares of its common stock to William Phillips. The fair value of the common stock was $28,000 based upon the closing price of common stock on the date of issuance, and was recorded in advertising and promotion expense in the accompanying consolidated statement of operations. No additional common stock will be issued to William Phillips under this agreement.

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Note 12: Net (Loss) Income per Share

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

The following securities were excluded from the computation of diluted net (loss) income per share for the periods presented because including them would have been antidilutive:

Note 13: Income Taxes

The Company recorded an income tax provision of $71,000 and $94,000 for the three months ended September 30, 2015 and 2014, respectively, and $104,000 and $171,000 for the nine months ended September 30, 2015 and 2014, respectively, related to foreign income taxes and state minimum taxes.

Income taxes are provided for the tax effects of transactions reported in the consolidated financial statements and consist of taxes currently due. Deferred taxes relate to differences between the basis of assets and liabilities for financial and income tax reporting which will be either taxable or deductible when the assets or liabilities are recovered or settled. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred income tax assets will not be realized. The ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred income tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based on consideration of these items, management has established a full valuation allowance as of September 30, 2015 and December 31, 2014 as it is more likely than not that a tax benefit will not be realized.

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Note 14: Geographical Information

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

Note 15: Related-Party Transactions

On October 9, 2015, the Company entered into loan modification agreements with the banking institution under its line of credit and term loan to: (i) change the maturity date of the loans to January 15, 2016, (ii) prohibit the loans to be declared in default prior to December 10, 2015, except for defaults resulting from failure to make timely payments, and (iii) delete certain financial covenants from the line of credit. In consideration for these modifications, the Company’s chairman of the board of directors and a family member provided their individual guaranty for the remaining balance of the loans ($6.2 million). In consideration for executing his guaranty, the Company issued the chairman of the board of directors 28,571 shares of common stock with a grant date fair value of $80,000 (based upon the closing price of common stock on the date of issuance).

Note 16: Subsequent Events

The Company has evaluated subsequent events for disclosure purposes through November 9, 2015, and determined there are no other items to disclose except as set forth below:

Note 7 and Note 15 are incorporated herein by reference.

On October 30, 2015 the Company learned that an action was filed on October 27, 2015 in the District Court for the State of Nevada, Clark County, entitled Brian D. Gartner, derivatively on behalf of Musclepharm Corporation v. Brad Pyatt, Lawrence S. Meer, Donald W. Prosser, Richard Estalella, Jeremy R. Deluca, Michael J. Doron, Cory Gregory, L. Gary Davis, James J. Greenwell, John H. Bluher, and Daniel J. McClory and Musclepharm Corporation (Case No. A-15-726810-B). The complaint generally claims breaches of fiduciary duty against certain members of the board of directors and management of the Company. As of the date of this report, the Company has not been served in this matter.

On November 6, 2015, the Company entered into a separation agreement with Cory Gregory, an executive vice president, for his amenable separation. Pursuant to the separation agreement, Cory Gregory will receive six months of base salary and the Company is entitled to use his image and website contributions in perpetuity.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q, and with our audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2014, as filed with the Securities and Exchange Commission on March 16, 2015. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below and those discussed in the section entitled “Risk Factors” included elsewhere in this Form 10-Q.

Overview

We are a scientifically driven, performance lifestyle Company that develops, manufactures, markets and distributes branded nutritional supplements. We offer a broad range of powders, capsules, tablets and gels. Our portfolio of recognized brands, including MusclePharm® Hybrid and Core Series, Arnold Schwarzenegger Series™, and FitMiss®, are marketed and sold in more than 120 countries and available in over 45,000 retail outlets globally. These clinically developed scientifically driven nutritional supplements are developed through a multi-stage research process that utilizes the expertise of leading nutritional scientists, doctors and universities. We believe we are an innovator in the sports nutrition industry.

Our core marketing strategy is to brand MusclePharm as the “must have” fitness brand for workout enthusiasts and elite athletes. We seek to be known as The Athlete’s Company®, run by athletes who create their products for other athletes both professional and otherwise. We believe that our marketing mix is an optimal strategy to increase sales.

On August 24, 2015, the board of directors approved a restructuring plan for the Company. The approved restructuring plan was designed to reduce costs and to better align the Company’s resources for profitable growth. Specifically, during the quarter ended September 30, 2015, the restructuring plan resulted in: 1) a reduction in the Company’s workforce; 2) the Company abandoning certain leased facilities; and 3) the Company renegotiating or terminating a number of contracts with endorsers in a strategic shift away from such arrangements and towards more grass-roots marketing and advertising efforts. Management is continuing to execute on the approved restructuring plan, and as such, additional restructuring charges may be necessary in the fourth quarter of 2015.

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Components of Results of Operations

Revenue

We derive our revenues through the sales of our various branded nutritional supplements. Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable and collection is reasonably assured which generally occurs upon shipment or delivery of the products. We record sales discounts as a direct reduction of revenue for various discounts provided to our customers consisting primarily of volume incentive rebates and advertising 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.

During the three months ended September 30, 2015, our two largest customers, Costco and GNC, each individually accounted for more than 10% of our net revenue, and in total represented 28% of our net revenue. During the nine months ended September 30, 2015, our three largest customers, Costco, Bodybuilding.com and GNC, each individually accounted for more than 10% of our net revenue, and in total represented 42% of our net revenue.

During the three months ended September 30, 2014, our two largest customers, Costco and Bodybuilding.com each individually accounted for more than 10% of our net revenue, and in total represented 31% of our net revenue. During the nine months ended September 30, 2014, our two largest customers, Costco and Bodybuilding.com each individually accounted for more than 10% of our revenue, and in total represented 28% of our net revenue.

Cost of Revenue and Gross Margin

Cost of revenue and gross margin are principally related to the direct production, manufacturing and freight-in costs of the related products purchased from third party contract manufacturers. We mainly ship customer orders from our distribution centers in Spring Hill, Tennessee and Pittsburg, California. The distribution centers are operated with our equipment and employees, and we own the inventory. We also use contract manufacturers to drop ship products directly to our customers.

Our gross margin fluctuates due to several factors, including new product introductions, changes to existing product lines, changes in customer mix and product mix, product demand mix, sales discounts, shipment volumes, product costs, and pricing and inventory write downs. We expect cost of revenues to increase or decrease in absolute dollars as our revenue increases or decreases, however, cost of revenue may be expected to decrease as a percentage of revenue due primarily to increases in revenue while anticipating cost efficiencies from volume purchasing and inventory cost reductions.

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Operating Expenses

Advertising and Promotion

Our advertising and promotions have historically consisted primarily of product giveaways, trade show events, broker fees, athletic endorsements and sponsorship, strategic partnerships, and digital and print advertising. Advertising and promotions are a large part of both our strategy and brand awareness. Historically, we built strategic partnerships with sports athletes and fitness enthusiasts through endorsements, licensing, co-branding agreements and co-developing product lines. During the third quarter 2015, we began executing our restructuring and wrote off $6.4 million of prepaid stock compensation and other prepaid assets as we are reducing reliance on sports and athlete arrangements which we do not plan to continue or rely heavily upon in future periods and incurred contract termination fees of $6.6 million which were recorded in restructuring and other charges in the accompanying consolidated statements of operations. We expect our advertising and promotion expenses to decrease in absolute dollars in future periods. Furthermore, advertising and promotion expense is expected to decline as a percentage of revenue due primarily to our focusing on specific grassroots advertising and promotion programs independently and with our customers, social media, and trade shows and less on expensive professional athlete endorsements.

Salaries and Benefits

Salaries and benefits consist primarily of salaries, bonuses, commissions, benefits and stock-based compensation. During the third quarter 2015, we began executing a restructuring resulting in a reduction in force and incurred severance and termination costs of $1.2 million and stock-based compensation for terminated employees of $1.7 million. Personnel costs are a significant component of our operating expenses and we expect these expenses to decrease in absolute dollars in future periods. Additionally, salaries and benefits are expected to decrease as a percentage of revenue due primarily to our expectation of efficiently increasing our revenue by leveraging our existing employee base.

Selling, General and Administrative

Our selling, general and administrative expenses consist primarily of office expenses, insurance, depreciation, amortization, sales commissions, travel, freight out, settlement costs, director fees, miscellaneous expenses incurred by our board, executive, finance, information technology, legal, human resources, and other administrative functions, and other corporate expenses. We expect our selling, general and administrative expenses to decrease in absolute dollars in future periods, and decrease as a percentage of revenue due primarily to resolution of pending legal matters for which expenses were incurred through 2015 and our expectation of efficiently increasing our revenue while realizing respective cost efficiencies associated with such increase.

Research and Development

Research and development expenses primarily consist of salaries, bonuses and benefits, laboratory development of our scientific nutritional supplements, testing and compliance and allocated facilities costs. We expense research and development costs as incurred. Research and development is not the primary driver of our operating expenses but we expect research and development to decrease in absolute dollars in future periods, and decrease as a percentage of revenue due primarily to our expectation of efficiently increasing our revenue while realizing respective cost efficiencies associated with such increase.

Professional Fees

Professional fees consist primarily of fees for outside legal, audit, accounting and tax services, investor relations and consulting fees, and we expect these expenses to increase in absolute dollars in future periods as we continue to grow our business and utilize assistance from professional service providers, defend ongoing and new legal matters and expand our global reach. Professional fees are expected to decrease as a percentage of revenue due primarily to the anticipated reduction in activities related to the SEC Investigation.

Other (Expense) Income, net

Other (expense) income, net consists of interest income and expense, gains and losses on foreign currency transactions, settlement of accounts payable, and other miscellaneous expenses.

Provision for Income Taxes

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

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Results of Operations

The following tables present our historical operating results in dollars and as a percentage of revenue, net for the periods presented: