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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
MARCH 31, 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)
8140 WALNUT HILL LANE, SUITE 1000
DALLAS, TEXAS 75231
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(214) 890-9050
(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 MAY 14, 1997: 11,335,418
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SOURCE MEDIA, INC.
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 1997
PART I. FINANCIAL INFORMATION
Page Number
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Item 1. Consolidated Financial Statements
Consolidated Balance Sheets (Unaudited).......................... 3
March 31, 1997 and December 31, 1996
Consolidated Statements of Operations (Unaudited)................ 5
Three months ended March 31, 1997 and 1996
Consolidated Statements of Cash Flows (Unaudited)................ 6
Three months ended March 31, 1997 and 1996
Notes to Consolidated Financial Statements....................... 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................ 11
PART II. OTHER INFORMATION
Item 1. Legal Proceedings....................................... 17
Item 2. Changes in Securities................................... N/A
Item 3. Defaults Upon Senior Securities......................... N/A
Item 4. Submission of Matters to a Vote of Security Holders..... N/A
Item 5. Other Information....................................... N/A
Item 6. Exhibits and Reports on Form 8-K........................ 19
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PART I - FINANCIAL INFORMATION
SOURCE MEDIA, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
DECEMBER 31, MARCH 31,
1996 1997
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ASSETS
Current assets:
Cash and cash equivalents $ 4,302,943 $ 82,194
Restricted investments 611,182 611,182
Trade accounts receivable, less allowance
for doubtful accounts of $62,504 and
$47,934 in 1996 and 1997, respectively 956,078 1,154,581
Deferred expenses 729,819 708,503
Prepaid expenses and other current assets 1,167,201 878,306
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Total current assets 7,767,223 3,434,766
Property and equipment:
Production equipment 3,951,502 3,902,900
Computer equipment 1,937,826 2,147,884
Other equipment 2,520,885 3,215,986
Furniture and fixtures 128,235 446,506
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8,538,448 9,713,276
Accumulated depreciation 3,576,999 4,175,243
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Net property and equipment 4,961,449 5,538,033
Intangible assets:
Patents 3,597,989 14,813,062
Goodwill 3,010,137 3,010,137
Contract rights 1,121,000 1,121,000
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7,729,126 18,944,199
Accumulated amortization 5,541,770 6,366,642
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Net intangible assets 2,187,356 12,577,557
Other non-current assets 980,745 315,068
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Total assets $15,896,773 $21,865,424
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SOURCE MEDIA, INC.
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(UNAUDITED)
DECEMBER 31, MARCH 31,
1996 1997
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LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable $ 917,462 $ 1,659,606
Accrued payroll 420,926 588,109
Other accrued liabilities 1,483,373 1,305,567
Amounts payable related to acquisitions 1,350,000 1,350,000
Unearned income 3,976,244 3,436,063
Current portion of capital lease obligations 85,683 42,624
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Total current liabilities 8,233,688 8,381,969
Long-term debt, net of discount 4,612,021 4,971,362
Capital lease obligations, less current portion 22,706 19,240
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
$133,675 in 1996 and 1997, respectively (666,931) (681,058)
------------ ------------
2,998,173 3,158,494
Stockholders' equity:
Common stock, $.001 par value:
Authorized shares - 50,000,000
Issued shares - 10,327,041 and 11,716,769
in 1996 and 1997, respectively 10,327 11,717
Less treasury stock, at cost - 381,351 shares (3,757,641) (3,757,641)
Capital in excess of par value 60,815,785 71,200,065
Accumulated deficit (56,931,832) (61,971,163)
Foreign currency translation 3,737 (41,195)
Notes receivable and accrued interest
from stockholders (110,191) (107,424)
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Total stockholders' equity 30,185 5,334,359
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Total liabilities and stockholders' equity $ 15,896,773 $ 21,865,424
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SEE ACCOMPANYING NOTES.
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SOURCE MEDIA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
1996 1997
---------- ----------
Monetary revenues $2,281,868 $2,628,855
Nonmonetary revenues 2,879,173 1,687,520
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Total revenues 5,161,041 4,316,375
Monetary cost of sales 952,334 1,351,035
Nonmonetary cost of sales 2,879,173 1,687,520
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Total cost of sales 3,831,507 3,038,555
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Gross profit 1,329,534 1,277,820
Selling, general and administrative expenses 2,388,158 4,572,982
Amortization of intangible assets 257,834 824,872
Research and development expenses 1,221,473 778,913
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3,867,465 6,176,767
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Operating loss (2,537,931) (4,898,947)
Interest expense 4,959 207,527
Interest income (212,784) (52,179)
Other (income) expense (6,091) (5,994)
Minority interest in losses of consolidated
subsidiaries (103,359) (8,970)
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Net loss ($2,220,656) ($5,039,331)
----------- -----------
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Net loss per common share ($0.22) ($0.45)
----------- -----------
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Weighted average common shares outstanding 9,936,099 11,103,797
----------- -----------
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SEE ACCOMPANYING NOTES.
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SOURCE MEDIA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
THREE MONTHS ENDED MARCH 31,
1996 1997
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<S> <C> <C>
OPERATING ACTIVITIES
Net loss ($2,220,656) ($5,039,331)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation 231,965 598,244
Amortization of intangible assets 257,834 824,872
Non-cash interest expense - 205,970
Provision for losses on accounts receivable 13,105 -
Minority interest in net losses (103,359) (8,970)
Other, net (18,430) (11,360)
Changes in operating assets and liabilities:
Trade accounts receivable (317,782) (198,503)
Prepaid expenses and other current assets 21,469 288,895
Deferred expenses 76,877 21,316
Trade accounts payable (228,926) 742,144
Accrued payroll (105,489) 167,183
Other accrued liabilities (381,425) (4,743)
Unearned income 226,767 (540,181)
----------- -----------
Net cash used in operating activities (2,548,050) (2,954,464)
INVESTING ACTIVITIES
Capital expenditures (248,514) (1,174,828)
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Net cash used in investing activities (248,514) (1,174,828)
FINANCING ACTIVITIES
Payments on capital lease obligations (44,106) (46,525)
Other (20,799) -
----------- -----------
Net cash used in financing activities (64,905) (46,525)
Effect of exchange rate changes on cash and cash equivalents 21,049 (44,932)
----------- -----------
Net decrease in cash and cash equivalents (2,840,420) (4,220,749)
Cash and cash equivalents at beginning of period 17,479,223 4,302,943
----------- -----------
Cash and cash equivalents at end of period $14,638,803 $ 82,194
----------- -----------
----------- -----------
</TABLE>
SEE ACCOMPANYING NOTES.
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SOURCE MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
UNLESS THE CONTEXT OTHERWISE REQUIRES, (a) ALL REFERENCES TO THE "COMPANY" OR
"SOURCE" INCLUDE SOURCE MEDIA, INC. AND ITS WHOLLY-OWNED SUBSIDIARIES, IT
NETWORK, INC. ("IT") AND INTERACTIVE CHANNEL TECHNOLOGIES INC. ("ICT" WHICH
WAS FORMERLY KNOWN AS CABLESHARE INC.), AND (b) ALL REFERENCES TO THE
COMPANY'S ACTIVITIES, RESULTS OF OPERATIONS OR FINANCIAL CONDITION PRIOR TO
JUNE 23, 1995 RELATE TO IT.
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
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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 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.
LITTLE. On January 17, 1997, William T. Little, a stockholder of Source
and former director of IT , and a trust of which Mr. Little is the trustee,
commenced a legal proceeding in the United States District Court, Western
District of Michigan, against the Company and certain of its executive
officers and directors, alleging that he and various convertible noteholders
converted their notes based upon misrepresentations by IT and those officers
and directors. The plaintiff claims that he suffered damages in excess of
$26 million because an alleged promise was made that IT would engage in a
public offering of its stock for approximately $56 per share, which did not
occur. The plaintiff further claims that IT offered to issue to him, during
the time he was serving as a director of IT, an unspecified number of shares
of IT common stock in consideration of his release of any claims related to
such alleged misrepresentations and that IT agreed to pay him and other
noteholders an unspecified amount in equivalent interest relating to the
conversion of notes. Although the ultimate outcome of this action cannot be
determined at this time, the Company disputes all of the plaintiff's claims
as meritless and intends to vigorously assert its position in this
litigation. In addition, management believes the ultimate outcome of this
action will not have a material impact on the consolidated financial
condition or results of operations of the Company. The Company and each of
the defendants have filed answers denying the plaintiff's allegations.
Certain of the individual defendants also have made counterclaims against Mr.
Little for breach of fiduciary duty during his tenure as a director of the
Company and are seeking exemplary and punitive damages.
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.
The costs of defending litigation and other claims are expensed as incurred.
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
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the acquisition of approximately $675,000. The aggregate purchase price for
the acquisition of the ICT minority interest was approximately $11.2 million,
and the acquisition was accounted for by the purchase method of accounting.
The purchase price was allocated primarily 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 three months ended March 31, 1997 would not have differed materially from
the actual results.
Three Months Ended
March 31, 1996
--------------
(In thousands, except
per share amount)
Total revenues $ 5,161
Gross profit 1,330
Operating loss (3,098)
Net loss (2,885)
Net loss per common share (0.25)
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 is 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 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 fees and expenses associated with the transaction upon
the issuance of additional senior notes (the "Second Tranche Notes") in the
principal amount of $15.0 million and warrants (the
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"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 are due on
March 31, 2002 and bear 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, interest payments may be made
through the issuance of additional senior notes; however, to the extent
interest payments are 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 must also be issued to the holders of the
Aggregate First and Second Tranche Notes for each dollar of principal amount
of such senior notes. On March 31, 2001, the Company must make a prepayment
of the notes equal to 33.33% of the then outstanding principal (together with
accrued interest to date on such principal amount). The notes are secured by
a lien on all of the Company's assets. Except for the required prepayment
described above, the note agreement provides for a prepayment penalty and
customary covenants and events of default.
The amendment of the Aggregate First Tranche Notes and First Tranche
Warrant will be 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.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
UNLESS THE CONTEXT OTHERWISE REQUIRES, (a) ALL REFERENCES TO THE "COMPANY" OR
"SOURCE" INCLUDE SOURCE MEDIA, INC. AND ITS WHOLLY-OWNED SUBSIDIARIES, IT
NETWORK, INC. ("IT") AND INTERACTIVE CHANNEL TECHNOLOGIES INC. ("ICT" WHICH
WAS FORMERLY KNOWN AS CABLESHARE INC.), AND (b) ALL REFERENCES TO THE
COMPANY'S ACTIVITIES, RESULTS OF OPERATIONS OR FINANCIAL CONDITION PRIOR TO
JUNE 23, 1995 RELATE TO IT.
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 need for additional financing, general
economic conditions, the projected and historical losses of the Company,
evolving nature of its business, limited access to channels, uncertainty of
subscriber acceptance of the INTERACTIVE CHANNEL, possible unavailability of
programming, possible obsolescence of the Company's technology, sources and
degrees of competition, possible unavailability of equipment 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 provider of information and services to consumers
through the television and telephone. In September 1996, in Colorado Springs,
Colorado, the Company commercially introduced the INTERACTIVE CHANNEL, its
television programming service which provides a range of on-demand information
and services to consumers utilizing cable television and telephone lines. In
November 1996, the Company also commercially introduced the INTERACTIVE CHANNEL
in Denton, Texas. Source utilizes the interactive television system of its
wholly-owned Canadian subsidiary, Interactive Channel Technologies Inc., to
deliver the INTERACTIVE CHANNEL. Source has announced distribution agreements
for the INTERACTIVE CHANNEL with three cable operators, Marcus Cable Company,
L.P., Cablevision Systems Corporation and Century Communications Corporation,
and is currently offering the INTERACTIVE CHANNEL on the systems of two of these
operators. The INTERACTIVE CHANNEL offers over 80 interactive programs
including on demand local and national news, sports and weather, home shopping
with
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companies such as J.C. Penney, Hallmark Connections and Waldenbooks,
interactive Yellow Pages, television and movie guides, travel information and
games.
Since 1988, the Company has been delivering audiotext information to
consumers through the touch-tone telephone. Through its IT NETWORK telephone
business, the Company provides consumers with information on demand, such as
news, weather and sports, together with topical information for health, legal
and other matters of consumer interest. Source's principal IT NETWORK
telephone business product, called the Network Guide, consists of
approximately 800 specific information topics listed in a stand-alone insert
generally bound in the front of Yellow Pages directories distributed by
certain Regional Bell Operating Companies or their affiliates or other Yellow
Pages publishers (collectively, "Directory Publishers").
The Company has earned monetary revenues through advertising
sponsorships in the Network Guide, 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 3 to 12 months). The
Company also has earned monetary revenues from sales of audiotext services,
principally its Consumer Tips service, to certain Directory Publishers.
In each of its 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 programming on the IT NETWORK telephone
business in exchange for promotional messages on the IT NETWORK telephone
business 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. However, the Company expects that nonmonetary
revenues as a percentage of total revenues will 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
the INTERACTIVE CHANNEL 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 previously owned a majority
interest in ICT until the acquisition of the remaining interest.
THREE MONTHS ENDED MARCH 31, 1997 AND 1996
MONETARY REVENUES increased 15 percent to $2.6 million for the quarter
ended March 31, 1997. The net increase of $347,000 was related to an
increase of $986,000 attributable to the Company's audiotext services as a
result of the new services and advertising contracts recently acquired from
The Reuben H. Donnelly Corporation ("Donnelly") and GTE Directories
Corporation ("GTE"). This increase was partially offset by declines of (i)
$251,000 attributable
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to the Network Guide product, (ii) $237,000 attributable to ICT and (iii)
$151,000 attributable to the Company's Consumer Tips service.
The decline in Network Guide monetary revenues primarily reflects the
termination of distribution in 18 designated market areas ("DMAs"), nine of
which are located within the Ameritech region, five within the Southwestern
Bell region, three within the DonTech region and one within the BellSouth
region. Total Network Guide revenues in the 18 terminated DMAs were $46,000
for the quarter ended March 31, 1997 and $496,000 for the quarter ended March
31, 1996. Network Guide revenues within the Company's other 35 existing DMAs
declined slightly during the first quarter of 1997 compared with the same
period in 1996. These declines were partially offset by increases totaling
$208,000 related to 14 new DMAs in which the Network Guide is distributed.
Until February 1, 1996, the Company published the Network Guide in
Yellow Pages directories in certain DMAs within the Ameritech region and
produced the related audiotext messages in exchange for a share of the
Network Guide revenues generated in those DMAs. The Company's agreement with
Ameritech was terminated by Ameritech, and the Company's Network Guide has
not been included in any Ameritech Yellow Pages directories published after
September 1996. Accordingly, revenues in those Ameritech DMAs will end in
the third quarter of 1997 due to the conclusion of revenue from Network Guide
contracts in effect prior to the termination of the Ameritech agreement.
Total monetary revenues for both the Network Guide and Consumer Tips products
in the Ameritech region accounted for approximately six and 27 percent of the
Company's monetary revenues in the first quarter of 1997 and 1996,
respectively. On February 5, 1996, Source initiated litigation against
Ameritech in Texas state court related to the termination. In early 1997, in
connection with the pending settlement of the litigation, the Company and
Ameritech agreed to enter into a definitive agreement pursuant to which the
Company will be the exclusive audiotext sales and service provider in up to
38 Ameritech Yellow Pages directories for a three year period commencing in
January 1998.
The Company expects to partially offset such Ameritech revenue declines
in 1997 with revenues generated through (i) its recently-signed sales agency
agreement with Donnelly to sell advertising in the Network Guide in Yellow
Pages published by Donnelly in six top-100 DMAs in the mid-Atlantic region,
(ii) its recently-completed purchase of certain assets from Donnelly and a
related audiotext service contract with Donnelly under which the Company will
provide audiotext services in Yellow Pages published by Donnelly in eight
top-100 DMAs located throughout the United States, (iii) its recently-signed
sales agency agreement with GTE to sell advertising in the Network Guide in
Yellow Pages published by GTE in four top-100 DMAs located throughout the
United States, (iv) its recently-completed purchase of certain assets from
GTE and a related audiotext service contract with GTE under which the Company
will provide audiotext services in Yellow Pages published by GTE in nine
top-100 DMAs located throughout the United States, and (v) its
recently-signed agreement with Southern New England Telephone ("SNET") to
sell advertising in the Network Guide in Yellow Pages published by SNET in a
top-100 DMA located in the northeastern United States.
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The decrease in ICT's revenues in the first 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.
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 41 percent
to $1.7 million for the quarter ended March 31, 1997 from $2.9 million for
the quarter ended March 31, 1996. Substantially all of this $1.2 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 42 percent to $1.4 million, for the
quarter ended March 31, 1997 from $952,000 for the quarter ended March 31,
1996. This increase resulted from operations' personnel salaries,
depreciation expenses and various other operating expenses totaling $463,000
attributable to the Interactive Channel's operations in Colorado Springs and
Denton. In the prior period, costs incurred by the INTERACTIVE CHANNEL were
research and development in nature, as the INTERACTIVE CHANNEL was not yet
available for commercial deployment.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES, INCLUDING AMORTIZATION OF
INTANGIBLE ASSETS, increased 104 percent to $5.4 million for the quarter
ended March 31, 1997 from $2.6 million for the quarter ended March 31, 1996.
This increase resulted from certain programming, personnel salaries,
subscriber acquisition, travel and various other INTERACTIVE CHANNEL expenses
totaling $1.9 million as well as increased operating, customer service,
sales, marketing and administrative expenses incurred by the IT NETWORK
telephone business to support new services and advertising contracts acquired
from Donnelly and GTE. Amortization of intangible assets increased by
$567,000 during the first 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.
RESEARCH AND DEVELOPMENT EXPENSES declined 36 percent to $779,000 for
the quarter ended March 31, 1997 from $1.2 million for the quarter ended
March 31, 1996. This decrease reflects lower INTERACTIVE CHANNEL
development expenses following the commercial introduction of the INTERACTIVE
CHANNEL.
OTHER INCOME AND EXPENSES. Net interest expense was $155,000 for the
quarter ended March 31, 1997 compared with net interest income of $208,000
for the quarter ended March 31, 1996, reflecting interest expense on certain
debt outstanding during the first quarter of 1997 and interest income on the
proceeds from a public offering of the Company's common stock in December
1995 during the first quarter of 1996.
14
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company has experienced substantial operating
losses and net losses as a result of its efforts to develop, deploy and
support its IT NETWORK telephone business and to develop, conduct trials and
commercially launch the INTERACTIVE CHANNEL. As of March 31, 1997, the
Company had an accumulated deficit of approximately $62.0 million and had
used cumulative net cash in operations of $40.3 million. The difference at
March 31, 1997 between the accumulated deficit and cumulative net cash used
in operations since inception was attributable to (i) $18.4 million of
nonmonetary charges related to financing incentives, write-down of intangible
assets, depreciation and amortization and other non-cash expenses and (ii)
$3.3 million of unearned income, accounts payable and accrued liabilities in
excess of accounts receivable, prepaid expenses and inventory. Source
expects that these losses will increase throughout 1997 as a result of, among
other things, its continuing expenditures relating to its efforts to
commercially introduce, deploy and enhance the INTERACTIVE CHANNEL. Source
expects to continue to incur operating losses through 1997 in excess of the
amount of the operating losses experienced in past years and may incur
operating losses at similar or greater levels thereafter.
Since its inception, the Company has financed its operations primarily
through an aggregate $65.5 million raised from various financing activities,
including the incurrence of debt and issuance of the Company's common and
preferred stock.
In October 1996, the Company acquired certain audiotext servicing assets
from Donnelly for an aggregate purchase price of $750,000, of which $600,000
was paid in October 1996 and $150,000 is payable in June 1997. In December
1996, the Company acquired certain audiotext servicing assets from GTE for an
aggregate purchase price of $1.8 million, of which $600,000 was paid in
December 1996 and $1.2 million is payable in $600,000 installments due in May
1997 and August 1997. The Company may consider additional strategic
acquisitions in either of its lines of business from time to time and has
identified a number of potential acquisition candidates in its telephone
division. Although there can be no assurance that the Company will
consummate any such transactions, to the extent that it does so, such
acquisitions would require the Company to expend funds, issue additional
equity securities or incur additional debt. The incurrence of additional
indebtedness by the Company could result in a substantial portion of the
Company's operating cash flow being dedicated to the payment of principal and
interest on such indebtedness, could render the Company more vulnerable to
competitive pressures and economic downturns and could impose restrictions on
the Company's operations.
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.
15
<PAGE>
On April 9, 1997, the Company received cash proceeds of approximately
$13.9 million net of fees and expenses associated with the transaction upon
the issuance of additional senior notes (the Second Tranche Notes) in the
principal amount of $15.0 million and warrant (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 are due on March 31, 2002
and bear 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, interest payments may be made through the issuance of
additional senior notes; however, to the extent interest payments are 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 must also be issued to the holders of the Aggregate First and Second
Tranche Notes for each dollar of principal amount of such senior notes. On
March 31, 2001, the Company must make a prepayment of the notes equal to
33.33% of the then outstanding principal (together with accrued interest to
date on such principal amount). The notes are secured by a lien on all of
the Company's assets. Except for the required prepayment described above,
the note agreement provides for a prepayment penalty and customary covenants
and events of default. The Company also granted holders of the warrants
demand and "piggyback" registration rights covering the shares of the
Company's common stock issuable upon exercise of the warrants.
The Company's future capital requirements will depend on many factors,
including, but not limited to, (i) the success and timing of the development,
introduction and deployment of the INTERACTIVE CHANNEL, (ii) the operating
results of its IT NETWORK telephone business, (iii) the levels of advertising
required to attain a competitive position in the marketplace for its
products, (iv) the extent of market acceptance of such products, (v) the
funds required by ICT and the Company to fund their costs of litigation, and
(vi) potential acquisitions or asset purchases and (vii) competitive factors.
Following the issuance of the Second Tranche Notes, the Company believes its
current 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 the INTERACTIVE CHANNEL in the Company's existing
markets and the further development of its telephone business through the end
of 1997. However, the Company may seek additional funds or enter into other
arrangements that could allow it to pursue a more extensive business plan,
including the possible deployment of the INTERACTIVE CHANNEL in additional
markets and the consideration of potential acquisitions in its IT NETWORK
telephone business. If cash generated by operations is insufficient to
satisfy the Company's liquidity requirements, the Company may attempt to sell
additional equity securities or incur additional indebtedness. To the extent
that future financing requirements are satisfied through the issuance of
equity securities, Source's shareholders may experience dilution. The
incurrence of additional debt financing could result in a substantial portion
of Source's operating cash flow being dedicated to the payment of principal
16
<PAGE>
and interest on such indebtedness, could render Source more vulnerable to
competitive pressures and economic downturns and could impose restrictions on
Source's operations.
NET OPERATING LOSS CARRYFORWARDS
At December 31, 1996, IT 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 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 denied and ICT has applied for review of
this decision before a three judge panel.
LITTLE. On January 17, 1997, William T. Little, a stockholder of Source
and former director of IT , and a trust of which Mr. Little is the trustee,
commenced a legal proceeding in the United
17
<PAGE>
States District Court, Western District of Michigan, against the Company and
certain of its executive officers and directors, alleging the he and various
convertible noteholders converted their notes based upon misrepresentations
by IT and those officers and directors. The plaintiff claims that he
suffered damages in excess of $26 million because an alleged promise was made
that IT would engage in a public offering of its stock for approximately $56
per share, which did not occur. The plaintiff further claims that IT offered
to issue to him, during the time he was serving as a director of IT, an
unspecified number of shares of IT common stock in consideration of his
release of any claims related to such alleged misrepresentations and that IT
agreed to pay him and other noteholders an unspecified amount in equivalent
interest relating to the conversion of notes. Although the ultimate outcome
of this action cannot be determined at this time, the Company disputes all of
the plaintiff's claims as meritless and intends to vigorously assert its
position in this litigation. In addition, management believes the ultimate
outcome of this action will not have a material impact on the consolidated
financial condition or results of operations of the Company. The Company and
each of the defendants have filed answers denying the plaintiff's
allegations. Certain of the individual defendants also have made
counterclaims against Mr. Little for breach of fiduciary duty during his
tenure as a director of the Company and are seeking exemplary and punitive
damages.
REVENUE CANADA. In June 1993, Revenue Canada, the Canadian taxing
authority, sent a notice of reassessment to ICT related to Cdn$1.9 million of
investment tax credits claimed in fiscal 1988. In addition, Revenue Canada
demanded repayment from ICT of refundable tax credits paid for the 1988
fiscal year totaling Cdn$315,000, as well as accrued interest thereon. In
January 1997, the matter was resolved. Revenue Canada reduced ICT's
investment tax credits for the 1988 fiscal year by Cdn$1.1 million. In
settlement of the refundable tax credits, the Company committed to pay to
Revenue Canada, on behalf of ICT, Cdn$371,945 consisting of Cdn$146,945 plus
an approximate amount of accrued interest thereon of Cdn$225,000. Source
committed to pay the sum to Revenue Canada in equal payments over a 12 month
period commencing in March 1997.
BAUER. In November 1996, Jeanna Bauer, a former employee of IT,
commenced a proceeding in the United States District Court for the Southern
District of Ohio, Western District at Dayton, against IT, alleging
discrimination on the basis of sex and pregnancy and seeking reinstatement
and compensatory damages in the amount of $250,000 and an equivalent amount
of punitive damages. The Company denies the charges of discrimination and
contends that it provided the plaintiff the standard six week maternity
leave, even though the plaintiff did not technically qualify for such leave.
The Company intends to vigorously assert its position in this litigation. No
trial date has yet been set. 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.
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.
Unnamed shareholders of ICT advised the ICT directors in June 1995 that they
questioned certain of the directors' actions under Ontario law. ICT's
attorney responded to the shareholders' substantive points and the
shareholders have not taken further action.
18
<PAGE>
Further, the Company and ICT are 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 - not applicable
(b) Reports on Form 8-K during the three months ended March 31, 1997
Form 8-K regarding additional acquisition of ICT shares, filed
January 16, 1997
19
<PAGE>
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: May 14, 1997 By: /s/ Michael G. Pate
----------------------------------
Michael G. Pate
Chief Financial Officer and Treasurer
(Principal Financial Officer
and Duly Authorized Officer)
20
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