SWWI Simon Worldwide Inc (CE)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared by Simon Worldwide, Inc. (the “Company” or “Simon”) pursuant to the rules and regulations of the Securities and Exchange Commission regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes in accordance with accounting principles generally accepted in the United States of America for complete financial statements and should be read in conjunction with the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 (“2013 10-K”). Certain prior period amounts were reclassified to conform to current period presentation.

The Company consolidates all entities that it controls by ownership of a majority voting interest as well any variable interest entities (“VIEs”) for which the Company is the primary beneficiary. The Company eliminates from its financial results all intercompany transactions, including the intercompany transactions with any consolidated VIEs.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments, consisting only of those considered necessary for fair presentation of the Company’s financial position, results of operations, and cash flows at the dates and for the periods presented.

Prior to August 2001, the Company was a multi-national, full service promotional marketing company. In August 2001, McDonald’s Corporation (“McDonald’s”), the Company’s principal customer, terminated its 25-year relationship with the Company as a result of the embezzlement by a former Company employee of winning game pieces from McDonald’s promotional games administered by the Company. Other customers also terminated their relationships with the Company, resulting in the Company no longer having a business. By April 2002, the Company had effectively eliminated a majority of its ongoing promotions business operations and was in the process of disposing of its assets and settling its liabilities related to the promotions business and defending and pursuing litigation with respect thereto. As a result of these efforts, the Company has been able to resolve a significant number of outstanding liabilities that existed in August 2001 or arose subsequent to that date.

The Company is managed by the Chief Executive Officer, Greg Mays, and Chief Financial Officer, Anthony Espiritu, together with an acting general counsel. The Board of Directors has considered various alternative courses of action for the Company, including possibly acquiring or combining with one or more operating businesses. The Board of Directors has reviewed and analyzed a number of proposed transactions. On March 22, 2013, the Company announced in a current report on Form 8-K that it, together with Richard Beckman, Joel Katz and OA3, LLC (“OA3”), had entered into the limited liability company agreement (the “LLC Agreement”) of Three Lions Entertainment, LLC (“Three Lions”) on March 18, 2013.

Pursuant to the LLC Agreement, the Company contributed $3.15 million to Three Lions in exchange for membership units representing 60% of the economic returns of Three Lions, including certain preferences with respect to common holders on operating returns and on a liquidation or sale of Three Lions. In respect of such previously issued membership units, the Company made a second capital contribution to Three Lions in the amount of $1.85 million on April 26, 2013, and a third and final capital contribution to Three Lions in the amount of $3.5 million on October 2, 2013. As a result of these transactions, the Company’s business substantially consists of acting as the majority equityholder of, and holding a membership interest in, Three Lions. The Company cannot predict whether its investment in Three Lions will be successful. The business and operations of Three Lions are managed and directed by a five person Executive Board, three of whom the Company has the power to designate. The Executive Board governs under majority vote, subject to certain major decisions that require the unanimous approval of either the members of Three Lions or its Executive Board (“Special Approval”).

The operating results for the three months ended March 31, 2014, are not necessarily indicative of the results to be expected for the full year.

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2. Variable Interest Entity (“VIE”)

CONSOLIDATION OF VARIABLE INTEREST ENTITIES

Under certain criteria as provided for in Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 810, “Consolidation,” the Company may consolidate a partially-owned affiliate. To determine whether to consolidate a partially-owned affiliate, the Company first determines if the entity is a variable interest entity (VIE). An entity is considered to be a VIE if it has one of the following characteristics: 1) the entity is thinly capitalized; 2) residual equity holders do not control the entity; 3) equity holders are shielded from economic losses or do not participate fully in the entity’s residual economics; or 4) the entity was established with non-substantive voting. If the entity meets one of these characteristics, the Company then determines if it is the primary beneficiary of the VIE. The party with the power to direct activities of the VIE that most significantly impact the VIE’s economic performance and the potential to absorb benefits or losses that could be significant to the VIE is considered the primary beneficiary and consolidates the VIE.

Three Lions meets the definition of a variable interest entity as the total equity investment at risk in Three Lions is not sufficient to permit Three Lions to finance its activities without further subordinated financial support by any parties, including the equity holders. Management determined at the date of the Company’s third contribution that the entity was a variable interest entity primarily based on the current equity investment at risk in Three Lions totaling $9.0 million, which consists of three contributions by the Company of $3.1 million on March 18, 2013, $1.9 million on April 26, 2013, and $3.5 million on October 2, 2013, and founder contributions of $.5 million, compared to capital in excess of that amount deemed necessary to develop and produce content, market and air the first revenue-generating event in 2014. The Company’s contributions total $8.5 million and the founders’ contributions total $.5 million. As the Company did not have sufficient cash on hand to make its third contribution, the Company raised capital through an offering of its common stock to its shareholders.

The Company’s equity interest in Three Lions represents a variable interest in a VIE. Due to certain requirements under the LLC Agreement of Three Lions, the Company, through its voting rights associated with its LLC units, does not have the sole power to direct the activities of Three Lions that most significantly impact Three Lion’s economic performance and the obligation to absorb losses of Three Lions that could potentially be significant to Three Lions or the right to receive benefits from Three Lions that could potentially be significant to Three Lions. Specifically, the Company shares power with the founders who control the common units of Three Lions to approve budgets and business plans and make key business decisions all of which require unanimous consent from all the executive board members. As a result, the Company is not the primary beneficiary of Three Lions and thus does not consolidate it. However, the Company has significant influence over Three Lions and therefore, accounts for its ownership interest in Three Lions under the equity method of accounting.

Through March 31, 2014, the Company’s total contributions of $8.5 million are reduced by Simon’s absorption of its share of Three Lions’ operating losses from the period March 18, 2013, through March 31, 2014, which brings the carrying value of its Three Lions investment to $5.1 million. The Company’s contributions to Three Lions is greater than its share of Three Lions’ net assets. This excess represents equity method goodwill which totaled $3.4 million at March 31, 2014. Also, the Company was required to issue a cash collateralized bank letter of credit on April 12, 2013 in the amount of $.2 million with an expiration date of April 15, 2015, to guarantee payments on an office lease obtained by Three Lions. The Company’s investment, and guarantee, related to Three Lions totaled $8.7 million at March 31, 2014, representing the Company’s maximum exposures to loss.

A summary of the assets and liabilities as of March 31, 2014 and operating results for the three months then ended, related to Three Lions are as follows (in thousands):

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3. Loss Per Share Disclosure

The Company calculates its loss per share in accordance with ASC 260-10, “Earnings Per Share.” There were 74,501,559 and 50,611,879 weighted average shares outstanding on a basic and diluted basis for the three months ended March 31, 2014 and 2013, respectively. In addition, there were 55,000 weighted average shares related to stock options exercisable for the three months ended March 31, 2013 that were not included in the computation of diluted earnings per share because to do so would have been antidilutive as the Company had a net loss for the period. All outstanding stock options of the Company either were exercised or expired during 2013. Accordingly, there were no stock options outstanding during the three months ended March 31, 2014.

4. Income Taxes

The Company had a provision for income taxes for the three months ended March 31, 2014 and 2013 that consisted of the following (in thousands):

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The Company annually evaluates the positive and negative evidence bearing upon the realizability of its deferred tax assets. The Company, however, has considered results of current operations and concluded that it is more likely than not that the deferred tax assets will not be realizable. As a result, the Company has determined that a valuation allowance of $31.6 million and $31.9 million is required at March 31, 2014, and December 31, 2013, respectively. The valuation allowance decreased primarily due to a decrease in deferred tax assets arising from current year’s net operating losses. The tax effects of temporary differences that gave rise to deferred tax assets at March 31, 2014, and December 31, 2013, were as follows (in thousands):

As of March 31, 2014, the Company had federal NOLs of approximately $78.2 million that will expire from 2021 through 2034. The Company had post-apportionment state NOLs of approximately $31.3 million that will expire from 2014 through 2034. The Company also has pre-apportionment NOLs from New York State and New York City totaling $105.0 million at March 31, 2014. Since the Company has no revenue-generating operations in New York State and New York City, management has determined that none of the NOLs should be recognized. If the Company were to commence operations in New York State or New York City in future years, the realizability of the NOLs and related deferred tax assets will be assessed at such time. The NOLs from New York State and New York City carry forward for 20 years and begin to expire in 2021 through 2034.

The federal and state NOLs may be subject to certain limitations under Section 382 of the Internal Revenue Code, which could significantly restrict the Company’s ability to use the NOLs to offset taxable income in subsequent years. The Company completed a review of any potential limitation on the use of its net operating losses under Section 382 on August 9, 2008, and an update to this review on June 7, 2013. Based on such reviews, the Company does not believe Section 382 of the Internal Revenue Code will adversely impact its ability to use its current net operating losses to offset future taxable income, if any, including any income from Three Lions.

The following is a reconciliation of the statutory federal income tax rate to the actual effective income tax rate:

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5. Subsequent Events

Previously, on April 12, 2013, the Company issued a letter of credit in the amount of $.2 million and with an original expiration date of April 15, 2014, to guarantee payments on an office lease obtained by Three Lions and subject to the Company providing to Three Lions a 30-day notice of intent to terminate the letter of credit. The Company allowed the letter of credit to continue beyond the original expiration by it not providing the required 30-day notice of intent to terminate the letter of credit to Three Lions. However, the Company can terminate the letter of credit at any time after the original expiration date of April 15, 2014, provided the Company provides the required 30-day notice of intent to terminate the letter of credit to Three Lions.

On May 13, 2013, the Company announced in a current report on Form 8-K, (the “SunTrust 8-K”), that on May 7, 2014, the Company had entered into an amendment of the LLC Agreement with the other members of Three Lions (the “First Amendment”), which amended the transfer restrictions in the LLC Agreement to permit each member to pledge 100% of its interest in Three Lions as security in order to enable Three Lions to obtain additional line of credit financing from SunTrust Bank (“SunTrust”). The First Amendment also amended the provision of the LLC Agreement pursuant to which OA3, an affiliate of the Company’s controlling shareholder, is obligated to make available to Three Lions, upon the request of its chief executive officer, a revolving loan facility in a principal amount not to exceed $6,000,000 on the terms set forth in the LLC Agreement (the “OA3 Loan Facility”). Under the First Amendment, Three Lions is only permitted to draw on the OA3 Loan Facility for the sole purpose of providing funding necessary for Three Lions to cure any defaults under the SunTrust credit facility, and the OA3 Loan Facility is made subordinate and junior in right of payment of the obligations under the SunTrust facility.

The Company also announced in the SunTrust 8-K that on May 7, 2014, the Company entered into a pledge agreement with SunTrust (the “Pledge Agreement”), wherein the Company pledged all of its equity interests in Three Lions and the proceeds therefrom (the “Pledged Securities”) to SunTrust as security for Three Lions’ obligations under the SunTrust facility, in order to satisfy a condition precedent to SunTrust’s agreement to provide such financing. Unless and until an event of default shall have occurred and be continuing under the SunTrust facility, the Company shall retain all voting rights, and rights to receive any cash dividends or distributions paid while no event of default is continuing, with respect to the Pledged Securities so long as such rights are exercised in a manner not inconsistent with the terms of the Pledge Agreement and the SunTrust facility. The Company’s pledge of the Pledged Securities under the Pledge Agreement shall terminate only upon the payment in full and termination of Three Lions’ obligations under the SunTrust facility. The Pledge Agreement expressly provides that SunTrust shall not have any claim, remedy or right to proceed against the Company for any deficiency in payment or performance of the obligations under the SunTrust facility, from any source other than the Pledged Securities pledged by the Pledge Agreement.

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