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Introduction

After a long hiatus, MusclePharm's (OTCQB:MSLP) CEO, Brad Pyatt, finally communicated with its shareholders. In his letter addressed to shareholders, Mr. Pyatt talked about the company's success in cleaning up the balance sheet by eliminating all derivative liabilities, and the recent financing to create a debt-free capital structure, reported unaudited revenue number for 2012 ($78 million, up 300% from prior year), provided updates on company initiatives to improve sales margin and laid out future plans. It is great to know that MusclePharm management has identified inefficiencies in its cost structure and taken some important measures to improve the bottom line. As suggested by some Seeking Alpha contributors, MusclePharm renegotiated terms with its manufacturers and refined its distribution model, both of which are likely to improve gross margin. Mr. Pyatt also expressed his intention to seek listing on a major stock exchange this summer after 2013 first quarter results are published. All this is very positive for shareholders, but the letter lacks some important details that gave rise to a couple of questions in my mind.

Did MusclePharm make any money in Q4 - 2012?

Although Mr. Pyatt stated that MusclePharm continued to grow at a triple-digit rate in 2012, he stopped short of commenting on the operating performance of the company in 4th quarter, keeping everybody guessing about the financial health of the company. The letter indicated that the company recorded net sales of $27 million in Q4-2012, which is quite significant and equivalent to a yearly revenue of $108 million. Let's assume MusclePharm could not manage to renegotiate terms with its manufacturers until after the end of 2012. In that case, it is likely that its gross margin in Q4 - 2012 remained somewhat close to the average of first three quarters' (of 2012) or approximately 20%.

At 20% gross margin, MusclePharm may have realized a gross profit of $5.4 million. If we deduct $4.8 million in General and Administrative (G & A) expenses ($4.8 million is a generous estimate given the product development costs of the fitmiss line recently launched by the company) for Q4- 2012, which is equal to normalized G & A expenses for prior quarter, we get a net profit of $0.6 million. This number is as good as anybody's. It is a "pure speculation" on my part and used for illustrative purposes only. $0.6 million is paltry compared to the working capital deficit the company has carried over from prior periods. It may be mentioned here that MusclePharm had a working capital deficit of $9. 1 million at the end of Q3 - 2012. This alludes to my next question.

Does MusclePharm have enough money to carry out its business plan?

Given MusclePharm's huge working capital deficit at the end of Q3 - 2012, would the money raised recently ($10.8 million net) be enough for the company to execute its business plan? Let's try to find out the financing requirement for the company. MusclePharm's original S1 filed

on October 26 last year gives us a clue. As per that S1, the company wanted to raise $19.55 million and intended to use the need proceeds as follows:

We currently intend to use the net proceeds that we receive in this offering as follows: (I) $3.6 million for working capital; (ii) $3.4 million for repayment of our outstanding debt balance principal amount of debt held by non-affiliated parties, which will be due upon completion of this offering (as set forth below), (III) to pay interest of approximately $0.1 million, representing interest payable, (iv) $1.4 million for aged accounts payable; (V) $6.0 million for inventory and related items; (vi) $2.0 million for international marketing development; and (VII) and the remainder for general corporate purposes.

This is fairly consistent with the company's funding requirement for working capital given $9.1 million working capital deficit as of September 30, 2012, more efficient handling of its inventory and international business development. It may be mentioned here that international markets accounted for 22% of MusclePharm's total revenue in Q3 -2012 and grew 502% compared to Q3 - 2011. MusclePharm, however, amended the S1 three times and raised $10.8 million net recently. Below is what the company stated how it would use the funds in its Amendment no. 3 to form S1:

We currently intend to use the net proceeds that we receive in this offering in the following order of priority: ($1.0 million for repayment of the bridge loan which was used for working capital (ii) $3.5 million for repayment of our outstanding debt balance principal amount of debt held by non-affiliated parties, which will be due after completing of this offering (as set forth below),

to pay interest of approximately $0.1 million, representing interest payable, (iv) $1.1 million for aged account payable; and the remainder for general corporate purposes.

Conclusion:

424 B 4 filed by the company in connection with the latest financing indicates that MusclePharm, subsequent to filing of the original S1 in late October 2012, may have made some progress in reducing working capital deficit ($2.9 million less in working capital requirement, including aged accounts payables, assuming the $1 million bridge loan was used for working capital purposes), and may not need additional capital for inventory and related items, nor for international business development that could constrain its business growth and profitability. Or, does it indicate the company was unable to raise what it actually requires? If that's the case, how could it affect MusclePharm's sales growth and profitability? What does it mean to company's shareholders? Is further dilution coming down the road? Shareholders may have to wait up to April 15 when MusclePharm is expected to publish its 2012 financial results to find the answer, or the company may clarify it sooner.

Source: Some Thoughts On MusclePharm CEO's Letter To Shareholders