ARTCRAFT ENTERTAINMENT, INC. ---------------------------- \*\*TABLE OF CONTENTS\*\* - - - - - - Page
ArtCraft Entertainment, Inc. A Delaware Corporation ---------------------------------------------------------
Financial Statements (Unaudited) December 31, 2016 and 2015 --------------------------------------------------------------------
FINANCIAL STATEMENTS (UNAUDITED) AS OF DECEMBER 31, 2016 and 2015 AND FOR THE YEARS THEN ENDED: Balance Sheets 1-2Statements of Operations 3Statements of Changes in Stockholders’ Equity (Deficiency) 4Statements of Cash Flows 5Notes to Financial Statements 6–14\*\*NOTE 1: NATURE OF OPERATIONS\*\* ArtCraft Entertainment, Inc. (the “Company”), is a corporation organized May 20, 2013 under the laws of Delaware. The Company is a developer and publisher of massive multiplayer online role playing games. As of December 31, 2016, the Company has not yet commenced planned principal operations nor generated significant revenue. The Company’s activities since inception have consisted of formation activities, product development, and efforts to raise additional capital. The Company is dependent upon additional capital resources for the commencement of its planned principal operations and is subject to significant risks and uncertainties; including failing to secure additional funding to operationalize the Company’s planned operations. \*\*NOTE 2: GOING CONCERN\*\* The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company is a business that has not commenced planned principal operations, has not generated sales revenues or profits since inception, and has sustained net losses of $3,519,806 and $3,488,790 for the years ended December 31, 2016 and 2015, respectively. The Company’s ability to continue as a going concern for the next twelve months is dependent upon its ability to generate sufficient cash flows from operations to meet its obligations, which it has not been able to accomplish to date, and/or to obtain additional capital financing. No assurance can be given that the Company will be successful in these efforts. These factors, among others, raise substantial doubt about the ability of the Company to continue as a going concern for a reasonable period of time. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. \*\*NOTE 3: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\*\* Basis of PresentationThe accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America (GAAP). The Company adopted the calendar year as its basis of reporting. Use of EstimatesThe preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash Equivalents and Concentration of Cash BalanceThe Company considers all highly liquid securities with an original maturity of less than three months to be cash equivalents. The Company’s cash and cash equivalents in bank deposit accounts, at times, may exceed federally insured limits. Accounts Receivable and Allowance for Doubtful AccountsAccounts receivable are carried at their estimated collectible amounts and are periodically evaluated for collectability based on past credit history with clients and other factors. Provisions for losses on accounts receivable are determined on the basis of loss experience, known and inherent risk in the account balance and current economic conditions. There are no accounts receivable or associated allowances for doubtful accounts established as of December 31, 2016 or 2015. Capital AssetsProperty and equipment are recorded at cost. Depreciation is recorded for property and equipment using the straight-line method over the estimated useful lives of assets. The Company reviews the recoverability of all long-lived assets, including the related useful lives, whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset might not be recoverable. Capital assets as of December 31, 2016 and 2015 are as follows: Software Development CostsThe Company accounts for software development costs in accordance with FASB 985-20, Costs of Computer Software to be Sold, Leased, or Marketed. Costs incurred during the period of planning and development, and prior to determining technological feasibility, are expensed to operations as research and development in the period incurred. Technological feasibility is generally determined once substantially all product development and testing has been completed, including development of a working model. The Company capitalizes certain costs in the development of its proprietary games for the period after technological feasibility was determined and prior to marketing and initial sales. Costs incurred after determination of readiness for market are expensed to operations in the period incurred. The Company expensed $3,245,305 and $3,047,073 of costs related to the development of its game software during the years ended December 31, 2016 and 2015, respectively, to research and development, as the technological feasibility of the game was not achieved as of December 31, 2016 or 2015. Fair Value of Financial Instruments- - - - - - Financial Accounting Standards Board (“FASB”) guidance specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect market assumptions. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). The three levels of the fair value hierarchy are as follows:
Level 1 - Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 1 primarily consists of financial instruments whose value is based on quoted market prices such as exchange-traded instruments and listed equities. Level 2 - Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly (e.g., quoted prices of similar assets or liabilities in active markets, or quoted prices for identical or similar assets or liabilities in markets that are not active). Level 3 - Unobservable inputs for the asset or liability. Financial instruments are considered Level 3 when their fair values are determined using pricing models, discounted cash flows or similar techniques and at least one significant model assumption or input is unobservable.- - - - - - The carrying amounts reported in the balance sheets approximate their fair value. Revenue RecognitionThe Company recognizes revenue when: (1) persuasive evidence exists of an arrangement with the customer reflecting the terms and conditions under which products or services will be provided; (2) delivery has occurred or services have been provided; (3) the fee is fixed or determinable; and (4) collection is reasonably assured. No revenues have been earned or recognized as of December 31, 2016 or 2015. The Company conducted a Kickstarter campaign to pre-sell the product it is developing, and continued to pre-sell the product on its own website after completion of the Kickstarter campaign. No pre-sale orders have been fulfilled as of December 31, 2016, so all proceeds have been recorded to deferred revenues as of December 31, 2016, in the amount of $4,031,328. These deferred revenues will be recognized upon completion of the revenue recognition process, which includes delivery of the product. Income TaxesThe Company uses the liability method of accounting for income taxes as set forth in FASB ASC 740, Income Taxes. Under the liability method, deferred taxes are determined based on the temporary differences between the financial statement and tax basis of assets and liabilities using tax rates expected to be in effect during the years in which the basis differences reverse. A valuation allowance is recorded when it is unlikely that the deferred tax assets will be realized. The Company assesses its income tax positions and records tax benefits for all years subject to examination based upon its evaluation of the facts, circumstances and information available at the reporting date. In accordance with ASC 740-10, for those tax positions where there is a greater than 50% likelihood that a tax benefit will be sustained, the Company’s policy is to record the largest amount of tax benefit that is more likely than not to be realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. For those income tax positions where there is less than 50% likelihood that a tax benefit will be sustained, no tax benefit will be recognized in the financial statements. The Company has determined that there are no material uncertain tax positions. The Company converted from a subchapter S-Corporation to a C-Corporation for tax purposes effective on May 31, 2014. Accordingly, all earnings and losses prior to the conversion passed through to the ownership and were not taxable to the Company. Therefore, the Company does not receive the net operating loss carryforward credits for losses prior to the conversion date. Measurement of deferred income items is based on enacted tax laws including tax rates, with the measurement of deferred income tax assets being reduced by available tax benefits not expected to be realized in the immediate future. As of December 31, 2016 and 2015, the Company had net operating loss carryforwards of $3,184,204 and $1,564,844, respectively. The Company incurs Federal and Texas income taxes at rates of approximately 34% and 1% of gross margin, respectively, and has used an effective blended rate of 34.7% to derive a net deferred tax asset of $2,500,903 and $1,313,425 as of December 31, 2016 and 2015, respectively, related to tax-effected net operating loss carryforwards, non-qualified stock option expense, book-to-tax accrual differences, deferred revenue recognized as taxable income in 2016 and 2015, and other items. Due to the uncertainty as to the Company’s ability to generate sufficient taxable income in the future and utilize the net operating loss carryforwards before they begin to expire in 2034, the Company has recorded a full valuation allowance to reduce the net deferred tax asset to zero. Under Section 382 and 383 of the Internal Revenue Code of 1986, as amended, or the Code, if a corporation undergoes an "ownership change," the corporation's ability to use its pre-change net operating loss carryforwards and other pre-change attributes to offset its post-change income may be limited. In general, an "ownership change" will occur if there is a cumulative change in our ownership by "5-percent shareholders" that exceeds 50 percentage points over a rolling three-year period. Utilization of the Company’s net operating loss carryforwards may be subject to annual limitations due to ownership changes. Such annual limitations could result in the expiration of our net operating loss carryforwards before they are utilized. The Company reviews tax positions taken to determine if it is more likely than not that the position would be sustained upon examination resulting in an uncertain tax position. The Company recognizes interest accrued and penalties related to unrecognized tax benefits in tax expense. During the years ended December 31, 2016 and 2015, the Company recognized no interest and penalties. The Company files U.S. federal and Texas state income tax returns. All tax periods since inception remain open to examination by the taxing jurisdictions to which the Company is subject. \*\*NOTE 4: STOCKHOLDERS’ EQUITY (DEFICIENCY)\*\* The Company amended and restated its articles of incorporation in November 2016, authorizing 20,000,000 shares of $0.0001 par value common stock and 8,504,354 shares of $0.0001 par value preferred stock, designated as 4,304,354 shares of Series Seed Preferred Stock, 2,000,000 shares of Series Seed-1 Preferred Stock, 586,273 shares designated as Series Seed-2 Preferred Stock, and 1,613,727 shares designated as Series Seed-3 Preferred Stock. Preferred stockholders have liquidation preferences of a multiple of 1.5 of the purchase price (as defined in the articles of incorporation) and various other rights and preferences over common stockholders. Common Stock IssuancesIn May of 2013, the Company issued its founder 7,000,000 shares of common stock at par value of $0.0001 per share, for total proceeds of $700. An additional $1,300 was contributed to the Company by the founder. In March 2014, the Company issued a total of 3,100,000 shares of common stock to eight employees in exchange for services to the Company at a price of $0.0001 per share, providing total proceeds of $310. These issuances were under restricted stock purchase agreements which stipulated repurchase options subject to vesting schedules. One such agreement stipulated vesting of 800,000 shares upon issuance, and an additional 2,000,000 shares which vest monthly at a rate of 80,000 shares per month, commencing in March of 2014. 2,560,000 and 1,600,000 shares have vested under this arrangement as of December 31, 2016 and 2015, respectively. The remaining seven restricted stock purchase agreements stipulated vesting of all issued shares (a total 300,000) upon an initial public offering. Unvested shares under these agreements are subject to a repurchase option upon termination of service with the Company, as defined in the agreement. The repurchase price on the 2,800,000 share agreement stipulated repurchase at par value of $0.0001, while the remaining seven agreements stipulate a repurchase price of the fair value of the Company at the termination date, as determined by the Board of Directors. All shares issued under these arrangements become fully vested immediately prior to a change in control event, as defined in the agreements. In April 2014, two employees exercised restricted stock purchase right grants into 240,000 shares of common stock at an exercise price of $0.0001 per share, providing proceeds of $24. In May through June of 2015, two employees exercised stock options into 83,777 shares of common stock at exercise prices of $0.06-$0.09 per share, resulting in proceeds of $6,826. A stock option was exercised in 2016 for 6,000 shares of common stock, providing proceeds of $360. As of December 31, 2016 and 2015, 10,429,777 and 10,423,777 shares of common stock were issued and outstanding, respectively. As of December 31, 2016 and 2015, 10,429,777 and 9,883,777 shares of common stock were vested and no longer subject to repurchase options, respectively. Series Seed Preferred Stock IssuancesIn 2014, the Company issued 2,445,657 shares of Series Seed Preferred Stock at a price per share of $0.6133, resulting in proceeds of $1,499,922. This issuance triggered the conversion of all outstanding convertible notes payable at the issuance date, resulting in the issuance of an additional 1,858,697 shares of Series Seed Preferred Stock after relieving $855,000 of convertible note payable principal. Series Seed-1 Preferred Stock IssuancesIn 2015, the Company issued 1,266,088 shares of Series Seed-1 Preferred Stock at a price per share of $1.0427, resulting in proceeds of $1,320,150. In 2016, the Company issued an additional 733,912 shares of Series Seed-1 Preferred Stock at a price per share of $1.0427, resulting in proceeds of $765,250. Series Seed-2 Preferred Stock IssuancesIn 2016, the Company issued 586,273 shares of Series Seed-2 Preferred Stock at a price per share of $1.0427, resulting in proceeds of $611,307. Series Seed-3 Preferred Stock IssuancesSubsequently, in 2017, the Company issued 549,626 shares of Series Seed-3 Preferred Stock for gross proceeds of $613,342. Stock PlanIn April 2014, the Company approved its 2014 Stock Incentive Plan (the “Plan”) to provide employees, officers, non-employee directors, contractors, and consultants to the Company with stock based awards. The Company has reserved 2,700,000 shares of common stock for issuance under the Plan. \*\*NOTE 5: SHARE BASED PAYMENTS\*\* The Company has adopted the 2014 Stock Incentive Plan, as amended and restated (the “Plan”), which provides for the grant of shares of stock options, stock appreciation rights, and stock awards (performance shares) to employees, non-employee directors, and non-employee consultants. Under the Plan, the number of shares available to be granted was 2,700,000 and 1,900,000 shares as of December 31, 2016 and 2015, respectively. The options generally have a term of ten years. The amounts granted each calendar year to an employee or non-employee is limited depending on the type of award. Shares available for grant under the Plan amounted to 1,195,023 and 728,000 as of December 31, 2016 and 2015, respectively. Vesting generally occurs over a period of immediately to four years. During 2014, the Company issued 240,000 restricted stock purchase right grants under the Plan, which vested upon issuance and were exercised immediately at the $0.0001 per share exercise price, resulting in the issuance of 240,000 shares of common stock. These issuances are not considered in the following tables, which only contemplate stock option grants. A summary of information related to stock options for the years ended December 31, 2016 and 2015 is as follows: The Company measures employee stock-based awards at grant-date fair value and recognizes employee compensation expense on a straight-line basis over the vesting period of the award. Determining the appropriate fair value of stock-based awards requires the input of subjective assumptions, including the fair value of the Company’s common stock, and for stock options, the expected life of the option, and expected stock price volatility. The Company used the Black-Scholes option pricing model to value its stock option awards. The assumptions used in calculating the fair value of stock-based awards represent management’s best estimates and involve inherent uncertainties and the application of management’s judgment. As a result, if factors change and management uses different assumptions, stock-based compensation expense could be materially different for future awards. The expected life of stock options was estimated using the “simplified method,” which is the midpoint between the vesting start date and the end of the contractual term, as the Company has limited historical information to develop reasonable expectations about future exercise patterns and employment duration for its stock options grants. For stock price volatility, the Company uses comparable public companies as a basis for its expected volatility to calculate the fair value of options grants. The risk-free interest rate is based on U.S. Treasury notes with a term approximating the expected life of the option. The estimation of the number of stock awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from the Company’s current estimates, such amounts are recognized as an adjustment in the period in which estimates are revised. The assumptions utilized for option grants during the years ended December 31, 2016 and 2015 are as follows: Stock-based compensation expense of $32,322 and $11,188 was recognized under FASB ASC 718 for the years ended December 31, 2016 and 2015, respectively. Total unrecognized compensation cost related to non-vested stock option awards amounted to $40,816 and $39,283 as of December 31, 2016 and 2015, respectively. \*\*NOTE 6: RELATED PARTIES\*\* Officers of the Company have advanced funds to the Company. The amounts due to these related parties as of December 31, 2016 and 2015 amounted to $2,285 and $1,547, respectively. \*\*NOTE 7: LICENSING AGREEMENT\*\* In May 2016, the Company entered into a licensing agreement with a European publisher (the “Licensee”), providing the Licensee exclusive rights to market, operate, and commercially exploit the Company’s product in certain languages in certain countries for an initial term of ten years from the commercial launch of the product. Under the agreement terms, the Company is to receive a non-refundable, non-recoupable license fee totaling $2,000,000, along with royalties on the Licensee’s net revenues from the licensed rights. As of December 31, 2016, $1,150,000 of the license fee was been received. As the up-front licensing fee is congruent to the intellectual property rights conveyed in the agreement, following ASC 606-10-55-56, the Company has determined it appropriate to account for the upfront fee portion of the licensing fee as a payment on a single performance obligation over the life of the contract, and therefore has deferred these revenues until performance of the contractual obligations under the terms of the agreement. \*\*NOTE 8: LEASE COMMITMENTS\*\* In October 2015, the Company entered into a sublease agreement for office space commencing in October 2015 and expiring May 2016. Rent obligations under this sublease agreement were $10,302 per month as long as the sublessor continues to vacate a portion of the leased space, then $13,226 per month thereafter. A $13,226 deposit was paid on this lease agreement. The Company and the lessor terminated the lease in February 2016 and the deposit was returned. In December of 2015, the Company entered into a lease agreement for office space to commence March 1, 2016 and continue for a 39 month term ending May 31, 2019. Rent payments escalate annually, ranging from $6,828 to $7,397 per month. A deposit of $11,532 was paid on this lease agreement. Future payment obligations under this lease agreement are as follows: \*\*NOTE 9: RECENT ACCOUNTING PRONOUNCEMENTS\*\* Management does not believe that any recently issued, but not yet effective, accounting standards could have a material effect on the accompanying financial statements. As new accounting pronouncements are issued, we will adopt those that are applicable under the circumstances. \*\*NOTE 10: SUBSEQUENT EVENTS\*\* In 2017, the Company sold 549,626 shares of its Series Seed-3 Preferred Stock for total proceeds of $613,342. During 2017, the Company issued three convertible notes payable for a total of $1,100,000 of principal. The notes bear interest at 2% per annum and mature on December 31, 2017. Maturity is subject to an acceleration clause in the case of a change in control. The convertible notes become convertible into preferred stock upon the next qualified equity offering, as defined in the agreements, of $500,000 or greater, inclusive of the notes. Therefore, any preferred stock issuance after the issuance the convertible notes payable will trigger conversion. The conversion price is the lesser of the pricing in the triggering equity financing or $0.965175 per share. The convertible notes payable are also automatically convertible into the Company’s Series Seed-3 Preferred Stock upon reaching maturity, if not otherwise converted beforehand, at a price per share of $0.965175. The Company has evaluated subsequent events through April 28, 2017, the date the financial statements were available to be issued. Based on the evaluation, no additional material events were identified which require adjustment or disclosure.