The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our consolidated financial
statements and related notes included elsewhere in this Annual Report on Form
10-K. This discussion contains forward-looking statements that involve risks and
uncertainties. Our actual results could differ materially from those discussed
below. See "Forward Looking Statements" and "Item 1A. Risk Factors." Except as
otherwise indicated herein, the terms "
Overview
Our offerings are clinically developed through a six-stage research process, and all of our manufactured products are rigorously vetted for banned substances by the leading quality assurance program, Informed-Choice. While we initially drove growth in the Specialty retail channel, in recent years we have expanded our focus to drive sales and retailer growth across leading e-commerce, Food Drug & Mass ("FDM"), and Club retail channels, including Amazon, Costco, Kroger, Walgreens, 7-Eleven, and many others. Our primary distribution channels are Specialty, International and FDM.
Our consolidated financial statements are prepared using the accrual method of
accounting in accordance with generally accepted accounting principles in
1)
reduced our workforce; 2) renegotiated or terminated a number of contracts with endorsers in a strategic shift away from such arrangements and toward more cost-effective marketing and advertising efforts; and 3) discontinued a number of stock keeping units ("SKUs") and wrote down inventory to net realizable value, or to zero in cases where the product was discontinued. 17
In addition, during the fourth quarter of 2019, management implemented the following additional measures to improve gross margin:
1)
reduced or eliminate sales to low or negative margin customers; 2) reduced product discounts and promotional activity; 3) implemented a more aggressive SKU reduction; and 4) formed a pricing committee to review all orders to better align gross margin expectations with product availability.
As a result of these measures, as well as a reduction in protein prices, the
Company realized increased gross margins in the fourth quarter of 2019, a trend
which continued through the first and second quarters of 2020. Beginning in
See "Liquidity and Capital Resources" for a further discussion of management's plans.
COVID-19
Our results of operations are affected by economic conditions, including
macroeconomic conditions and levels of business confidence. There continues to
be significant volatility and economic uncertainty in many markets and the
ongoing COVID-19 pandemic has increased that level of volatility and uncertainty
and has created economic disruption. As COVID-19 infections have been reported
throughout
The ultimate impact of the COVID-19 pandemic on the Company's operations is unknown and will depend on future developments, which are highly uncertain and cannot be predicted with confidence, including the duration of the COVID-19 outbreak, new information which may emerge concerning the severity of the COVID-19 pandemic, and any additional preventative and protective actions that governments, or the Company, may direct, which may result in an extended period of continued business disruption, reduced customer traffic and reduced operations. Any resulting financial impact cannot be reasonably estimated at this time but may have a material impact on our business, financial condition and results of operations.
While we expect our revenue for 2020 to be down compared to 2019, there are
multiple factors contributing to this decline. While revenue for
Outlook
As we continue to execute our growth strategy and focus on our core products, we believe that we can, over time, continue to improve our operating margins and expense structure. In addition, we have implemented plans focused on cost containment, customer profitability, product and pricing controls that we believe will improve our gross margin and reduce our losses.
We expect that our advertising and promotion expense will continue to decrease as we focus on reducing our expenses and shifting our promotional costs, in part, from general branding and product awareness to acquiring customers and driving sales from existing customers. We expect that our discounts and allowances will continue to decrease, both overall and as a percentage of revenue, as we further reduce certain discretionary promotional activity that does not result in a commensurate increase in revenues. In addition, we expect our gross margin to increase in future periods due to a decrease in protein prices which began in the fourth quarter of 2019, although protein prices will continue to fluctuate. 18 Results of Operations Comparison of the Year EndedDecember 31, 2019 to the Year EndedDecember 31, 2018 For the Years Ended December 31, ($ in thousands) 2019 2018 $ Change % Change Revenue, net$79,667 $88,113 $(8,446) (10)% Cost of revenue 70,979 69,719 1,260 2 Gross profit 8,688 18,394 (9,706) (53) Operating expenses: Advertising and promotion 2,487 2,939 (452) (15) Salaries and benefits 7,910 8,328 (418) (5) Selling, general and administrative 8,899 11,610 (2,711) (23) Research and development 893 751 142 19 Professional fees 3,606 2,598 1,008 39 Total operating expenses 23,795 26,226 (2,431) (9) Loss from operations (15,107) (7,832) 7,275 93 Other (expense) income:
(Loss) gain on settlement of obligations (125) 1,074 (1,199) (112)
Interest and other expense, net (3,609) (3,897) (288) (7) Loss before provision for income taxes (18,841) (10,655) 8,186 77 Provision for income taxes 86 100 (14) (14) Net loss$(18,927) $(10,755) $8,171 76% 19
The following table presents our operating results as a percentage of revenue, net for the periods presented:
For the Years Ended December 31, 2019 2018 Revenue, net 100% 100% Cost of revenue 89 79 Gross profit 11 21 Operating expenses: Advertising and promotion 3 3 Salaries and benefits 10 9 Selling, general and administrative 11 13 Research and development 1 1 Professional fees 5 3 Total operating expenses 30 29 Loss from operations (19) (8) Other (expense) income:
(Loss) gain on settlement obligations - 1
Interest and other expense, net (5) (4) Loss before provision for income taxes (24) (11) Provision for income taxes - - Net loss (24)% (11)% 20 Revenue, net
We derive our revenue through the sales of our various branded sports nutrition products and nutritional supplements. Revenue is recognized when control of a promised good is transferred to a customer in an amount that reflects the consideration the Company expects to be entitled to in exchange for the good. This usually occurs when finished goods are delivered to the Company's customers or when finished goods are picked up by a customer or a customer's carrier.
Net revenue reflects the transaction prices for contracts, which includes goods shipped at selling list prices reduced by variable consideration. We record sales incentives as a direct reduction of revenue for various discounts provided to our customers, consisting primarily of promotional related credits. We accrue for sales discounts over the period they are earned. Sales discounts are a significant part of our marketing plan to our customers as they help drive increased sales and brand awareness with end users through promotions that we support through our distributors and re-sellers.
MusclePharm brands are marketed across major global retail distribution channels - Specialty, International, and Food, Drug, and Mass ("FDM"). Below is a table of net revenue by our major distribution channel:
For the Years Ended December 31, 2019 % of Total 2018 % of Total Distribution Channel Specialty$35,812 45%$35,690 41% International 22,691 28% 32,143 36% FDM 21,164 27% 20,280 23% Total$79,667 100%$88,113 100%
Net revenue decreased
Discounts and sales allowances decreased to 25% of gross revenue, or
During the year ended
21
Cost of Revenue and Gross Margin
Cost of revenue for
Our gross profit fluctuates due to several factors, including sales incentives, new product introductions and upgrades to existing product lines, changes in customer and product mixes, the mix of product demand, shipment volumes, our product costs, pricing, and inventory write-downs. Cost of revenue will continue to fluctuate, primarily due to changes in protein prices, which prices are impacted, in part, by our ability to negotiate better pricing with our manufacturers. Protein prices increased for most of 2019, only declining at the end of the year.
Costs of revenue increased 2% to
Operating Expenses
Operating expenses for the year ended
Our advertising and promotion expense consists primarily of digital, print and media advertising, athletic endorsements and sponsorships, promotional giveaways, trade show events and various partnering activities with our trading partners. Historically, advertising and promotions were a large part of both our growth strategy and brand awareness, in particular strategic partnerships with sports athletes and fitness enthusiasts through endorsements, licensing, and co-branding agreements. Additionally, we co-developed products with sports athletes and teams. In connection with our restructuring plan, we terminated the majority of these contracts in a strategic shift away from such costly arrangements, and moved toward more cost-effective brand partnerships as well as grass-roots marketing and advertising efforts. We expect our advertising and promotion expenses to remain relatively constant in future periods as we continue to leverage existing brand recognition and move towards lower cost advertising outlets including social media and trade advertising.
Advertising and promotion expense decreased
Salaries and Benefits
Salaries and benefits consist primarily of salaries, bonuses, benefits and stock-based compensation paid or provided to our employees.
Salaries and benefits continued to decrease due to additional headcount reductions and limited headcount additions, as well as a reduction of restricted stock awards and a reduction in amortization of existing stock-based grants through the end of 2019.
Salaries and benefits decreased by
22
Selling, General and Administrative
Our selling, general and administrative expenses consist primarily of depreciation and amortization, information technology equipment and network costs, facilities related expenses, director's fees, which include both cash and stock-based compensation, insurance, rental expenses related to equipment leases, supplies, legal settlement costs, broker fees and other corporate expenses.
Selling, general and administrative expenses decreased by 23% to
Research and Development
Research and development expenses consist primarily of R&D personnel salaries, bonuses, benefits, and stock-based compensation, product quality control, which includes third-party testing, and research fees related to the development of new products. We expense research and development costs as incurred.
Research and development expenses increased 19% to
Professional Fees
Professional fees consist primarily of legal fees, accounting and audit fees, consulting fees, which include both cash and stock-based compensation, and investor relations costs.
Professional fees increased 39% to
To the extent our ongoing legal matters are reduced, in addition to this resulting in a reduction in professional fees, we expect to see a further decline in legal costs for specific settlement activities. We intend to continue to invest in strengthening our governance, internal controls, and process improvements, which is expected to require support from third-party service providers.
Settlement of obligations
For the year ended
Interest and other expense, net
For the years ended
23 For the Year Ended December 31, 2019 2018 Interest expense, related party$(1,597) $(2,160) Interest expense, related party debt discount (60) (60) Interest expense, other (894) (486)
Interest expense, secured borrowing arrangement (1,205) (1,094) Foreign currency transaction loss
(236) (115) Other 383 18 Total interest and other expense, net$(3,609) $(3,897)
"Other" for 2019 includes sublease income and interest income.
Interest and other expense, net for the year ended
Provision for income taxes
Provision for income taxes consists primarily of federal and state income taxes
in the
Liquidity and Capital Resources
The Company has incurred significant losses and experienced negative cash flows
since inception. As of
The ability to continue as a going concern is dependent upon us achieving profitable operations in the future and/or obtaining the necessary financing to meet our obligations and repay our liabilities when they come due. Management is on an ongoing basis evaluating strategies to obtain financing to fund our expenses and achieve a level of revenue adequate to support our current cost structure. Financing strategies may include, but are not limited to, private placements of capital stock, debt borrowings, partnerships and/or collaborations. There is no assurance that we will be able to obtain additional financing on acceptable terms or at all or to generate an adequate level of revenues.
In response to the Company's continued losses, in 2018, management implemented the following plans to improve the Company's operating costs:
1)
reduced our workforce; 2) renegotiated or terminated a number of contracts with endorsers in a strategic shift away from such arrangements and toward more cost-effective marketing and advertising efforts; and 3) discontinued a number of stock keeping units ("SKUs") and wrote down inventory to net realizable value, or to zero in cases where the product was discontinued. 24
Despite these measures, during 2019, the Company continued to incur substantial losses.
In addition, during the fourth quarter of 2019, management implemented the following additional measures to improve gross margin:
1)
reduced or eliminate sales to low or negative margin customers; 2) reduced product discounts and promotional activity; 3) implemented a more aggressive SKU reduction; and 4) formed a pricing committee to review all orders to better align gross margin expectations with product availability.
As a result of these measures, as well as a reduction in protein prices, the
Company realized increased gross margins in the fourth quarter of 2019, a trend
which continued through the first and second quarters of 2020. Beginning in
Management believes reductions in operating costs, and continued focus on gross margin, primarily pricing controls and a reduction in product discounts and promotional activity with the Company's customers, will allow us to ultimately achieve profitability, however, we can give no assurances that this will occur.
Cash Flows
Our net consolidated cash flows are as follows (in thousands):
For the Years Ended December 31, 2019 2018 Consolidated Statements of Cash Flows Data: Net cash (used in) provided by operating activities$(6,524) $1,981 Net cash used in investing activities (13) (132) Net cash provided by (used in) financing activities 5,742 (5,726) Effect of exchange rate changes on cash 10 (34) Net change in cash$(785) $(3,911) Operating Activities
Our cash (used in) provided by operating activities is driven primarily by sales of our products and vendor-provided credit limits. Our primary uses of cash from operating activities have been for inventory purchases, advertising and promotion expenses, personnel-related expenditures, manufacturing costs, professional fees (including legal fees), and costs related to our facilities. Our cash flows from operating activities is expected to continue to be affected principally by results of operations and the extent to which we increase spending on personnel expenditures, sales and marketing activities, and our working capital requirements.
Our operating cash outflows were
25
The source of cash of
Investing Activities
Cash used in investing activities was
Cash used in investing activities was
Financing Activities
Cash provided by financing activities was
Cash used in financing activities was
To manage cash flow, we have entered into numerous financing arrangement outlined below.
Indebtedness Agreements
Related-Party Refinanced Convertible Note
On
The
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
26
On
The outstanding principal and the interest, due on
For the years ended
Related-Party Revolving Note
On
The Revolving Note contains customary events of default, including, among
others, the failure by the Company to make a payment of principal or interest
when due. Following an event of default,
In connection with the Revolving Note, the Company and
Related-Party Note Payable
The Company entered into a collateral receipt and security agreement with
Line of Credit - Inventory Financing
On
Under the Security Agreement, the Company has agreed to grant Crossroads a
security interest in all our present and future accounts, chattel paper, goods
(including inventory and equipment), instruments, investment property,
documents, general intangibles, intangibles, letter of credit rights, commercial
tort claims, deposit accounts, supporting obligations, documents, records and
the proceeds thereof. As of
On
On
27 Secured Borrowing Arrangement
In
In addition, we granted Prestige a continuing security interest in and lien upon
all accounts receivable, inventory, fixed assets, general intangibles and other
assets. Prestige will have no recourse against the Company if payments are not
made due to the insolvency of an account debtor within 90 days of invoice date,
with the exception of international and certain domestic customers. The Purchase
and Sale Agreement's term previously was extended to
On
For the years ended
HSBF Note
On
Off-Balance Sheet Arrangements
We did not have any off-balance sheet arrangements as of
Non-GAAP Adjusted EBITDA
In addition to disclosing financial results calculated in accordance with GAAP, this Form 10-K discloses Adjusted EBITDA, which is net loss adjusted for stock-based compensation, gain on settlement of accounts payable, loss on disposal of property and equipment, amortization of prepaid sponsorship fees, interest and other expense, net, depreciation of property and equipment, amortization of intangible assets, provision for doubtful accounts, settlement related charges (including legal) and taxes.
Management uses Adjusted EBITDA as a supplement to GAAP measures to further evaluate period-to-period operating performance, as well as the Company's ability to meet future working capital requirements. The exclusion of non-cash charges, including stock-based compensation and depreciation and amortization, is useful in measuring the Company's cash available for operations and performance of the Company. Management believes these non-GAAP measures will provide investors with important additional perspectives in evaluating the Company's ongoing business performance.
The GAAP measure most directly comparable to Adjusted EBITDA is net loss. The non-GAAP financial measure of Adjusted EBITDA should not be considered as an alternative to net loss. Adjusted EBITDA is not a presentation made in accordance with GAAP and has important limitations as an analytical tool and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. Because Adjusted EBITDA excludes some, but not all, items that affect net loss and is defined differently by different companies, our definition of Adjusted EBITDA may not be comparable to similarly titled measures of other companies.
Set forth below are reconciliations of our reported GAAP net loss to Adjusted EBITDA (in thousands): 28 Year Year ended ended Dec. 31, Dec. 31, 2019 2018 Net loss$(18,927) $(10,755) Non-GAAP adjustments: Stock-based compensation 284 496 Loss on disposal of property and equipment 5 - Interest and other expense, net 3,609 3,897
Depreciation and amortization of property and equipment 339 529 Amortization of intangible assets
320 320 Bad debt expense 21 1,848 Income taxes 86 100 Adjusted EBITDA$(14,263) $(3,565)
Critical Accounting Policies and Estimates
Our consolidated financial statements have been prepared in accordance with GAAP and form the basis for the following discussion and analysis on critical accounting policies and estimates. The preparation of the consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates and assumptions on a regular basis. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from these estimates and those differences could have a material effect on our business, financial condition and results of operations.
Inventory
29 Revenue Recognition
Our revenue represents sales of finished goods inventory and is recognized when control of the promised goods is transferred to the Company's customers in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. The reserves for trade promotions and product discounts, including sales incentives, are established based on our best estimate of the amounts necessary to settle future and existing credits for product sold as of the balance sheet date.
All such costs are netted against sales. These costs include end-aisle or other in-store displays, contractual advertising fees and product discounts, and other customer specific promotional activity. We provide reimbursement to our customers for such amounts as credits against amounts owed. To determine the appropriate timing of recognition of consideration payable to a customer, all consideration payable to our customers is reflected in the transaction price at inception and reassessed routinely.
For the years ended
Share-Based Payments and Stock-Based Compensation
Share-based compensation awards, including stock options and restricted stock awards, are recorded at estimated fair value on the awards' grant date, based on the estimated number of shares that are expected to vest. The grant date fair value is amortized on a straight-line basis over the time in which the awards are expected to vest, or immediately if no vesting is required. Share-based compensation awards issued to non-employees for services are also recorded at fair value on the grant date. The fair value of restricted stock awards is based on the fair value of the stock underlying the awards on the grant date as there is no exercise price.
The fair value of stock options is estimated using the Black-Scholes option-pricing model. The determination of the fair value of each stock award using this option-pricing model is affected by our assumptions regarding a number of complex and subjective variables. These variables include, but are not limited to, the expected stock price volatility over the term of the awards and the expected term of the awards based on an analysis of the actual and projected employee stock option exercise behaviors and the contractual term of the awards. We recognize stock-based compensation expense over the requisite service period, which is generally consistent with the vesting of the awards, based on the estimated fair value of all stock-based payments issued to employees and directors that are expected to vest.
Intangible Assets
Acquired intangible assets are recorded at estimated fair value, net of accumulated amortization, and costs incurred in obtaining certain trademarks are capitalized, and are amortized over their related useful lives, using a straight-line basis consistent with the underlying expected future cash flows related to the specific intangible asset. Expected future cash flows are subject to management estimation. Costs to renew or extend the life of intangible assets are capitalized and amortized over the remaining useful life of the asset. Amortization expenses are included as a component of "Selling, general and administrative" expenses in the consolidated statements of operations.
Leases
A lease is defined as a contract, or part of a contract, that conveys the right to control the use of identified assets for a period of time in exchange for consideration. An entity controls the use when it has a right to obtain substantially all of the benefits from the use of the identified asset and has the right to direct the use of the asset. The Company determines if an arrangement is a lease at contract inception. For all classes of underlying assets, the Company includes both the lease and non-lease components as a single component and accounts for it as a lease. Lease liabilities are recognized based on the present value of the lease payments over the lease term at the commencement date.
30Advertising and Promotion
Our advertising and promotion expenses consist primarily of digital, print and media advertising, athletic endorsements and sponsorships, promotional giveaways, trade show events and various partnering activities with our trading partners, and are expensed as incurred. For major trade shows, the expenses are recognized within a calendar year over the period in which we recognize revenue associated with sales generated at the trade show. Some of the contracts provide for contingent payments to endorsers or athletes based upon specific achievement in their sports, such as winning a championship. We record expense for these payments if and when the endorser achieves the specific achievement.
Contingencies
The Company records loss contingencies when management determines that the outcome of future events is probable of occurring and when the amount of the loss can be reasonably estimated. Gain contingencies are recognized in the consolidated financial statements when they are realized. The determination of an accrual for a loss contingency is based on management's judgment and estimates with respect to the likely outcome of the matter. Liabilities are recorded or adjusted when events or circumstances cause these judgments or estimates to change.
The Company provides disclosures for material contingencies when there is a reasonable possibility that a loss or an additional loss may be incurred. In assessing whether a loss is a reasonable possibility, the Company may consider the following factors, among others: the nature of the litigation, claim or assessment, available information, opinions or views of legal counsel and other advisors, and the experience gained from similar cases.
See additional information in "Note 9. Commitment and Contingencies."
Recently Issued Accounting Pronouncements
See Note 2 to the to the accompanying Consolidated Financial Statements for a discussion of recent accounting pronouncements or changes in accounting pronouncements that are of significance, or potential significance, to us.
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