MusclePharm Corp - Quarter Report: 2018 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

For the quarterly period ended: March 31, 2018

 

OR

For the transition period from   to  

Commission File Number: 000-53166

 

MusclePharm Corporation

(Exact name of registrant as specified in its charter)

 

 

Nevada	77-0664193
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
4400 Vanowen St. Burbank, CA	91505
(Address of principal executive offices)	(Zip code)

 

(800) 292-3909

(Registrant’s telephone number, including area code)

 

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

Indicate by check mark whether the registrant has submitted electronically 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, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer [ ]	Accelerated filer [ ]		Non-accelerated filer   [ ] (Do not check if a smaller reporting company)
Smaller reporting company [X]			Emerging Growth Company [ ]

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]

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

Number of shares of the registrant’s common stock outstanding at May 1, 2018: 14,731,667, excluding 875,621 shares of common stock held in treasury.

 

MusclePharm Corporation

Form 10-Q

TABLE OF CONTENTS

 

		Page
Note About Forward-Looking Statements		1
PART I – FINANCIAL INFORMATION		2
Item 1.	Financial Statements	2
	Condensed Consolidated Balance Sheets as of March 31, 2018 (unaudited) and December 31, 2017	2
	Condensed Consolidated Statements of Operations for the three months ended March 31, 2018 and 2017 (unaudited)	3
	Condensed Consolidated Statements of Comprehensive Loss for the three months ended March 31, 2018 and 2017 (unaudited)	4
	Condensed Consolidated Statement of Changes in Stockholders’ Deficit for the three months ended March 31, 2018 (unaudited)	5
	Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2018 and 2017 (unaudited)	6
	Notes to Condensed Consolidated Financial Statements (unaudited)	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	22
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	34
Item 4.	Controls and Procedures	34
PART II – OTHER INFORMATION		35
Item 1.	Legal Proceedings	35
Item 1A.	Risk Factors	36
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	36
Item 3.	Defaults Upon Senior Securities.	37
Item 4.	Mine Safety Disclosures	37
Item 5.	Other Information	37
Item 6.	Exhibits	37
	Signatures	38

 

Forward-Looking Statements

 

 Except as otherwise indicated herein, the terms “Company,” “we,” “our” and “us” refer to MusclePharm Corporation and its subsidiaries. This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements contained in this Quarterly Report on Form 10-Q other than statements of historical fact, including statements regarding our future results of operations and financial position, including our future profits, financing sources and our ability to satisfy our liabilities, our business strategy and plans, and our objectives for future operations, are forward-looking statements. The words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect,” and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives, and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in Item 1A, “Risk Factors” in our Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”) on April 2, 2018. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the future events and trends discussed in this Quarterly Report on Form 10-Q may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.

 

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

 

 

 

 

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

MusclePharm Corporation

Condensed Consolidated Balance Sheets

(In thousands, except share and per share data)

 

	March 31, 2018	December 31, 2017
	(Unaudited)
ASSETS
Current assets:
Cash	$5,114	$6,228
Accounts receivable, net of allowance for doubtful accounts of $1,518 and $1,363, respectively	16,925	16,668
Inventory	7,738	6,484
Prepaid giveaways	111	89
Prepaid expenses and other current assets	895	993
Total current assets	30,783	30,462
Property and equipment, net	1,632	1,822
Intangible assets, net	1,237	1,317
Other assets	239	225
TOTAL ASSETS	$33,891	$33,826
LIABILITIES AND STOCKHOLDERS’ DEFICIT
Current liabilities:
Accounts payable	$14,897	$11,742
Accrued liabilities	7,441	7,761
Accrued restructuring charges, current	560	595
Obligation under secured borrowing arrangement	5,547	5,385
Line of credit	2,000	3,000
Total current liabilities	30,445	28,483
Convertible note with a related party, net of discount	16,917	16,669
Accrued restructuring charges, long-term	110	120
Other long-term liabilities	1,060	1,088
Total liabilities	48,532	46,360
Commitments and contingencies (Note 8)
Stockholders' deficit:
Common stock, par value of $0.001 per share; 100,000,000 shares authorized 15,607,288 and 15,526,175 shares issued as of March 31, 2018 and December 31, 2017, respectively; 14,731,667 and 14,650,554 shares outstanding as of March 31, 2018 and December 31, 2017, respectively	14	14
Additional paid-in capital	159,798	159,608
Treasury stock, at cost; 875,621 shares	(10,039)	(10,039)
Accumulated other comprehensive loss	(142)	(150)
Accumulated deficit	(164,272)	(161,967)
TOTAL STOCKHOLDERS’ DEFICIT	(14,641)	(12,534)
TOTAL LIABILITIES AND STOCKHOLDERS’ DEFICIT	$33,891	$33,826

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

MusclePharm Corporation

Condensed Consolidated Statements of Operations

(In thousands, except share and per share data)

(Unaudited)

 

	Three Months Ended March 31,
	2018	2017
Revenue, net	$26,547	$26,009
Cost of revenue	18,328	19,539
Gross profit	8,219	6,470
Operating expenses:
Advertising and promotion	3,661	1,888
Salaries and benefits	2,154	3,269
Selling, general and administrative	2,546	2,886
Research and development	212	137
Professional fees	572	882
Total operating expenses	9,145	9,062
Loss from operations	(926)	(2,592)
Gain on settlement of accounts payable	—	449
Other expense, net	(1,310)	(978)
Loss before provision for income taxes	(2,236)	(3,121)
Provision for income taxes	69	28
Net loss	$(2,305)	$(3,149)
Net loss per share, basic and diluted	$(0.16)	$(0.23)
Weighted average shares used to compute net loss per share, basic and diluted	14,615,677	13,773,508

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

 

MusclePharm Corporation

Condensed Consolidated Statements of Comprehensive Loss

(In thousands)

(Unaudited)

 

	Three Months Ended March 31,
	2018	2017
Net loss	$(2,305)	$(3,149)
Other comprehensive income:
Change in foreign currency translation adjustment	8	6
Comprehensive loss	$(2,297)	$(3,143)

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

 

MusclePharm Corporation

Condensed Consolidated Statement of Changes in Stockholders’ Deficit

(In thousands, except share data)

(Unaudited)

 

					Accumulated
			Additional		Other		Total
	Common Stock		Paid-in	Treasury	Comprehensive	Accumulated	Stockholders’
	Shares	Amount	Capital	Stock	Loss	Deficit	Deficit
Balance—December 31, 2017	14,650,554	$14	$159,608	$(10,039)	$(150)	$(161,967)	$(12,534)
Stock-based compensation related to issuance and amortization of restricted stock awards to employees, executives and directors	—	—	121	—	—	—	121
Stock-based compensation related to issuance of stock options to an executive and a director	—	—	16	—	—	—	16
Issuance of shares of common stock related to the payment of interest on a related party note	81,113	—	53	—	—	—	53
Change in foreign currency translation adjustment	—	—	—	—	8	—	8
Net loss	—	—	—	—	—	(2,305)	(2,305)
Balance—March 31, 2018	14,731,667	$14	$159,798	$(10,039)	$(142)	$(164,272)	$(14,641)

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

 

MusclePharm Corporation

Condensed Consolidated Statements of Cash Flows

(Unaudited, in thousands)

 

	Three Months Ended March 31,
	2018	2017
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$(2,305)	$(3,149)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization	287	420
Gain on settlement of accounts payable	—	(449)
Bad debt expense	164	—
Amortization of debt discount	248	153
Stock-based compensation	137	607
Other	—	363
Changes in operating assets and liabilities:
Accounts receivable	(443)	(1,925)
Inventory	(1,255)	2,463
Prepaid giveaways	(23)	132
Prepaid expenses and other current assets	100	(387)
Other assets	(14)	—
Accounts payable and accrued liabilities	2,917	803
Accrued restructuring charges	(45)	(73)
Net cash used in operating activities	(232)	(1,042)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment	(14)	—
Net cash used in investing activities	$(14)	$—
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on line of credit	(1,000)	—
Proceeds from secured borrowing arrangement, net of reserves	13,494	4,087
Payments on secured borrowing arrangement, net of fees	(13,332)	(4,951)
Repayment of capital lease obligations	(34)	(36)
Net cash used in financing activities	(872)	(900)
Effect of exchange rate changes on cash	4	15
NET CHANGE IN CASH	(1,114)	(1,927)
CASH — BEGINNING OF PERIOD	6,228	4,943
CASH — END OF PERIOD	$5,114	$3,016
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest	$614	$672
Cash paid for taxes	$68	$8
SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES:
Property and equipment acquired in conjunction with capital leases	$—	$12
Purchase of property and equipment included in current liabilities	$13	$9
Interest paid through issuance of shares of common stock	$53	$—

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

 

MusclePharm Corporation

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 1. Description of Business

 

Description of Business

 

MusclePharm Corporation, or the Company, was incorporated in Nevada in 2006. Except as otherwise indicated herein, the terms “Company,” “we,” “our” and “us” refer to MusclePharm Corporation and its subsidiaries. The Company is a scientifically driven, performance lifestyle company that develops, manufactures, markets and distributes branded nutritional supplements. The Company is headquartered in Burbank, California and as of March 31, 2018 had the following wholly-owned operating subsidiaries: MusclePharm Canada Enterprises Corp. (“MusclePharm Canada”), MusclePharm Ireland Limited (“MusclePharm Ireland”) and MusclePharm Australia Pty Limited (“MusclePharm Australia”). A former subsidiary of the Company, BioZone Laboratories, Inc. (“BioZone”), was sold on May 9, 2016.

 

Management’s Plans with Respect to Liquidity and Capital Resources

 

Management believes the restructuring plan, the continued reduction in ongoing operating costs and expense controls, and growth strategy, will enable us to ultimately achieve profitability. Management believes that the Company has sufficiently reduced its operating expenses, and that the Company’s ongoing sources of revenue that will be sufficient to cover these expenses for the foreseeable future. The Company can give no assurances that this will occur.

 

As of March 31, 2018, the Company had a stockholders’ deficit of $14.6 million and recurring losses from operations. To manage cash flow, the Company entered into a secured borrowing arrangement, pursuant to which the Company has the ability to borrow up to $12.5 million subject to sufficient amounts of accounts receivable to secure the loan. The secured borrowing arrangement’s term has been extended to July 31, 2018. In October 2017, the Company also entered into a loan and security agreement to borrow against the Company’s inventory up to a maximum of $3.0 million for an initial six-month term which was automatically extended for six additional months. As of March 31, 2018, the Company owed $2.0 million under this loan and security agreement.

 

On November 3, 2017, the Company entered into a refinancing transaction with Mr. Ryan Drexler, the Company’s Chairman of the Board, Chief Executive Officer and President, to restructure all of the $18.0 million in notes payable to him, which are now due on December 31, 2019. Accordingly, such debt is classified as a long-term liability at March 31, 2018.

 

As of March 31, 2018, the Company had approximately $5.1 million in cash and $0.3 million in working capital.

 

The accompanying Condensed Consolidated Financial Statements as of and for the quarter ended March 31, 2018 was prepared on the basis of a going concern, which contemplates, among other things, the realization of assets and satisfaction of liabilities in the ordinary course of business. Accordingly, they do not give effect to adjustments that could be necessary should we be required to liquidate our assets.

 

The Company’s ability to continue as a going concern and raise capital for specific strategic initiatives could also depend on obtaining adequate capital to fund operating losses until it becomes profitable. The Company can give no assurances that any additional capital that it is able to obtain, if any, will be sufficient to meet its needs, or that any such financing will be obtainable on acceptable terms.

 

Mr. Drexler has verbally both stated his intent and ability to put more capital into the business if necessary. However, Mr. Drexler is under no obligation to the Company to do so, and the Company can give no assurances that Mr. Drexler will be willing or able to do so at a future date and/or that he will not demand payment of his refinanced convertible note on December 31, 2019.

 

 

Our capital resources as of March 31, 2018, available borrowing capacity and current operating plans are expected to be sufficient to fund the planned operations for at least twelve months from the date of filing this report.

Note 2. Summary of Significant Accounting Policies

Basis of Presentation and Principles of Consolidation

 

The accompanying Condensed Consolidated Financial Statements have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”). The Condensed Consolidated Financial Statements include the accounts of MusclePharm Corporation and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

 

Unaudited Interim Financial Information

 

The accompanying unaudited interim Condensed Consolidated Financial Statements have been prepared in accordance with GAAP and with the instructions to Form 10-Q and Article 10 of Regulation S-X for interim financial information. Accordingly, these statements do not include all of the information and notes required by GAAP for complete financial statements. The Company’s management believes the unaudited interim Condensed Consolidated Financial Statements include all adjustments of a normal recurring nature necessary for the fair presentation of the Company’s financial position as of March 31, 2018, results of operations for the three months ended March 31, 2018 and 2017, and cash flows for the three months ended March 31, 2018 and 2017. The results of operations for the three ended March 31, 2018 are not necessarily indicative of the results to be expected for the year ending December 31, 2018.

 

These unaudited interim Condensed Consolidated Financial Statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, filed with the SEC on April 2, 2018.

 

Use of Estimates

 

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

 

Revenue Recognition

 

The Company's previous revenue recognition policy was to recognize revenue when persuasive evidence of an arrangement existed, delivery had occurred, the fee was fixed or determinable and collection was reasonably assured.

 

The Company’s standard terms and conditions of sale allowed for product returns or replacements in certain cases. Estimates of expected future product returns were recognized at the time of sale based on analyses of historical return trends by customer type. Upon recognition, the Company reduced revenue and cost of revenue for the estimated return. Return rates could fluctuate over time, but were sufficiently predictable with established customers to allow the Company to estimate expected future product returns, and an accrual was recorded for future expected returns when the related revenue was recognized.

 

 

The Company also offered sales incentives through various programs, consisting primarily of volume incentive rebates and sales incentive reserves. Volume incentive rebates were provided to certain customers based on contractually agreed upon percentages once certain thresholds had been met. Sales incentive reserves were computed based on historical trending and budgeted discount percentages, which were typically based on historical discount rates with adjustments for any known changes, such as future promotions or one-time historical promotions that would not repeat for each customer. The Company recorded sales incentive reserves and volume rebate reserves as a reduction to revenue.

 

With the adoption of ASC 606, the Company reviewed its previous revenue recognition policy as described above and under ASC 606 the Company determined that there were no material changes resulting from the adoption. Revenue would be recognized when control of the promised goods or services is transferred to the Company’s customers in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. This is consistent with the revenue recognition policy previously used by the Company. The Company also reviewed the timing and recognition of accounts receivable within the different distribution channels for which the Company generates revenue.

 

During the three months ended March 31, 2018 and 2017, the Company recorded discounts, and to a lesser degree, sales returns, totaling $4.9 million and $8.0 million, respectively, which accounted for 16% and 23% of gross revenue in each period, respectively.

 

Concentrations

 

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and accounts receivable. The Company minimizes its credit risk associated with cash by periodically evaluating the credit quality of its primary financial institution. The cash balance at times may exceed federally insured limits. Management believes the financial risk associated with these balances is minimal and has not experienced any losses to date.

 

Significant customers are those which represent more than 10% of the Company’s net revenue for each period presented. For each significant customer, revenue as a percentage of total revenue is as follows:

 

	Percentage of Net Revenue for the Three Months Ended March 31,
	2018	2017
Customers
Costco Wholesale Corporation	37%	35%

 

Share-Based Payments and Stock-Based Compensation

 

Share-based compensation awards, including stock options and restricted stock awards, are recorded at estimated fair value on the applicable award’s grant date, based on estimated number of awards that are expected to vest. The grant date fair value is amortized on a straight-line basis over the time in which the awards are expected to vest, or immediately if no vesting is required. Share-based compensation awards issued to non-employees for services are recorded at either the fair value of the services rendered or the fair value of the share-based payments whichever is more readily determinable. The fair value of restricted stock awards is based on the fair value of the stock underlying the awards on the grant date as there is no exercise price.

 

 

The fair value of stock options is estimated using the Black-Scholes option-pricing model. The determination of the fair value of each stock award using this option-pricing model is affected by the Company’s assumptions regarding a number of complex and subjective variables. These variables include, but are not limited to, the expected stock price volatility over the term of the awards and the expected term of the awards based on an analysis of the actual and projected employee stock option exercise behaviors and the contractual term of the awards. Due to the Company’s limited experience with the expected term of options, the simplified method was utilized in determining the expected option term as prescribed in Staff Accounting Bulletin No. 110. The Company recognizes stock-based compensation expense over the requisite service period, which is generally consistent with the vesting of the awards, based on the estimated fair value of all stock-based payments issued to employees and directors that are expected to vest.

 

Recent Accounting Pronouncements

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which supersedes Topic 840, Leases (“ASU 2016-02”). The guidance in this new standard requires lessees to put most leases on their balance sheets but recognize expenses on their income statements in a manner similar to the current accounting and eliminates the current real estate-specific provisions for all entities. The guidance also modifies the classification criteria and the accounting for sales-type and direct financing leases for lessors. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years, with early adoption permitted. The Company is currently evaluating the impact of the adoption of ASU 2016-02.

 

Note 3. Fair Value of Financial Instruments

 

Management believes the fair values of the obligations under the secured borrowing arrangements and the convertible notes with a related party approximate carrying value because the debt carries market rates of interest available to the Company. The Company’s remaining financial instruments consisted primarily of accounts receivable, accounts payable, accrued liabilities and accrued restructuring charges, all of which are short-term in nature with fair values approximating carrying value. As of March 31, 2018 and December 31, 2017, the Company held no assets or liabilities that required re-measurement at fair value on a recurring basis.

 

Note 4. Restructuring

 

As part of an effort to better focus and align the Company’s resources toward profitable growth, on August 24, 2015, the Board authorized the Company to undertake steps to commence a restructuring of the business and operations, which concluded during the third quarter of 2016.

 

The following table illustrates the provision of the restructuring charges and the accrued restructuring charges balance as of March 31, 2018 (in thousands):

 

	Contract Termination Costs	Purchase Commitment of Discontinued Inventories Not Yet Received	Abandoned Lease Facilities	Total
Balance as of December 31, 2017	$308	$175	$232	$715
Expensed	—	—	132	132
Cash payments	—	—	(177)	(177)
Balance as of March 31, 2018	308	175	187	670

 

 

The total future payments under the restructuring plan as of March 31, 2018 are as follows (in thousands):

 

	For the Years Ending December 31,
Outstanding Payments	2018	2019	2020	Total
Contract termination costs	$308	$—	$—	$308
Purchase commitment of discontinued inventories not yet received	175	—	—	175
Abandoned leased facilities	67	91	29	187
Total future payments	$550	$91	$29	$670

 

Note 5. Balance Sheet Components

 

Inventory

 

Inventory consisted solely of finished goods as of March 31, 2018 and December 31, 2017.

 

The Company records charges for obsolete and slow-moving inventory based on the age of the product as determined by the expiration date or otherwise determined to be obsolete. Products within one year of their expiration dates are considered for write-off purposes. Historically, the Company has had minimal returns with established customers. Other than write-off of inventory during restructuring activities, the Company incurred insignificant inventory write-offs during the three months ended March 31, 2018 and 2017. Inventory write-downs, once established, are not reversed as they establish a new cost basis for the inventory.

 

Property and Equipment

 

Property and equipment consisted of the following as of March 31, 2018 and December 31, 2017 (in thousands):

 

	As of March 31, 2018	As of December 31, 2017
Furniture, fixtures and equipment	$3,614	$3,597
Leasehold improvements	2,044	2,044
Manufacturing and lab equipment	3	3
Vehicles	86	86
Displays	484	485
Website	462	462
Property and equipment, gross	6,693	6,677
Less: accumulated depreciation and amortization	(5,061)	(4,855)
Property and equipment, net	$1,632	$1,822

 

Depreciation and amortization expense related to property and equipment was $0.2 million and $0.3 million for the three months ended March 31, 2018 and 2017, respectively, which is included in “Selling, general, and administrative” expense in the accompanying Condensed Consolidated Statements of Operations.

 

 

Intangible Assets

 

Intangible assets consisted of the following (in thousands):

 

	As of March 31, 2018
	Gross Value	Accumulated Amortization	Net Carrying Value	Remaining Weighted-Average Useful Lives (years)
Amortized Intangible Assets
Brand (apparel rights)	$2,244	$(1,007)	$1,237	3.9
Total intangible assets	$2,244	$(1,007)	$1,237

 

	As of December 31, 2017
	Gross Value	Accumulated Amortization	Net Carrying Value	Remaining Weighted-Average Useful Lives (years)
Amortized Intangible Assets
Brand (apparel rights)	$2,244	$(927)	$1,317	4.1
Total intangible assets	$2,244	$(927)	$1,317

 

Intangible assets amortization expense was $0.1 million for each of the three months ended March 31, 2018 and 2017, respectively, which is included in “Selling, general, and administrative” expense in the accompanying Condensed Consolidated Statements of Operations.

As of March 31, 2018, the estimated future amortization expense of intangible assets is as follows (in thousands):

For the Year Ending December 31,
Remainder of 2018	$241
2019	321
2020	321
2021	321
2022	33
Total amortization expense	$1,237

 

Note 6. Other Expense, net

 

For the three months ended March 31, 2018 and 2017, “Other expense, net” consisted of the following (in thousands):

 

	For the Three Months Ended March 31,
	2018	2017
Other expense, net:
Interest expense, related party	$(541)	$(422)
Interest expense, related party debt discount	(248)	-
Interest expense, other	(67)	(159)
Interest expense, secured borrowing arrangement	(346)	(104)
Foreign currency transaction loss	(113)	(12)
Other	5	(281)
Total other expense, net	$(1,310)	$(978)

 

 

Note 7. Debt

 

As of March 31, 2018 and December 31, 2017, the Company’s debt consisted of the following (in thousands):

 

	As of March 31, 2018	As of December 31,2017
2017 Refinanced Convertible Note due December 31, 2019 with a related party	$18,000	$18,000
Obligations under secured borrowing arrangement	5,547	5,385
Secured line of credit	2,000	3,000
Unamortized debt discount with a related party	(1,083)	(1,331)
Total debt	24,464	25,054
Less: current portion	(7,547)	(8,385)
Long term debt	$16,917	$16,669

 

Related-Party Notes Payable

On November 3, 2017, the Company entered into a refinancing transaction (the “Refinancing”) with Mr. Ryan Drexler, the Company’s Chairman of the Board of Directors, Chief Executive Officer and President. As part of the Refinancing, the Company issued to Mr. Drexler an amended and restated convertible secured promissory note (the “Refinanced Convertible Note”) in the original principal amount of $18,000,000, which amends and restates (i) a convertible secured promissory note dated as of December 7, 2015, and amended as of January 14, 2017, in the original principal amount of $6,000,000 with an interest rate of 8% prior to the amendment and 10% following an 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 are due on December 31, 2019, unless converted earlier.

Mr. Drexler may convert the outstanding principal and accrued interest into shares of the Company’s common stock at a conversion price of $1.11 per share at any time. The Company may prepay the Refinanced Convertible Note by giving Mr. Drexler between 15 and 60 days’ notice depending upon the specific circumstances, subject to Mr. Drexler’s conversion right.

The Refinanced Convertible Note contains customary events of default, including, among others, the failure by the Company to make a payment of principal or interest when due. Following an event of default, interest will accrue at the rate of 14% per annum. In addition, following an event of default, any conversion, redemption, payment or prepayment of the Refinanced Convertible Note will be at a premium of 105%. The Refinanced Convertible Note also contains customary restrictions on the ability of the Company to, among other things, grant liens or incur indebtedness other than certain obligations incurred in the ordinary course of business. The restrictions are also subject to certain additional qualifications and carveouts, as set forth in the Refinanced Convertible Note. The Refinanced Convertible Note is subordinated to certain other indebtedness of the Company.

 

As part of the Refinancing, the Company and Mr. Drexler entered into a restructuring agreement (the “Restructuring Agreement”) pursuant to which the parties agreed to enter into the Refinanced Convertible Note and to amend and restate the security agreement pursuant to which the Prior Notes were secured by all of the assets and properties of the Company and its subsidiaries whether tangible or intangible, by entering into the Third Amended and Restated Security Agreement (the “Amended Security Agreement”). Pursuant to the Restructuring Agreement, the Company agreed to pay, on the effective date of the Refinancing, all outstanding interest on the Prior Notes through November 8, 2017 and certain fees and expenses incurred by Mr. Drexler in connection with the Restructuring.

In connection with the refinancing, the Company recorded a debt discount of $1.2 million. The debt discount is equal to the change in the fair value of the conversion option between the Refinanced Convertible Note and the Prior Notes. The fair value of the conversion option was determined using a Monte Carlo simulation and the model of stock price behavior known as GBM which simulates a future period as a random step from a previous period. Significant assumptions were: expected stock price premium of 40%, expected trading days of 252 days, and volatility of 60%.

In addition, the Refinanced Convertible Note contains two embedded derivatives for default interest and an event of default put. Due to the unlikely event of default, the embedded derivatives have a de minimis value as of March 31, 2018.

For the three months ended March 31, 2018 and 2017, interest expense related to the related party notes was $0.8 million and $0.4 million, respectively. During the three months ended March 31, 2018 and 2017, $0.3 million and $0.4 million, respectively, in interest was paid in cash to Mr. Drexler.

 

Inventory Financing

On October 6, 2017, the Company and its affiliate (together with the Company, “Borrower”) entered into a Loan and Security Agreement (“Security Agreement”) with Crossroads Financial Group, LLC (“Crossroads”). Pursuant to the Security Agreement, the Company may borrow up to 70% of its Inventory Cost or up to 75% of Net Orderly Liquidation Value (each as defined in the Security Agreement), up to a maximum amount of $3.0 million at an interest rate of 1.5% per month, subject to a minimum monthly fee of $22,500. The initial term of the Security Agreement is six months from the date of execution, and such initial term is extended automatically in six-month increments, unless earlier terminated pursuant to the terms of the Security Agreement. The Security Agreement contains customary events of default, including, among others, the failure to make payments on amounts owed when due, default under any other material agreement or the departure of Mr. Drexler. The Security Agreement also contains customary restrictions on the ability of the Company to, among other things, grant liens, incur debt and transfer assets. Under the Security Agreement, the Company has agreed to grant Crossroads a security interest in all of the Company’s present and future accounts, chattel paper, goods (including inventory and equipment), instruments, investment property, documents, general intangibles, intangibles, letter of credit rights, commercial tort claims, deposit accounts, supporting obligations, documents, records and the proceeds thereof. As of March 31, 2018, the Company owed $2.0 million to Crossroads under this agreement.

Secured Borrowing Arrangement

 

In January 2016, the Company entered into a Purchase and Sale Agreement (the “Purchase and Sale Agreement”) with Prestige Capital Corporation (“Prestige”) pursuant to which the Company agreed to sell and assign and Prestige agreed to buy and accept, certain accounts receivable owed to the Company (“Accounts”). Under the terms of the Purchase and Sale Agreement, upon the receipt and acceptance of each assignment of Accounts, Prestige will pay the Company 80% of the net face amount of the assigned Accounts, up to a maximum total borrowings of $12.5 million subject to sufficient amounts of accounts receivable to secure the loan. The remaining 20% will be paid to the Company upon collection of the assigned Accounts, less any chargeback, disputes, or other amounts due to Prestige. Prestige’s purchase of the assigned Accounts from the Company will be at a discount fee which varies based on the number of days outstanding from the assignment of Accounts to collection of the assigned Accounts. In addition, the Company granted Prestige a continuing security interest in and lien upon all accounts receivable, inventory, fixed assets, general intangibles and other assets. The Purchase and Sale Agreement’s term has been extended to July 31, 2018. At March 31, 2018, we had approximately $5.5 million of outstanding borrowings under the Purchase and Sale Agreement.

 

 

During the three months ended March 31, 2018, the Company sold to Prestige accounts with an aggregate face amount of approximately $16.9 million, for which Prestige paid to the Company approximately $13.5 million in cash. During the three months ended March 31, 2018, $13.3 million was repaid to Prestige, including fees and interest.

 

During the three months ended March 31, 2017, the Company sold to Prestige accounts with an aggregate face amount of approximately $5.5 million, for which Prestige paid to the Company approximately $4.4 million in cash. During the three months ended March 31, 2017, $5.1 million was repaid to Prestige, including fees and interest.

 

Note 8. Commitments and Contingencies

 

Operating Leases

 

The Company leases office and warehouse facilities under operating leases, which expire at various dates through 2022. The amounts reflected in the table below are for the aggregate future minimum lease payments under non-cancelable facility operating leases for properties that have not been abandoned as part of the restructuring plan. See Note 4 for additional details regarding the restructured leases. Under lease agreements that contain escalating rent provisions, lease expense is recorded on a straight-line basis over the lease term. Rent expense was $0.2 million and $0.1 million for the three months ended March 31, 2018 and 2017, respectively.

 

As of March 31, 2018, future minimum lease payments are as follows (in thousands):

 

For the Year Ending December 31,
Remainder of 2018	$645
2019	845
2020	735
2021	481
2022	369
Thereafter	—
Total minimum lease payments	$3,075

 

Capital Leases

As of March 31, 2018, the Company was leasing two vehicles under a fleet leasing agreement which were included in “Property and equipment, net” in the accompanying Consolidated Balance Sheets. The original cost of leased assets was $86,000 and the associated accumulated depreciation was $60,000 as of March 31, 2018. The Company also leases manufacturing and warehouse equipment under capital leases, which expire at various dates through February 2020.

 

As of March 31, 2018 and December 31, 2017, short-term capital lease liabilities of $119,000 and $126,000, respectively, were included as a component of current accrued liabilities, and the long-term capital lease liabilities of $119,000 and $146,000, respectively, were included as a component of long-term liabilities in the accompanying Condensed Consolidated Balance Sheets.

 

 

As of March 31, 2018, the Company’s future minimum lease payments under capital lease agreements, are as follows (in thousands):

 

For the Year Ending December 31,
Remainder of 2018	$99
2019	101
2020	50
Total minimum lease payments	250
Less amounts representing interest	(12)
Present value of minimum lease payments	$238

 

Purchase Commitment

 

Upon the completion of the sale of BioZone, the Company entered into a manufacturing and supply agreement whereby the Company is required to purchase a minimum of approximately $2.5 million of products per year from BioZone annually for an initial term of three years. If the minimum order quantities of specific products are not met, a $3.0 million minimum purchase of other products must be met in order to waive the shortfall, which is at 25% of the realized shortfall. Due to the timing of achieving the minimum purchase quantities, we are below these targets. As a result, we have provided for the estimated purchase commitment shortfall adjustment in the three months ended March 31, 2018.

 

Settlements

 

Manchester City Football Group

 

The Company was engaged in a dispute with City Football Group Limited (“CFG”), the owner of Manchester City Football Group, concerning amounts allegedly owed by the Company under a sponsorship agreement with CFG (the “Sponsorship Agreement”). In August 2016, CFG commenced arbitration in the United Kingdom against the Company, seeking approximately $8.3 million for the Company’s purported breach of the Sponsorship Agreement.

 

On July 28, 2017, the Company approved a Settlement Agreement (the “CFG Settlement Agreement”) with CFG effective July 7, 2017. The CFG Settlement Agreement represents a full and final settlement of all litigation between the parties. Under the terms of the agreement, the Company has agreed to pay CFG a sum of $3 million, consisting of a $1 million payment that was advanced by a related party on July 7, 2017, and subsequent $1 million installments to be paid by July 7, 2018 and July 7, 2019, respectively. The 2018 payment is accrued in current liabilities and the 2019 payment is accrued in other long-term liabilities.

 

The Company recorded a charge in its Statement of Operations for the year ended December 31, 2017 for approximately $1.5 million, representing the discounted value of the unrecorded settlement amount. During the three months ended March 31, 2018, the Company recorded a charge of $0.1 million, representing imputed interest.

 

Contingencies

 

In the normal course of business or otherwise, the Company may become involved in legal proceedings. The Company will accrue a liability for such matters when it is probable that a liability has been incurred and the amount can be reasonably estimated. When only a range of possible loss can be established, the most probable amount in the range is accrued. If no amount within this range is a better estimate than any other amount within the range, the minimum amount in the range is accrued. The accrual for a litigation loss contingency might include, for example, estimates of potential damages, outside legal fees and other directly related costs expected to be incurred. As of March 31, 2018, the Company was involved in the following material legal proceedings described below.

 

 

ThermoLife

 

In January 2016, ThermoLife International LLC (“ThermoLife”), a supplier of nitrates to MusclePharm, filed a complaint against the Company in Arizona state court. In its complaint, ThermoLife alleges that the Company failed to meet minimum purchase requirements contained in the parties’ supply agreement and seeks monetary damages for the deficiency in purchase amounts. In March 2016, the Company filed an answer to ThermoLife’s complaint, denying the allegations contained in the complaint, and filed a counterclaim alleging that ThermoLife breached its express warranty to MusclePharm because ThermoLife’s products were defective and could not be incorporated into the Company’s products. Therefore, the Company believes that ThermoLife’s complaint is without merit. The lawsuit continues to be in the discovery phase.

 

Former Executive Lawsuit

 

In December 2015, the Company accepted notice by Mr. Richard Estalella (“Estalella”) to terminate his employment as the Company’s President. Although Estalella sought to terminate his employment with the Company for “Good Reason,” as defined in Estalella’s employment agreement with the Company (the “Employment Agreement”), the Company advised Estalella that it deemed his resignation to be without Good Reason.

 

In February 2016, Estalella filed a complaint in Colorado state court against the Company and Ryan Drexler, Chairman of the Board, Chief Executive Officer and President, alleging, among other things, that the Company breached the Employment Agreement, and seeking certain equitable relief and unspecified damages. The Company believes Estalella’s claims are without merit. As of the date of this report, the Company has evaluated the potential outcome of this lawsuit and recorded the liability consistent with its policy for accruing for contingencies. The discovery phase of the lawsuit has concluded and the Company was preparing for trial which was scheduled to commence on May 7, 2018. On May 7, 2018, the Court vacated the trial in contemplation of the parties’ settlement of this matter. Settlement discussions are in progress.

 

Insurance Carrier Lawsuit

 

The Company is engaged in litigation with an insurance carrier, Liberty Insurance Underwriters, Inc. (“Liberty”), arising out of Liberty’s denial of coverage. In 2014, the Company sought coverage under an insurance policy with Liberty for claims against directors and officers of the Company arising out of an investigation by the Securities and Exchange Commission (“SEC”). Liberty denied coverage, and, on February 12, 2015, the Company filed a complaint in the District Court, City and County of Denver, Colorado against Liberty claiming wrongful and unreasonable denial of coverage for the cost and expenses incurred in connection with the SEC investigation and related matters. Liberty removed the complaint to the United States District Court for the District of Colorado, which in August 2016 granted Liberty’s motion for summary judgment, denying coverage and dismissing the Company’s claims with prejudice, and denied the Company’s motion for summary judgment. The Company filed an appeal in November 2016. The Company filed its opening brief on February 1, 2017 and Liberty filed its response brief on April 7, 2017. The Company filed its reply brief on May 5, 2017. The case moved to the 10th Circuit Court of Appeals. In October 2017, the 10th Circuit affirmed the lower court’s grant of summary judgment in favor of Liberty. The Company is currently working with Liberty to determine what amounts are recoverable under the policy that fall outside of the litigation.

 

IRS Audit

 

On April 6, 2016, the Internal Revenue Service (“IRS”) selected the Company’s 2014 Federal Income Tax Return for audit. As a result of the audit, the IRS proposed certain adjustments with respect to the tax reporting of the Company’s former executives’ 2014 restricted stock grants. Due to the Company’s current and historical loss position, the proposed adjustments would have no material impact on its Federal income tax. On October 5, 2016, the IRS commenced an audit of the Company’s employment and withholding tax liability for 2014. The IRS is contending that the Company inaccurately reported the value of the restricted stock grants and improperly failed to provide for employment taxes and federal tax withholding on these grants. In addition, the IRS is proposing certain penalties associated with the Company’s filings. On April 4, 2017, the Company received a “30-day letter” from the IRS asserting back taxes and penalties of approximately $5.3 million, of which $0.4 million related to employment taxes and $4.9 million related to federal tax withholding and penalties. Additionally, the IRS is asserting that the Company owes information reporting penalties of approximately $2.0 million. The Company’s counsel has submitted a formal protest to the IRS disputing on several grounds all of the proposed adjustments and penalties on the Company’s behalf, and the Company intends to pursue this matter vigorously through the IRS appeal process. Due to the uncertainty associated with determining the Company’s liability for the asserted taxes and penalties, if any, and to the Company’s inability to ascertain with any reasonable degree of likelihood, as of the date of this report, the outcome of the IRS appeals process, the Company has recorded an estimate for its potential liability, if any, associated with these taxes.

 

 

Sponsorship and Endorsement Contract Liabilities

 

The Company has various non-cancelable endorsement and sponsorship agreements with terms expiring through 2019. The total value of future contractual payments as of March 31, 2018 are as follows (in thousands):

 

	For the Years Ending December 31,
	Remainder of 2018	2019	Total
Outstanding Payments
Endorsement	$191	$62	$253
Sponsorship	67	55	122
Total future payments	$258	$117	$375

 

Note 9. Stockholders’ Deficit

Common Stock

 

For the three months ended March 31, 2018, the Company had the following transactions related to its common stock including restricted stock awards (in thousands, except share and per share data):

 

Transaction Type	Quantity (Shares)	Valuation ($)	Range of Value per Share
Stock issued to related party for interest	81,133	$52	0.65
Total	81,133	$52	$0.65

 

The fair value of all stock issuances above is based upon the quoted closing trading price on the date of issuance.

 

Common stock outstanding as of March 31, 2018 and December 31, 2017 includes shares legally outstanding even if subject to future vesting.

 

Warrants

 

In November 2016, the Company issued a warrant to purchase 1,289,378 shares of its common stock to the parent company of Capstone related to the settlement of a dispute between the Company and Capstone. The exercise price of this warrant was $1.83 per share, with a contractual term of four years. The Company has valued this warrant by utilizing the Black-Scholes model at approximately $1.8 million with the following assumptions: contractual life of four years, risk free interest rate of 1.27%, dividend yield of 0%, and expected volatility of 118.4%.

 

In July 2014, the Company issued a warrant to purchase 100,000 shares of its common stock related to an endorsement agreement. The exercise price of this warrant was $11.90 per share, with a contractual term of five years.

 

 

Note 10. Stock-Based Compensation

 

Restricted Stock

 

The Company’s stock-based compensation for the three months ended March 31, 2018 and 2017 consist primarily of restricted stock awards. The activity of restricted stock awards granted to employees, executives and Board members was as follows:

 

	Unvested Restricted Stock Awards
	Number of Shares	Weighted Average Grant Date Fair Value
Unvested balance – December 31, 2017	487,267	$2.32
Granted	—	—
Vested	(383,423)	1.95
Cancelled	—	—
Unvested balance – March 31, 2018	103,844	3.70

 

The total fair value of restricted stock awards granted to employees and the Board was $0.7 million for the three months ended March 31, 2017. There were no restricted stock awards granted during the three months ended March 31, 2018. As of March 31, 2018, the total unrecognized expense for unvested restricted stock awards, net of expected forfeitures, was $0.4 million, which is expected to be amortized over a weighted average period of 0.6 years.

 

Restricted Stock Awards Issued to Ryan Drexler, Chairman of the Board, Chief Executive Officer and President

 

In January 2017, the Company issued Mr. Drexler 350,000 shares of restricted stock pursuant to an Amended and Restated Executive Employment Agreement dated November 18, 2016 with a grant date value of $0.7 million based upon the closing price of the Company’s common stock on the date of issuance. These shares of restricted stock vested in full upon the first anniversary of the grant date.

 

Accelerated Vesting of Restricted Stock Awards Related to Terminations of Employment

 

In March 2017, Brent Baker, the Company’s former Executive Vice President of International Business, terminated employment with the Company. In connection with his termination of employment in March 2017, 10,000 shares of restricted stock held by Mr. Baker vested in full upon his termination of employment in accordance with the original grant terms. In connection with the accelerated vesting of these restricted stock awards, the Company recognized stock compensation expense of $42,902, which is included in “Salaries and Benefits” in the accompanying Consolidated Statements of Operations for the three months ended March 31, 2017.

 

Stock Options

 

The Company may grant options to purchase shares of the Company’s common stock to certain employees and directors pursuant to the 2015 Incentive Compensation Plan (the “2015 Plan”). Under the 2015 Plan, all stock options are granted with an exercise price equal to or greater than the fair market value of a share of the Company’s common stock on the date of grant. Vesting is generally determined by the Compensation Committee of the Board within limits set forth in the 2015 Plan. No stock option will be exercisable more than ten years after the date it is granted.

 

 

In February 2016, the Company issued options to purchase 137,362 shares of its common stock to Mr. Drexler, the Company’s Chairman of the Board, Chief Executive Officer, and President, and options to purchase 54,945 shares of its common stock to Michael Doron, the former Lead Director of the Board. Upon resignation from the Board of Directors in June 2017, Mr. Doron forfeited 20,604 of the options issued. These stock options were granted with an exercise price of $1.89 per share, a contractual term of 10 years and a grant date fair value of $1.72 per share, or $0.3 million in the aggregate, which is amortized on a straight-line basis over the vesting period of two years. The Company determined the fair value of the stock options using the Black-Scholes model. The table below sets forth the assumptions used in valuing such options.

 

	For the Year Ended  December 31, 2016
Expected term of options	6.5 years
Expected volatility-range used	118.4%-131.0%
Expected volatility-weighted average	125.7%
Risk-free interest rate-range used	1.27%-1.71%

 

For the three months ended March 31, 2018 and 2017, the Company recorded stock compensation expense related to options of $16,000 and $0.1 million, respectively.

 

Note 11. Net Loss per Share

 

Basic net loss per share is computed by dividing net loss for the period by the weighted average number of shares of common stock outstanding during each period. There was no dilutive effect for the outstanding potentially dilutive securities for the three months ended March 31, 2018 and 2017, respectively, as the Company reported a net loss for both periods.

 

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

 

	For the Three Months Ended March 31,
	2018	2017
Net loss	$(2,305)	$(3,149)
Weighted average common shares used in computing net loss per share, basic and diluted	14,615,677	13,773,508
Net loss per share, basic and diluted	$(0.16)	$(0.23)

 

Diluted net income per share is computed by dividing net income for the period by the weighted average number of shares of common stock, common stock equivalents and potentially dilutive securities outstanding during each period. The Company uses the treasury stock method to determine whether there is a dilutive effect of outstanding potentially dilutive securities, and the if-converted method to assess the dilutive effect of the convertible notes.

 

There was no dilutive effect for the outstanding awards for the three months ended March 31, 2018 and 2017, as the Company reported a net loss for both periods. However, if the Company had net income for the three months ended March 31, 2018, the potentially dilutive securities included in the earnings per share computation would have been 17,881,141. If the Company had net income for the three months ended March 31, 2017, the potentially dilutive securities included in the earnings per share computation would have been 10,871,479.

 

 

Total outstanding potentially dilutive securities were comprised of the following:

 

	As of March 31,
	2018	2017
Stock options	171,703	192,307
Warrants	1,389,378	1,389,378
Unvested restricted stock	103,844	670,170
Convertible notes	16,216,216	8,619,624
Total common stock equivalents	17,881,141	10,871,479

 

Note 12. Income Taxes

 

The Company recorded a tax provision of $69,000 and $28,000 for the three months ended March 31, 2018 and 2017, respectively.

Income taxes are provided for the tax effects of transactions reported in the Condensed Consolidated Financial Statements and consist of taxes currently due. Deferred taxes relate to differences between the basis of assets and liabilities for financial and income tax reporting which will be either taxable or deductible when the assets or liabilities are recovered or settled. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred income tax assets will not be realized. The ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred income tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based on consideration of these items, management has established a full valuation allowance as it is more likely than not that the tax benefits will not be realized as of March 31, 2018.

Note 13. Segments, Geographical Information

 

The Company’s chief operating decision maker reviews financial information presented on a consolidated basis for purposes of allocating resources and evaluating financial performance. As such, the Company currently has a single reporting segment and operating unit structure. In addition, substantially all long-lived assets are attributable to operations in the U.S. for both periods presented.

 

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

 

	For the Three Months Ended March 31,
	2018	2017
Revenue, net:
United States	$15,300	$17,590
International	11,247	8,419
Total revenue, net	$26,547	$26,009

 

Note 14. Subsequent Events

 

GAAP requires an entity to disclose events that occur after the balance sheet date but before financial statements are issued or are available to be issued (“subsequent events”) as well as the date through which an entity has evaluated subsequent events. There are two types of subsequent events. The first type consists of events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements, (“recognized subsequent events”). The second type consists of events that provide evidence about conditions that did not exist at the date of the balance sheet but arose subsequent to that date (“non-recognized subsequent events”).

 

Recognized Subsequent Events

 

None.

 

Unrecognized Subsequent Events

 

None.

 

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our Condensed Consolidated Financial Statements and related notes included elsewhere in this Quarterly Report on Form 10-Q (the “Form 10-Q”), and with our audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2017, as filed with the Securities and Exchange Commission on April 2, 2018, or the 2017 Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below and those discussed in the section entitled “Risk Factors” included elsewhere in this Form 10-Q. Except as otherwise indicated herein, the terms “Company,” “we,” “our” and “us” refer to MusclePharm Corporation and its subsidiaries.

 

Overview

 

We are a scientifically-driven performance lifestyle company that develops, manufactures, markets and distributes branded sports nutrition products and nutritional supplements. We offer a broad range of performance powders, bars and capsules, which seek to help athletes of all types achieve a heightened level of performance and satisfaction. Our portfolio consists of sports nutrition staples, such as protein powders and bars, and preworkout powders, as well as well-known supplements like creatine, BCAA, fish oil, a multi-vitamin and more. These products fall under globally-recognized brands, MusclePharm® and FitMiss®, which are marketed and sold in more than 100 countries globally. Our corporate headquarters is located in Burbank, CA.

 

Our 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, and Club retail channels, including Amazon, Costco, Kroger, Walgreens and 7-Eleven. Our sales in the e-commerce space grew approximately 250% in 2017 compared to the 2016 and we expect to see continued growth in 2018. Additionally, BodyBuilding.com named our Combat Crunch Bar as Protein Bar of the Year in each of 2015, 2016 and 2017.

 

Outlook

 

As we continue to execute our growth strategy and focus on our core operations, we anticipate both continued improvement in our operating margins and expense structure, as well as topline sales advancement. The termination of the Arnold Schwarzenegger product-line licensing agreement, discontinuance of unprofitable SKUs and product families, as well as the migration to new product suppliers have impacted revenue growth for the short-term. However, we anticipate revenues and growth margin to strengthen as we increase focus on our core MusclePharm products. In addition, the sale of our wholly-owned subsidiary, BioZone, in May 2016, enables us to further narrow our focus on core products, and further innovate and develop new products. We also anticipate continued savings in advertising and promotions expenses as we focus on effective marketing and advertising strategies, and move away from celebrity endorsements.

 

Management’s Plans with Respect to Liquidity and Capital Resources

 

Management believes the restructuring plan, the continued reduction in ongoing operating costs and expense controls, and the aforementioned growth strategy, will enable us to ultimately achieve profitability. We have reduced our operating expenses sufficiently and believe that our ongoing sources of revenue will be sufficient to cover these expenses for the foreseeable future.

 

 

As of March 31, 2018, we had a stockholders’ deficit of $14.6 million and recurring losses from operations. To manage cash flow, we entered into a secured borrowing arrangement, pursuant to which we have the ability to borrow up to $12.5 million subject to sufficient amounts of accounts receivable to secure the loan. The Agreement’s term has been extended to July 31, 2018. In October 2017, we also entered into a loan and security agreement to borrow against our inventory up to a maximum of $3.0 million for an initial six-month term which was automatically extended for six additional months. As of March 31, 2018, we owed $2.0 million on this credit line.

 

On November 3, 2017, we entered into a refinancing transaction with Mr. Ryan Drexler, our Chairman of the Board, Chief Executive Officer and President, to restructure all of the $18.0 million in notes payable to him, which are now due on December 31, 2019. Accordingly, such debt is classified as a long-term liability at March 31, 2018.

 

As of March 31, 2018, we had approximately $5.1 million in cash and $0.3 million in working capital.

 

Our Condensed Consolidated Financial Statements as of and for the three months ended March 31, 2018 were prepared on the basis of a going concern, which contemplates, among other things, the realization of assets and satisfaction of liabilities in the ordinary course of business. Accordingly, they do not give effect to adjustments that could be necessary should we be required to liquidate our assets.

 

Our ability to continue as a going concern and raise capital for specific strategic initiatives could also depend on obtaining adequate capital to fund operating losses until it becomes profitable. We can give no assurances that any additional capital that it is able to obtain, if any, will be sufficient to meet our needs, or that any such financing will be obtainable on acceptable terms.

 

Mr. Drexler has verbally both stated his intent and ability to put more capital into the business if necessary. However, Mr. Drexler is under no obligation to us to do so, and we can give no assurances that Mr. Drexler will be willing or able to do so at a future date and/or that he will not demand payment of his refinanced convertible note on December 31, 2019.

 

We believe that our capital resources as of March 31, 2018, available borrowing capacity and current operating plans will be sufficient to fund the planned operations for at least twelve months from the date of filing this report.

 

Results of Operations

 

Comparison of the Three Months Ended March 31, 2018 to the Three Months Ended March 31, 2017

 

	For the Three Months Ended March 31,
	2018	2017	$ Change	% Change
	($ in thousands)
Revenue, net	$26,547	$26,009	$538	2.1%
Cost of revenue	18,328	19,539	(1,211)	(6.2)
Gross profit	8,219	6,470	1,749	27.0
Operating expenses:
Advertising and promotion	3,661	1,888	1,773	93.9
Salaries and benefits	2,154	3,269	(1,115)	(34.1)
Selling, general and administrative	2,546	2,886	(340)	(11.8)
Research and development	212	137	75	54.7
Professional fees	572	882	(310)	(35.1)
Total operating expenses	9,145	9,062	83	0.9
Loss from operations	(926)	(2,592)	1,666	(64.3)
Gain on settlement of accounts payable	—	449	(449)	N/A
Other expense, net	(1,310)	(978)	(332)	33.9
Loss before provision for income taxes	(2,236)	(3,121)	885	(28.4)
Provision for income taxes	69	28	41	146.4
Net loss	$(2,305)	$(3,149)	$844	(26.8)%

 

 

The following table presents our operating results as a percentage of revenue, net for the periods presented:

 

	For the Three Months Ended March 31,
	2018	2017
Revenue, net	100%	100%
Cost of revenue	69	75
Gross profit	31	25
Operating expenses:
Advertising and promotion	14	7
Salaries and benefits	8	13
Selling, general and administrative	10	11
Research and development	1	1
Professional fees	2	3
Total operating expenses	35	35
Loss from operations	(3)	(10)
Gain on settlement of accounts payable	—	2
Other expense, net	(5)	(4)
Loss before provision for income taxes	(8)	(12)
Provision for income taxes	—	—
Net loss	(9)%	(12)%

 

Revenue, net

Specialty Website Sales

 

We generate specialty revenues from the sale of nutritional supplements to customers in the United States through our website. For sales made through our website, we recognize revenue upon shipment to the customer as that is when the customer obtains control of the promised good. We require cash or credit card payment at the point of sale or when the order is placed on our website. Accounts Receivable from Specialty Website Sales represent amounts due from credit card companies and are generally collected within a few days of the purchase. As such, we have determined that no allowance for doubtful accounts is necessary.

 

Wholesale (Specialty, International and FDM)

 

For our distribution sales, we recognize revenue at the point of sale. We generate wholesale revenues primarily from the sale of nutritional supplements to retailers and distributors in the United States and Canada. Our revenue contracts are identified when purchase orders are received and accepted from customers, and represent a single performance obligation to sell our products to a customer. We recognize revenue upon shipment to the customer as that is when the customer obtains control of the promised goods. We typically extend credit terms to our wholesale customers based on their creditworthiness and generally do not receive advance payments. As such, we record accounts receivable at the time of shipment, when the Company’s right to the consideration becomes unconditional. Accounts receivable from our wholesale customers are typically due within 30 days of invoicing. An allowance for doubtful accounts is provided based on a periodic analysis of individual account balances, including an evaluation of days outstanding, payment history, recent payment trends, and the Company’s assessment of its customers’ creditworthiness.

 

Net revenues reflect the transaction prices for contracts, which include products shipped at selling list prices reduced by variable consideration. We record sales incentives as a direct reduction of revenue for various discounts provided to our customers consisting primarily of volume incentive rebates and promotional related credits. We accrue for sales discounts over the period they are earned. Sales discounts are a significant part of our marketing plan to our customers as they help drive increased sales and brand awareness with end users through promotions that we support through our distributors and re-sellers.

 

 

Net revenue increased $0.5 million, or 2.1%, to $26.5 million for the three months ended March 31, 2018, compared to $26.0 million for the three months ended March 31, 2017. Net revenue for the three months ended March 31, 2018 increased due to growth in our international sales of $2.8 million, which was partially offset by reduced domestic sales of $2.3million. Discounts and sales allowances decreased to 16% of gross revenue, or $4.9 million, for the three months ended March 31, 2018 from 23% of gross revenue, or $8.0 million for the same period in 2017. The decrease in discounts and allowances is primarily related to a shift away from traditional discounts and allowances toward partnership advertising and marketing efforts with key customers.

 

During the three months ended March 31, 2018 and 2017, our largest customer, Costco Wholesale Corporation (both domestic and foreign), or Costco, accounted for approximately 37% and 35% of our net revenue, respectively. The increase in Costco revenue is due to improved performance of a special promotion during the three months ended March 31, 2018.

 

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. This facility is operated with our equipment and employees, and we own the related inventory. We also use contract manufacturers to drop ship products directly to our customers.

 

Our gross profit fluctuates due to several factors, including sales incentives, new product introductions and upgrades to existing product lines, changes in customer and product mixes, the mix of product demand, shipment volumes, our product costs, pricing, and inventory write-downs. Our cost of revenue for the three months ended March 31, 2018 decreased from 2017 primarily as a result of improved revenue per unit which resulted in increased revenue with a lower cost of goods sold and an overall decrease in the costs of protein products.

 

Costs of revenue decreased 6.2% to $18.3 million for the three months ended March 31, 2018, compared to $19.5 million for the same period in 2017. Accordingly, gross profit for the three months ended March 31, 2018 increased $1.7 million to $8.2 million compared to $6.5 million for the same period in 2017. Gross profit margin was 31% for the three months ended March 31, 2018 compared to 25% for the same period in 2017. Positively impacting this gross profit percentage is the aforementioned decrease in discounts and allowances and our ability to offset our inflationary cost increase in our protein products that negatively impacted our costs in 2017.

 

Operating Expenses

 

Operating expenses for the each of the three months ended March 31, 2018 and 2017 were $9.1 million. Our operating expenses overall have remained at 34% of net revenue. We have been focused on instituting new strategies focusing on new advertising and promotions, while at the same time reducing other operating expenses.

 

Advertising and Promotion

Our advertising and promotion expense consists primarily of digital, print and media advertising, athletic endorsements and sponsorships, promotional giveaways, trade show events and various partnering activities with our trading partners. Prior to our restructuring which began during the third quarter of 2015, advertising and promotions were a large part of both our growth strategy and brand awareness. We built strategic partnerships with sports athletes and fitness enthusiasts through endorsements, licensing, and co-branding agreements. Additionally, we co-developed products with sports athletes and teams. In connection with our restructuring plan, we have terminated the majority of these contracts in a strategic shift away from such costly arrangements, and moved toward more 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 increased 93.9% to $3.7 million for the three months ended March 31, 2018, or 14% of revenue, compared to $1.9 million, or 7% of revenue, for the same period in 2017. Advertising and promotion expense for the three months ended March 31, 2018 included expenses primarily related to partnership advertising, giveaways, tradeshows, athlete endorsements and international marketing support. Advertising and promotion expense for the three months ended March 31,2017 primarily included expenses related to strategic partnerships with athletes and sports teams. The increase of $1.8 million was primarily due to increased expenses related to store support and partnership advertising with our key trade partners.

 

Salaries and Benefits

 

Salaries and benefits consist primarily of salaries, bonuses, benefits, and stock-based compensation. Personnel costs are a significant component of our operating expenses.

 

Salaries and benefits decreased 34.1% to $2.2 million, or 8% of revenue, for the three months ended March 31, 2018 compared to $3.3 million, or 13% of revenue, for the same period in 2017 primarily related to a reduction in stock-based compensation expense which decreased $0.3 million and other compensation expense which decreased by $0.8 million related to the reduction of headcount.

 

Selling, General and Administrative

 

Our selling, general and administrative expenses consist primarily of depreciation and amortization, information technology equipment and network costs, facilities related expenses, director’s fees, which include both cash and stock-based compensation, insurance, rental expenses related to equipment leases, supplies, legal settlement costs, and other corporate expenses.

 

Selling, general and administrative expenses decreased 11.8% to $2.5 million, or 10% of revenue, for the three months ended March 31, 2018 compared to $2.9 million, or 11% of revenue, for the same period in 2017 primarily due to lower board costs of $0.1 million, lower office expenses and other miscellaneous cost savings of $0.3 million, lower depreciation and amortization of $0.1 million, and a decrease of $0.1 million related to information technology. These reductions were partially offset by an increase in rent expense of $0.1 million and an increase in our bad debt provision of $0.1 million.

 

Research and Development

 

Research and development expenses consist primarily of R&D personnel salaries, bonuses, benefits, and stock-based compensation, product quality control, which includes third-party testing, and research fees related to the development of new products. We expense research and development costs as incurred.

 

Research and development expenses increased 54.7% to $0.2 million, or 1% or revenue, for three months ended March 31, 2018 compared to $0.1 million, or also 1% of revenue, for the same period in 2017 primarily due to increased quality control testing fees.

 

Professional Fees

 

Professional fees consist primarily of legal fees, accounting and audit fees, consulting fees, which includes both cash and stock-based compensation, and investor relations costs. We expect our professional fees to decrease slightly as we continue to rationalize our professional service providers and focus on key initiatives. Also, as our ongoing legal matters are reduced, we expect to see a further decline in legal costs for specific settlement activities. We intend to continue to invest in strengthening our governance, internal controls, and process improvements which may require some support from third-party service providers.

 

 

Professional fees decreased 35.1% to $0.6 million, or 2% of revenue, for the three months ended March 31, 2018, compared to $0.9 million, or 3% of revenue, for the same period in 2017 primarily due to lower legal fees as a result of reduced litigation.

 

Other Expense, net

 

For the three months ended March 31, 2018 and 2017, “Other expense, net” consisted of the following (in thousands):

 

	For the Three Months Ended March 31,
	2018	2017
Other expense, net:
Interest expense, related party	$(541)	$(422)
Interest expense, related party debt discount	(248)	-
Interest expense, other	(67)	(159)
Interest expense, secured borrowing arrangement	(346)	(104)
Foreign currency transaction loss	(113)	(12)
Other	5	(281)
Total other expense, net	$(1,310)	$(978)

 

Net other expense for the three months ended March 31, 2018 increased 33.9%, or $0.3 million, compared to the same period in 2017 primarily related to interest expense with a related party.

 

Provision for Income Taxes

 

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

 

Liquidity and Capital Resources

 

Management believes the restructuring plan, the continued reduction in ongoing operating costs and expense controls, and the aforementioned growth strategy, will enable us to ultimately achieve profitability. We have reduced our operating expenses sufficiently and believe that our ongoing sources of revenue will be sufficient to cover these expenses for the foreseeable future, however, we can give no assurances that this will occur.

 

As of March 31, 2018, we had a stockholders’ deficit of $14.6 million and recurring losses from operations. To manage cash flow, we entered into a secured borrowing arrangement, pursuant to which we have the ability to borrow up to $12.5 million subject to sufficient amounts of accounts receivable to secure the loan. The agreement’s term has been extended to July 31, 2018. In October 2017, we also entered into a loan and security agreement to borrow against our inventory up to a maximum of $3.0 million for an initial six-month term which automatically extends for six additional months. As of March 31, 2018, we owed $2.0 million on this credit line.

 

On November 3, 2017, we entered into a refinancing transaction with Mr. Ryan Drexler, our Chairman of the Board, Chief Executive Officer and President, to restructure all of the $18.0 million in notes payable to him, which are now due on December 31, 2019. Accordingly, such debt is classified as a long-term liability at March 31, 2018.

 

As of March 31, 2018, we had approximately $5.1 million in cash and $0.3 million in working capital.

 

 

Our Condensed Consolidated Financial Statements as of and for the three months ended March 31, 2018 were prepared on the basis of a going concern, which contemplates, among other things, the realization of assets and satisfaction of liabilities in the ordinary course of business. Accordingly, they do not give effect to adjustments that could be necessary should we be required to liquidate our assets.

 

Our ability to continue as a going concern and raise capital for specific strategic initiatives could also depend on obtaining adequate capital to fund operating losses until it becomes profitable. We can give no assurances that any additional capital that it is able to obtain, if any, will be sufficient to meet our needs, or that any such financing will be obtainable on acceptable terms.

 

Mr. Drexler has verbally both stated his intent and ability to put more capital into the business if necessary. However, Mr. Drexler is under no obligation to us to do so, and we can give no assurances that Mr. Drexler will be willing or able to do so at a future date and/or that he will not demand payment of his refinanced convertible note on December 31, 2019.

 

We believe that our capital resources as of March 31, 2018, available borrowing capacity and current operating plans will be sufficient to fund the planned operations for at least twelve months from the date of filing this report.

Our net consolidated cash flows are as follows (in thousands):

	For the Three Months Ended March 31,
	2018	2017
Consolidated Statements of Cash Flows Data:
Net cash used in operating activities	$(232)	$(1,042)
Net cash used in investing activities	(14)	—
Net cash used in financing activities	(872)	(900)
Effect of exchange rate changes on cash	4	15
Net change in cash	$(1,114)	$(1,927)

 

Operating Activities

Our cash used in operating activities is driven primarily by sales of our products and vendor provided credit. Our primary uses of cash from operating activities have been for inventory purchases, advertising and promotion expenses, personnel-related expenditures, manufacturing costs, professional fees, costs related to our facilities, and legal fees. Our cash flows from operating activities will continue to be affected principally by the results of operations and the extent to which we increase spending on personnel expenditures, sales and marketing activities, and our working capital requirements.

 

Our operating cash flows were $0.8 million higher for the three months ended March 31, 2018 compared to the same period in 2017. The variance primarily relates to net loss adjusted for non-cash charges, which resulted in a use of cash of $1.5 million for the three months ended March 31, 2018, compared to a use of cash of $2.1 million for the same period in 2017. This increase also included a net change in net operating assets and liabilities, which resulted in a source of cash of $1.2 million for the three months ended March 31, 2018 compared to a source of cash of $1.0 million for the same period in 2017. During the three months ended March 31, 2018, an increase in accounts payable resulted in a $2.9 million cash flow from working capital. This increase was offset by an increase in our accounts receivable balance of $0.4 million and an increase in inventory balance of $1.3 million, which provided a use of working capital of $1.7 million. During the three months ended March 31, 2017, a decrease in inventory resulted in a $2.5 million cash flow from working capital. This increase was offset by an increase in our accounts receivable balance, which provided a use of working capital of $1.9 million.

 

Investing Activities

 

During the three months ended March 31, 2018, we used $14,000 for the purchase of equipment. During the three months ended March 31, 2017, we used no cash for investing activities.

 

 

Financing Activities

 

Cash used in financing activities was $0.9 million for each of the three months ended March 31, 2018 and 2017. Cash provided from the secured borrowing arrangement in both periods was offset by repayments of outstanding debt.

 

Indebtedness Agreements

 

Related-Party Notes Payable

 

On November 3, 2017, we entered into a refinancing transaction (the “Refinancing”) with Mr. Ryan Drexler, our Chairman of the Board of Directors, Chief Executive Officer and President. As part of the Refinancing, we issued to Mr. Drexler an amended and restated convertible secured promissory note (the “Refinanced Convertible Note”) in the original principal amount of $18,000,000, which amends and restates (i) a convertible secured promissory note dated as of December 7, 2015, and amended as of January 14, 2017, in the original principal amount of $6,000,000 with an interest rate of 8% prior to the amendment and 10% following the amendment (the “2015 Convertible Note”), (ii) a convertible secured promissory note dated as of November 8, 2016, in the original principal amount of $11,000,000 with an interest rate of 10% (the “2016 Convertible Note”) , and (iii) a secured demand promissory note dated as of July 27, 2017, in the original principal amount of $1,000,000 with an interest rate of 15% (the “2017 Note”, and together with the 2015 Convertible Note and the 2016 Convertible Note, collectively, the “Prior Notes”). The due date of the 2015 Convertible Note and the 2016 Convertible Note was November 8, 2017. The 2017 Note was due on demand.

2017 Refinanced Convertible Note

The $18 million Refinanced Convertible Note bears interest at the rate of 12% per annum. Interest payments are due on the last day of each quarter. At our option (as determined by its independent directors), we may repay up to one sixth of any interest payment by either adding such amount to the principal amount of the note or by converting such interest amount into an equivalent amount our common stock. Any interest not paid when due shall be capitalized and added to the principal amount of the Refinanced Convertible Note and bear interest on the applicable interest payment date along with all other unpaid principal, capitalized interest, and other capitalized obligations.

Both the principal and the interest under the Refinanced Convertible Note are due on December 31, 2019, unless converted earlier.

Mr. Drexler may convert the outstanding principal and accrued interest into shares of our common stock at a conversion price of $1.11 per share at any time. We may prepay the Refinanced Convertible Note by giving Mr. Drexler between 15 and 60 days’ notice depending upon the specific circumstances, subject to Mr. Drexler’s conversion right.

The Refinanced Convertible Note contains customary events of default, including, among others, the failure by us to make a payment of principal or interest when due. Following an event of default, interest will accrue at the rate of 14% per annum. In addition, following an event of default, any conversion, redemption, payment or prepayment of the Refinanced Convertible Note will be at a premium of 105%. The Refinanced Convertible Note also contains customary restrictions on the ability of us to, among other things, grant liens or incur indebtedness other than certain obligations incurred in the ordinary course of business. The restrictions are also subject to certain additional qualifications and carveouts, as set forth in the Refinanced Convertible Note. The Refinanced Convertible Note is subordinated to certain other indebtedness of us.

As part of the Refinancing, we and Mr. Drexler entered into a restructuring agreement (the “Restructuring Agreement”) pursuant to which the parties agreed to enter into the Refinanced Convertible Note and to amend and restate the security agreement pursuant to which the Prior Notes were secured by all of the assets and properties of us and our subsidiaries whether tangible or intangible, by entering into the Third Amended and Restated Security Agreement (the “Amended Security Agreement”). Pursuant to the Restructuring Agreement, we agreed to pay, on the effective date of the Refinancing, all outstanding interest on the Prior Notes through November 8, 2017 and certain fees and expenses incurred by Mr. Drexler in connection with the Restructuring.

 

In connection with the refinancing, we recorded a debt discount of $1.2 million. The debt discount is equal to the change in the fair value of the conversion option between the Refinanced Convertible Note and the Prior Notes. The fair value of the conversion option was determined using a Monte Carlo simulation and the model of stock price behavior known as GBM which simulates a future period as a random step from a previous period.

In addition, the Refinanced Convertible Note contains two embedded derivatives for default interest and an event of default put. Due to the unlikely event of default, the embedded derivatives have a de minimis value as of March 31, 2018.

For the three months ended March 31, 2018 and 2017, interest expense related to the related party convertible secured promissory notes was $0.8 million and $0.4 million, respectively. During the three months ended March 31, 2018 and 2017, $0.3 million and $0.4 million, respectively, in interest was paid in cash to Mr. Drexler.

 

Inventory Financing

On October 6, 2017, we and our affiliate (together with us, “Borrower”) entered into a Loan and Security Agreement (“Security Agreement”) with Crossroads Financial Group, LLC (“Crossroads”). Pursuant to the Security Agreement, Borrower may borrow up to 70% of its Inventory Cost or up to 75% of Net Orderly Liquidation Value (each as defined in the Security Agreement), up to a maximum amount of $3.0 million at an interest rate of 1.5% per month, subject to a minimum monthly fee of $22,500. The initial term of the Security Agreement is six months from the date of execution, and such initial term is extended automatically in six-month increments, unless earlier terminated pursuant to the terms of the Security Agreement. The Security Agreement contains customary events of default, including, among others, the failure to make payments on amounts owed when due, default under any other material agreement or the departure of Mr. Drexler. The Security Agreement also contains customary restrictions on the ability of Borrower to, among other things, grant liens, incur debt and transfer assets. Under the Security Agreement, Borrower has agreed to grant Crossroads a security interest in all our present and future accounts, chattel paper, goods (including inventory and equipment), instruments, investment property, documents, general intangibles, intangibles, letter of credit rights, commercial tort claims, deposit accounts, supporting obligations, documents, records and the proceeds thereof. As of March31, 2018, we had borrowed $2 million from Crossroads.

Secured Borrowing Arrangement

In January 2016, we entered into a Purchase and Sale Agreement (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 chargeback, disputes, or other amounts due to Prestige. Prestige’s purchase of the assigned Accounts from us will be at a discount fee which varies based on the number of days outstanding from the assignment of Accounts to collection of the assigned Accounts. In addition, we granted Prestige a continuing security interest in and lien upon all accounts receivable, inventory, fixed assets, general intangibles and other assets. The Purchase and Sale Agreement’s term has been extended to July 31, 2018. At March 31, 2018, we had approximately $5.5 million of outstanding borrowings.

 

During the three months ended March 31, 2018, we sold to Prestige accounts with an aggregate face amount of approximately $16.9 million, for which Prestige paid us approximately $13.5 million in cash. During the three months ended March 31, 2018, $13.3 million was repaid to Prestige, including fees and interest.

 

During the three months ended March 31, 2017, we sold to Prestige accounts with an aggregate face amount of approximately $5.5 million, for which Prestige paid us approximately $4.4 million in cash. During the three months ended March 31, 2017, $5.1 million was repaid to Prestige, including fees and interest.

 

 

Contractual Obligations

 

Our principal commitments consist of obligations under operating leases for office and warehouse facilities, capital leases for manufacturing and warehouse equipment, debt, restructuring liability and non-cancelable endorsement and sponsorship agreements. The following table summarizes our commitments to settle contractual obligations in cash as of March 31, 2018:

 

	Payments Due by Period
	1Year	2 to 3 Years	4 to 5 Years	Thereafter	Total
	(in thousands)
Operating lease obligations(1)	$857	$1,489	$729	$—	$3,075
Capital lease obligations	125	125	—	—	250
Secured borrowing arrangements	7,547	—	—	—	7,547
Convertible notes with a related party(2)	1,800	19,250	—	—	21,050
Restructuring liability	560	110	—	—	670
Settlement agreement	1,000	1,000	—	—	2,000
Other contractual obligations(3)	875	350	—	—	1,225
Total	$12,764	$22,324	$729	$—	$35,817

 

 

Off-Balance Sheet Arrangements

 

We did not have any off-balance sheet arrangements as of March 31, 2018.

 

Critical Accounting Policies and Estimates

The preparation of accompanying Condensed Consolidated Financial Statements and related disclosures in conformity with GAAP and our discussion and analysis of our financial condition and operating results require our management to make judgments, assumptions and estimates that affect the amounts reported in these Condensed Consolidated Financial Statements and accompanying notes. Management bases its estimates on historical experience and on various other assumptions we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates, and such differences may be material.

Note 2, “Summary of Significant Accounting Policies” in Part I, Item 1 of this Form 10-Q and in the Notes to Consolidated Financial Statements in Part II, Item 8 of the 2017 Form 10-K, and “Critical Accounting Policies and Estimates” in Part I, Item 7 of the 2017 Form 10-K describe the significant accounting policies and methods used in the preparation of our Condensed Consolidated Financial Statements. There have been no material changes to our critical accounting policies and estimates since the 2017 Form 10-K, other than the adoption of the new revenue recognition standards as of January 1, 2018.

Non-GAAP Adjusted EBITDA

 

In addition to disclosing financial results calculated in accordance with U.S. Generally Accepted Accounting Principles (GAAP), this Form 10-K discloses Adjusted EBITDA, which is net loss adjusted for stock-based compensation, restructuring and asset impairment charges, gain/(loss) on settlement of accounts payable, loss on sale of subsidiary, amortization of prepaid sponsorship fees, other expense, net, amortization of prepaid stock compensation, depreciation and amortization of property and equipment, amortization of intangible assets, (recovery)/provision for doubtful accounts, issuance of common stock warrants, settlement related, including legal and income taxes. In addition, we provide an Adjusted EBITDA, excluding one-time events which excludes charges related to executive severance, discontinued business/product lines, unusual credits against revenue and unusual spikes in whey protein costs. Management believes that these non-GAAP measures provide investors with important additional perspectives into our ongoing business performance.

The GAAP measure most directly comparable to Adjusted EBITDA is net loss. The non-GAAP financial measure of Adjusted EBITDA 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):

			Three Months Ended
	Three Months Ended Mar. 31, 2018	Year Ended Dec. 31, 2017	Dec. 31, 2017	Sept. 30, 2017	June 30, 2017	Mar. 31, 2017
Net loss	$(2,305)	$(10,973)	$(2,547)	$(2,128)	$(3,149)	$(3,149)
Non-GAAP adjustments:
Stock-based compensation	137	2,096	408	540	541	607
Restructuring and asset impairment charges	—	180	180	—	—	—
Gain on settlement of accounts payable	—	(430)	41	—	(22)	(449)
Amortization of prepaid sponsorship fees	91	461	86	120	110	145
Other expense, net	1,310	4,072	1,546	858	690	978
Depreciation and amortization of property and equipment	207	1,139	230	279	290	340
Amortization of intangible assets	80	320	80	80	80	80
Provision for doubtful accounts	164	1,524	310	990	144	80
Settlement, including legal	332	3,643	866	532	1,942	303
Provision for income taxes	69	142	24	14	76	28
Adjusted EBITDA	$85	$2,174	$1,224	$1,285	$702	$(1,037)
One-time events:
Executive Severance	55	831	109	66	134	522
Discontinued business/product lines	—	272	—	—	132	140
Unusual credits against revenue	—	1,141	—	—	—	1,141
Whey protein costs	—	1,322	—	—	296	1,026
Total one-time adjustments	55	3,566	109	66	562	2,829
Adjusted EBITDA excluding one-time events	$140	$5,740	$1,333	$1,351	$1,264	$1,792