UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: September 30, 2014

OR

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______________ to ______________

Commission File Number: 000-53166

 

MUSCLEPHARM CORPORATION

(Exact name of registrant as specified in its charter)

 

 

Nevada

 

77-0664193

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

4721 Ironton Street, Building A

Denver, Colorado 80239

(Address of principal executive offices and zip code)

(303) 396-6100

(Registrant’s telephone number, including area code)

 

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

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 o

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

 

Large accelerated filer

o

 

Accelerated filer

o

Non-accelerated filer

o

 

Smaller reporting company

x

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

As of November 13, 2014, there were 13,111,792 shares (which includes 2,536,500 issued and unvested shares issued pursuant to restricted stock award agreements) outstanding of the registrant’s common stock.

 

 

 

 

 

 


 

MusclePharm Corporation

Form 10-Q – Quarterly Report

For the Quarter Ended September 30, 2014

TABLE OF CONTENTS

 

PART I

 

 

 

 

 

Item 1.

Financial Statements

 

 

Consolidated Balance Sheets – September 30, 2014 (unaudited) and December 31, 2013

3

 

Consolidated Statements of Operations – Three and Nine Months Ended September 30, 2014 and 2013 (unaudited)

4

 

Consolidated Statements of Cash Flows – Nine Months Ended September 30, 2014 and 2013 (unaudited)

5

 

Notes to Consolidated Financial Statements (unaudited)

7

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

28

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

36

 

 

 

Item 4.

Controls and Procedures

36

 

 

 

PART II

 

 

 

 

 

Item 1.

Legal Proceedings

37

 

 

 

Item 1A.

Risk Factors

37

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

38

 

 

 

Item 2C.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

38

 

 

 

Item 3.

Defaults Upon Senior Securities

39

 

 

 

Item 4.

Mine Safety Disclosures

39

 

 

 

Item 5.

Other Information

39

 

 

 

Item 6.

Exhibit Index

39

 

 

 

Signatures

 

40

 

 

 

Exhibits

 

 

 

 

 

2


 

MusclePharm Corporation

Consolidated Balance Sheets

 

 

September 30, 2014

 

 

December 31, 2013

 

 

(unaudited)

 

 

 

 

Assets

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash

$

2,949,773

 

 

$

5,411,515

 

Cash - restricted

 

-

 

 

 

2,500,014

 

Investment in debt securities

 

-

 

 

 

259,715

 

Accounts receivable - net

 

23,220,072

 

 

 

13,741,180

 

Derivative instrument

 

-

 

 

 

119,248

 

Inventory

 

24,027,143

 

 

 

15,772,368

 

Prepaid giveaways

 

1,434,850

 

 

 

1,177,539

 

Prepaid stock compensation

 

4,419,721

 

 

 

3,023,717

 

Prepaid sponsorship and endorsement fees

 

506,478

 

 

 

1,145,161

 

Prepaid expenses

 

1,832,217

 

 

 

1,335,218

 

Other assets

 

637,424

 

 

 

40,805

 

Total current assets

 

59,027,678

 

 

 

44,526,480

 

Property and equipment - net

 

7,303,012

 

 

 

2,613,584

 

Intangible assets - net

 

6,866,064

 

 

 

155,165

 

Prepaid stock compensation

 

6,142,750

 

 

 

4,718,238

 

Other assets

 

270,582

 

 

 

144,229

 

Total assets

$

79,610,086

 

 

$

52,157,696

 

Liabilities and Stockholders' Equity

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Accounts payable

$

28,096,948

 

 

$

26,048,483

 

Accrued liabilities

 

4,894,350

 

 

 

2,317,901

 

Capital lease - short term

 

97,925

 

 

 

26,653

 

Customer deposits

 

250,413

 

 

 

265,652

 

Line of credit

 

8,000,000

 

 

 

2,500,000

 

Notes payable

 

45,600

 

 

 

62,502

 

Derivative liabilities

 

-

 

 

 

1,147,330

 

Total current liabilities

 

41,385,236

 

 

 

32,368,521

 

Capital lease - long term

 

135,689

 

 

 

54,639

 

Total liabilities

 

41,520,925

 

 

 

32,423,160

 

Commitments and Contingencies (Note 12)

 

 

 

 

 

 

 

Stockholders' Equity:

 

 

 

 

 

 

 

Series D, Convertible Preferred Stock, $0.001

   par value; 1,600,000 shares authorized, 1,500,000

   shares issued; none and 131,500 shares outstanding,

   respectively

 

-

 

 

 

132

 

Common Stock, $0.001 par value; 100,000,000 shares

   authorized; 11,266,142 and 9,259,411 shares issued,

   respectively; and 10,996,221 and 9,089,490 shares

   outstanding, respectively

 

11,266

 

 

 

9,260

 

Additional paid-in capital

 

125,014,545

 

 

 

103,064,901

 

Treasury stock, at cost; 619,921 and 169,921 shares,

respectively

 

(7,481,179

)

 

 

(1,498,298

)

Accumulated other comprehensive (loss)

 

(32,392

)

 

 

(14,042

)

Accumulated deficit

 

(79,423,079

)

 

 

(81,827,417

)

Total stockholders' equity

 

38,089,161

 

 

 

19,734,536

 

Total Liabilities and Stockholders' Equity

$

79,610,086

 

 

$

52,157,696

 

 

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

 

 

3


 

MusclePharm Corporation

Consolidated Statements of Operations

(unaudited)

 

 

For the Three Months Ended

September 30,

 

 

For the Nine Months Ended

September 30,

 

 

2014

 

 

2013

 

 

2014

 

 

2013

 

Sales - net

$

47,768,320

 

 

$

25,343,968

 

 

$

144,717,761

 

 

$

73,385,193

 

Cost of sales

 

32,811,630

 

 

 

17,937,768

 

 

 

96,241,239

 

 

 

49,900,891

 

Gross profit

 

14,956,690

 

 

 

7,406,200

 

 

 

48,476,522

 

 

 

23,484,302

 

Operating Expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Advertising and promotion

 

7,749,156

 

 

 

4,043,064

 

 

 

19,996,905

 

 

 

9,635,642

 

Salaries and benefits

 

6,041,157

 

 

 

3,854,945

 

 

 

17,185,451

 

 

 

6,667,313

 

Selling, general, and administrative

 

3,651,739

 

 

 

1,936,610

 

 

 

7,881,047

 

 

 

5,000,831

 

Research and development

 

735,472

 

 

 

181,908

 

 

 

2,996,301

 

 

 

441,269

 

Professional fees

 

1,316,621

 

 

 

2,262,453

 

 

 

3,393,711

 

 

 

10,074,439

 

Total operating expenses

 

19,494,145

 

 

 

12,278,980

 

 

 

51,453,415

 

 

 

31,819,494

 

Operating (loss)

 

(4,537,455

)

 

 

(4,872,780

)

 

 

(2,976,893

)

 

 

(8,335,192

)

Other income (expense), net

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative expense

 

-

 

 

 

-

 

 

 

-

 

 

 

(96,913

)

Change in fair value of derivative liabilities

 

-

 

 

 

305,421

 

 

 

373,944

 

 

 

(5,466,542

)

Gain on settlement of accounts payable and debt

 

-

 

 

 

67,489

 

 

 

31,477

 

 

 

392,144

 

Gain (loss) on derivative instrument and debt security

 

-

 

 

 

444,059

 

 

 

(386,103

)

 

 

444,059

 

Accretion of note discount

 

-

 

 

 

115,429

 

 

 

-

 

 

 

115,429

 

Bargain purchase gain

 

5,264,854

 

 

 

-

 

 

 

5,264,854

 

 

 

-

 

Interest expense

 

(28,659

)

 

 

(1,302

)

 

 

(85,047

)

 

 

(782,747

)

Foreign currency transaction loss

 

(1,577

)

 

 

(4,152

)

 

 

(36,073

)

 

 

(9,865

)

Interest income

 

-

 

 

 

-

 

 

 

223,049

 

 

 

-

 

Other income, net

 

-

 

 

 

-

 

 

 

166,622

 

 

 

10,000

 

Total other income (expense), net

 

5,234,618

 

 

 

926,944

 

 

 

5,552,723

 

 

 

(5,394,435

)

Net income (loss) before income taxes

 

697,163

 

 

 

(3,945,836

)

 

 

2,575,830

 

 

 

(13,729,627

)

Provision for income taxes

 

(94,545

)

 

 

-

 

 

 

(171,492

)

 

 

-

 

Net income (loss) after income taxes

$

602,618

 

 

$

(3,945,836

)

 

$

2,404,338

 

 

$

(13,729,627

)

Other comprehensive income (loss)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net change in foreign currency translation

 

(37,057

)

 

 

(13,027

)

 

 

(18,349

)

 

 

(6,950

)

Net change in debt securities

 

-

 

 

 

58,438

 

 

 

-

 

 

 

58,438

 

Total other comprehensive income (loss)

 

(37,057

)

 

 

45,411

 

 

 

(18,349

)

 

 

51,488

 

Total comprehensive income (loss)

$

565,561

 

 

$

(3,900,425

)

 

$

2,385,989

 

 

$

(13,678,139

)

Net income (loss) per share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

$

0.05

 

 

$

(0.47

)

 

$

0.23

 

 

$

(2.07

)

Diluted

$

0.05

 

 

$

(0.47

)

 

$

0.20

 

 

$

(2.07

)

Weighted average number of shares used in per share calculations - Basic

 

11,032,996

 

 

 

8,475,084

 

 

 

10,652,781

 

 

 

6,626,125

 

Weighted average number of shares used in per share calculations - Diluted

 

12,612,896

 

 

 

8,475,084

 

 

 

12,112,017

 

 

 

6,626,125

 

 

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

 

 

 

4


 

MusclePharm Corporation

Consolidated Statements of Cash Flows

(unaudited)

 

 

Nine Months Ended

 

 

September 30,

 

 

2014

 

 

2013

 

Cash Flows From Operating Activities:

 

 

 

 

 

 

 

Net income (loss)

$

2,404,338

 

 

$

(13,729,627

)

Adjustments to reconcile net loss to net cash

   used in operating activities:

 

 

 

 

 

 

 

Depreciation of property & equipment

 

950,166

 

 

 

510,890

 

Bad debt

 

163,897

 

 

 

158,578

 

Amortization of prepaid stock compensation

 

2,688,442

 

 

 

5,384,654

 

Amortization of prepaid sponsorship fees

 

5,016,456

 

 

 

2,856,040

 

Amortization of intangible assets

 

422,102

 

 

 

-

 

Stock-based compensation

 

6,942,357

 

 

 

1,588,067

 

Amortization of debt issuance costs

 

1,136

 

 

 

335,433

 

Accretion of conversion option on debt security

 

(222,140

)

 

 

(115,429

)

Bargain purchase gain

 

(5,264,854

)

 

 

-

 

Gain on settlement of accounts payable

 

(31,477

)

 

 

(392,144

)

Loss on disposal of property & equipment

 

30,606

 

 

 

-

 

Derivative expense

 

-

 

 

 

96,913

 

Loss on debt security and derivative instrument

 

386,103

 

 

 

-

 

Change in fair value of derivative assets

 

-

 

 

 

(444,059

)

Change in fair value of derivative liabilities

 

(373,944

)

 

 

5,466,542

 

Changes in operating assets and liabilities, net of acquisition

 

 

 

 

 

 

 

Accounts receivable

 

(9,148,133

)

 

 

(7,767,673

)

Inventory

 

(7,424,271

)

 

 

(9,375,189

)

Prepaid giveaways

 

(257,311

)

 

 

(233,622

)

Prepaid sponsorship fees

 

(4,405,354

)

 

 

(3,610,512

)

Prepaid assets

 

(652,516

)

 

 

62,736

 

Other assets

 

(354,330

)

 

 

(1,445

)

Accounts payable

 

2,039,228

 

 

 

14,652,512

 

Accrued liabilities

 

1,552,297

 

 

 

(3,504,756

)

Other long-term liabilities

 

(7,811

)

 

 

7,554

 

Net Cash Used In Operating Activities

 

(5,545,013

)

 

 

(8,054,537

)

Cash Flows From Investing Activities:

 

 

 

 

 

 

 

Purchase of convertible promissory note and warrant

 

-

 

 

 

(2,000,000

)

Purchase of property and equipment

 

(3,735,411

)

 

 

(825,164

)

Change in restricted cash balance

 

-

 

 

 

9,148

 

Proceeds from sale of investment in debt security

 

215,000

 

 

 

-

 

Proceeds from disposal of property and equipment

 

1,814

 

 

 

1,694

 

Purchase of trademark

 

-

 

 

 

(104,725

)

Net Cash Used In Investing Activities

 

(3,518,597

)

 

 

(2,919,047

)

Cash Flows From Financing Activities:

 

 

 

 

 

 

 

Proceeds from line of credit

 

8,000,000

 

 

 

-

 

Payment on notes payable

 

(16,902

)

 

 

(4,397,107

)

Repurchase of common stock (treasury stock)

 

(1,362,881

)

 

 

(103,537

)

Proceeds from issuance of preferred stock

 

-

 

 

 

12,000,000

 

Proceeds from issuance of common stock and warrants

 

-

 

 

 

10,827,501

 

Stock issuance costs

 

-

 

 

 

(1,662,667

)

Net Cash Provided by Financing Activities

 

6,620,217

 

 

 

16,664,190

 

 

 

 

 

 

 

 

 

Effect of exchange rates on cash and cash equivalents

 

(18,349

)

 

 

(6,950

)

 

 

 

 

 

 

 

 

5


 

 

Nine Months Ended

 

 

September 30,

 

 

2014

 

 

2013

 

Net (decrease) increase in cash

 

(2,461,742

)

 

 

5,683,656

 

 

 

 

 

 

 

 

 

Cash at beginning of period

 

5,411,515

 

 

 

-

 

 

 

 

 

 

 

 

 

Cash at end of period

$

2,949,773

 

 

$

5,683,656

 

 

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

 

 

Cash paid for interest

$

78,820

 

 

$

410,846

 

Cash paid for taxes

$

240,304

 

 

$

-

 

 

 

 

 

 

 

 

 

Supplemental disclosure of non-cash investing

   and financing activities:

 

 

 

 

 

 

 

Stock issued for future services - third parties

$

5,402,300

 

 

$

13,879,997

 

Stock issued for Biozone acquisition

$

9,478,330

 

 

$

-

 

Treasury stock received in Biozone claim

$

4,620,000

 

 

$

-

 

Warrants issued in conjunction with equity issuances

$

-

 

 

$

8,175,459

 

Stock issued to settle accounts payable and accrued

   expenses- third parties

$

-

 

 

$

5,916,252

 

Stock issued for executive and board compensation

$

115,358

 

 

$

152,412

 

Reclassification of derivative liability to additional paid in capital

$

773,386

 

 

$

11,688,463

 

Change in fair value of debt securities in other comprehensive

   income

$

-

 

 

$

58,438

 

Capital leases

$

88,861

 

 

$

-

 

 

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

 

 

 

6


 

MusclePharm Corporation

Notes to Consolidated Financial Statements

(Unaudited)

 

 

Note 1: The Company and Basis of Presentation

MusclePharm Corporation (the “Company”) is a scientifically driven, performance lifestyle Company that develops, manufactures, markets and distributes branded nutritional supplements. The Company was incorporated in Nevada in 2006, and principal executive offices are located in Denver, Colorado.

The accompanying interim unaudited consolidated financial statements as of September 30, 2014 and 2013, and for the three and nine months then ended, have been prepared by the Company in accordance with generally accepted accounting principles (“GAAP”) in the United States (“U.S.”) for interim financial information. The amounts as of December 31, 2013 have been derived from the Company’s annual audited financial statements. In the opinion of management, the accompanying unaudited consolidated financial statements reflect all adjustments necessary (consisting of normal recurring adjustments) to state fairly the financial position of the Company and its results of operations and cash flows as of and for the periods presented. These financial statements should be read in conjunction with the annual audited financial statements and notes thereto as of and for the year ended December 31, 2013, included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013, filed on March 31, 2014 (the “Form 10-K”).

The results of operations for the three and nine months ended September 30, 2014 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2014 or any future period and the Company makes no representations related thereto.

Reclassification

The Company has reclassified certain prior period amounts to conform to the current period presentation. These reclassifications had no effect on the financial position, results of operations or cash flows for the periods presented.

 

Note 2: Summary of Significant Accounting Policies

Principles of Consolidation

The consolidated financial statements include the accounts of MusclePharm Corporation and its wholly-owned subsidiaries MusclePharm Canada Enterprises Corp (“MusclePharm Canada”) and Biozone Laboratories, Inc. (“Biozone Labs”). MusclePharm Canada began operations in April 2012 and Biozone Labs was acquired in January 2014. All intercompany accounts and transactions have been eliminated upon consolidation.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The accounting estimates and assumptions that require management’s most significant, difficult, and subjective judgment include the recognition and measurement of allowance for doubtful accounts, inventory write down, derivatives, allocation of acquisition purchase price, warrant and option valuation, and sales discounts and allowances reserve among others. Actual results experienced by the Company may differ from management’s estimates.

Risks and Uncertainties

The Company operates in an industry that is subject to rapid change and intense competition. The Company’s operations will be subject to significant risk and uncertainties including financial, operational, technological, regulatory, industry adverse publicity and other risks, including the potential risk of business failure.

7


 

Recently Adopted Accounting Pronouncements

In July 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2013-11, “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carry-forward, a Similar Tax Loss, or a Tax Credit Carry-forward Exists.” This ASU provides explicit guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carry forward or a tax credit carry forward exists. Under the ASU, the Company’s unrecognized tax benefit should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carry forward or a tax credit carry forward. This ASU applies to all entities that have unrecognized tax benefits when a net operating loss carry-forward, a similar tax loss, or a tax credit carry-forward exists at the reporting date.  The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The adoption of this ASU did not have a material impact on the Company's financial statements.

Recent Accounting Pronouncements

 

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

 

In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers" (“ASU 2014-09”), which provides guidance for revenue recognition. ASU 2014-09 affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets and supersedes the revenue recognition requirements in Topic 605, “Revenue Recognition,” and most industry-specific guidance. This ASU also supersedes some cost guidance included in Subtopic 605-35, “Revenue Recognition- Construction-Type and Production-Type Contracts.” ASU 2014-09’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which a company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under today’s guidance, including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. ASU 2014-09 is effective for the Company beginning January 1, 2017 and, at that time, the Company may adopt the new standard under the full retrospective approach or the modified retrospective approach. Early adoption is not permitted. The Company is currently evaluating the method and impact the adoption of ASU 2014-09 will have on the Company’s unaudited condensed consolidated financial statements and disclosures.

 

In April 2014, the FASB issued ASU 2014-08, "Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity." ASU 2014-08 changes the criteria for reporting a discontinued operation. Under the new pronouncement, a disposal of a part of an organization that has a major effect on its operations and financial results is a discontinued operation. The Company is required to adopt ASU 2014-08 prospectively for all disposals or components of its business classified as held for sale during fiscal periods beginning after December 15, 2014. The adoption of ASU 2014-08 is not expected to have a material effect on the Company’s unaudited consolidated financial statements or disclosures.

Significant Accounting Policies:

Cash and Cash Equivalents

The Company considers all highly liquid instruments purchased with an original or remaining maturity of three months or less at the date of purchase to be cash equivalents. At September 30, 2014 and December 31, 2013, respectively, the Company had no cash equivalents.

8


 

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, and at September 30, 2014 we had one bank account that exceeded the federally insured limit, and at December 31, 2013 we had two bank accounts that exceeded the federally insured limit.

Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable represents trade obligations from customers that are subject to normal trade collection terms. The Company’s finance department monitors the status of customer receivables and takes actions to collect past due balances as necessary. The Company periodically evaluates the collectability of its accounts receivable and considers the need to establish an allowance for doubtful accounts based upon historical collection experience and specific customer information. Accordingly, the actual amounts could vary from the recorded allowances. There is also a review of customer discounts at the period end and an accrual made for discounts earned but not yet utilized by period end.

Management performs ongoing evaluations of the Company’s customers’ financial condition and generally does not require collateral. Some international customers are required to pay for their orders in advance of shipment. Management reviews accounts receivable quarterly and reduces the carrying amount by a valuation allowance that reflects management’s best estimate of amounts that may not be collectible. Allowances, if any, for uncollectible accounts receivable are determined based upon the aging of accounts receivable, changes in customer credit worthiness, general market and economic conditions, and historical experience. Bad debt expense recognized as a result of our valuation allowance is classified under selling, general and administrative expense in the Consolidated Statement of Operations.  If receivable amounts are ultimately deemed to be uncollectible, the Company writes off the receivable balance against the valuation allowance.  

The Company does not charge interest on past due receivables. Receivables are determined to be past due based on the payment terms of the original invoices.

Inventory

Inventory is valued at the lower of cost or market value. The cost of product inventory for MusclePharm and MusclePharm Canada is computed using actual cost on a First-In First-Out basis, and the cost of inventory for Biozone Labs is computed using an average cost basis. Adjustments to reduce the cost of inventory to its net realizable value are made, if required, and estimates are made for obsolescence, excess or slow-moving inventories, non-conforming inventories, and expired inventory.

Prepaid Giveaways

Prepaid giveaways represent non-inventory samples, which are given away to aid in promotion of the brand and products.

Prepaid Sponsorship and Endorsement Fees

Prepaid sponsorship and endorsement fees represent fees paid in connection with Company sponsorships of certain events and trade shows as well as prepaid athlete endorsement fees, which are expensed over the period the fees are earned. A significant amount of the Company’s promotional expenses results from payments under endorsement and sponsorship contracts. Accounting treatment for endorsement and sponsorship payments is based upon specific contract provisions. Generally, endorsement and sponsorship payments are expensed straight-line over the term of the contract after giving recognition to periodic performance compliance provisions of the contract. Prepayments made under the contracts are included in either current or long-term prepaid expenses depending on the performance period for which the prepayment applies.

Prepaid Stock Compensation

Prepaid stock compensation represents amounts paid with stock for future contractual benefits to be received. The Company amortizes these contractual benefits over the life of the contracts using the straight-line method.

Prepaid Expenses

Prepaid expenses consist of various payments that the Company has made in advance for goods or services to be received in the future. These prepaid expenses include legal retainers, print advertising, insurance and service contracts requiring up-front payments.

9


 

Property and Equipment

Property and equipment are stated at cost and depreciated to their estimated residual value over their estimated useful lives. When assets are retired or otherwise disposed of, the assets and related accumulated depreciation are relieved from the accounts and the resulting gains or losses are included in the Statements of Operations. Repairs and maintenance costs are expensed as incurred. Depreciation is provided using the straight-line method for all property and equipment. We review our property and equipment for impairment when events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. We use an estimate of future undiscounted net cash flows of the related assets or groups of assets over their remaining lives in measuring whether the assets are recoverable. An impairment loss is calculated by determining the difference between the carrying values and the estimated fair values of these assets. We did not consider any of our property and equipment to be impaired during the nine months ended September 30, 2014 or 2013.

Intangible Assets

Definite-lived intangible assets are amortized over their related useful lives, using a straight-line basis consistent with the underlying expected future cash flows related to the specific intangible asset. Costs to renew or extend the life of intangible assets are capitalized and amortized over the remaining useful life of the asset.  Intangible assets are reviewed for impairment whenever events or changes in circumstances exist that indicate the carrying amount of an asset may not be recoverable. When indicators of impairment exist, an estimate of undiscounted net cash flows is used in measuring whether the carrying amount of the asset or related asset group is recoverable. Measurement of the amount of impairment, if any, is based upon the difference between the asset's carrying value and estimated fair value. Fair value is determined through various valuation techniques, including market and income approaches as considered necessary. See Note 17 for further disclosure of intangible assets.

Accrued Liabilities

Accrued liabilities consist of amounts estimated by management for future liability payments that relate to the current accounting period. Management reviews these estimates periodically to determine their reasonableness and fair presentation.

Debt

The Company defines short term debt as any debt payment due less than one year from the date of the financial statements. Long term debt is defined as any debt payment due more than one year from the date of the financial statements. Refer to Note 8 for further disclosure of debt liabilities.

Derivatives

Fair value accounting requires bifurcation of embedded derivative instruments such as conversion features in equity instruments and warrants granted, and measurement of their fair value. In determining the appropriate fair value, the Company uses Black-Scholes or lattice option-valuation models. In assessing the convertible equity instruments, management determines if the convertible equity instrument is conventional convertible equity and further if the beneficial conversion feature requires separate measurement.

Once derivative instruments are determined, they are adjusted to reflect fair value at the end of each reporting period. Any increase or decrease in the fair value is recorded in results of operations as an adjustment to fair value of derivatives. In addition, the fair value of freestanding derivative instruments such as warrants, are also valued using a Black-Scholes or lattice option-pricing model. Once a derivative liability ceases to exist any remaining fair value is reclassified to additional paid-in capital if redeemed or through earnings if forfeited or expired.

Fair Value of Financial Instruments

The Company measures assets and liabilities at fair value based on an expected exit price which represents the amount that would be received on the sale of an asset or paid to transfer a liability, as the case may be, in an orderly transaction between market participants. As such, fair value may be based on assumptions that market participants would use in pricing an asset or liability. The authoritative guidance on fair value measurements establishes a consistent framework for measuring fair value on either a recurring or nonrecurring basis whereby inputs, used in valuation techniques, are assigned a hierarchical level.

10


 

The following are the hierarchical levels of inputs to measure fair value:

·

Level 1: Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

·

Level 2: Inputs reflect quoted prices for identical assets or liabilities in markets that are not active; quoted prices for similar assets or liabilities in active markets; inputs other than quoted prices that are observable for the assets or liabilities; or inputs that are derived principally from or corroborated by observable market data by correlation or other means.

·

Level 3: Unobservable inputs reflecting the Company’s assumptions incorporated in valuation techniques used to determine fair value. These assumptions are required to be consistent with market participant assumptions that are reasonably available.

The determination of where assets and liabilities fall within this hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

The Company’s financial instruments consisted primarily of accounts receivable, accounts payable, accrued liabilities, notes payable, and debt. The Company’s notes payable and debt approximate fair value based upon current borrowing rates available to the Company for debt with similar maturities. The carrying amounts of the Company’s financial instruments generally approximated their fair values as of September 30, 2014 and December 31, 2013, respectively, due to the short-term nature of these instruments.

Stock-Based Compensation

Generally, all forms of stock-based compensation, including stock option grants, warrants, restricted stock grants, and stock appreciation rights are measured at their fair value on the awards’ grant date, based on estimated number of awards that are ultimately expected to vest and expensed on a straight-line basis. Share-based compensation awards issued to non- employees for services rendered are recorded at either the fair value of the services rendered or the fair value of the stock-based compensation, whichever is more readily determinable.

Revenue Recognition

The Company derives revenue primarily from sale of products. The Company records revenue when all of the following have occurred: (1) persuasive evidence of an arrangement exists, (2) product has been shipped or delivered, (3) the sales price to the customer is fixed or determinable, and (4) collectability is reasonably assured.

Depending on individual customer agreements, sales are recognized either upon shipment of products to customers or upon delivery. For all Canadian sales, which represent 3% of total sales, recognition occurs upon shipment.

The Company records sales allowances and discounts as a direct reduction of sales. The Company grants volume incentive rebates to certain customers based on contractually agreed upon percentages once certain thresholds have been met. These volume incentive rebates are recorded as a direct reduction to sales.

The Company has determined that customer advertising related credits are accounted for based on the guidance of ASC No. 605-50-55 (“Revenue Recognition” – Customer Payments and Incentives), which indicates that, absent evidence of benefit to the vendor, appropriate treatment requires netting these types of payments against revenues and not expensing as advertising expense.

Advertising and Promotion

Advertising and promotion expenses include digital and print advertising, trade show events, athletic endorsements and sponsorships, and promotional giveaways. Advertising expenses are recognized in the month that the advertising appears while costs associated with trade show events are expensed when the event occurs. For major trade shows, the expenses are recognized within the calendar year over the period in which we recognize revenue associated with sales generated at the trade show. Costs related to promotional giveaways are expensed when the product is either given out at a promotional event or shipped to the customer.

A significant amount of the Company’s promotional expenses results from payments under endorsement and sponsorship contracts. Accounting treatment for endorsement and sponsorship payments is based upon specific contract provisions. Generally, endorsement payments are expensed straight-line over the term of the contract after giving recognition to periodic performance compliance provisions of the contract. Prepayments made under the contracts are included in either current or long-term prepaid expenses depending on the period for which the prepayment applies.

Some of the contracts provide for contingent payments to endorsers or athletes based upon specific achievement in their sports (e.g. winning a championship). The Company records expense for these payments when the endorser achieves the specific achievement.

11


 

Income Taxes

Income taxes are accounted for using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Beginning with the adoption of Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes, (included in FASB ASC Subtopic 740-10, Income Taxes — Overall), the Company recognizes the effect of income tax positions only if those positions are more likely than not to be sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely to be realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs.

The Company records interest and penalties related to unrecognized tax benefits in income tax expense. There were no interest or penalties related to unrecognized tax benefits for the three and nine months ended September 30, 2014 and 2013.

Foreign Currency

MusclePharm began operations in Canada in April 2012. The Canadian Dollar was determined to be the functional currency as the majority of the transactions related to the day to day operations of the business are in Canadian Dollars. At the end of the period, the financial results of the Canadian operation are translated into the U.S. Dollar, which is the reporting currency, and added to the U.S. operations for consolidated company financial results. The revenue and expense items are translated using the average rate for the month and the assets and liabilities at the month end of rate. Transactions that have completed the accounting cycle and resulted in a gain or loss related to translation are recorded in realized gain or loss due to foreign currency translation under other income and expense on the income statement. Transactions that have not completed their accounting cycle but appear to have gain or loss due to the translation process are recorded as unrealized gain or loss due to translation and recorded as accumulated other comprehensive income (loss) in the equity section on the balance sheet until such date the accounting cycle of the transaction is complete and the actual realized gain or loss is recognized.

 

 

Note 3: Composition of Certain Financial Statement Captions

Accounts Receivable

Accounts receivable, net of allowance consisted of the following at September 30, 2014 and December 31, 2013:

 

 

As of

 

 

As of

 

 

September 30, 2014

 

 

December 31, 2013

 

Accounts receivable

$

24,224,380

 

 

$

14,830,487

 

Less: allowance for discounts

 

(851,275

)

 

 

(1,060,000

)

Less: allowance for doubtful accounts

 

(153,033

)

 

 

(29,307

)

Accounts receivable - net

$

23,220,072

 

 

$

13,741,180

 

 

Inventory

Inventory, net consisted of the following at September 30, 2014 and December 31, 2013:

 

 

As of

 

 

As of

 

 

September 30, 2014

 

 

December 31, 2013

 

Raw materials inventory

$

2,221,068

 

 

$

-

 

Work in process inventory

 

59,533

 

 

 

-

 

Finished goods inventory

 

21,746,542

 

 

 

15,772,368

 

Inventory

$

24,027,143

 

 

$

15,772,368

 

 

12


 

Prepaid Expenses

Prepaid expenses consisted of the following at September 30, 2014 and December 31, 2013:

 

 

As of

 

 

As of

 

 

September 30, 2014

 

 

December 31, 2013

 

Prepaid advertising and promotion

$

855,963

 

 

$

760,740

 

Prepaid professional services

 

195,368

 

 

 

74,730

 

Prepaid insurance

 

164,089

 

 

 

280,878

 

Prepaid software license fees

 

135,738

 

 

 

86,205

 

Inventory deposit

 

131,413

 

 

 

-

 

Prepaid rent

 

117,854

 

 

 

-

 

Prepaid director fees

 

72,890

 

 

 

-

 

Prepaid taxes

 

37,675

 

 

 

-

 

Prepaid research & development fees

 

20,897

 

 

 

22,500

 

Prepaid support agreements

 

13,500

 

 

 

3,499

 

Prepaid license fees

 

-

 

 

 

90,623

 

Prepaid - other

 

86,830

 

 

 

16,043

 

 

$

1,832,217

 

 

$

1,335,218

 

 

Other Current Assets

Other current assets consisted of the following at September 30, 2014 and December 31, 2013:

 

 

As of

 

 

As of

 

 

September 30, 2014

 

 

December 31, 2013

 

Volume rebate receivable

$

226,174

 

 

$

-

 

Vendor credit

 

260,017

 

 

 

-

 

Line of credit fees - net

 

80,664

 

 

 

-

 

Credit card pre-payments

 

26,027

 

 

 

-

 

Other current assets

 

44,542

 

 

 

40,805

 

 

$

637,424

 

 

$

40,805

 

 

Property and Equipment

Property and equipment consisted of the following at September 30, 2014 and December 31, 2013:

 

 

As of

September 30, 2014

 

 

As of

December 31, 2013

 

 

Furniture, fixtures and equipment

$

3,646,144

 

 

$

1,849,462

 

 

Leasehold improvements

 

2,262,558

 

 

 

619,159

 

 

Manufacturing and lab equipment

 

1,248,993

 

 

 

-

 

 

Vehicles

 

444,065

 

 

 

442,300

 

 

Displays

 

341,346

 

 

 

33,683

 

 

Website

 

193,809

 

 

 

11,462

 

 

Construction in process

 

1,433,081

 

 

 

1,018,509

 

 

Total

 

9,569,996

 

 

 

3,974,575

 

 

Less: Accumulated depreciation and amortization

 

(2,266,984

)

 

 

(1,360,991

)

 

 

$

7,303,012

 

 

$

2,613,584

 

 

 

13


 

Other Assets

Other assets consisted of the following at September 30, 2014 and December 31, 2013:

 

 

As of

 

 

As of

 

 

September 30, 2014

 

 

December 31, 2013

 

Security deposit

$

108,394

 

 

$

85,419

 

Prepaid advertising and promotion - long term

 

155,139

 

 

 

58,810

 

Other

 

7,049

 

 

 

-

 

 

$

270,582

 

 

$

144,229

 

 

Accrued Liabilities

Accrued liabilities consisted of the following at September 30, 2014 and December 31, 2013:

 

 

As of

 

 

As of

 

 

September 30, 2014

 

 

December 31, 2013

 

Accrued payables

$

2,603,001

 

 

$

1,044,520

 

Employee compensation and benefits

 

2,235,759

 

 

 

1,137,681

 

Accrued taxes

 

6,430

 

 

 

71,771

 

Other

 

49,160

 

 

 

63,929

 

 

$

4,894,350

 

 

$

2,317,901

 

 

Sales and Discounts

Sales for the three and nine months ended September 30, 2014 and 2013 were as follows:

 

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

 

2014

 

 

2013

 

 

2014

 

 

2013

 

Sales

$

55,634,539

 

 

$

31,080,225

 

 

$

164,168,386

 

 

$

84,519,744

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Discounts and returns

 

(7,866,219

)

 

 

(5,736,257

)

 

 

(19,450,625

)

 

 

(11,134,551

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sales - Net

$

47,768,320

 

 

$

25,343,968

 

 

$

144,717,761

 

 

$

73,385,193

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Discounts and returns as a percent of gross sales

 

14

%

 

 

18

%

 

 

12

%

 

 

13

%

 

The Company has an informal seven day right of return for products. There were nominal returns for the three and nine months ended September 30, 2014 and 2013.

The Company offers discounts and sales allowances for: volume rebates, product promotions, early payments, and other discounts and allowances. The Company accounts for sales discounts and allowances over the period they are earned. Because of the inherent uncertainty surrounding volume rebate programs and product promotions that are based on sales, actual results could generate liabilities greater or less than the amounts estimated and recorded.

Cost of Sales

Cost of sales for MusclePharm and MusclePharm Canada represent costs directly related to the production, manufacturing and freight-in of the Company’s products purchased from third party manufacturers.  The Company mainly ships customer orders from its distribution center in Franklin, Tennessee. The facility is operated with the Company’s equipment and employees, and inventory is owned by the Company. The Company also utilizes contract manufacturers to drop ship product directly to customers.

Cost of sales for products produced by Biozone Labs consist of raw material, direct labor, freight-in, and other supply and equipment rental expenses.  The Company mainly ships customer orders from its distribution center in Pittsburg, California.  

 

14


 

Note 4:  Concentrations

Accounts Receivable

At September 30, 2014 and December 31, 2013, the Company had the following concentrations of accounts receivable:

 

Customer

 

As of September 30, 2014

 

 

As of December 31, 2013

 

Bodybuilding.com

 

 

16

%

 

 

14

%

B

 

 

10

%

 

*

%

C

 

 

10

%

 

*

%

D

 

*

%

 

 

24

%

E

 

*

%

 

 

16

%

 

*

Less than 10% of total accounts receivable

Revenue

The Company had the following concentrations of revenues:

 

 

 

Three Months Ended September 30,

 

Customer

 

2014

 

 

2013

 

Bodybuilding.com

 

 

14

%

 

 

32

%

B

 

 

10

%

 

*

%

C

 

*

%

 

 

10

%

 

 

 

 

Nine Months Ended September 30,

 

Customer

 

2014

 

 

2013

 

Bodybuilding.com

 

 

14

%

 

 

30

%

B

 

*

%

 

*

%

C

 

*

%

 

 

11

%

 

*

Less than 10% of gross sales

Vendors

The Company uses five non-affiliated principal contract manufacturers of our products. We have quality control and manufacturing agreements in place with our primary manufacturers to support our growth and ensure consistency in production and quality. The agreements ensure products are manufactured to the Company’s specifications and the contract manufacturers will bear the costs of any recalled product due to defective manufacturing.

The Company had the following concentration of purchases with contract manufacturers:

 

 

 

Three Months Ended September 30,

 

Vendor

 

2014

 

 

2013

 

A

 

 

58%

 

 

 

27%

 

B

 

 

36%

 

 

 

72%

 

 

 

 

 

Nine Months Ended September 30,

 

Vendor

 

2014

 

 

2013

 

A

 

 

51%