MusclePharm Improves Financial Status, Faces New Lawsuits

MusclePharm (OTCBB:MSLP) has achieved several financial goals of its major restructuring program, but it still faces legal issues in various areas of its business, including protein products and manufacturing partnerships.

Under interim CEO/President/Chairman Ryan Drexler, who took over late last year in the wake of MusclePharm Founder Brad Pyatt’s departure, the company has managed to save a huge amount of future cost commitments related to high-end athlete endorsements, as well as business partnerships and selling off subsidiary businesses.

MusclePharm announced May 26 it has managed to reduce future financial commitments by US$45 million, including about $39.5 million from terminated or renegotiated contracts and $6 million from reduced headcount. 

The contractual savings were tied to an agreement a week earlier between the company and ETW Corp., which terminated its prior endorsement contract with and future commitments to pro golfer Tiger Woods. MusclePharm paid $2.5 million to ETW as part of this agreement.

Also in May, MusclePharm terminated an endorsement Licensing and co-branding contract with Arnold Schwarzenegger, Marine MP, LLC, and Fitness Publications, under which MusclePharm developed a supplement product line bearing Schwarzenegger’s name and likeness. The move saved $22.5 million in future expenses.

Further, in April, the MusclePharm sold its BioZone subsidiary to an undisclosed buyer for $8.3 million, with an additional $1.5 million dependent on the performance of BioZone over the next 12 months.  MusclePharm bought BioZone back in 2013 for 1.2 million MSLP shares (worth approximately $11 to 12 million total), due in part to patented technology that improves absorption of topical and other drugs.

Despite the gains, the restructuring program, started in August 2015, is not yet complete. “We still haven’t completely turned the corner, but we are making significant progress in stabilizing the company and positioning for future growth and value creation," Drexler said.

The costs of restructuring hit $.57 million for its first quarter (1Q) ended March 31, 2016, but other operational costs were decreased in the quarter, compared to the same period last year. Reflecting the terminated endorsements, advertising and promotion fell sharply from the comparable prior year amounts, while selling, general and administrative costs were down slightly to about 10 percent of revenues.

On the other hand, salaries and benefits were up significantly (36 percent), due in part to severance expenses for Pyatt, who stepped down in late 2015 under pressure from investors over his performance and allegations from the Securities and Exchange Commission (SEC) for accounting and disclosure violations related to a slew of executive perks under Pyatt’s watch—a settlement was reached in September 2015, resulting in a $.70 million penalty paid by MusclePharm. In its 10-Q filing the company reported Pyatt’s $5.3 million severance contributed to a 1Q net loss of $6.6 million.

At the end of 1Q, MusclePharm had $9.1 million in cash, $2 million more than it had at the end of 2015. However, its working capital deficit widened to $27.4 million, as did its accumulated deficit of $154.1 million.

Cash problems were central to a recent lawsuit filed against MusclePharm by its contract manufacturing partner Capstone Nutrition. The complaint filed on May 16 alleged breach of contract, claiming MusclePharm accepted delivery of $22.5 million worth of products but didn’t pay for them.

“During the course of the parties’ business relationship, MusclePharm has essentially turned Capstone into its bank," the complaint stated. “MusclePharm ordered product and expected Capstone to manufacture and deliver it, while at the same time ignoring its 60-day payment terms for previously ordered product and falling further and further into debt." Capstone further claimed it had to chase MusclePharm for payment, and even spent about a year trying to work it out, but the defendant’s debt spiraled out of control.

The suit also stated the agreement stipulated minimum purchases by MusclePharm, and Capstone spent $10 million building out its facilities to meet MusclePharm’s capacity needs.

“In the third and fourth quarters of 2015 alone, MusclePharm missed its minimum volume requirements by over $12 million," the suit claimed. “These requirements continue over the term of the manufacturing agreement, and total damage to Capstone for its profits on these contractually mandated amounts is in excess of $40 million over that term."

In addition to the $62.5 million from the past and future commitments, Capstone asked for relief to cover the difference in contracted price and liquidated price for orders MusclePharm refused  to take delivery of, as well as attorney fees and court costs.

Another lawsuit was filed against MusclePharm in May by Hi-Tech Pharmaceuticals, which alleged Pyatt and company deliberately spiked the protein content of its Arnold Schwarzenegger Series Iron Mass supplement and violated the Lanham Act by using false and misleading descriptions and representations in marketing and advertising the product, which resulted in unfair competition against HI-Tech’s NitroPro supplement.

In its complaint, Hi-Tech alleged the MusclePharm product label claimed 40 g of total protein and misleadingly implied this total amount came from “MUSCLE PLASMA PROTEIN TECHNOLOGY: 40g of a potent blend of hydrolyzed beef protein and lactoferrin protein." These were the only two ingredients called “proteins" on the label, under the proprietary blend heading, the complaint alleged, but the blend also referenced a “Performance Growth & Muscle Volumizer" that listed undisclosed amounts of free form and non-protein amino acids. Hi-Tech claimed these amino acids were falsely and deliberately increased the product’s protein content.

“As a result, nitrogen tests performed on MusclePharm’s … product would misleadingly indicate that the product contains the superior protein content represented when it does not, in fact, contain the amount of whole protein or quality ingredients advertised," the complaint stated.

The complaint further noted lab tests performed on the Musclepharm product found the actual total protein content was 19.4 g/serving.  

This isn’t the first time MusclePharm has been accused of protein spiking. A class action lawsuit was filed in January 2015 alleging a similar spiking of the same Schwarzenegger product. That case was dismissed in February this year, but the plaintiffs have filed an appeal for which briefs are scheduled to begin in mid-June 2016.

There were a number of protein spiking lawsuits filed against various companies in 2015, with at least one settlement finalized, a class action against Iovate Health Sciences USA. The settlement involved about $2.5 million in refunds to purchasers of the involved products (MuscleTech, Six Star, Sam’s Club, Fuel One, and EPIQ), as well as changes to Iovate’s testing, labeling and advertising of its protein products.

One of the key factors central to the protein spiking issue has been FDA’s lack of enforcement and a vague regulations that allows companies to calculate total dietary protein as a factor of nitrogen content. This allows non-protein, nitrogen-containing (NPN) ingredients—creatine, glycine, arginine, etc.—to be included in listed total protein content amounts.

Addressing the regulatory gap, several dietary supplement trade associations issued voluntary guidelines stating NPN ingredients should not be included in total protein content.