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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED
SEPTEMBER 30, 1997
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ....... TO .......
COMMISSION FILE NUMBER 0-21894
SOURCE MEDIA, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 13-3700438
(STATE OF INCORPORATION) (I.R.S. EMPLOYER
IDENTIFICATION NUMBER)
5400 LBJ FREEWAY, SUITE 680
DALLAS, TEXAS 75240
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(972) 701-5400
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING
THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS
REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS.
YES X NO
--- ---
NUMBER OF SHARES OF COMMON STOCK OUTSTANDING AT NOVEMBER 13, 1997: 11,514,047
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SOURCE MEDIA, INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
Page Number
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PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets (Unaudited)
September 30, 1997 and December 31, 1996 3
Consolidated Statements of Operations (Unaudited)
Three and nine months ended
September 30, 1997 and 1996 5
Consolidated Statements of Cash Flows (Unaudited)
Nine months ended September 30, 1997 and 1996 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 2. Changes in Securities N/A
Item 3. Defaults Upon Senior Securities N/A
Item 4. Submission of Matters to a Vote of Securities Holders N/A
Item 5. Other Information N/A
Item 6. Exhibits and Reports on Form 8-K 20
</TABLE>
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PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
SOURCE MEDIA, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1996 1997
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<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 4,302,943 $ 4,158,379
Restricted investments 611,182 --
Trade accounts receivable, less allowance
for doubtful accounts of $62,504 and $50,682
in 1996 and 1997, respectively 956,078 1,156,771
Deferred expenses 729,819 1,039,464
Prepaid expenses and other current assets 1,167,201 892,563
------------ ------------
Total current assets 7,767,223 7,247,177
Property and equipment:
Production equipment 3,951,502 4,084,751
Computer equipment 1,937,826 2,386,983
Other equipment 2,520,885 3,886,018
Furniture and fixtures 128,235 490,580
------------ ------------
8,538,448 10,848,332
Accumulated depreciation 3,576,999 5,138,338
------------ ------------
Net property and equipment 4,961,449 5,709,994
Intangible assets:
Patents 3,597,989 14,936,508
Goodwill 3,010,137 3,010,137
Contract rights 1,121,000 1,121,000
------------ ------------
7,729,126 19,067,645
Accumulated amortization 5,541,770 8,310,843
------------ ------------
Net intangible assets 2,187,356 10,756,802
Other non-current assets 980,745 974,831
------------ ------------
Total assets $ 15,896,773 $ 24,688,804
============ ============
</TABLE>
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SOURCE MEDIA, INC.
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(UNAUDITED)
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1996 1997
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LIABILITIES AND STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY)
Current liabilities:
Trade accounts payable $ 917,462 $ 813,924
Accrued payroll 420,926 440,760
Other accrued liabilities 1,483,373 1,433,305
Amounts payable related to acquisitions 1,350,000 --
Unearned income 3,976,244 3,586,328
Current portion of capital lease obligations 85,683 28,861
------------ ------------
Total current liabilities 8,233,688 6,303,178
Long-term debt, net of discount 4,612,021 19,470,151
Capital lease obligations, less current portion 22,706 25,913
Minority interests in consolidated subsidiaries 3,665,104 3,839,552
Note receivable and accrued interest from minority
stockholder, net of discount of $137,152 and
$105,866 in 1996 and 1997, respectively (666,931) (709,436)
------------ ------------
2,998,173 3,130,116
Stockholders' equity (capital deficiency):
Common stock, $.001 par value:
Authorized shares - 50,000,000
Issued shares - 10,327,041 and 11,874,578 in 1996
and 1997, respectively 10,327 11,875
Less treasury stock, at cost - 381,351 shares (3,757,641) (3,757,641)
Capital in excess of par value 60,815,785 75,152,939
Accumulated deficit (56,931,832) (75,505,547)
Foreign currency translation 3,737 (40,248)
Notes receivable and accrued interest
from stockholders (110,191) (101,932)
------------ ------------
Total stockholders' equity (capital deficiency) 30,185 (4,240,554)
------------ ------------
Total liabilities and stockholders' equity (capital deficiency) $ 15,896,773 $ 24,688,804
============ ============
</TABLE>
See accompanying notes.
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SOURCE MEDIA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPT. 30, NINE MONTHS ENDED SEPT. 30,
1996 1997 1996 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Monetary revenues $ 1,819,422 $ 2,652,251 $ 6,405,778 $ 7,988,259
Nonmonetary revenues 2,366,560 1,517,204 8,041,541 4,927,961
------------ ------------ ------------ ------------
Total revenues 4,185,982 4,169,455 14,447,319 12,916,220
Monetary cost of sales 854,946 2,043,173 2,707,457 4,944,983
Nonmonetary cost of sales 2,366,560 1,517,204 8,041,541 4,927,961
------------ ------------ ------------ ------------
Total cost of sales 3,221,506 3,560,377 10,748,998 9,872,944
------------ ------------ ------------ ------------
Gross profit 964,476 609,078 3,698,321 3,043,276
Selling, general and administrative expenses 3,111,836 4,728,858 8,081,441 13,803,350
Amortization of intangible assets 257,835 925,461 773,503 2,769,073
Research and development expenses 1,763,316 837,120 4,414,119 2,681,587
------------ ------------ ------------ ------------
5,132,987 6,491,439 13,269,063 19,254,010
------------ ------------ ------------ ------------
Operating loss (4,168,511) (5,882,361) (9,570,742) (16,210,734)
Interest expense 167,907 1,681,272 360,617 2,661,647
Interest income (223,147) (83,329) (661,931) (238,578)
Other income (6,592) (1,475) (32,207) (51,119)
Minority interest in earnings (losses) of consolidated
subsidiaries 40,501 -- (68,823) (8,970)
------------ ------------ ------------ ------------
Net loss $ (4,147,180) $ (7,478,829) $ (9,168,398) $(18,573,714)
============ ============ ============ ============
Net loss per common share $ (0.42) $ (0.65) $ (0.92) $ (1.64)
============ ============ ============ ============
Weighted average common shares outstanding 9,934,238 11,434,443 9,932,528 11,292,655
============ ============ ============ ============
</TABLE>
See accompanying notes.
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SOURCE MEDIA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPT. 30,
1996 1997
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OPERATING ACTIVITIES
Net loss ($ 9,168,398) ($18,573,714)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation 645,323 1,561,339
Amortization of intangible assets 773,502 2,769,073
Non-cash interest expense -- 2,630,392
Provision for losses on accounts receivable 86,983 32,712
Minority interest in net losses (68,823) (8,970)
Write-off of debt issue costs -- 315,068
Warrants issued for services provided -- 279,571
Issuance of common stock in litigation settlement -- 299,063
Other, net (157,152) (34,246)
Changes in operating assets and liabilities:
Trade accounts receivable (59,353) (233,405)
Prepaid expenses and other current assets 146,733 274,638
Deferred expenses 121,226 (309,645)
Trade accounts payable (387,145) (103,538)
Accrued payroll (45,685) 19,834
Other accrued liabilities (70,786) 122,995
Unearned income (217,434) (389,916)
------------ ------------
Net cash used in operating activities (8,401,009) (11,348,749)
INVESTING ACTIVITIES
Capital expenditures (1,449,213) (1,675,544)
Acquisition of equipment and contract rights -- (1,350,000)
------------ ------------
Net cash used in investing activities (1,449,213) (3,025,544)
FINANCING ACTIVITIES
Net proceeds from issuance of long-term debt and warrants 4,606,109 13,922,625
Proceeds from issuance of common stock and exercise
of stock options 79,712 551,308
Payments on capital lease obligations (151,466) (76,773)
Other (30,043) (123,446)
------------ ------------
Net cash provided by financing activities 4,504,312 14,273,714
Effect of exchange rate changes on cash and cash equivalents 26,112 (43,985)
------------ ------------
Net decrease in cash and cash equivalents (5,319,798) (144,564)
Cash and cash equivalents at beginning of period 17,479,223 4,302,943
------------ ------------
Cash and cash equivalents at end of period $ 12,159,425 $ 4,158,379
============ ============
</TABLE>
See accompanying notes.
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SOURCE MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Unless the context otherwise requires,all references to the "Company" or
"Source" include Source Media, Inc. and its wholly-owned subsidiaries, SMI
Holdings, Inc. ("Holdings"), IT Network, Inc., Interactive Channel, Inc. and
Interactive Channel Technologies Inc. ("ICT"), which was formerly known as
Cableshare Inc.
1. Basis of Presentation
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for
interim financial information and the instructions for 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 these financial statements
include all adjustments, consisting of normal recurring accruals, necessary to
present fairly the financial position, results of operations and cash flows of
Source Media, Inc. and its consolidated subsidiaries for the periods indicated.
The balance sheet at December 31, 1996 has been derived from the audited
financial statements at that date. For further information, refer to the
consolidated financial statements and notes thereto included in the Company's
Annual Report on Form 10-K for the year ended December 31, 1996.
2. Net Loss Per Common Share
The computation of net loss per common share in each period is based
on the weighted average number of common shares outstanding for each period.
Convertible securities and stock options are not included in the net loss per
common share calculation for each period because they are anti-dilutive. In
February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS No. 128),
which the Company will be required to adopt in the fourth quarter of 1997. The
Company anticipates that the adoption of SFAS No. 128 will have no impact on
its reporting of net loss per common share for 1997 or prior years.
3. Contingencies
Lerch. On December 15, 1993, Marvin Lerch, the former Chief Executive
Officer and a former shareholder of ICT, and certain of his relatives who are
also former ICT shareholders, commenced a legal proceeding in Ontario, Canada
in the Ontario Court (General Division) against Source and certain executive
officers of Source and a director of ICT on the grounds that the defendants
took actions intended to depress the value of ICT to allow Source to acquire a
portion of ICT at a favorable price. The plaintiffs seek, among other things,
orders that certain actions by ICT's board were invalid; a declaration that
ICT's board was incapable of managing its affairs due to conflicts of interest;
an injunction against Source from voting its ICT shares for three years;
purchase by the defendants of the plaintiffs' ICT shares for Cdn$20 per share
or
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exchange of the plaintiffs' ICT shares for Source Common Shares of equal value;
and damages in the amount of Cdn$8 million to compensate the plaintiffs for the
reduced value of their ICT shares and damages in the amount of Cdn$6 million to
compensate Mr. Lerch for the loss of certain ICT stock options. ICT disputes
all of the claims and no trial date has as yet been set. The plaintiffs have
amended their statement of claim for punitive damages in the amounts of Cdn$1
million against Source and an aggregate of Cdn$2 million against certain
officers of Source. Although the ultimate outcome of this action cannot be
determined at this time, management believes the claims are without merit and
intends to vigorously defend its positions. In addition, management believes
the ultimate outcome of these actions will not have a material impact on the
consolidated financial condition or results of operations of Source.
The Company is party to ordinary routine litigation and other claims
incidental to its business, none of which is expected to have a material
adverse effect on the Company's results of operations or financial condition.
4. Acquisitions
In January 1997, the Company acquired all of the outstanding shares of
ICT held by minority interest shareholders in exchange for approximately
1,390,000 shares of the Company's common stock, making ICT a wholly-owned
subsidiary of the Company. The Company also issued options to purchase 177,000
shares of the Company's common stock at exercise prices ranging from $1.43 to
$4.96 per share to certain employees and directors of ICT in exchange for their
outstanding options to purchase ICT common shares, and incurred cash expenses
related to the acquisition of approximately $795,000. The aggregate purchase
price for the acquisition of the ICT minority interest was approximately $11.3
million, and the acquisition was accounted for by the purchase method of
accounting. The purchase price was allocated to patents, which are being
amortized over a five year period.
The following represents the unaudited pro forma results of operations
as if the above acquisition had occurred as of January 1, 1996, after giving
effect to certain adjustments, including amortization of intangibles resulting
from the allocation of the purchase price. Pro forma results for the nine
months ended September 30, 1997 would not have differed materially from the
actual results.
Nine Months Ended
September 30, 1996
------------------
(In thousands, except
per share amount)
Total revenues $14,447
Gross profit 3,698
Operating loss (11,272)
Net loss (10,938)
Net loss per common share $(0.97)
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The pro forma results given above are not necessarily indicative of
what actually would have occurred if the acquisition had been in effect during
the period presented, and are not intended to be a projection of future results
or trends.
5. Long-Term Debt and Notes Payable
On April 3, 1996, the Company issued a senior note (the "First Tranche
Note") in the principal amount of $5.0 million and a warrant (the "First
Tranche Warrant") which entitled the holder thereof to purchase 500,000 shares
of the Company's common stock at a purchase price of $10.21 per share. On
September 30, 1996 and March 31, 1997, the Company issued additional senior
notes in the amounts of $326,806 and $350,090, respectively, for the payment of
interest on the First Tranche Note. The First Tranche Note and the additional
senior notes (collectively, the "Aggregate First Tranche Notes") were due on
March 31, 2001 and bore interest at the rate of 13% per annum through March 31,
1998 and 12% thereafter. The estimated fair market value of the First Tranche
Warrant of $746,000 was credited to capital in excess of par value and the
First Tranche Note was recorded at a corresponding discount. The discount on
the First Tranche Note was being amortized to interest expense using the
effective interest rate method over the stated term of the First Tranche Note,
resulting in an effective interest rate of 16.2%. As of December 31, 1996, the
carrying value of the Aggregate First Tranche Notes, which had no public
market, approximated their fair market value, which was estimated using a
discounted cash flow analysis.
On April 9, 1997, the Company received cash proceeds of approximately
$13.9 million, net of related fees and expenses, upon the issuance of
additional senior notes (the "Second Tranche Notes") in the principal amount of
$15.0 million and additional warrants (the "Second Tranche Warrants") entitling
the holders thereof to purchase in the aggregate 2,000,000 shares of the
Company's common stock at a purchase price of $6.00 per share at any time until
their expiration on March 31, 2004. Additionally, in connection with the
issuance of the Second Tranche Notes and the Second Tranche Warrants, the
Aggregate First Tranche Notes and the First Tranche Warrant were amended and
restated to terms identical to those of the Second Tranche Notes and the Second
Tranche Warrants, respectively. The amended Aggregate First Tranche Notes and
the Second Tranche Notes (collectively, the "Aggregate Second Tranche Notes")
were due on March 31, 2002 and bore interest at the rate of either: (i) 12% per
annum through March 31, 1999 if paid in cash, or (ii) 13% per annum through
March 31, 1999 if paid through the issuance of additional notes, and 12%
thereafter. At the option of the Company, to the extent interest payments were
made through the issuance of additional senior notes, additional warrants to
purchase .125 of the Company's common stock at a purchase price of $6.00 per
share were required to be issued to the holders of the Aggregate Second Tranche
Notes for each dollar of principal amount of such additional senior notes
issued.
The amendment of the Aggregate First Tranche Notes and First Tranche
Warrant was accounted for as the extinguishment and replacement of the existing
senior notes and the cancellation of the existing warrants and issuance of new
warrants due to the significance of the modification to the terms of the senior
notes and warrant. The extinguishment of the Aggregate First Tranche Notes
resulted in a loss of approximately $315,000, which was included in other
(income) expense during the second quarter of 1997. The estimated fair market
value of the
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amended First Tranche Warrant and the Second Tranche Warrant of approximately
$1.7 million was credited to capital in excess of par value and the Aggregate
Second Tranche Notes were recorded at a corresponding discount. The discount
on the Aggregate Second Tranche Notes was being amortized to interest expense
using the effective interest rate method over the stated term of the Aggregate
Tranche Notes resulting in an effective interest rate of 15.4%.
On September 30, 1997, the Company issued additional senior notes,
with terms identical to those of the Aggregate Second Tranche Notes, in the
amount of approximately $1.3 million and warrants to purchase approximately
165,000 shares of Common Stock. The estimated fair market value of the senior
notes and warrants issued in lieu of a cash interest payment on September 30,
1997 was approximately $2.2 million, which was recorded as interest expense
during the second and third quarters of 1997. The notes were secured by a lien
on all of the Company's assets.
On October 30, 1997, a portion of the proceeds received from the
private placement described in the Subsequent Events footnote below was used to
pay off the Aggregate Second Tranche Notes, including accrued interest thereon,
and the senior notes issued on September 30, 1997 in lieu of a cash interest
payment. The early extinguishment of these notes resulted in a charge to
earnings of approximately $3.5 million related to unamortized discount on the
senior notes and unamortized issuance costs which will be recorded as an
extraordinary item in the fourth quarter of 1997.
6. Subsequent Events
Brite Voice Asset Acquisition. On October 30, 1997, the Company,
through a subsidiary, acquired certain of the electronic publishing assets of
Brite Voice Systems, Inc. ("Brite") pursuant to the terms of a purchase
agreement (the "Brite Acquisition"). These assets consisted primarily of
contract rights and equipment used in Brite's voice information services
business. The purchase price for these assets was approximately $35.6 million
in cash.
VNN Asset Acquisition. On October 30, 1997, the Company, through a
subsidiary, acquired the electronic publishing assets of Voice News Network,
Inc. ("VNN") pursuant to the terms of a purchase agreement (the "VNN
Acquisition"). These assets consisted primarily of contract rights and
equipment used in VNN's voice information services business. The purchase
price for these assets was $9.0 million in cash.
Both of these acquisitions were financed with funds acquired in a
private placement made in accordance with Rule 506 of Regulation D and Rule
144A under the Securities Act of 1933 of $100,000,000 of the Company's 12%
Senior Secured Notes due 2004 and Units representing $20,000,000 of the
Company's 13.5% Senior PIK Preferred Stock and Warrants to purchase 447,000
shares of the Company's common stock at a purchase price of $0.01 per share.
The Company intends to file registration statements with the Securities and
Exchange Commission within 45 days of the closing of the offerings, and, after
those registration statements have been declared effective, will exchange the
privately placed Senior Secured Notes and Senior PIK Preferred Stock for
substantially identical Senior Secured Notes and Senior PIK Preferred Stock.
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The Company also intends to file a registration statement covering the shares
of common stock underlying the Warrants within six months of the closing of the
offerings.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Unless the context otherwise requires,all references to the "Company" or
"Source" include Source Media, Inc. and its wholly-owned subsidiaries, SMI
Holdings, Inc. ("Holdings"), IT Network, Inc.,Interactive Channel, Inc. and
Interactive Channel Technologies Inc. ("ICT"), which was formerly known as
Cableshare Inc.
FORWARD LOOKING INFORMATION AND RISK FACTORS
The Company or its representatives may make forward looking
statements, oral or written, including statements in this report's Management's
Discussion and Analysis of Financial Condition and Results of Operations, press
releases and filings with the Securities and Exchange Commission about
confidence and strategies and plans and expectations about demand, demand and
acceptance of new and existing products, potential acquisitions, potential for
profits and returns on investments in products and markets that are forward
looking statements involving risks and uncertainties that could significantly
impact the Company. Although the Company believes that the expectations
reflected in these forward looking statements are reasonable, there can be no
assurance that the actual results or developments anticipated by the Company
will be realized or, even if substantially realized, that they will have the
expected effects on its business or operations. Among the factors that could
cause actual results to differ materially from the Company's expectations are
its ability to secure distribution for Cable SuperSites; failure to make
available advanced analog or digital set-top boxes incorporating the Company's
technology; general economic and business conditions; industry trends;
competition; equipment costs and availability; terms and deployment of capital;
availability of qualified personnel; changes in, or the failure to comply with,
government regulation; and other factors discussed from time to time in the
Company's Annual Report on Form 10-K and other Securities and Exchange
Commission filings.
GENERAL
Source Media, Inc. is a leader in providing on-demand information,
services and programming through the telephone and cable television, delivered
over the Company's proprietary digital operating systems to mass market
consumers through its two operating subsidiaries, IT Network and Interactive
Channel. IT Network is a leading provider of on-demand information through
advertiser-sponsored telephone hotlines advertised in Yellow Pages and
newspapers. Interactive Channel provides on-demand information and services
and can provide Internet access to the cable television industry over existing
cable infrastructure and telephone lines.
IT Network is the nation's leading provider of voice information
services through telephone directories and newspapers. The Company also
provides related support services to a majority of its Yellow Pages directory
and newspaper publisher partners. The Company sells advertising and provides
related support services to advertising clients who pay to sponsor and deliver
a promotional message before and after the delivery of the voice information
services.
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The Company provides voice information services to eight of the nine largest
Yellow Pages directory publishers in the country.
Interactive Channel's cable television network, Cable SuperSites,
supplies programming and services which allow a subscriber to access on-demand
local and national news, weather, sports and school information; view
programming guides; purchase goods; and can allow a subscriber to browse the
Internet, send and receive e-mail and access a variety of other attractive
offerings over existing cable infrastructure and telephone lines. Cable
SuperSites is broadcast by cable operators utilizing the Company's proprietary
two-way operating system, SourceWare.
The Company has earned monetary revenues through advertising
sponsorships in the Network Guide, an IT Network advertising product, which are
recorded as unearned income when billed and recognized on a straight-line basis
as earned over the terms of the respective contracts (which are typically from
three to twelve months). The Company also has earned monetary revenues from
sales of voice information services, principally its Consumer Tips service, to
certain publisher partners. The Company is beginning to earn a significant
percentage of its monetary revenues by acting as a sales agent for advertising
in directories published by publisher partners and providing voice information
services in those directories.
In most of its major markets, the Company has entered into
nonmonetary barter agreements with local television and radio stations. These
media sponsors provide the Company with advertising time on their stations and
update local news, weather and sports voice information messages in exchange
for promotional messages and print advertisements in the Network Guide.
Revenues and cost of sales associated with these nonmonetary barter
transactions are included in the Company's consolidated statements of
operations at the estimated fair value of the on-air advertisements and
information content provided to the Company by media sponsors. The Company
expects that nonmonetary revenues as a percentage of total revenues will
continue to decline in the future as the Company earns a higher percentage of
its revenues as a service provider or sales agent rather than from sales of
advertising in the Network Guide.
On January 14, 1997, the Company acquired all of the outstanding
shares that it did not already own of ICT in exchange for approximately
1,390,000 shares of the Company's common stock, making ICT a wholly-owned
subsidiary of the Company. ICT owns the patented technology utilized by the
Company for Cable SuperSites and provides research and development services for
the Company. The Company's historical consolidated results of operations and
financial condition include ICT as the Company owned a majority interest in ICT
before the acquisition of the remaining interest.
THREE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
Monetary revenues increased 46 percent to $2.7 million for the quarter
ended September 30, 1997 from $1.8 million for the comparable period in 1996.
The net increase of $833,000 was the result of an increase of $1.0 million
attributable to the Company's voice information services related to new service
contracts acquired from The Reuben H. Donnelly Corporation
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("Donnelly") and GTE Directories Corporation ("GTE") as well as the
introduction of the Company's "LocalSource" product, a comprehensive, local
directory of Internet addresses and voice information services. This increase
was partially offset by declines of $114,000 attributable to the Network Guide
product and $84,000 attributable to ICT.
The decline in Network Guide monetary revenues primarily reflects the
termination of distribution in 20 designated market areas ("DMAs"), 14 of which
are located within the Ameritech region, three within the Southwestern Bell
region and three within the DonTech region. Total Network Guide revenues in
the 20 terminated DMAs were $13,000 for the quarter ended September 30, 1997
compared with $487,000 for the quarter ended September 30, 1996. Network Guide
revenues within the Company's other 30 existing DMAs declined slightly during
the third quarter of 1997 compared with the same period in 1996. These
declines were partially offset by increased revenues totaling $396,000 related
to 17 new DMAs.
The decrease in ICT's revenues in the third quarter of 1997 compared
with the same period in 1996 reflects a portion of the one-time license fee
paid in 1996 to ICT by GTE Corporation and GTE MainStreet for the use of ICT's
United States patents as part of an agreement to end litigation between ICT and
GTE, as well as certain hardware and software sales made in connection with a
trial of ICT technology.
Nonmonetary revenues and nonmonetary cost of sales declined 36 percent
to $1.5 million for the quarter ended September 30, 1997 from $2.4 million for
the quarter ended September 30, 1996. Substantially all of this decrease in
nonmonetary revenues and nonmonetary cost of sales occurred because of the
termination of distribution agreements in certain DMAs and because, in other
DMAs, the Company reduced the amount of space devoted to information provided
by media sponsors for lesser amounts of promotional advertising.
Monetary cost of sales increased 139 percent to $2.0 million, for the
quarter ended September 30, 1997 from $855,000 for the quarter ended September
30, 1996. This increase resulted from (i) operating personnel salaries,
depreciation expenses, and various other operating expenses totaling $626,000
attributable to Interactive Channel operations in Colorado Springs and Denton,
(ii) a $356,000 write-off of electronic components used by the Company for
building set-top boxes (related to progress in integrating SourceWare into
major set-top manufacturers' digital and smart-analog set-top boxes) and (iii)
increased operating personnel salaries and various other operating expenses
totaling $218,000 incurred by IT Network to support new services and
advertising contracts acquired from Donnelly and GTE as well as its new
LocalSource product. In the prior period, costs incurred by Interactive
Channel were research and development in nature, because Cable SuperSites had
not been commercially deployed.
Selling, general and administrative expenses, including amortization
of intangible assets, increased 68 percent to $5.7 million for the quarter
ended September 30, 1997 from $3.4 million for the quarter ended September 30,
1996. This increase resulted from (i) certain programming, personnel salaries,
subscriber acquisition, travel and various other Interactive Channel expenses
totaling $1.7 million, (ii) additional customer service, sales, marketing and
administrative
14
<PAGE> 15
expenses incurred by IT Network to support new services and advertising
contracts acquired from Donnelly and GTE as well as its new LocalSource
product, and (iii) costs associated with, and settlement of, an ongoing legal
dispute in the third quarter of 1997. Amortization of intangible assets
increased by $668,000 during the third quarter of 1997 as a result of the
amortization of patents related to the Company's acquisition of the remaining
shares of ICT during the first quarter of 1997 as well as the amortization of
certain contract rights acquired from Donnelly and GTE. In the prior period,
costs incurred by Interactive Channel were research and development in nature,
because Cable SuperSites had not been commercially deployed.
Research and development expenses declined 53 percent to $837,000 for
the quarter ended September 30, 1997 from $1.8 million for the quarter ended
September 30, 1996. This decrease reflects lower Interactive Channel
development expenses following the commercial introduction of Cable SuperSites.
Other income and expenses. Net interest expense was $1.6 million for
the quarter ended September 30, 1997 compared with net interest income of
$55,000 for the quarter ended September 30, 1996, reflecting the approximate
$1.1 million estimated fair market value of warrants issued by the Company
related to an interest payment in kind on an outstanding senior debt security
as well as interest expense on higher debt balances outstanding during the
third quarter of 1997.
NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
Monetary revenues increased 25 percent to $8.0 million for the nine
months ended September 30, 1997 from $6.4 million for the nine months ended
September 30, 1996. The net increase of $1.6 million was the result of an
increase of $3.1 million attributable to the Company's voice information
services related to new service contracts acquired from Donnelly and GTE as
well as the introduction of the Company's LocalSource product. This increase
was partially offset by declines of (i) $710,000 attributable to the Network
Guide product, (ii) $620,000 attributable to ICT and (iii) $213,000
attributable to the Company's Consumer Tips service.
The decline in Network Guide monetary revenues primarily reflects the
termination of distribution in 20 DMAs, 14 of which are located within the
Ameritech region, three within the Southwestern Bell region and three within
the DonTech region. Total Network Guide revenues in the 20 terminated DMAs
were $275,000 for the nine months ended September 30, 1997 compared with $1.8
million for the nine months ended September 30, 1996. Network Guide revenues
within the Company's other 30 existing DMAs declined slightly during the first
nine months of 1997 compared with the same period in 1996. These declines were
partially offset by increases of $905,000 related to 17 new DMAs.
The decrease in ICT's revenues in the first nine months of 1997
compared with the same period in 1996 reflects a portion of the one-time
license fee paid in 1996 to ICT by GTE Corporation and GTE MainStreet for the
use of ICT's United States patents as part of an
15
<PAGE> 16
agreement to end litigation between ICT and GTE, as well as certain hardware
and software sales made in connection with a trial of ICT technology.
The decline in Consumer Tips revenues is the result of the February
1996 termination of the Company's agreement with Ameritech. Ameritech Consumer
Tips revenues ended completely in the second quarter of 1996.
Nonmonetary revenues and nonmonetary cost of sales declined 39 percent
to $4.9 million for the nine months ended September 30, 1997 from $8.0 million
for the nine months ended September 30, 1996. Substantially all of this $3.1
million decrease in nonmonetary revenues and nonmonetary cost of sales occurred
because of the termination of distribution agreements in certain DMAs and
because, in other DMAs, the Company reduced the amount of space devoted to
information provided by media sponsors for lesser amounts of promotional
advertising.
Monetary cost of sales increased 83 percent to $4.9 million for the
nine months ended September 30, 1997 from $2.7 million for the nine months
ended September 30, 1996. This increase resulted from (i) operating personnel
salaries, depreciation expenses, and various other operating expenses totaling
$1.7 million attributable to Interactive Channel operations in Colorado Springs
and Denton, (ii) a $356,000 write-off of electronic components used by the
Company for building set-top boxes and (iii) increased operating personnel
salaries and various other operating expenses totaling $256,000 incurred by IT
Network to support new services and advertising contracts acquired from
Donnelly and GTE as well as its new LocalSource product. In the prior period,
costs incurred by Interactive Channel were research and development in nature,
because Cable SuperSites had not been commercially deployed.
Selling, general and administrative expenses, including amortization
of intangible assets, increased 87 percent to $16.6 million for the nine months
ended September 30, 1997 from $8.9 million for the nine months ended September
30, 1996. This increase resulted from (i) certain programming, personnel
salaries, subscriber acquisition, travel and various other Interactive Channel
expenses totaling $5.5 million, (ii) increased customer service, sales,
marketing and administrative expenses incurred by IT Network to support new
services and advertising contracts acquired from Donnelly and GTE as well as
its new LocalSource product and (iii) costs associated with, and settlement of,
an ongoing legal dispute in the third quarter of 1997. Amortization of
intangible assets increased by $2.0 million during the nine months ended
September 30, 1997 as a result of the amortization of patents related to the
Company's acquisition of the remaining shares of ICT during the first quarter
of 1997 as well as the amortization of certain contract rights acquired from
Donnelly and GTE. In the prior period, costs incurred by Interactive Channel
were research and development in nature, because Cable SuperSites had not been
commercially deployed.
Research and development expenses declined 39 percent to $2.7 million
for the nine months ended September 30, 1997 from $4.4 million for the nine
months ended September 30, 1996. This decrease reflects lower Interactive
Channel development expenses following the commercial introduction of Cable
SuperSites.
16
<PAGE> 17
Other income and expenses. Net interest expense was $2.4 million for
the nine months ended September 30, 1997 compared with net interest income of
$301,000 for the nine months ended September 30, 1996, reflecting interest
expense on higher debt balances outstanding during the first nine months of
1997 as well as the approximate $1.1 million estimated fair market value of
warrants issued by the Company related to an interest payment in kind on an
outstanding senior debt security compared to net interest income generated from
the proceeds from a public offering of the Company's common stock in December
1995 during the first nine months of 1996.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company has experienced substantial operating
losses and net losses as a result of its efforts to (i) develop, deploy and
support IT Network, (ii) acquire a controlling interest in ICT, and (iii)
develop, conduct trials and commercially launch Cable SuperSites. As of
September 30, 1997, the Company had an accumulated deficit of approximately
$75.5 million and had used cumulative net cash in operations of $48.6 million.
The difference at September 30, 1997 between the accumulated deficit and
cumulative net cash used in operations since inception was attributable
primarily to nonmonetary charges related to financing incentives, write-down of
intangible assets, depreciation and amortization and other non-cash expenses.
The Company expects that these losses will increase in the quarter ended
December 31, 1997 as a result of, among other things, its continuing
expenditures relating to its efforts to commercially introduce, deploy and
enhance Cable SuperSites, non-recurring charges related to the early
extinguishment of its April 1996 senior secured notes (the "Extinguished
Aggregate Second Tranche Notes") and non- recurring charges related to
transition costs associated with the Brite and VNN acquisitions. The Company
may incur operating losses at similar or greater levels in 1998, although it
expects that cash used in operations will decline as a result of the Brite and
VNN acquisitions discussed below.
Since its inception through September 30, 1997, the Company has
financed its operations primarily through an aggregate $65.7 million raised
from various financing activities, including the incurrence of debt and
issuance of the Company's common stock. In April 1997, the Company issued
$15.0 million of the Extinguished Aggregate Second Tranche Notes and amended
$5.8 in outstanding Extinguished Aggregate Second Tranche Notes so that the
terms would be identical to the new Extinguished Aggregate Second Tranche Notes
and also issued warrants to purchase 2,500,000 shares of Common Stock at an
exercise price of $6.00 per share. As of September 30, 1997, the Company had
cash and cash equivalents totaling $4.2 million.
As of September 30, 1997, the Company had commitments to pay
approximately $330,000 to a manufacturer in connection with electronic
components used in the manufacturing of set-top boxes.
Recent Developments
Brite Voice Asset Acquisition. On October 30, 1997, the Company,
through a subsidiary, acquired certain of the electronic publishing assets of
Brite Voice Systems, Inc. ("Brite")
17
<PAGE> 18
pursuant to the terms of a purchase agreement (the "Brite Acquisition"). These
assets consisted primarily of contract rights and equipment used in Brite's
voice information services business. The purchase price for these assets was
approximately $35.6 million in cash.
VNN Asset Acquisition. On October 30, 1997, the Company, through a
subsidiary, acquired the electronic publishing assets of Voice News Network,
Inc. ("VNN") pursuant to the terms of a purchase agreement (the "VNN
Acquisition"). These assets consisted primarily of contract rights and
equipment used in VNN's voice information services business. The purchase
price for these assets was $9.0 million in cash.
Both of these acquisitions were financed with funds acquired in a
private placement made in accordance with upon Rule 506 of Regulation D and
Rule 144A under the Securities Act of 1933 of $100,000,000 of the Company's 12%
Senior Secured Notes due 2004 (the "Senior Notes") and Units representing
$20,000,000 of the Company's 13.5% Senior PIK Preferred Stock (the "Preferred
Stock") and Warrants to purchase 447,000 shares of the Company's common stock
at a purchase price of $0.01 per share (the "Warrants"). The Company intends
to file registration statements with the Securities and Exchange Commission
within 45 days of the closing of the offerings, and, after those registration
statements have been declared effective, will exchange the privately placed
Senior Secured Notes and Senior PIK Preferred Stock for substantially identical
Senior Secured Notes and Senior PIK Preferred Stock. The Company also intends
to file a registration statement covering the shares of common stock underlying
the warrants within six months of the closing of the closing of the offerings.
The Company expects that during 1998, as compared with 1997, (i)
depreciation and amortization will increase by more than $7 million, (ii) net
interest expense will increase by more than $7 million, (iii) preferred stock
dividends (which the Company expects to pay in kind during the first five years
subsequent to the offering of the Senior Notes, the Preferred Stock and the
Warrants) will increase by approximately $3 million and (iv) capital
expenditures will be approximately $8 million, primarily consisting of
purchases of file servers and feature expansion modules in support of
anticipated Cable SuperSites market expansions. The interest escrow account
established by the Company in connection with the offerings will be used to
fund the first four semiannual interest payments related to the Senior Notes.
Accordingly, the Company believes its resources will be sufficient to meet the
Company's anticipated cash needs for working capital and other capital
expenditures related to the further development of Cable SuperSites and IT
Network at least through 1999.
The Company's future capital requirements will depend on many factors,
including, but not limited to, (i) the operating results of IT Network,
including the Company's ability to successfully integrate the businesses
purchased through the Acquisitions into its existing business, (ii) the success
and timing of the development, introduction and deployment of Cable SuperSites,
(iii) the number of file servers and set-top boxes which the Company purchases
in support of Cable SuperSites, (iv) the levels of advertising expenditures
necessary to increase awareness of Cable SuperSites, (v) the extent of market
acceptance of such products, (vi) the funds required by ICT and the Company to
fund their costs of litigation, (vii) potential acquisitions or asset purchases
and (viii) competitive factors.
18
<PAGE> 19
NET OPERATING LOSS CARRYFORWARDS
At December 31, 1996, Holdings had net operating loss carryforwards of
approximately $42.2 million for United States income tax purposes, which begin
to expire in 2003. The Internal Revenue Code of 1986, as amended, imposes
limitations on the use of net operating loss carryforwards if certain stock
ownership changes occur. Consequently, the Company's utilization of pre-1996
net operating losses is limited to approximately $3.5 million in a given year.
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings
Lerch. On December 15, 1993, Marvin Lerch, the former Chief Executive
Officer and a former shareholder of ICT, and certain of his relatives who were
also former ICT shareholders, commenced a legal proceeding in Ontario, Canada
in the Ontario Court (General Division) against Source and certain executive
officers of Source and a director of ICT on the grounds that the defendants
took actions intended to depress the value of ICT to allow Source to acquire a
portion of ICT at a favorable price. The plaintiffs seek, among other things,
orders that certain actions by ICT's board were invalid; a declaration that
ICT's board was incapable of managing its affairs due to conflicts of
interest; an injunction against Source from voting its ICT shares for three
years; purchase by the defendants of the plaintiffs' ICT shares for Cdn$20 per
share or exchange of the plaintiffs' ICT shares for Source Common Shares of
equal value; and damages in the amount of Cdn$8 million to compensate the
plaintiffs for the reduced value of their ICT shares and damages in the amount
of Cdn$6 million to compensate Mr. Lerch for the loss of certain ICT stock
options. ICT disputes all of the claims and no trial date has as yet been set.
The plaintiffs have amended their statement of claim for punitive damages in
the amounts of Cdn$1 million against Source and an aggregate of Cdn$2 million
against certain officers of Source. Although the ultimate outcome of this
action cannot be determined at this time, management believes the claims are
without merit and intends to vigorously defend its position. In addition,
management believes the ultimate outcome of these actions will not have a
material impact on the consolidated financial condition or results of
operations of Source.
On January 25, 1994, Mr. Lerch also commenced a proceeding against ICT
and several persons who are, or have been, officers and directors of ICT
claiming wrongful termination of Mr. Lerch's employment with ICT and seeking
damages in the amount of Cdn$350,000. ICT denied the claim. The trial of
this action began in London, Ontario on April 23, 1996 and was completed May 3,
1996. Judgment was rendered against ICT in the amount of Cdn$200,000. ICT's
appeal of this decision was initially denied and ICT has applied for a review
of this decision before a three judge panel, which granted the Company leave to
appeal the decision. A decision on the Company's appeal is not expected for
approximately two years.
Others. The Company is aware of certain claims against the Company and
ICT that have not developed into litigation, or if they have, are dormant.
Further, the Company and ICT are
19
<PAGE> 20
parties to ordinary routine litigation incidental to their business, none of
which is expected to have a material adverse effect on the Company's results of
operations or financial condition.
Item 2 - Changes in Securities - not applicable
Item 3 - Defaults Upon Senior Securities - not applicable
Item 4 - Submission of Matters to a Vote of Security Holders - not applicable
Item 5 - Other information - not applicable
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits:
2.1 Asset Purchase Agreement dated September 23, 1997 between IT
Network, Inc. and Brite Voice Systems, Inc. (filed as Exhibit
2.1 to the Registrant's Current Report on Form 8-K dated
October 30, 1997 and incorporated herein by reference).
2.2 Amendment dated October 7, 1997 between IT Network, Inc. and
Brite Voice Systems, Inc. to Asset Purchase Agreement dated
September 23, 1997 between IT Network, Inc. and Brite Voice
Systems, Inc. (filed as Exhibit 2.2 to the Registrant's
Current Report on Form 8-K dated October 30, 1997 and
incorporated herein by reference).
2.3 Asset Purchase Agreement dated September 23, 1997 between
Source Media, Inc., and IT Network, Inc. and Voice News
Network, Inc. (filed as Exhibit 2.3 to the Registrant's
Current Report on Form 8-K dated October 30, 1997 and
incorporated herein by reference).bc
27 Financial Data Schedule
(b) Reports on Form 8-K during the three months ended September 30, 1997 -
not applicable
20
<PAGE> 21
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
as amended, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
SOURCE MEDIA, INC.
(Registrant)
Date: November 13, 1997 By: /s/ MICHAEL G. PATE
-------------------------------------
Michael G. Pate
Chief Financial Officer and Treasurer
(Principal Financial Officer and Duly
Authorized Officer)
21
<PAGE> 22
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description
------- -----------
<S> <C>
2.1 Asset Purchase Agreement dated September 23, 1997 between IT Network, Inc. and Brite Voice
Systems, Inc. (filed as Exhibit 2.1 to the Registrant's Current Report on Form 8-K dated October
30, 1997 and incorporated herein by reference).
2.2 Amendment dated October 7, 1997 between IT Network, Inc. and Brite Voice Systems, Inc. to Asset
Purchase Agreement dated September 23, 1997 between IT Network, Inc. and Brite Voice Systems,
Inc. (filed as Exhibit 2.2 to the Registrant's Current Report on Form 8-K dated October 30, 1997
and incorporated herein by reference).
2.3 Asset Purchase Agreement dated September 23, 1997 between Source Media, Inc., and IT Network,
Inc. and Voice News Network, Inc. (filed as Exhibit 2.3 to the Registrant's Current Report on
Form 8-K dated October 30, 1997 and incorporated herein by reference).
27 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 4,158,379
<SECURITIES> 0
<RECEIVABLES> 1,156,771
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 7,247,177
<PP&E> 10,848,332
<DEPRECIATION> 5,138,338
<TOTAL-ASSETS> 24,688,804
<CURRENT-LIABILITIES> 6,303,178
<BONDS> 19,470,151
0
0
<COMMON> 11,875
<OTHER-SE> (4,228,679)
<TOTAL-LIABILITY-AND-EQUITY> 24,688,804
<SALES> 12,916,220
<TOTAL-REVENUES> 12,916,220
<CGS> 9,872,944
<TOTAL-COSTS> 19,254,010
<OTHER-EXPENSES> (60,089)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,423,069
<INCOME-PRETAX> (18,573,714)
<INCOME-TAX> 0
<INCOME-CONTINUING> (18,573,714)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (18,573,714)
<EPS-PRIMARY> (1.64)
<EPS-DILUTED> (1.64)
</TABLE>
