Olivier Colombo - Consultant & Corporate Advisor
My Blog

MusclePharm: Improving but still in a tough position - Seekingalpha article.

MusclePharm: Improving but still in a tough position - Seekingalpha article

  • SummaryTaking steps to improve chances of longevity.
  • Discussion of liquidity ratios.
  • Analysis of Capstone lawsuit.
  • Cash going forward.

MusclePharm (OTCQB:MSLP) has been in dire straits since everything seemed to go wrong in Q4 of 2014 when revenues collapsed and expenses continued to rise. A company that had shown so much promise, had experienced massive growth, and looked to have turned the corner, finally fell back to Earth. Recently, Ryan Drexler has taken over as the interim CEO and president replacing Brad Pyatt, the previous CEO and founder. Pyatt's departure took far too long, but now the steps to avoid a potential bankruptcy have finally started to take place. Yet, even as management looks to do away with mistakes of the past, it still has a long road ahead.

Since my last article, the new management has taken over and started to act on many of the strategies that the previous management had talked about, yet continuously undelivered on. Some of the recent events and the company's current financial situation are examined below.

Settling Long-Term Contracts & Liquidity As noted above, the key to the survival of MusclePharm is controlling its operating expenses. To do that, it has to cut back on advertising and professional endorsements, which the company has started to try and settle. It recently agreed to pay Tiger Woods $2.5 million, ending the contract and saving $4.5 million compared to what was the overall contract value. Including Tiger, the company has reduced about $39.5 million in future commitmentsand an additional $6 million annually from headcount reductions. By ending these, MSLP is able to lower costs in the long run back to a sustainable level, saving cash overall. The downside is, with upfront payments now, the company only becomes more fragile in the short term. A benefit of being in this rough situation now is that parties may come to the table for an agreement to ensure they receive some benefit now rather than a possible bankruptcy and a far more worthless contract in the future.

Looking at its current cash position ($9.1 million in Q1 '16), it is larger than where it has been historically, but that does not mean the company is in a safer position. Taking a look at the liquidity ratios, the picture is not pretty.

Source: Personal

Liabilities are starting to add up and MusclePharm is not making cash. MSLP has trouble generating positive net income, let alone cash flow. These ratios need to turn around in a hurry or the company will go bankrupt. When I started to view its cash conversion cycle though, I was pleasantly surprised how quick it went. As of the end of 2015, its CCC stood at -13.84 days, which means MSLP is very efficient at using its working capital and is not paying for its inventory until after its goods are sold. In this instance, it does scare me a little as the days payable outstanding (DPO) increased from 81.7 to 111.9 year over year as days sales outstanding (DSO) only increased from 31.3 to 42.3. It is great that the company has been given this time to pay its bills, but it also could be a result of its struggle for cash and holding off. As long it has the ability of this extended timeline with no repercussions, this should be viewed as a benefit and as it is not too far out of the norm from where these ratios have been historically.

Capstone Now off that, Capstone Nutrition recently filed a $65 million breach of a contract suit. Capstone Nutrition is a major supplier of MusclePharm's products, and just over 12 months ago, had signed a multi-year (seven) strategic supply agreement. In this agreement, MusclePharm agreed to produce a minimum of $90 million of its powder and capsule businesses with Capstone each year after an initial scale-up period during 2015. Now in that press release of this agreement, Capstone's Chief Innovation Officer Peter Miller said this:

"We expect that the expanded capacity, capabilities and buying power represented by the additional MusclePharm business will have advantages across our entire customer base."

Now, MusclePharm's rapid expansion in sales has halted in the past year as the company's focus has shifted to survival rather than revenue growth. Much of that capacity mentioned above could very well be unneeded with this change in strategy. In the filed breach, Capstone claims it was not paid for $22.5 million in products. Now, MusclePharm's accounts payable has remained pretty consistent around $40 million the past four quarters. There has been no massive jump. There is a $10 million jump from what the average accounts payable was previously beyond four quarters ago, but still no $22.5 million difference. MusclePharm may be taking longer to pay, but looking at the balance sheet, no $22.5 million of a payables increase exists. Now the other accusation is that MusclePharm owes $40 million in a failure to reach its minimum volume requirement. Now, according its 2015 10K, Capstone represented its largest manufacturer.

In particular, one of our third-party suppliers, Capstone, was responsible for 59% of our manufacturing spend in 2015.We have undertaken an evaluation of our agreements with Capstone, and at this time cannot anticipate whether Capstone will continue to be a principal vendor to us.

If this is calculated from the price of the final product, then it produced $98.5 million in business with Capstone in 2015. If it is calculated from the COGS, then the order would be $64.9 million and $25 million less, but not $40 million. The company also noted how it had to evaluate the relationship. This is all a very odd series of events seeing Capstone was its #1 manufacturer on the long-term contract it recently signed. MusclePharm went on to note that there were supply issues during the year which limited its inventory. Its attorney Marc Kasowitz said the claim was without merit and Capstone was the one to breach the agreement by failing on deliveries in an article in the Denver Post. MusclePharm is also seeking damages from Capstone.

Here is the official summary from the 10K:

Third-Party Manufacturer Dispute

The Company is engaged in a dispute with Capstone concerning amounts allegedly owed under the Manufacturing Agreement. Capstone claims that it is owed approximately $22.0 million of outstanding accounts payable. The Company claims that Capstone owes the Company at least $13.5 million in losses caused by, among other things, Capstone's failure to timely manufacture and supply the Company's products. On February 12, 2016, Capstone commenced a mediation with the American Arbitration Association. As of the date of this report, the mediation has not yet been scheduled.

Conclusion 
In conclusion, even though MusclePharm has begun to take the right steps to save the company, there is still a lot of work ahead. The best strategy here is to wait it out as the price has taken such a hit and the stock is so illiquid that a short position is dangerous. The company needs to continue progressing to a point where its financials can project favorably. It is hard to see the company having positive earnings or cash flow this year as its cash flows from operations in 2015 were only positive due to inventory write-downs, corporate restructuring, and stock-based compensation.

Selling off BioZone Labs for $9.5 million while also having the ability to use receivables to finance an additional $10 million after its deal with Prestige Capital does add some much needed financial flexibility. Many will claim that the stock has gone so low and the upside could be massive. It could be, but as buy-and-hold investors have seen, this strategy has only led to compounding losses and dilution. If the stock heads to $0, all money will still be lost. I believe Drexler will do all he can, seeing he took such a large position in the company and sees the potential of the products which drew so many small investors to the stock. The only question is, did he come too late?

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.