RIHT Rightscorp Inc (PK)

Notes to Condensed Consolidated Financial Statements

Three months ended March 31, 2017 and 2016 

(Unaudited)

Note 1 – Nature of the Business and Summary of Significant Accounting Policies

Rightscorp, Inc., a Nevada corporation (the “Company”) was organized under the laws of the State of Nevada on April 9, 2010, and its fiscal year end is December 31. The Company is the parent company of Rightscorp, Inc., a Delaware corporation formed on January 20, 2011 (“Rightscorp Delaware”). On October 25, 2013, the Company acquired Rightscorp Delaware in a transaction treated as a reverse acquisition, and the business of Rightscorp Delaware became the business of the Company.

The Company has developed products and intellectual property rights relating to providing data and analytics regarding copyright infringement on the Internet. The Company is dedicated to the vision that digital creative works should be protected economically so that the next generation of great music, movies, video games and software can be made and their creators can prosper. The Company has a patent-pending, proprietary method for gathering and analyzing infringement data and for solving copyright infringement by collecting payments from illegal downloaders via notifications sent to their ISP’s.

Going Concern

The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. As reflected in the accompanying consolidated financial statements, during the three months ended March 31, 2017, the Company incurred a net loss of $408,488, and at March 31, 2017, the Company had a stockholders’ deficit of $2,161,753. These factors raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date that the financial statements are issued. The Company’s financial statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern.

At March 31, 2017, the Company had cash of $2,256. Effective April 26, 2017, the Company sold 2,500,000 shares of common stock at $0.04 per share price for an aggregate purchase price of $100,000. Management believes that the Company will need at least another $500,000 to $1,000,000 in 2017 to fund operations based on our current operating plans. Management’s plans to continue as a going concern include raising additional capital through borrowings and/or the sale of common stock. No assurance can be given that any future financing will be available or, if available, that they will be on terms that are satisfactory to the Company. Even if the Company is able to obtain additional financing, it may contain undue restrictions on our operations, in the case of debt financing, or cause substantial dilution for our stock holders, in case of an equity financing.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements and related notes have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted pursuant to such rules and regulations. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month period ended March 31, 2017 are not necessarily indicative of the results that may be expected for the year ended December 31, 2017. The condensed consolidated balance sheet at December 31, 2016, has been derived from the audited consolidated financial statements at such date. For further information, refer to the consolidated financial statements and footnotes thereto included in Rightscorp, Inc.’s annual report on Form 10-K for the year ended December 31, 2016, as filed with the SEC on April 14, 2017.

Principles of Consolidation

The financial statements include the accounts of Rightscorp Inc., and its wholly-owned subsidiary Rightscorp Delaware. Intercompany balances and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of the financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of expenses during the reporting period. Significant estimates include accounting for potential liabilities, and the assumptions made in valuing share-based instruments issued for services, derivative liabilities, and the valuation allowance for deferred income taxes. Actual results could differ from those estimates.

Concentrations

For the three months ended March 31, 2017, one customer accounted for approximately 42% of our revenue. No other customers accounted for 10% or more of our revenue during the three months ended March 31, 2017 or 2016.

Stock-Based Compensation

The Company periodically grants stock options and warrants to employees and non-employees in non-capital raising transactions as compensation for services rendered. The Company accounts for stock option and stock warrant grants to employees based on the authoritative guidance provided by the Financial Accounting Standards Board where the value of the award is measured on the date of grant and recognized over the vesting period. The Company accounts for stock option and stock warrant grants to non-employees in accordance with the authoritative guidance of the Financial Accounting Standards Board where the value of the stock compensation is determined based upon the measurement date at either a) the date at which a performance commitment is reached, or b) at the date at which the necessary performance to earn the equity instruments is complete. Non-employee stock-based compensation charges generally are amortized over the vesting period on a straight-line basis. In certain circumstances where there are no future performance requirements by the non-employee, option or warrant grants are immediately vested and the total stock-based compensation charge is recorded in the period of the measurement date.

The fair value of the Company’s common stock option and warrant grants is estimated using a Black-Scholes-Merton option pricing model, which uses certain assumptions related to risk-free interest rates, expected volatility, expected life of the common stock options, and future dividends. Compensation expense is recorded based upon the value derived from the Black-Scholes-Merton option pricing model, and based on actual experience. The assumptions used in the Black-Scholes-Merton option pricing model could materially affect compensation expense recorded in future periods.

Derivative Financial Instruments

The Company evaluates its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in the statements of operations. The Company uses a probability weighted average Black-Scholes-Merton model to value the derivative instruments. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is evaluated at the end of each reporting period. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument could be required within 12 months of the balance sheet date.

Fair Value of Financial Instruments

Under current accounting guidance, fair value is defined as the price at which an asset could be exchanged or a liability transferred in a transaction between knowledgeable, willing parties in the principal or most advantageous market for the asset or liability. Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or parameters are not available, valuation models are applied. A fair value hierarchy prioritizes the inputs used in measuring fair value into three broad levels as follows:

Level 1 – Quoted prices in active markets for identical assets or liabilities.

Level 2 – Inputs, other than the quoted prices in active markets, are observable either directly or indirectly.

Level 3 – Unobservable inputs based on the Company’s assumptions.

The Company is required to use observable market data if such data is available without undue cost and effort. As of March 31, 2017, the amounts reported for cash, accrued liabilities and accrued interest approximated fair value because of their short-term maturities.

At March 31, 2017 and December 31, 2016, derivative liabilities of $175,577 and $280,316, respectively, were valued using Level 2 inputs.

Basic and diluted loss per share

Basic loss per share is computed by dividing net loss applicable to common stockholders by the weighted average number of outstanding common shares during the period. Diluted loss per share is computed by dividing the net loss applicable to common stockholders by the weighted average number of common shares outstanding plus the number of additional common shares that would have been outstanding if all dilutive potential common shares had been issued. Potential common shares are excluded from the computation when their effect is anti-dilutive.

At March 31, 2017 and 2016, the dilutive impact of outstanding stock options for 5,150,000 and 970,000 shares, respectively, and outstanding warrants for 46,718,081 and 53,310,140 shares, respectively, have been excluded because their impact on the loss per share is anti-dilutive.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers. ASU 2014-09 is a comprehensive revenue recognition standard that will supersede nearly all existing revenue recognition guidance under current U.S. GAAP and replace it with a principle based approach for determining revenue recognition. Under ASU 2014-09, revenue is recognized when a customer obtains control of promised goods or services and is recognized in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The FASB has recently issued ASU 2016-08, ASU 2016-10, ASU 2016-11, ASU 2016-12, ASU 2016-20, and ASU 2017-05, all of which clarify certain implementation guidance within ASU 2014-09. ASU 2014-09 is effective for interim and annual periods beginning after December 15, 2017. Early adoption is permitted only in annual reporting periods beginning after December 15, 2016, including interim periods therein. The standard can be adopted either retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the cumulative catch-up transition method). The Company is currently in the process of analyzing the information necessary to determine the impact of adopting this new guidance on its financial position, results of operations, and cash flows. The Company will adopt the provisions of this statement in the first quarter of fiscal 2018.

In February 2016, the FASB issued ASU No. 2016-02, Leases. This update will require the recognition of a right-of-use asset and a corresponding lease liability, initially measured at the present value of the lease payments, for all leases with terms longer than 12 months. For operating leases, the asset and liability will be expensed over the lease term on a straight-line basis, with all cash flows included in the operating section of the statement of cash flows. For finance leases, interest on the lease liability will be recognized separately from the amortization of the right-of-use asset in the statement of comprehensive income and the repayment of the principal portion of the lease liability will be classified as a financing activity while the interest component will be included in the operating section of the statement of cash flows. ASU 2016-02 is effective for annual and interim reporting periods beginning after December 15, 2018. Early adoption is permitted. Upon adoption, leases will be recognized and measured at the beginning of the earliest period presented using a modified retrospective approach. The Company is currently evaluating the impact of the adoption of ASU 2016-02 on its financial statements and related disclosures.

Other recent accounting pronouncements issued by the FASB, including its Emerging Issues Task Force, the American Institute of Certified Public Accountants, and the Securities and Exchange Commission did not or are not believed by management to have a material impact on the Company’s present or future consolidated financial statements.

Depreciation and amortization expense for the three months ended March 31, 2017 and March 31, 2016 was $18,184 and $22,816, respectively.

In November 2014, the Company was named as defendant in a class action complaint (see Note 7). In August 2015 the Company reached a preliminary settlement in the matter and at December 31, 2015 and 2016, had accrued a settlement of $200,000 related to this, which was net of expected insurance proceeds of $250,000. In November 2016, the settlement was finalized and on January 7, 2017, BMG Rights Management (US) LLC (“BMG”) advanced the Company $200,000, which was used to pay off the settlement. The advance from BMG is to be applied to future billings from the Company to BMG for consulting services.

Note 4 – Derivative Liabilities

At March 31, 2017 and at December 31, 2016, the Company had warrants exercisable into 9,212,000 shares of common stock. The warrants have a term of five years and an exercise price as adjusted of $0.01 per share. The exercise price is subject to further adjustment if the Company issues securities at a price lower than the exercise price of these warrants (see Note 7).

Pursuant to FASB authoritative guidance on determining whether an instrument (or embedded feature) is indexed to an entity’s own stock, instruments, which do not have fixed settlement provisions, are deemed to be derivative instruments. The exercise price of the warrants did not have fixed settlement provisions because their exercise prices could be lowered if the Company issues securities at lower prices in the future. In accordance with the FASB authoritative guidance, the Company determined that the exercise feature of the warrants was not considered to be indexed to the Company’s own stock, and bifurcated the exercise feature of the warrants and recorded a derivative liability. The derivative liability is re-measured at the end of every reporting period with the change in fair value reported in the statement of operations.

At December 31, 2016, the fair value of the derivative liabilities was $280,316. During the three months ended March 31, 2017, the fair value of the derivative liabilities decreased by $104,739. At March 31, 2017, the fair value of the derivative liabilities was $175,577.

At March 31, 2017 and 2016, the fair value of the derivative liabilities was determined through use of a probability-weighted Black-Scholes-Merton valuation model based on the following assumptions:

The expected volatilities are based on historical volatility of the Company’s stock. The expected life of the warrants was based on the remaining term of the warrants. The risk-free interest rates were based on rates established by the Federal Reserve Bank. The expected dividend yield was based on the fact that the Company has not customarily paid dividends in the past and does not expect to pay dividends in the future.

Note 5 – Common stock

On January 13, 2017, the Company issued 3,000,000 shares of common stock valued at $106,500 to a consultant for services rendered. The shares were valued at the market price of $0.0035 per share on the date the shares were granted. For the three months ended March 31, 2017, the total fair value of $106,500 is included in general and administrative expense.

On February 14, 2017, the Company entered into an employment agreement with Cecil Kyte, the Company’s chief executive officer. As part of the employment agreement, the Company issued 5,000,000 shares of common stock to Kyte valued at $161,500. The shares were valued at the market price of $0.0032 per share on the date the shares were granted. For the three months ended March 31, 2017, the total fair value of $161,500 is included in general and administrative expense.

During the three months ended March 31, 2016, the Company sold an aggregate of 10,000,000 shares of its common stock at $0.05 per share and warrants to purchase 10,000,000 shares of its common stock for total gross proceeds of $500,000.

Note 6 – Stock Options and Warrants

Options

On February 14, 2017, pursuant to the employment agreement with the Company CEO, the Company granted options to purchase 5,000,000 shares of common stock with an exercise price of $0.05 to the Company’s CEO. Options exercisable into 1,000,000 shares of common stock vested immediately and the options exercisable into 4,000,000 shares of common stock will vest over 48 months beginning on February 14, 2018. The fair value of these options was determined to be $160,416 using the Black-Scholes-Merton option-pricing model based on the following assumptions:

The expected volatility is based on historical volatility of the Company’s stock. The expected life of the options was based on the term of the options. The risk-free interest rate was based on rates established by the Federal Reserve Bank. The expected dividend yield was based on the fact that the Company has not customarily paid dividends in the past and does not expect to pay dividends in the future. For the three months ending March 31, 2016, the Company had no stock options requiring an assessment of value.

During the three months ended March 31, 2017 and 2016, the Company recorded compensation costs of $38,203 and $11,942, respectively, relating to the vesting of stock options. As of March 31, 2017, the aggregate value of unvested options was $125,516, which will continue to be amortized as compensation cost as the options vest over terms ranging from one to four years, as applicable.  

The stock option activity for the three months ended March 31, 2017 is as follows: 

At March 31, 2017, the Company’s outstanding and exercisable options had no intrinsic value.

Warrants

On February 14, 2017, pursuant to the employment agreement with the Company CEO, warrants exercisable into 3,000,000 shares of common stock issued to the Company’s CEO in 2015 were deemed fully vested and the exercise price of the warrants was reduced from $0.25 per share to $0.05 per share. The Company determined the expense related to this modification was $13,023 and is included in general and administrative expense.

On January 20, 2017 , the Company issued warrants exercisable into 350,000 shares of common stock for services. The fair value of warrants issued for services was determined to be $9,378. The Company recorded the full $9,378 in general and administrative expense since it determined that the award is a certainty and the service performance and its future benefit are not assured in this arrangement.

For the three months ending March 31, 2017 and 2016, the fair value of warrant awards was estimated using the Black-Scholes-Merton option-pricing model with the following assumptions:

The risk-free interest rate was based on rates established by the Federal Reserve Bank. The expected life of the exercise feature of the warrants was based on the remaining term of the warrants. The expected dividend yield was based on the fact that the Company has not customarily paid dividends in the past and does not expect to pay dividends in the future.

During the three months ended March 31, 2017 and 2016, the Company recorded compensation costs of $10,191 and $26,410, respectively, relating to the vesting of stock warrants. As of March 31, 2017, the aggregate value of unvested warrants was $0.

A summary of the Company’s warrant activity during the three months ended March 31, 2017 is presented below:

At March 31, 2017, the Company’s outstanding warrants had an intrinsic value of $216,521.  

Note 7 – Commitments & Contingencies

In 2015, the Company was named as a defendant in a legal proceeding. The plaintiffs sought relief for alleged violations of the Telephone Consumer Protection Act. In 2015, the parties agreed to mediate the dispute and reached a settlement in principal. A hearing regarding final approval of the settlement was held November 14, 2016 and a settlement was approved in which the Company agreed to pay plaintiffs $450,000. At December 31, 2016 and 2015, the Company had recorded a reserve for an estimated settlement of $200,000 related to this, which was net of insurance proceeds of $250,000, and on January 7, 2017, the accrued settlement of $200,000 was paid.