Notes
to Condensed Consolidated Financial Statements
Three
and nine months ended September 30, 2016 and 2015
(Unaudited)
Note
1 – Nature of the Business
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.
Note
2 – Summary of Significant Accounting Policies
Basis
of Presentation
The
accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial
statements. 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 nine-month period ended September 30, 2016 are not necessarily
indicative of the results that may be expected for the year ended December 31, 2016. The condensed consolidated balance sheet
at December 31, 2015, has been derived from the audited consolidated financial statements of that date but does not include all
of the information and footnotes required by generally accepted accounting principles for complete financial statements. 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, 2015.
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 nine months ended September 30, 2016, the Company
incurred a net loss of $1,380,698, and used cash in operations of $802,161, and at September 30, 2016, the Company had a stockholders’
deficiency of $2,156,862. These factors raise substantial doubt about the Company’s ability to continue as a going concern.
In addition, the Company’s independent registered public accounting firm, in its report on the Company’s December
31, 2015 financial statements, has expressed substantial doubt about the Company’s ability to continue as a going concern.
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.
On
February 22, 2016, the Company sold to accredited investors an aggregate of 10,000,000 shares of its common stock and warrants
to purchase 10,000,000 shares of common stock for total proceeds of $500,000 (See Note 7). At September 30, 2016, the Company
had cash of $6,653. Management believes that our existing cash on hand and ongoing revenues will be sufficient to fund our operations
through December 2016. 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 it 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.
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, and derivative liabilities. Actual results could differ from those estimates.
Revenue
The
Company provides a service to copyright owners under which copyright owners retain the Company to identify and collect settlement
payments from Internet users who have infringed on their copyrights. Revenue is recognized when the Company collects a settlement
fee which acts as a waiver of the infringement. Generally, the Company has agreed to remit 50% of such collections to the copyright
holder. The Company also provides services to copyright holders. Service fee revenue is recognized when the service has been provided.
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 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 option pricing model,
and based on actual experience. The assumptions used in the Black-Scholes 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 September 30,
2016, the amounts reported for cash, accrued liabilities and accrued interest approximated fair value because of their short-term
maturities.
Derivative
liabilities of $348,005 and $1,210,430 were valued using Level 2 inputs as of September 30, 2016 and December 31, 2015, respectively.
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
September 30, 2016 and 2015, the dilutive impact of outstanding stock options for 906,666 and 579,990 shares, respectively, and
outstanding warrants for 47,048,890 and 34,810,140 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. ASU 2014-09
will require that companies recognize revenue based on the value of transferred goods or services as they occur in the contract.
The ASU also will require additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising
from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to
obtain or fulfill a contract. 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. Entities
will be able to transition to the standard either retrospectively or as a cumulative-effect adjustment as of the date of adoption.
The Company is in the process of evaluating the impact of ASU 2014-09 on the Company’s financial statements and disclosures.
In
February 2016, the FASB issued Accounting Standards Update (ASU) No. 2016-02, Leases. ASU 2016-02 requires a lessee to record
a right of use asset and a corresponding lease liability on the balance sheet for all leases with terms longer than 12 months.
ASU 2016-02 is effective for all interim and annual reporting periods beginning after December 15, 2018. Early adoption is permitted.
A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered
into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients
available. The Company is currently evaluating the expected impact that the standard could have on its financial statements and
related disclosures.
In
August 2014, the FASB issued Accounting Standards Update No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability
to Continue as a Going Concern, which provides guidance on determining when and how to disclose going-concern uncertainties in
the financial statements. ASU 2014-15 requires management to perform interim and annual assessments of an entity’s ability
to continue as a going concern within one year of the date the financial statements are issued. An entity must provide certain
disclosures if conditions or events raise substantial doubt about the entity’s ability to continue as a going concern. ASU
2014-15 is effective for annual periods ending after December 15, 2016, and interim periods thereafter. Early adoption is permitted.
The Company is currently evaluating the expected impact that the standard could have 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.
Note
3 – Fixed Assets
As
of September 30, 2016 and December 31, 2015, fixed assets consisted of the following:
|
|
|
September
30, 2016
|
|
|
December
31, 2015
|
|
|
|
|
(Unaudited)
|
|
|
|
|
|
Computer
equipment and fixtures
|
|
$
|
312,756
|
|
|
$
|
312,756
|
|
|
Accumulated
depreciation
|
|
|
(237,878
|
)
|
|
|
(170,236
|
)
|
|
Fixed
assets, net
|
|
$
|
74,878
|
|
|
$
|
142,520
|
|
Depreciation
and amortization expense for the nine months ended September 30, 2016 and September 30, 2015 was $67,643 and $86,490, respectively.
Note
4 – Accounts Payable and Accrued Liabilities
As
of September 30, 2016 and December 31, 2015, accounts payable and accrued liabilities consisted of the following:
|
|
|
September
30, 2016
|
|
|
December
31, 2015
|
|
|
|
|
(Unaudited)
|
|
|
|
|
|
Accounts
payable
|
|
$
|
886,672
|
|
|
$
|
683,488
|
|
|
Due
to copyright holders
|
|
|
564,089
|
|
|
|
414,688
|
|
|
Accrued
settlement
|
|
|
200,000
|
|
|
|
200,000
|
|
|
Accrued
payroll
|
|
|
225,692
|
|
|
|
62,908
|
|
|
Insurance
premium financing payable
|
|
|
-
|
|
|
|
46,780
|
|
|
Total
|
|
$
|
1,876,453
|
|
|
$
|
1,407,864
|
|
In
November 2014, the Company was named as defendant in a class action complaint (see
John Blaha v. Rightscorp, Inc
in Note
8). In August 2015 the Company reached a preliminary settlement in the matter and at December 31, 2015 and September 30, 2016,
has accrued a settlement of $200,000 related to this, which is net of expected insurance proceeds of $250,000 (see Note 8).
Note
5 - Notes Payable
During
the three months ended September 30, 2016, a third-party shareholder loaned the Company $50,000 for working capital purposes.
The $50,000 is due on demand, unsecured, and interest is at 4% per annum.
The
Company issued warrants to purchase 500,000 shares of common stock in consideration of the loans for $50,000. The warrants have
an exercise price of $0.02 per share and expire in 10 years. The Company determined that the fair value of the warrants was $16,691
and included it as a financing cost in interest expense for the period ended September 30, 2016.
Note
6 – Derivative Liabilities
In
September 2014, the Company issued warrants exercisable into 17,892,000 shares of common stock in relation to the sale of 11,928,000
shares of its common stock. The warrants had a term of five years and an exercise price of $0.25 per share, subject to adjustment,
as defined, if the Company issues securities at a price lower than the exercise price of these warrants in the future (see Note
7). At December 31, 2015, 15,792,000 of these warrants were outstanding. During the nine months ended September 30, 2016, 6,580,000
of these warrants were exercised, and at September 30, 2016, 9,212,000 of these warrants were outstanding.
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 issued in September 2014 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, 2015, the fair value of the derivative liabilities was $1,210,430. During the nine months ended September 30, 2016,
6,580,000 warrants accounted for as derivative liabilities were exercised and as such their corresponding fair value at the exercise
date of $394,620 was extinguished from the derivative liabilities balance. During the nine months ended September 30, 2016, the
fair value of the derivative liabilities decreased by $467,805, and at September 30, 2016, the fair value of the derivative liabilities
was $348,005.
At
September 30, 2016, the fair value of the derivative liabilities was determined through use of a probability-weighted Black-Scholes-Merton
valuation model. At September 30, 2015, the fair value of the derivative liabilities was determined through use of a Black-Scholes-Merton
option pricing model. At September 30, 2016 and December 31, 2015, fair values were based on the following assumptions:
|
|
|
September
30, 2016
|
|
|
December
31, 2015
|
|
|
Expected
volatility
|
|
|
152
|
%
|
|
|
274
|
%
|
|
Risk-free
interest rate
|
|
|
0.9
|
%
|
|
|
1.0
|
%
|
|
Expected
dividend yield
|
|
|
0
|
%
|
|
|
0
|
%
|
|
Expected
life
|
|
|
3.0
years
|
|
|
|
4.5
years
|
|
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.
Note
7 – Common Stock
During
the nine months ended September 30, 2016, the Company sold units to accredited investors for 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. The warrants have a term of three years and an exercise price of $0.10 per share.
During
the nine months ended September 30, 2016, the Company issued 6,580,000 shares of its common stock upon the exercise of 6,580,000
warrants for gross proceeds of $65,800.
Note
8 – Stock Options and Warrants
Options
During
the nine months ended September 30, 2016 and 2015, the Company recorded compensation costs of $35,777 and $25,571 in general and
administrative expense, respectively, relating to the vesting of stock options. As of September 30, 2016, the aggregate value
of unvested options was $53,939, which will continue to be amortized as compensation cost as the options vest over terms ranging
from one to three years, as applicable.
The
stock option activity for the nine months ended September 30, 2016 is as follows:
|
|
|
Number
of Options
|
|
|
Weighted
Average
Exercise Price
|
|
|
Weighted
Average
Remaining Contractual
Term
|
|
|
Balance
outstanding, December 31, 2015
|
|
|
970,000
|
|
|
$
|
0.17
|
|
|
|
6.71
|
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Forfeited/expired
|
|
|
(63,334)
|
|
|
$
|
0.25
|
|
|
|
-
|
|
|
Balance
outstanding, September 30, 2016
|
|
|
906,666
|
|
|
$
|
0.17
|
|
|
|
5.15
|
|
|
Exercisable,
September 30, 2016
|
|
|
113,330
|
|
|
$
|
0.25
|
|
|
|
8.27
|
|
At
September 30, 2016, the Company’s outstanding and exercisable options had no intrinsic value.
Warrants
During
the nine months ended September 30, 2016, the Company sold equity units that included warrants exercisable into 10,000,000 shares
of common stock to accredited investors (see Note 7). In addition, the Company issued warrants to purchase 8,000,000 shares of
common stock with an exercise price of $0.15 per share for services. The fair value of the 8,000,000 warrants issued for services
was determined to be $330,210. The Company recorded $330,210 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. In addition, during
the nine months ended September 30, 2016 and 2015, the Company recorded compensation costs of $120,973 and $138,624 in general
and administrative expense, respectively, relating to the vesting of other stock warrants.
For
the nine months ending September 30, 2016 and 2015, the fair value of warrant awards was estimated using the Black-Scholes-Merton
option-pricing model with the following assumptions:
|
|
|
September
30, 2016
|
|
|
September
30, 2015
|
|
|
Expected
volatility
|
|
|
121
|
%
|
|
|
254
|
%
|
|
Risk-free
interest rate
|
|
|
1.08
|
%
|
|
|
1.5
|
%
|
|
Expected
dividend yield
|
|
|
0
|
%
|
|
|
0
|
%
|
|
Expected
life
|
|
|
3
years
|
|
|
|
5
years
|
|
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.
As
of September 30, 2016, the aggregate value of unvested warrants was $294,458, which will continue to be amortized as compensation
cost as the warrants vest over two years.
A
summary of the Company’s warrant activity during the nine months ended September 30, 2016 is presented below:
|
|
|
Number
of Warrants
|
|
|
Weighted
Average
Exercise Price
|
|
|
Weighted
Average
Remaining Contractual
Term
|
|
|
Balance
outstanding, December 31, 2015
|
|
|
35,310,140
|
|
|
$
|
0.09
|
|
|
|
3.21
|
|
|
Granted
|
|
|
18,500,000
|
|
|
|
0.12
|
|
|
|
2.41
|
|
|
Exercised
|
|
|
(6,580,000
|
)
|
|
|
0.01
|
|
|
|
2,98
|
|
|
Forfeited/expired
|
|
|
(181,250
|
)
|
|
|
0.09
|
|
|
|
-
|
|
|
Balance
outstanding, September 30, 2016
|
|
|
47,048,890
|
|
|
$
|
0.11
|
|
|
|
2.38
|
|
|
Exercisable,
September 30, 2016
|
|
|
46,048,890
|
|
|
$
|
0.11
|
|
|
|
4,73
|
|
At
September 30, 2016, the Company’s outstanding and exercisable warrants had an intrinsic value of $401,106.
Note
9 – Commitments & Contingencies
Legal
proceeding
John
Blaha v. Rightscorp, Inc
, C.D. Cal. (Original Complaint Filed November 21, 2014; First Amended Complaint Filed March 9, 2015).
Nature
of Matter: This matter seeks relief for alleged violations of the Telephone Consumer Protection Act (47 U.S.C. § 227). The
action is brought on behalf of the individual named plaintiff as well as on behalf of a putative nationwide classes.
Progress
of Matter to Date: This matter was previously captioned with Karen J. Reif and Isaac Nesmith as lead plaintiffs. On March 9, 2015,
plaintiff filed a First Amended Complaint replacing the lead plaintiffs, dropping their second and third causes of action for
Violations of the Fair Debt Collection Practices Act (15 U.S.C. § 1692, et seq.) and Violations of the Rosenthal Fair Debt
Collection Practices Act (Cal. Civ. Code § 1788 et seq.) (and dropping associated putative class claims), and naming BMG
Rights Management (US) LLC and Warner Bros. Entertainment Inc. as additional defendants.
The
First Amended Complaint also contained a cause of action for Abuse of Process. In response to the Abuse of Process claim, defendants
brought a special motion to strike the claim under California’s anti-SLAPP statute. Defendants’ anti-SLAPP motion
was granted on May 8, 2015. Pursuant to the Court’s May 8, 2015 Order, the Abuse of Process claim (and associated putative
class claim) was stricken from the case and plaintiff was ordered to pay defendants’ attorney’s fees incurred in bringing
the anti-SLAPP motion.
Following
the dismissal of Plaintiff’s Abuse of Process claim, the parties agreed to mediate the dispute and reached a settlement
in principal. On June 24, 2016, the Court issued an order granting plaintiff’s motion for preliminary approval of class
action settlement. On August 1, 2016, notice was sent to the class. A hearing regarding final approval of the settlement is set
for November 14, 2016. The Company has recorded a reserve for the estimated settlement of $200,000 related to this, which is net
of expected insurance proceeds of $250,000.
WINDSTREAM
SERVICES, LLC Plaintiff V. BMG RIGHTS MANAGEMENT (US) LLC, et al. Defendant, S.D. NY. (Original Complaint Filed June 27, 2016).
Nature
of Matter:
This matter is a Civil action seeking declaratory relief under 17 U.S.C. §§ 101, et seq. and 28 U.S.C.
§§ 2201, et seq. Rightscorp was named as an additional Defendant in this matter. Plaintiff is seeking declaratory relief
that it is not liable for the copyright infringements of its customers.
Progress
of Matter to Date:
Company waived service of process on July 6, 2016. A pre-trial conference has yet to be scheduled. The
Company believes the case is without merit.
