NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
The accompanying consolidated financial statements as of September 30, 2013 and December 31, 2012 and for the three and nine months ended September 30, 2013 and 2012 reflect the results of operations of Circle Entertainment Inc., a Delaware corporation (hereinafter, “Circle” or the “Company”), and its consolidated subsidiaries, Circle Entertainment SV-I, LLC, Circle Entertainment SV-Management, LLC, Circle Entertainment SV-Orlando, LLC, Circle Entertainment Orlando-Property LLC, FXL, Inc., Circle Heron LLC, FX Luxury, LLC, and Circle I Drive LLC.
The consolidated financial statements for the three months ended September 30, 2013 and 2012 have not been audited, but in the opinion of management, all adjustments (which include normal recurring adjustments) necessary for a fair presentation have been made. The consolidated balance sheet at December 31, 2012 has been derived from the Company’s restated audited consolidated financial statements (other than its consolidated statement of operations) as of that date. These unaudited consolidated financial statements for the three months ended September 30, 2013 and 2012 should be read in conjunction with such restated audited consolidated financial statements and related notes thereto as of and for the year ended December 31, 2012 included in the Company’s Annual Report on Form 10-K/A (Amendment No. 1) for such year as filed with the Securities and Exchange Commission on May 8, 2013 (the “2012 Form 10-K/A”). As described in the 2012 Form 10-K/A, the Company restated its audited consolidated financial statements (other than its consolidated statements of operations) as of December 31, 2012 and for the year then ended to reflect the effects of accounting and reporting errors related to the incorrect classification and recording of the funds the Company received prior to December 31, 2012 under the Funding Agreement (as described in the 2012 Form 10-K/A and Note 2 below). The funds received by the Company prior to December 31, 2012 under the Funding Agreement were reclassified as a net contribution to equity because the Company has no obligation to repay such funds, as opposed to the original classification of debt due to a related party. The error resulted in an understatement of additional paid-in-capital of approximately $4.0 million, an overstatement of shareholders’ deficit of approximately $4.0 million and an overstatement of the liability due to related parties of approximately $4.0 million as of and for the year ended December 31, 2012. In the Company’s restated audited consolidated financial statements (other than its consolidated statement of operations) as of December 31, 2012 and for the year then ended and in these unaudited consolidated financial statements for the three and nine months ended September 30, 2013, the funds received under the Funding Agreement have been classified as equity contributions because of the material mutual ownership relationship of the parties to the Funding Agreement.
The operating results for the three and nine months ended September 30, 2013 and 2012 are not necessarily indicative of the results for the full year.
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2.
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Business of the Company
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The Company has been pursuing the development and commercialization of its location-based entertainment line of business since September 10, 2010, which has and will continue to require significant capital and financing. The Company does not currently generate any revenue from its location-based entertainment line of business and, as described below, its expenses are currently being funded by proceeds from a development loan for the Orlando, Florida project in which the Company has a minority ownership interest. This funding from the development loan may be inadequate to fund the Company’s expenses or cease under certain circumstances, in either case the Company’s ability to continue as a going concern will depend on its ability to complete equity and/or debt financings until such time, if ever, as it commercializes and generates significant revenue from its location-based entertainment line of business.
As has been previously reported, in November 2012, the Company restructured its position in the proposed co-development of an entertainment destination center on International Drive in Orlando, Florida (the “Orlando Project”). As a consequence of the restructuring, the Company now owns an 8.5% membership interest in I Drive Live Parent LLC, the owner of the Orlando Project (the “Project Owner”), pursuant to an operating agreement (the “Operating Agreement”). The Principals (as hereinafter defined), which include certain directors, officers, and greater than 10% stockholders of the Company (the “Company Principals”) and others (with the Company Principals, the “Principals”) own approximately 87.25% of the membership interests in the Project Owner, and a consultant to the Company owns an additional 4.25%. The Principals provided guarantees as a condition of obtaining financing from an institutional investor/lender (the “Financing Source”) that acquired the parcel of land designated for the Orlando Project (the “Square Parcel”) and has leased the Square Parcel to entities owned by the Project Owner. As part of the restructuring, the Company entered into a funding agreement (the “Funding Agreement”), pursuant to which the Company is to receive from the project development loan amounts between $100,000 and $250,000 per month to meet its ongoing overhead expenses as long as the Financing Source continues to fund the project development loan for the Orlando Project. For a more complete description of the restructuring of the Company’s position in the Orlando Project, including changes to the original transaction agreement (the “Transaction Agreement”) pursuant to the related First Amendment and Assignment of Rights Agreement (the “First Amendment”), reference is made to “
Item 1. Business—Overview of the Company and its Current Business”
of the 2012 Form 10-K/A
Pursuant to the Operating Agreement, the affairs of Project Owner will be managed by managers selected by the members other than the Company. The Company will be liable for its pro rata share of required additional capital contribution, but the remedies if it is unable to fund all or any portion of required additional capital contribution would be dilution of its membership interest (dilution of 25% and 50% for the first and second time, respectively, and dilution of 25% for each time thereafter), the Company's right to receive distributions of net cash flow would be subordinated and the Company's voting rights would be relinquished. Voting by members is in accordance with percentage interests, so the Company’s vote of 8.5% will, in all likelihood, not be significant in decision-making authority. The Operating Agreement further provides that the transfer of membership interests may only be made with consent of a super-majority of the non-transferring members. There are tag-along rights in the event a member decides to sell its membership interest. Under the Operating Agreement, distributions of cash or property will be made first, to members for a preferred return of 12% per annum on their capital contributions; second, to unreturned capital contributions; and third, in accordance with percentage interests. Because of the terms of the loans on the Square Parcel, aside from amounts under the Funding Agreement, it is not anticipated that the Company will receive any distributions until the $50,000,000 loan to construct the observation wheel (located on the Square Parcel) is paid off, as the Financing Source has a cash sweep provision and will apply all excess cash to repayment of the loan and interest earned thereon, estimated to be a minimum of more than 5 years from the opening of the Orlando Project. Construction of the Orlando Project is now underway and completion is estimated to occur by the first quarter 2015. There is no assurance that there will ever be distributions to the Company under the Operating Agreement or the amount of any such distributions.
Under the Funding Agreement, certain proceeds shall be disbursed to the Company from project financing, from time to time, only if, as and when disbursed by the lenders. The Funding Agreement includes a separate commitment to fund between $100,000 and $250,000 a month for ongoing overhead expenses of the Company from the monthly draws for construction and improvements to the property so long as such draws continue, which is anticipated to be approximately 18 to 20 months (from December 2012) during the construction period and if insufficient to meet those expenses, then each of Paul C. Kanavos and Mitchell J. Nelson, executive officers of the Company, have agreed to subordinate his salary to the payment of the other overhead expenses, and the consultant of the Company with the ownership interest in the Project Owner has also agreed to subordinate his consulting fees to the payment of the other overhead expenses.. As of September 30, 2013, the Company is in arrears on current year salaries and consulting fees due to its executive officers and consultants. Amounts accrued to Mr. Kanavos are approximately $178,051 as of September 30, 2013. Amounts accrued to Mr. Nelson are approximately $56,250 as of September 30, 2013.. The Company has amounts accrued to Maple Hill Companies LLC, the consultant referenced above, of approximately $225,000 as of September 30, 2013. Such amounts are included in the item “Accounts payable and accrued other” set forth on the Company’s consolidated balance sheets and consolidated statements of cash flows included elsewhere in this report.
As has been previously reported, on August 23, 2012, the Company, pursuant to a termination and settlement agreement, terminated (i) the Exclusive License Agreement with William J. Kitchen and US ThrillRides, LLC, pursuant to which the Company was granted a worldwide exclusive license to use and commercially exploit all of these counterparties’ patents and other intellectual property, trade secrets and know-how pertaining to all aspects of the adaptation of an observation wheel legally known as a SkyView™ including, without limitation, its engineering, design, development, construction, operation and maintenance, and (ii) the related Development Agreement with these counterparties (these agreements are collectively referred to as “SkyView Agreements” ). The Company’s obligations with respect to the SkyView Agreements have been satisfied in full.
The Transaction Agreement remains in effect as to the other property, known as the “OHI Parcel”, consisting of 10 acres in Orlando, Florida. As has been previously reported, on June 11, 2013, the Company and the other parties to the Transaction Agreement entered into the Second Amendment to Transaction Agreement pursuant to which the closing date for acquisition of the OHI Parcel was extended to December 31, 2013 from June 30, 2013. In addition, pursuant to the Second Amendment to Transaction Agreement, the Company’s required capital contribution to purchase the 65% interest in the OHI Parcel has been increased from $1,000,000.00 to $2,000,000.00. As an inducement for Charles Whittall and his affiliated entities (the “Whittal Parties”) to enter into the Second Amendment to Transaction Agreement, certain of the majority owners of the Project Owner, who are also the majority stockholders of the Company, agreed to extend the Whittal Parties a loan of up to $2,000,000.00 to fund tenant improvements on the OHI Parcel.
The Company will require at least $2,000,000 to fund closing the acquisition of the OHI Parcel. The Company does not currently have sufficient cash on hand or any financing commitment to fund the closing of the OHI Parcel. The Company is considering its alternatives for the OHI Parcel.
For a more detailed description of the Transaction Agreement, its First Amendment, the Operating Agreement, the Funding Agreement and the termination of the SkyView Agreements, reference is made to “
Item 1. Business—Overview of the Company and its Current Business”
of the 2012 Form 10-K/A.
The accompanying consolidated financial statements are prepared assuming that the Company will continue as a going concern and contemplates the realization of assets and satisfaction of liabilities in the ordinary course of business.
However, because the Company does not currently generate any revenue from its location-based entertainment line of business, the Company may not be able to continue as a going concern for the next twelve months. The Company’s ability to continue as a going concern for the next twelve months depends upon the Financing Source funding the construction requirements under the facility for the Orlando Project and the Project Owner continuing to provide the Company with funds under the Funding Agreement and/or its ability to complete equity and/or debt financings.
The Company has received an opinion from its auditor expressing substantial doubt as to its ability to continue as a going concern. Investors are encouraged to read the information set forth herein and in the 2012 Form 10-K/A in order to better understand the financial condition of, and risks of investing in, the Company.
Significant Accounting Policies
During the three months ended September 30, 2013, there has been no significant change in the Company’s significant accounting policies and estimates as disclosed in the 2012 Form 10-K/A.
Recent Accounting Pronouncements
There have been no recent accounting pronouncements or changes in accounting pronouncements that impacted the quarterly periods ended September 30, 2013 and 2012, or which are expected to impact future periods, which were not previously disclosed in prior periods.
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Reclassifications
Certain prior period amounts presented have been reclassified to conform to the current year presentation.
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5.
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Earnings (Loss) Per Share
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Earnings/(loss) per share is computed in accordance with Financial Accounting Standards concerning
Earnings Per Share
. Basic earnings/(loss) per share is calculated by dividing net income (loss) applicable to common stockholders by the weighted-average number of shares outstanding during the period. Diluted earnings/(loss) per share includes the determinants of basic earnings (loss) per share and, in addition, gives effect to potentially dilutive common shares. The diluted earnings (loss) per share calculations exclude the impact of all share-based stock plan awards because the effect would be anti-dilutive. For the three months ended September 30, 2013 and 2012, 5,563,350 and 5,563,350 shares, respectively, were excluded from the calculation of diluted earnings per share because their inclusion would have been anti-dilutive. For the nine months ended September 30, 2013 and 2012, 5,563,350 and 5,563,350 shares, respectively, were excluded from the calculation of diluted earnings per share because their inclusion would have been anti-dilutive.
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6.
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Loans Payable to Related Parties
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During 2012, the Company funded its working capital requirements through private debt financings. The debt financings made were unsecured demand loans, bearing interest at the rate of 6% per annum. The total loan proceeds for the year ended December 31, 2012 were $4,033,000.
Because certain of the directors, executive officers and greater than 10% stockholders of the Company made the loans, a majority of the Company’s disinterested directors approved the loans.
There was no compensation expense for stock option grants included in the accompanying consolidated statements of operations in selling, general and administrative expenses for the three and nine months ended September 30, 2013 and 2012, respectively.
In calculating the provision for income taxes on an interim basis, the Company uses an estimate of the annual effective tax rate based upon the facts and circumstances known at the time. The Company’s effective tax rate is based on expected income, statutory rates and permanent differences applicable to the Company in the various jurisdictions in which the Company operates.
For the three and nine months ended September 30, 2013 and 2012, respectively, the Company did not record a provision for income taxes because the Company has incurred taxable losses since its formation in 2007. As it has no history of generating taxable income, the Company reduces any deferred tax assets by a full valuation allowance.
The Company does not have any uncertain tax positions and does not expect any reasonably possible material changes to the estimated amount of liability associated with its uncertain tax positions through September 30, 2013.
There are no income tax audits currently in process with any taxing jurisdictions.
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9.
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Commitments and Contingencies
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Huff Litigation
As has been previously reported, on July 12, 2012, the Company’s then directors Harvey Silverman, Michael J. Meyer, John D. Miller, Robert Sudack, Paul C. Kanavos and Robert F.X. Sillerman, as defendants, Mitchell J. Nelson, an officer of the Company, as a defendant, Brett Torino, a stockholder and former officer of the Company, as a defendant, and certain entities owned and controlled by Messrs. Sillerman, Kanavos and Torino, as defendants, and The Huff Alternative Fund, L.P. and The Huff Alternative Parallel Fund, L.P., then stockholders of the Company, as plaintiffs (collectively, "Huff"), entered into a Stipulation and Settlement Agreement (the "Settlement Agreement") to settle the derivative lawsuit filed on April 28, 2010 by Huff on behalf of the Company in the Supreme Court of the State of New York, County of New York (Index No. 650338/2010E) subject to final approval by such Court. The Court approved entry of the order on December 13, 2012, and there was a 30-day period to appeal after entry of the order, after which (assuming no appeal was taken) the terms will be effective upon the payment of $950,000 to Huff. The appeal period was over on January 14, 2013 and the order was final. Under the Settlement Agreement, January 14, 2013 is deemed to be the “Effective Date” of the Settlement Agreement. The $950,000 was funded timely, $650,000 by the Company and $300,000 by its insurance carrier.
Under the Settlement Agreement, among other things, the Company agreed to elect to its board of directors an additional independent director, who shall also serve as a member of all committees of the board of directors. The Company is required to elect such additional independent director within sixty (60) days after the Effective Date and is not permitted to decrease the number of independent directors for a period of at least three (3) years from the Effective Date. Therefore, the Company’s Board of Directors, upon the recommendation of the Nominating and Corporate Governance Committee, unanimously elected Andrew Perel as a member of the Board of Directors, effective March 1, 2013, to serve until the next annual meeting of stockholders or the earlier of his resignation, removal and death and appointed Mr. Perel to serve as a member of the Board’s Audit Committee, Compensation Committee and Nominating and Corporate Governance Committee. Immediately prior to Mr. Perel’s election to the Board and his appointment to the Audit Committee, the Compensation Committee and the Nominating and Corporate Governance Committee, the Board increased the size of the Board to seven (7) members from six (6) members and increased the size of each of the Audit Committee, the Compensation Committee and the Nominating and Corporate Governance Committee by one member. Mr. Perel is an "independent" director (as defined in the Settlement Agreement and also as defined in the Company’s Charters for the Board of Directors’ Audit Committee, Compensation Committee and Nominating and Corporate Governance Committee, and by applicable rules of The NASDAQ Global Market and the Securities and Exchange Commission relating thereto). Mr. Perel was reelected as a member of the Board of Directors at the Company’s 2013 annual meeting of stockholders held on September 9, 2013.
Preferred Dividends in Arrears
As of September 30, 2013, there were total dividend arrearages on the Company’s outstanding Series A Convertible Preferred Stock and Series B Convertible Preferred Stock of approximately $420,208 and $584,020, respectively. These dividend arrearages constitute $280.14 and $233.61 per share of Series A Convertible Stock and Series B Convertible Preferred Stock, respectively
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10.
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Related Party Transactions
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Shared Services Agreement and Arrangement
Certain employees of Flag Luxury Properties, LLC (“Flag”) (a company owned and controlled by Paul Kanavos, Robert F.X. Sillerman and Brett Torino), from time to time, provide services for the Company. The Company is required to reimburse Flag for these services provided by such employees and other overhead costs in an amount equal to the fair value of the services as agreed between the parties and approved by the Company’s audit committee. For the three months ended September 30, 2013 and 2012, Flag incurred and billed the Company $0.1 million and $0.1 million, respectively and for the nine months ended September 30, 2013 and 2012, Flag incurred and billed the Company $0.4 and $0.4 million, respectively. The services provided for the three months ended September 30, 2013 and 2012 were approved by the Company’s audit committee. The services provided consisted primarily of accounting and legal services provided by Flag on behalf of Circle. Paul Kanavos, the Company’s President, and Mitchell Nelson, the Company’s General Counsel, under their respective employment agreements, as amended, are required to devote working time required to satisfy the provisions of their employment agreements and perform their functions for the Company, provided that they shall each be entitled to devote additional working time to such business or other affairs as each deems appropriate. This arrangement was approved by the Company’s independent directors. To the extent that they use Company employees and/or services for such purposes, they are required to reimburse the Company therefor. Such arrangement is reviewed by the Company’s audit committee quarterly and appropriate adjustments or reimbursements are made under the shared services agreement.
In late 2010, the Company entered into a shared services agreement with BPS Parent, LLC (“BPS”), a company substantially owned and controlled by Paul Kanavos and Brett Torino, pursuant to which the Company reimburses BPS for the services of management and related executive personnel in the field of real estate business development with respect to location-based entertainment businesses, advice in connection with specific development or construction projects, the preparation of financial projections, and construction administration and planning for the Company’s location-based entertainment business, and more particularly, development of the SkyView Technology. Reimbursement is based on the allocation of time spent with respect to Company matters and the allocable overhead pertaining thereto. The Chief Financial Officer reviews and, if appropriate, approves reimbursement, subject to further review and approval by the audit committee. A true-up will be made if there are any adjustments. The term of the shared services agreement runs until December 31, 2011, but may be extended or earlier terminated by either party upon 180 days’ prior written notice (or upon 90 days’ prior written notice if there is a determination in good faith that the provisions of the shared services agreement are not fair and consistent with those reasonably expected to apply in arm’s length agreements between affiliated parties). Payments under the agreement are made on a quarterly basis and are determined taking into account a number of factors, including but not limited to, the overall type and volume of services provided, the individuals involved, the amount of time spent by such individuals and their current compensation rate with the company with which they are employed. Each quarter, representatives determine the net payment due from one party to the other for provided services performed by the parties during the prior calendar quarter, and prepare a report in reasonable detail with respect to the provided services so performed, including the value of such services and the net payment due. For the three and nine months ended September 30, 2013 BPS incurred and billed the Company $0 and $0 million, respectively. For the three and nine months ended September 30, 2012, BPS incurred and billed the Company $0 million and $0.1 million, respectively. The shared services agreement with BPS was terminated on July 31, 2012.
As of February 15, 2011, the Company entered into a shared services agreement with Function (x) Inc., now known as Viggle Inc. (“Viggle”) (a company substantially owned and controlled by Robert F.X. Sillerman), pursuant to which it shares costs for legal and administrative services in support of Mitchell J. Nelson, the Company’s General Counsel and Executive Vice President to Viggle. The shared services agreement provides, in general, for sharing on a 50/50 basis of the applicable support provided by either company to Mr. Nelson in connection with his capacity as General Counsel, and an allocation generally based on the services provided by Mr. Nelson, which were initially estimated to be divided evenly between the companies. However, during the first quarter of 2013, Circle’s share was reduced to 25%. Viggle will initially be responsible for advancing the salary to Mr. Nelson for both companies and will be reimbursed by Circle for such salary and benefits (but not for any bonus, option or restricted share grant made by either company, which will be the responsibility of the company making such bonus, option or restricted share grant). The agreement provides for the president of each company to meet periodically to assess whether the services have been satisfactorily performed and to discuss whether the allocation has been fair. The audit committees of each company’s board of directors will then review and, if appropriate, approve the allocations made and whether payments need to be adjusted or reimbursed, depending on the circumstances. For the three months ended September 30, 2013 and 2012, Viggle incurred and billed the Company $0 and $0, respectively and for the nine months ended September 30, 2013 and 2012, Viggle incurred and billed the Company less than $0.2 million and $0.1 million, respectively.
As of January 4, 2013, the Company entered into a shared services agreement with SFX Holding Corporation, now known as SFX Entertainment Inc. (“SFX”) (a company substantially owned and controlled by Robert F.X. Sillerman), pursuant to which it shares costs for legal and administrative services in support of Mitchell J. Nelson, its Senior Legal Advisor and the Company’s General Counsel. The shared services agreement provides, in general, for sharing generally based on the services provided by Mr. Nelson. Mr. Nelson will continue to be paid by Viggle, and SFX will reimburse the Company or Viggle directly for its portion of such salary and benefits (but not for any bonus, option or restricted share grant made by either company, which will be the responsibility of the company making such bonus, option or restricted share grant). For the three months ended September 30, 2013, SFX’s share was 50%, which was reimbursed directly to Viggle.
Unsecured Demand Loans
During 2012, the Company funded its working capital requirements through private debt financings. The debt financings made were unsecured demand loans, bearing interest at the rate of 6% per annum. The total loan proceeds for the year ended December 31, 2012 were $4,033,000.
Because certain of the directors, executive officers and greater than 10% stockholders of the Company made the loans, a majority of the Company’s disinterested directors approved the loans.
FORWARD LOOKING STATEMENTS
In addition to historical information, this Form 10-Q (this “Quarterly Report”) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are those that predict or describe future events or trends and that do not relate solely to historical matters. You can generally identify forward-looking statements as statements containing the words “believe,” “expect,” “will,” “anticipate,” “intend,” “estimate,” “project,” “assume” or other similar expressions, although not all forward-looking statements contain these identifying words. All statements in this Quarterly Report regarding our future strategy, future operations, projected financial position, estimated future revenue, projected costs, future prospects, and results that might be obtained by pursuing management’s current plans and objectives are forward-looking statements. You should not place undue reliance on our forward-looking statements because the matters they describe are subject to known and unknown risks, uncertainties and other unpredictable factors, many of which are beyond our control. Our forward-looking statements are based on the information currently available to us and speak only as of the date on which this Quarterly Report is filed with the Securities and Exchange Commission (“SEC”). We expressly disclaim any obligation to issue any updates or revisions to our forward-looking statements, even if subsequent events cause our expectations to change regarding the matters discussed in those statements. Over time, our actual results, performance or achievements will likely differ from the anticipated results, performance or achievements that are expressed or implied by our forward-looking statements, and such difference might be significant and materially adverse to our stockholders.