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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
[ ] 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 No.)
5400 LBJ FREEWAY, SUITE 680
DALLAS, TEXAS 75240
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (972) 701-5400
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $.001 PER SHARE
(Title of class)
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. Yes [X] No [ ]
Aggregate market value of Common Stock held by non-affiliates as
of March 24, 1999 $192,639,150
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Number of shares of Common Stock outstanding as of
March 24, 1999 12,842,610
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DOCUMENTS INCORPORATED BY REFERENCE
Listed below are documents parts of which are incorporated herein by
reference and the part of this report into which the document is incorporated:
Proxy statement for the 1999 annual meeting of stockholders-- Part III
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Unless the context otherwise requires, all references to the "Company"
or "Source" include Source Media, Inc. and its wholly-owned subsidiaries, IT
Network, Inc. ("IT Network"), Interactive Channel, Inc. ("Interactive Channel"),
SMI Holdings, Inc. ("Holdings"), and Interactive Channel Technologies Inc.
marketed under the name of VirtualModem(TM) ("ICT", formerly known as Cableshare
Inc.).
ITEM 1. BUSINESS.
Source Media operates through its subsidiaries in two business
segments: IT Network and Interactive TV. The Interactive TV business includes
the Interactive Channel, Inc. and Interactive Channel Technologies Inc.
IT NETWORK
IT Network sells advertising and related support services to clients
who sponsor a promotional message with interactive content supplied or otherwise
managed by IT Network. IT Network's products and services are distributed
primarily through the Company's Publisher Partners which include over 500 Yellow
Page directories with distribution of over 100 million households and more than
200 daily newspapers with aggregate circulation of over 20 million. IT Network's
products and services are available in over 150 Dominant Market Areas (DMAs)
across North America, Hawaii and the Caribbean. Products and services are also
promoted and distributed over radio, television and the Internet.
Significant Yellow Page Publisher Partners include Ameritech, Bell
Atlantic, BellSouth, Pacific Bell, Southwestern Bell, GTE and Southern New
England Telephone. BellSouth is the Company's single largest customer,
representing approximately 12% of 1998 revenues. The Company's major newspaper
Publisher Partners include The Washington Post, The Houston Chronicle, The St.
Louis Post-Dispatch, The Arizona Republic, The Fort Worth Star-Telegram and The
San Francisco Chronicle. Printed inserts invite customers to call a specific
local phone number or log on to an Internet web site. Once connected, consumers
have access to a wide variety of helpful and entertaining audio information. The
Company and its Publisher Partners' voice information systems enable callers to
navigate to specific topics by entering a four digit code and often allow
consumers to talk directly to an advertiser at the push of a button. The
Company's web site (www.localsource.net) allows consumers to obtain similar
text information and streaming audio on the World Wide Web.
Products and Services
Interactive Advertising Sales and Sales Agency Services. The Company
sells interactive advertising on its own behalf and on behalf of its Publisher
Partners. This advertising directs consumers to interactive information content
that consumers can access over the telephone and the Internet. In situations
where IT Network sells interactive advertising on behalf of Publisher Partners,
it does so on a revenue sharing basis.
Interactive Content. IT Network offers more than 15,000 audio
information programs. The audio information is comprised of a variety of dynamic
audio programs and consumer information services. Dynamic audio programs include
news, weather, sports, horoscopes, soap opera updates, lottery results and other
entertainment features, which are updated as frequently as required. Consumer
information services provide local consumers with advice and information on a
wide array of topics that include health, law, finance and home repair.
Customers subscribing to these audio information services pay IT Network a
monthly license and distribution fee.
LocalSource(SM). LocalSource(SM) is an integrated product sold in
conjunction with IT Network's newspaper Publisher Partners. The product provides
local advertisers with a bundled advertising package that includes recurring
print newspaper or Yellow Page advertising, semi-annual print advertising in the
LocalSource (SM) magazine, audio sponsorship messages of information content,
banner sponsorships of Internet content on the LocalSource(SM) web site,
point-of-purchase material and the right to license the content in other media.
IT Network sells LocalSource(SM) advertising sponsorships. Revenue is usually
shared with participating daily newspapers.
Other Services. IT Network provides other services including advertiser
management and system management. The advertiser management service provides
advertising clients with call and web site statistics and updates for their
voice information advertisements on a regular basis. The systems management
service provides technical support and maintenance of voice information systems
for many of its Publisher Partners.
Distribution
The Company sells interactive advertising and provides advertiser
management, systems management and information services in accordance with
separate agreements with each of its Yellow Pages Publisher Partners. The
Company either purchases pages for a flat fee and retains all revenues, or it
shares a percentage of the advertising sales revenue with the Yellow Pages
Publisher Partner without purchasing pages. In revenue sharing arrangements, the
amount retained by the Company depends on the level of advertiser management,
systems management and information content services provided to the Publisher
Partner and the amount charged for the services.
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Pursuant to its agreements with its newspaper Publisher Partners, the
Company provides audio programming to newspaper publishers for a license and
distribution fee. The fee is determined by the amount and type of content
purchased, the size of the market and the circulation of the newspaper.
Technology and Programming
National news, weather, sports and advertiser messages are edited and
produced in the Company's studios. Copywriters prepare written scripts from
information obtained under contract from various news-gathering services. The
written scripts are then used to produce voice recordings with mixed background
music. The finished audio recording is loaded into a central computer system and
transmitted to local voice information systems through a wide-area network that
connects individual computer systems in each of the local markets with the
Company's central administration facility in Irving, Texas. Information may be
transmitted over IT Network's digital satellite network or over land lines.
Multiple telephone lines are connected to each system to process local incoming
calls. There is no charge to the caller. The finished audio product is also
distributed to World Wide Web sites using streaming audio technology.
Competition
The Company is aware of other companies currently offering some of the
information services provided by IT Network. Consumers can call a variety of
"900" services for information provided by, among others, AT&T, GTE, MCI and
certain major newspaper publishers. Callers are generally charged for calls to
these "900" services. In most of its markets, the Company is aware of a number
of companies, including local newspapers and radio stations, that provide
certain free, on-demand telephone programming similar to that offered by IT
Network. Other competitors, such as Associated Press, Interactive Media
Services, Inc., Interactive Information Services, L.L.C. and Interactive
Communications Inc. (a subsidiary of Century Telephone Enterprises), offer
services similar to those of IT Network. These competitors may use Yellow Pages
directories, newspapers, mailers or other print media to distribute and promote
their programming services. In addition to these providers of on-demand
telephone services, potential competitors include any information service
provider, newspaper or telephone company.
INTERACTIVE TELEVISION
The Company's Interactive TV business consists of the combined efforts
of the Interactive Channel and ICT subsidiaries.
Products and Services
The Company has designed and is developing proprietary software and
interactive programming services that can enable digital, two-way television
systems equipped with digital (or advanced analog) set-top boxes to deliver
two-way, interactive programming with the touch of a set-top remote or the use
of a wireless keyboard. The Company has focused its offerings on cable operators
who have upgraded their infrastructure to two-way digital systems and can
therefore offer these services:
Content. Subscribers may be offered a variety of local and national
information on-demand, including local and national news, weather and
sports; stock quotes; local school information such as lunch menus,
sports schedules, homework and artwork; on-line home shopping;
interactive Yellow Pages; movie guides; travel information; games and a
variety of other features.
E-mail. Subscribers may send and receive E-mail on their television
without the use of a personal computer.
Internet access. Subscribers may have Internet access on their
television without the use of a personal computer.
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Interactive Program Guide ("IPG"). Interactive TV's IPG can provide
viewers with a navigational tool for all of the cable operators'
digital offerings.
Other products. Electronic commerce, video-on-demand ("VOD") and
other interactive services are also possible with this service.
Technology
Interactive TV can be delivered by cable operators utilizing the
Company's proprietary server-based software platform, VirtualModem(TM). This
platform enables operators with upgraded digital, two-way systems to provide
interactive services to the subscriber's television set from the system
head-end to a VirtualModem(TM) enabled set-top box. The Company believes that
this server-based approach provides significant cost and administrative
advantages over other potential technologies as it requires neither additional
hardware in the home nor an installation visit. The widespread deployment of
Interactive TV is dependent on the adoption and distribution of digital set-top
boxes as the industry standard.
Proprietary rights and intellectual property
The deployment and operation of Interactive TV utilizes proprietary
technology which protects the Company's system for delivering individually
addressed video images and accompanying audio to television viewers in response
to viewer requests. The Company's proprietary technology also enables different
viewers within the system to receive video images over different television
channels. The Company owns twelve U.S. patents with expiration dates from 2005
through 2010 and twenty-three international patents or patent applications. The
Company's patents cover methods and applications for the selection, storage,
retrieval and presentation of video and audio messages presented over various
distribution outlets.
The Company relies on ICT for research and development of software for
multimedia file servers and digital set-top boxes. It is the Company's policy to
enter into confidentiality or license agreements with its employees, consultants
and other outside parties and to seek to control access to, and distribution of,
its proprietary information.
Distribution
In order to offer Interactive TV in a market, the Company negotiates
a carriage or affiliation agreement with the cable operator. This agreement
would authorize the cable operator to sell and promote Interactive TV and
contains terms and conditions regarding pricing, revenue sharing and joint
marketing arrangements.
In the past, the Company has had carriage agreements to offer its
services as a premium channel on analog systems with Century Communications in
Colorado Springs, Colorado and with Marcus Cable in Denton, Texas. The Company
and Century agreed to discontinue the analog-based pilot effective April 1,
1998 and the trial with Marcus was discontinued later in 1998.
The Company has decided to focus its resources on seeking distribution
as part of a tiered package in digital systems. The Company currently has an
agreement with Cablevision Systems L.P. ("Cablevision") and a Letter of Intent
with Insight Communications ("Insight"). Under the terms of the arrangement with
Insight, it is contemplated that subscribers will be introduced to various
interactive programming using the Company's technology and services in the
second quarter of 1999.
There is intense competition among programming suppliers for access
to cable channels. There can be no assurance that the Company will be able to
obtain agreements with any other cable system operators providing channel access
on terms favorable to the Company, if at all.
Competition
The Company believes that for the foreseeable future, consumer access
to interactive television will generally be through telephone lines, cable
systems and satellite systems. The Company believes that there are companies
offering similar services and alternative technologies. Some of these offerings
may become directly competitive while others may prove to be complementary to
the Company's products and services. Regardless, this is an industry of rapid
technological change, and new competitors can be expected.
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WebTV, which is owned by Microsoft, offers Internet access to the
television over telephone lines using a separate set-top device. It has been
announced that the operating system used for WebTV may be incorporated into the
next generation of set-top boxes. Roadrunner and @Home offer Internet services
through the cable system to the household PC; @Home has announced its intention
to provide its service to the television using a more advanced digital set-top
box. Wink TV provides a silent text overlay (with some graphics) displayed when
a consumer presses a button on a television remote control. WorldGate has
announced that it is testing a product that can deliver Internet access over
cable systems to the TV. The concept WorldGate has announced is similar to the
Company's Internet access and is the subject of patent litigation initiated by
the Company. GTE MainStreet is an interactive navigational system being
commercially deployed in Clearwater, Florida and Ventura, California and offers
interactive programming over cable systems. As a result of a patent litigation
settlement with GTE, the Company has licensed its technology to GTE for a fee.
Wink is available to the consumer without the purchase of additional equipment.
WorldGate and GTE Mainstreet currently require additional analog hardware
although they have announced their intent to provide digital services. There
are also other companies providing Internet access to the television either
through high-speed cable modems or satellites. These companies compete with the
Company for consumers seeking an interactive television experience.
To the extent that one or more competitors is successful in developing
an interactive television service, the Company could be materially adversely
affected. The Company competes with other potential interactive television
service providers, as well as other sources of programming, to establish
relationships with cable system operators. Microsoft Corporation, the owner of
WebTV, has invested in Comcast, Inc., one of the largest cable system operators.
In addition, the interactive television industry and Interactive TV face
competition for consumer usage from personal computer services and other
companies offering television access to the Internet.
PROPOSED TRANSACTION
On February 11, 1999, the Company, Prevue Ventures, Inc. and its
parent, United Video Satellite Group, Inc. (collectively "Prevue") executed a
Letter of Intent to enter into a joint venture ("Newco") to exploit the
Company's Interactive TV business. The Letter of Intent is subject to the
execution of definitive documentation, including representations and warranties,
covenants and conditions to closing. There can be no assurance that the Company
and Prevue will be able to agree on the form of such definitive documents or
that, if agreed upon, the transaction will be consummated.
Newco would be capitalized initially with a $5.0 million capital
contribution by Prevue in consideration for a 45% equity ownership in Newco. The
Company would grant to Newco an exclusive, perpetual, royalty free, irrevocable,
worldwide license, with the right to sublicense, to all of the Company's
intellectual property that has application in its VirtualModem(TM) and
Interactive Channel business, as well as to any future lines of business of
Newco, except that Newco's license would specifically exclude application in the
field of on-screen television program guides. The Company would grant to Prevue
an exclusive, perpetual, royalty free, irrevocable, worldwide license, with the
right to sublicense, to all of the Company's intellectual property solely for
use and application in the field of on-screen television program guides.
Prevue would also commit to provide Newco advances on an as-needed
basis, of up to an additional $5.0 million to fund the operations of Newco. Such
advances would be in the form of secured convertible subordinated debentures
("Newco Debentures") accruing interest at a compounding annual rate of 6%.
Interest would not be payable during the first five years, and the Newco
Debentures would mature after seven years, at which time all principal and the
interest accrued during the first five years would be payable. The Newco
Debentures would be convertible into super-voting equity interests of Newco.
Assuming the full funding in respect of the Newco Debentures and a full
conversion thereof, including conversion of accrued interest amounts for the
first five years, Prevue would have 59.5% equity ownership in Newco and 88.0% of
the total voting power of Newco.
The Company and Prevue have further committed to provide funding of
up to an additional $10.0 million proportionate with their respective
fully-diluted interests in Newco pursuant to capital calls made by Newco
management in accordance with the expenditures contained in an agreed-upon
budget. The funding of such $10.0 million and any additional funding that may
be required by Newco requires a 90% vote during the first three years and,
thereafter, a majority of the Newco votes, in accordance with specified capital
call procedures.
Prevue would also provide certain services to Newco, including
affiliate sales and marketing, network operations, accounting and national
advertising sales and support. The Company would provide to Newco
system-specific, locally-focused content, including local advertising, Yellow
Pages and classified advertising, local news and sports information. Prevue
would be required to use commercially reasonable efforts to facilitate
distribution of Newco's products through United Video's affiliates and other
contractual relations. In all cases, services will be provided on commercially
reasonable terms and on an arm's-length basis. Both Prevue and the Company have
agreed that they will not compete with the services of Newco while a significant
shareholder of Newco.
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The Company and Prevue would initially have equal management
representation in Newco. Prevue would have the right to nominate the President
and Chief Operating Officer of Newco, subject to Company approval. Upon the
acquisition by Prevue of a majority of the vote of Newco, Prevue would obtain
management control. However, certain special actions by Newco would continue to
require a 90% super-majority vote. Such special actions would include material
deviations from Newco's business strategies during the first three years,
(including a significant deviation in the amount of capital contributions by the
parties from an agreed upon business plan), issuance of additional equity,
distributions to equity holders, asset sales and other significant matters.
The Letter of Intent contemplates a "buy-sell" arrangement whereby
either party, following the third anniversary of the joint venture, may send to
the other party a notice specifying a price at which the other party can
purchase the notifying party's entire interest in Newco. If the notified party
does not elect to effect such purchase, it must sell its interest in Newco to
the notifying party at the specified price. All super-majority voting rights
would terminate upon the initiation of a buy-sell procedure or an initial public
offering of Newco. The Company would be required to redeem the warrants issued
to Prevue upon the initiation of a buy-sell procedure. The redemption price
would be payable, at the election of Prevue, either in the Company's common
stock or, if permitted by the Company's financing agreements, in cash. The
Letter of Intent also provides for certain transfer restrictions relating to
Newco interests, drag-along and tag-along rights with respect to such interests,
and rights upon a change in control of the Company.
Pursuant to the terms of the Letter of Intent, upon formation of Newco,
Prevue would acquire 842,105 shares of common stock of the Company for a
purchase price of $12.0 million in cash. The Company would also issue to Prevue
five-year warrants to acquire up to 14,155,356 shares of the Company's common
stock at an exercise price of $14.25 per share. The Company and Prevue would
enter into a stockholders agreement with provisions to protect Prevue's interest
in the Company, including preemptive rights and proportionate Board
representation. Initially, upon the closing of the transaction, the Company's
Board of Directors would consist of seven members, two of whom would be
designated by Prevue.
The Letter of Intent requires that the parties negotiate the definitive
documents in good faith, with commercially reasonable efforts, and exclusively
with each other for 90 days. If either the Company or Prevue fails to use its
good faith commercially reasonable efforts as such, the other has agreed to pay
as liquidated damages $3.0 million plus out-of-pocket costs and expenses
associated with due diligence and negotiation. In addition, the Company has
agreed to pay such liquidated damages and costs and expenses if it breaches the
exclusivity agreement prior to execution of definitive documents and, within 240
days after the execution of the Letter of Intent, enters into a significant
transaction with a third party.
Upon the execution of definitive documents, the Company intends to seek
the approval of its common stockholders, as well as the approval of the holders
of its long-term debt and preferred stock. The consummation of the definitive
documents will also be subject to any required clearance under the
Hart-Scott-Rodino Antitrust Improvements Act of 1976 ("Hart-Scott"). If for any
reason the transaction is not consummated after the execution of definitive
documents, other than a failure to satisfy the condition relating to Hart-Scott,
the Company would be required to grant to Prevue a perpetual and non-exclusive
license to the Company's intellectual property. Such license would require
payments of royalties to the Company in an amount equal to .001% of revenues
attributable to the intellectual property, but in no event less than $50,000
annually. If the transaction is not consummated after the execution of
definitive documents as a result of the Company's breach of the exclusivity
agreement and the Company enters into a significant transaction with a third
party within one year after the execution of the Letter of Intent, in addition
to such non-exclusive license grant, the Company would be required to pay Prevue
as liquidated damages $10.0 million plus out-of-pocket costs and expenses,
provide for two Prevue representatives on a seven-member Board of Directors of
the Company and issue to Prevue five-year warrants to acquire 3,208,700 shares
of the Company's common stock at an exercise price of $7.125 per share.
The obligations of Prevue under the Letter of Intent and the definitive
documents (as they are entered into) are guaranteed by United Video.
EMPLOYEES
As of March 15, 1999, the Company had a total of 275 full and part-time
employees. None of the Company's employees are subject to a collective
bargaining agreement. The Company has experienced no work stoppage and believes
that it has good relations with its employees.
REGULATORY MATTERS
The telecommunications and cable television industries are subject to
extensive regulation by federal, state and local governmental agencies. Existing
regulations were substantially affected by the passage of the Telecommunications
Act of 1996 (the "1996 Telecom Act") in February 1996. This legislation was
implemented in administrative proceedings conducted by the Federal
Communications Commission ("FCC") and state regulatory agencies.
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Most current regulatory and legislative activity addresses how
telephone companies and cable television companies may enter new lines of
business, the manner in which they can participate in new lines of business and
the rates they can charge consumers. Local exchange carriers, including the
Regional Bell Operating Companies ("RBOCs"), will be facing more serious
competition and will be able to enter new markets. Cable television companies
are now also permitted to provide telephone service. The federal and state
administrative proceedings may also affect the nature and extent of competition
that will be encountered by the Company.
The on-line information and services industry is evolving and will be
affected in the future by laws, regulations and policies adopted at the federal,
state and local levels of government. There are many laws, regulations and
policies, both existing and proposed, at all levels of government that may
impact, in varying degrees, the manner in which the Company markets and provides
Interactive Channel's and IT Network's products and services. Neither the
outcome of these proposals, nor their impact on the on-line information and
services industry in general, or on the Company in particular, can be predicted
at this time.
FORWARD LOOKING INFORMATION AND RISK FACTORS
The Company or its representatives from time to time may make, or may
have made, certain forward-looking statements, whether orally or in writing,
including without limitation any such statements made, or to be made, in the
Management's Discussion and Analysis of Financial Condition and Results of
Operations, press releases and other information contained in its various
filings with the Securities and Exchange Commission. The Company wishes to
ensure that such statements are accompanied by meaningful cautionary statements,
so as to ensure to the fullest extent possible the protections of the "safe
harbor" established in the Private Securities Litigation Reform Act of 1995.
Accordingly, such statements are qualified in their entirety by reference to,
and are accompanied by, the following discussion of certain important factors
that could cause actual results to differ materially from those projected in
such forward-looking statements.
The Company cautions you that this list of factors does not describe
all of the risks of an investment in our common stock. We operate in a rapidly
changing business environment, and new risk factors continually emerge. We
cannot predict every risk factor, nor can we assess the impact of all these risk
factors on our business or the extent to which any factor, or combination of
factors, may cause actual results to differ from those projected in any
forward-looking statements. Accordingly, you should not rely upon
forward-looking statements as a prediction of our actual results.
Substantial leverage; ability to service debt. Our high degree of
leverage could have certain negative consequences on our operations and
financial condition. We are highly leveraged and substantially all of our
assets are subject to security interests securing our 12% Senior Secured Notes
due 2004 ("Notes"). As of December 31, 1998, we had total indebtedness of
approximately $100 million in Notes and 13 1/2% Senior PIK Preferred Stock
("Preferred Stock") with a stated value of $22.8 million due in 2007.
Our high degree of leverage and the covenants imposed by our Notes and
our Preferred Stock could have certain negative consequences, including:
o Substantial cash flow from our operations will be required for
the payment of principal and interest on our Notes and will
not be available for other purposes;
o Our ability to obtain additional financing in the future may
be impaired;
o The indenture under which our Notes were issued imposes
significant financial and operating restrictions;
o We may be more leveraged than some of our competitors and this
may place us at a competitive disadvantage; and
o Our high degree of leverage may make us more vulnerable to
changes in economic conditions, limit our ability to withstand
competitive pressures and technological developments,
consummate acquisitions and capitalize on business
opportunities and make us a less attractive candidate for a
strategic transaction.
We require substantial cash flow to meet our payment obligations with
respect to our Notes and other indebtedness. Our cash flow is dependent on
future performance and is subject to financial, economic and other factors, some
of which are beyond our control. If we are unable to generate sufficient cash
flow from operations or otherwise satisfy our obligations on our Notes and other
indebtedness, we may be required to refinance all or a portion of these
obligations or sell some of our assets. We expect that any payment of the
principal on any of our Notes may have to be refinanced, including the
possibility that this financing may occur by selling some of our assets.
Likewise, the redemption of, or payment of cash dividends, on our Preferred
Stock or other indebtedness, may have to be refinanced, including the
possibility that this financing may occur by selling some of our assets.
However, the indenture underlying the Notes restricts our ability to incur
additional indebtedness and to sell assets. Additionally, we may not be able to
refinance or sell assets on acceptable terms when needed.
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Need for additional financing. We will require substantial additional
financing in order to pursue our current business plan for Interactive TV. We
have no current arrangements with respect to, or sources of, additional
financing and there can be no assurance that any such financing will be
available to us on commercially reasonable terms, or at all. If such financing
is available, the terms of such financing may limit the amount of additional
investment in the Interactive TV business. Moreover, if we raise this additional
capital through borrowing or other debt financing, we would incur additional
interest expense. Sales of additional equity securities will dilute, on a pro
rata basis, the percentage ownership of all holders of common stock. Any
inability to obtain additional financing will materially adversely affect us,
including possibly requiring us to significantly curtail operations.
Insufficient collateral. We may not have sufficient collateral to repay
our Notes. If an event of default under the indenture occurs, the collateral may
not be sufficient to repay our Notes in full. Although the collateral consists
of substantially all of our assets, most of the assets consist of cash,
investments, goodwill, other intangibles and accounts receivable. The tangible
assets (excluding cash, investments and receivables) included in the collateral,
as of December 31, 1998, had a net book value of approximately $4.4 million, and
consists primarily of computer and other equipment.
Change of control. A change of control would require us to offer to
purchase our Notes and Preferred Stock, for which we may not have sufficient
funds. If a change of control occurs, we must offer to repurchase our Notes at
101% of their principal amount, plus accrued and unpaid interest to the date of
repurchase, and our Preferred Stock at 101% of the liquidation preference plus
accumulated and unpaid dividends. We cannot be certain that we will have
sufficient funds to make any required repurchase. If we do not have sufficient
available funds to pay for our Notes tendered for repurchase, an event of
default will occur under the indenture. If an event of default occurs, this will
result in acceleration of maturity of our Notes unless waived by the holders of
our Notes and our Preferred Stock. If we are required to offer to repurchase our
Preferred Stock and we do not have sufficient available funds, the holders of
our Preferred Stock will have the right to elect two directors.
Historical and projected losses. We have reported both an operating
loss and a net loss in each year since our inception, including an operating
loss of $48.8 million and a net loss attributable to common stockholders of
$62.6 million in the year ended December 31, 1998, including a one-time non-cash
write-down of intangible assets of $25.9 million. We expect to incur operating
losses at least through 1999 and may incur operating losses thereafter.
Risks related to proposed transaction with Prevue. A number of risks
are posed by our proposed Letter of Intent with Prevue, including the following:
o We are required to use good faith commercially reasonable
efforts to negotiate definitive documents with Prevue. If we
are unsuccessful in completing definitive documents for the
transaction, we will have expended a significant amount of our
capital and resources in exploring the joint venture, and will
nonetheless be left without a significant strategic partner
for the exploitation of Interactive TV.
o We are also required to negotiate exclusively with Prevue
until May 12, 1999. If we are found to have breached this
exclusivity requirement, or to have failed to use good faith
commercially reasonable efforts to negotiate definitive
documents, we may be required to pay a $3.0 million liquidated
damages provision.
o The transaction will be subject to a number of conditions
precedent, including the approval of the holders of Notes and
Preferred Stock and the approval of our stockholders for the
issuance of the shares and warrants to Prevue. There is no
assurance that such approvals will be obtained or that we will
be able to consummate the transaction. If we are successful in
completing the definitive documents but are unable to
consummate the transaction, we will be required nonetheless to
grant Prevue and certain of its affiliates (including News
Corp. and Tele-Communications, Inc.) a perpetual and
non-exclusive license to our interactive television technology
for a nominal license fee. In such event, we will have
expended a significant amount of our capital and resources in
exploring the joint venture, and will be left without a
significant strategic partner for the exploitation of our
interactive television technologies.
o A number of risks are also posed if we do consummate the
proposed transaction with Prevue:
- If we are unable to raise the capital required by the
joint venture after a capital call, our equity
position in Newco will be diluted.
8
<PAGE> 9
- The success of Newco will be dependent upon the
ability of Prevue to obtain distribution and
negotiate licensing arrangements for the interactive
television technology.
- Even if Newco is successful in obtaining
distribution, there is no assurance that Newco will
be able to achieve profitability.
- We may be unable to negotiate commercially reasonable
terms with Newco for its anticipated purchase of our
information content and there can be no assurance
that the provision of such content will be profitable
to us.
- Newco may be unable to negotiate commercially
reasonable terms with Prevue for the anticipated
provision by Prevue of certain services to Newco.
- Prevue would own shares and warrants that would
enable it to purchase in the aggregate up to 40% of
our common stock on a fully-diluted basis, giving it
significant influence over the Company. Such
ownership stake could discourage a potential
acquirer, and could have a depressive effect on the
price of our stock, or on our ability to obtain a
premium for our stock in the event of any takeover
attempt.
- Future sales by Prevue of their shares, or even the
possibility of such sales, could have an adverse
effect on the price of our shares.
Access to channels on cable systems and uncertainty of subscriber
acceptance. Our ability to offer our programming services on any cable
television system depends on obtaining a satisfactory agreement from the cable
operator. Intense competition exists among suppliers of programming for access
to channels. We cannot be certain that we will enter into carriage agreements.
Even if carriage agreements are entered into, there is no assurance that our
programming services will be distributed as a result of such agreements.
Even if we have channel access and distribution, there is no assurance
that a significant market for interactive television will develop or that cable
subscribers will use the television as a source of interactive information and
services. In addition, our programming services will be competing with other
interactive information and entertainment sources. This competition includes
services offering access to the Internet through the television. There is no
assurance that our programming services will prove more desirable than these
competing services. If our programming services do not achieve market
acceptance, we will be unable to implement our business strategy and our
business will be materially adversely affected.
Availability of programming. If we obtain distribution for our
programming services, our success will be highly dependent on the availability
of high-quality programming applications. We depend on independent information
sources, such as third-party suppliers, local media, retailers and information
service providers in order to create, produce and update the programming at no,
or minimal, cost to us. There is no assurance that we will succeed in attracting
and retaining these independent programming sources. If independent information
sources do not develop high quality, up-to-date programming applications capable
of being delivered on our programming services and that appeal to subscribers,
or if suppliers are unwilling to provide these applications to us on favorable
terms, we will have to increase the extent to which we supplement the
independent programming services with our internal programming. This will
increase our operating costs.
Reliance upon proprietary technology. We rely heavily on our
proprietary technology. Our licenses of technology to third parties, including
grants of sub-license rights, could increase the competition we face or diminish
the value of our technology. Despite precautions taken by us, third parties may
copy or otherwise obtain and use our products or technology without
authorization or independently develop similar products and technology. In
addition, effective copyright and trade secret protection may be unavailable or
limited in certain foreign countries. We cannot be certain that the steps we
have taken will prevent misappropriation of our technology or that litigation
will not be necessary in the future to enforce our intellectual property rights,
protect our trade secrets, determine the validity and scope of the proprietary
rights of others, or defend against claims of infringement or invalidity. Such
litigation, including without limitation litigation which has previously been
disclosed, could result in the invalidation of our proprietary rights and, in
any event, would likely result in substantial costs and diversion of management
time, either of which could have a material adverse effect on our business.
We believe that our technology rights, including patents, are among our
most significant and valuable assets. If our technology rights are adversely
affected, if our technology becomes obsolete, if competitors develop alternative
technologies, or if one or more of our patents is invalidated, our prospects and
value may be diminished.
Further technical development is needed to improve the economics of
deploying Interactive TV to multiple cable systems. There are no assurances that
the necessary technology will be completed, or if it is, that it will be
completed on schedule or on budget.
9
<PAGE> 10
Delayed digital roll-out. Expansion of the Interactive TV business is
dependent upon the incorporation of our technology into digital set-top boxes,
the widespread distribution of digital set-top boxes, and the upgrading of cable
infrastructure to two-way, digital capabilities. If cable companies delay
conversion of their systems to digital set-top boxes or limit the number of
digital set-top boxes ordered, our business plan would be adversely affected.
Integration of technology with digital set-top boxes. Subscribers'
set-top boxes must be enabled with VirtualModem(TM) software in order to access
the Interactive TV services. We have completed the integration of our software
with General Instrument Corporation's DTC 2000 set-top boxes, and we are
working with Scientific-Atlanta, Inc. to integrate our software into the digital
set-top boxes they manufacture. However, neither company, nor any other set-top
manufacturer, is required to integrate our software, and there is no assurance
that they will integrate our software in their products. This would have a
material adverse effect on our business.
Competition. In an industry characterized by extensive capital
requirements and rapid technological change, we face potential competition for
the acceptance of our on-line programming and services from a number of
companies, most of which have significantly greater financial, technical,
manufacturing and marketing resources than us and may be in a better position to
compete in the industry. In addition, we face competition for advertiser
revenues from other media, including radio, television, newspapers, magazines
and the Internet. We believe that for the foreseeable future, public access to
on-line television will generally be through cable operators. Accordingly, we
must compete with other providers of television programming to establish
relationships with cable operators to gain channel access.
In addition, certain RBOCs have provided voice information services in
the past. There is no assurance that the RBOCs will not provide such services
again in the future. If one or more RBOCs begin providing such services, the
resulting competition may have a material adverse effect on our financial
condition and performance. In addition, certain former employees of a division
of Brite Voice System, Inc., acquired by the Company in October 1997 (some of
whom are also former employees of the Company), operate a competing business.
Evolving nature of business. The on-line information and services
industry is experiencing rapid change. Products or technologies developed by
others could render obsolete or otherwise significantly diminish the value of
our products or technologies. Our future performance depends substantially on
our ability to respond to competitive developments; upgrade our technologies and
programming; commercialize products and services incorporating upgraded
technologies and programming; and adapt our operational and financial control
systems as necessary to respond to continuing changes in our businesses. We
cannot be certain that we will be successful in these efforts.
Shareholder rights plan. We adopted a shareholder rights plan and
declared a dividend distribution of one common share purchase right on each
outstanding share of the common stock. Our shareholder rights plan has certain
anti-takeover effects. Generally, if a person or group acquires 15% or more of
the common stock, the rights will entitle shareholders other than the acquirer
to purchase shares of the common stock (or, in certain circumstances, cash,
other property or other securities) at half price. In addition, if, after the
acquisition by a person or group of 15% or more of the common stock, we sell
more than 50% of our assets or earning power or we are acquired in a merger or
other business combination transaction, the acquirer must assume the obligations
under the shareholder rights plan and the rights become exercisable to acquire
the shares of stock of the acquirer at the discounted price. The shareholder
rights plan, along with certain provisions of our Certificate of Incorporation
and Bylaws and of Delaware law, could delay or make difficult a merger, tender
offer or proxy contest involving us.
Stock volatility. Our common stock price can be extremely volatile and
has experienced substantial and sudden fluctuations. Speculation, whether or not
based in fact, has in the past and may in the future cause volatility or
speculative fluctuations in the price of our common stock.
Common stock price. The market price of our common stock could be
negatively affected if the sale of a substantial number of shares occurred. Sale
of a substantial number of shares of our common stock in the public market could
negatively impact the market price for our common stock. All shares of the
common stock outstanding are freely traded without restriction by persons other
than our "affiliates". In addition, as of March 15, 1999 there were options,
warrants and exchange rights outstanding entitling such holders to acquire
approximately 8.5 million shares of our common stock.
Year 2000. Although we have implemented a program to address the Year
2000 issue, we have not yet completed all necessary phases of the Year 2000
program. There can be no assurance that our efforts to solve our potential Year
2000 problems will
10
<PAGE> 11
be successful, or even partially successful. In the event that we do not
complete any additional phases, we may be unable to take customer orders,
provide services and products, invoice customers or collect payments. In
addition, disruptions in the economy generally resulting from Year 2000 issues
could also have a material adverse affect on us. We could be subject to
litigation for computer systems product failure, equipment shutdown or failure
to properly date business records. The amount of potential liability and lost
revenue cannot be reasonably estimated at this time.
Reliance on key personnel. Our future performance depends in large part
on the services of certain executive officers and other key personnel, the loss
of any one of which could be detrimental to our success. In addition, for us to
implement our strategy and continued development and growth, it will be
necessary to attract and retain qualified personnel in all areas.
Government regulation. Current and future government regulation may
have an impact on our business. The telecommunications and cable television
industries are heavily regulated by federal, state and local governmental
agencies. Existing regulations were substantially affected by the passage of the
1996 Telecom Act in February 1996, which allows cable television companies and
telephone companies both to enter and participate in new lines of business. This
introduces the possibility of new, non-traditional competition for both cable
television and telephone companies and may result in greater potential
competition for us. The outcome of federal and state administrative proceedings
may also affect the nature and extent of competition that we will encounter. In
addition, future regulations may prevent us from realizing sales of database
information about consumers obtained by us from our television and telephone
businesses. BellSouth is also allowed to terminate its agreement with us if it
determines that regulatory changes impact our ability to perform under such
agreement. These competitive developments, as well as other regulatory
requirements relating to privacy issues, may have a material adverse effect on
our business.
Organizational History
For financial reporting purposes, the Company operates in two business
segments: IT Network and Interactive TV. For information regarding revenues,
operating results, identifiable assets and certain other information by business
segment, see Note 13 - Segment Reporting, as presented in the Company's Notes to
Consolidated Financial Statements. The Company's operations are conducted
through its subsidiaries, IT Network, Interactive Channel and ICT. Holdings was
incorporated in Colorado on July 19, 1988 and reincorporated in Texas in 1991.
On June 23, 1995, Holdings merged with a wholly-owned subsidiary of HB
Communications Acquisition Corp. ("HBAC"), a public company formed in Delaware
for the purpose of acquiring a company engaged in the communications industry,
with Holdings surviving as a wholly-owned subsidiary of HBAC (the "Merger"). In
connection with the Merger, HBAC changed its name to Source Media, Inc., and the
outstanding common stock and preferred stock of Holdings were converted into
common stock of the Company. On January 14, 1997, Source acquired all of the
outstanding shares of ICT that it did not already own in exchange for 1,390,000
shares of common stock, making ICT a wholly-owned subsidiary of the Company.
Holdings owns the patented technology utilized by the Company for Interactive TV
and ICT provides research and development services for the Company. On October
30, 1997, the Company purchased certain of the electronic publishing assets of
Brite Voice Systems, Inc. ("Brite") for $35.6 million and certain of the assets
of Voice News Network ("VNN"), a unit of Tribune Company, for $9.0 million (the
"October 1997 Acquisitions"). In October 1997, Holdings formed IT Network and
Interactive Channel as wholly-owned operating subsidiaries.
ITEM 2. PROPERTIES
The Company leases approximately 16,200 square feet of office space at
5400 LBJ Freeway in Dallas, Texas for its corporate offices and for Interactive
Channel. This lease expires in September 2001. The Company also subleases from
GTE Directories Corporation approximately 17,800 square feet of office space at
5601 Executive Drive, Irving, Texas where it conducts IT Network operations.
This sublease expires in September 2000. The Company also has offices in major
DMAs where it maintains the on-line voice response system that supports IT
Network voice information services. The Company maintains five regional sales
offices across the country from which its sales force is based. These offices
operate under various leases which expire through March 2001. The Company
believes that its existing facilities are suitable to meet its requirements for
the immediate future but will evaluate facilities to accommodate the Company's
growth as necessary. Substantially all of the Company's assets are subject to a
security interest granted in connection with the issuance of the Notes.
11
<PAGE> 12
Item 3. Legal Proceedings and Claims
In October 1998, the Company settled all litigation in Ontario, Canada,
in connection with Marvin Lerch, the former Chief Executive Officer and a former
shareholder of ICT and certain of his relatives, also former ICT shareholders.
The settlement resolved all litigation by Lerch and his family members against
the Company, certain executive officers and a former director of ICT. Under the
terms of the settlement, the parties agreed to dismiss all actions, and the
Company agreed to transfer a total of 87,500 shares of the Company's common
stock to the plaintiffs. The Company recorded an additional expense of $0.5
million in the fourth quarter of 1998 reflecting this settlement.
On May 11, 1998, ICT and Holdings filed an action in U.S. District Court
for the District of Delaware against WorldGate Communications, Inc.
("WorldGate") alleging that WorldGate has infringed four of the Company's
patents. Each party has filed a Motion to Dismiss certain claims and no date has
been set for a hearing by the district court. The Company intends to
aggressively defend its patents.
In July 1998, the Company initiated an action in the Western District of
Michigan federal court against a former employee of Brite, Michael Shell
("Shell") and three companies (Interactive Media Services, Inc., Interactive
Information Services, LLC, and Talking Directories, Inc. ("TDI")), alleging
copyright infringement and breach of contract. On October 14, 1998, the federal
court issued a preliminary injunction in favor of the Company enjoining the
competitors from, among other things, selling, licensing, distributing or
reproducing works derived from the Company's information. On December 2, 1998,
the Company filed a Motion for Further Preliminary Injunctive Relief in Michigan
federal court against the same companies involved in the first action. The
action for Further Relief is based on alleged copyright infringement by the
defendant companies of the Company's proprietary satellite software used to
transmit the Company's voice information to its customers' receiving systems. A
trial date has been set for November 8, 1999. The Company is also involved in
certain litigation in federal and state courts in Kansas related to tortious
interference with the Company's contractual relationships with customers and to
violations of non-compete agreements by former employees of IT Network. The
Company intends to aggressively pursue all of these cases.
On January 11, 1999, Brite Voice Systems, Inc. ("Brite") filed a lawsuit
against IT Network and Source in the United States District Court of the
District of Kansas. Brite alleges three claims: (1) breach of a September 1997
Asset Purchase Agreement for which Brite seeks recovery of alleged damages of
approximately $112,000; (2) breach of an October 1997 Lease and Service
Agreement in connection with such Asset Purchase Agreement, for which Brite
seeks recovery of alleged damages of approximately $30,000; and (3) a
declaratory judgment with respect to all indemnity claims for which IT Network
has provided Brite notice pursuant to the Asset Purchase Agreement. The Company
is required to respond by April 26, 1999, and intends to vigorously defend
itself and to assert counterclaims.
On August 21, 1998, the first of fourteen class action cases was filed
against the Company and certain officers and directors in federal court in the
Northern District of Texas. The litigation is pursuant to the provisions of the
Private Securities Litigation Reform Act of 1995. The federal court has
appointed three firms collectively as the lead counsel, and on March 3, 1999 the
plaintiffs filed a Consolidated and Amended Class Action Complaint to which a
response is due by April 19, 1999. The Company believes that all of these cases
are without merit and will vigorously defend itself and its officers and
directors.
On October 6, 1998, Advanced Interactive, Inc. filed a complaint in U.S.
District Court for the Northern District of Illinois, Eastern Division, against
ICT and the following other companies: Matsushita Electric Corporation,
Matsushita Electric Industrial Co., Ltd., Sharp Electronics Corp., Sharp Corp.,
Thomson Consumer Electronics, Toshiba Consumer Products, Inc., Toshiba America,
Inc., Toshiba Corporation, General Instruments Corp., Scientific Atlanta, Inc.,
ATI Technologies, Inc., ADS Technologies Inc., Gateway 2000, Inc., STB Systems,
Inc., Hauppauge Computer Works, Inc., WebTV Networks, Inc. and WorldGate
Communications, Inc. (collectively the "Defendants"). Advanced Interactive
alleges that ICT infringed two claims of one of its patents by manufacturing,
using and/or selling or offering to sell "Sourceware(TM) ChannelLink(TM)". The
same allegation is made against each Defendant for its particular product or
service. The Plaintiff seeks damages, but makes no claims against ICT's or any
other Defendant's patents. ICT, and each of the Defendants, have filed an Answer
and seek to collectively join the Motion for Partial Summary Judgment submitted
by Matsushita Electric Corporation of America, Sharp Electronics Corp., Sharp
Corp. and the Toshiba Defendants. The court has not yet considered the
Defendant's collective Motion for Partial Summary Judgment. The Company believes
this case is totally without merit and intends to vigorously defend itself.
In addition, the Company is aware of certain claims against the Company
that have not developed into litigation, or if they have, are dormant, and in
any case are not expected to have a material adverse affect on the Company.
Further, the Company is party to ordinary routine litigation, none of which is
expected to have a material adverse effect on the Company's results of
operations or its financial condition.
EXECUTIVE OFFICERS OF THE COMPANY
Information regarding the Company's executive officers including their
respective ages at March 24, 1999 is set forth below:
<TABLE>
<CAPTION>
NAME AGE POSITION WITH THE COMPANY
---- --- -------------------------
<S> <C> <C>
Timothy P. Peters 41 Chairman of the Board, Chief Executive
Officer and Director
John J. Reed 41 President and Director
F. Paul Tigh 46 Chief Financial Officer and Treasurer
Maryann Walsh 51 General Counsel and Secretary
Daniel D. Maitland 48 Executive Vice President and President
of IT Network
W. Thomas Oliver 56 Executive Vice President and President
of Interactive Channel
</TABLE>
Timothy P. Peters has served as a director of Holdings since its
inception in 1988 and was elected Chief Executive Officer in December 1992 and
Chairman of the Board of Holdings in August 1994. Mr. Peters was President of
Holdings from 1988 to 1996. Mr. Peters has served as Chairman of the Board,
Chief Executive Officer and a director of the Company since June 23, 1995, the
effective date of the Merger and was President from that date until 1996. In
1986, Mr. Peters founded Information Express Co., an operator-assisted Yellow
Pages company that served the Denver area, where he acted as a Vice President
from 1986 to 1988.
John J. Reed has served as a director of Holdings since its inception
in 1988 and as President of Holdings since 1996. Mr. Reed has served as a
director of the Company since June 23, 1995, the effective date of the Merger
and served as Executive Vice President from that date until 1996, when he was
appointed President. From 1990 to December 1996, Mr. Reed served in various
positions with Holdings, including Executive Vice President of Sales and
Marketing. Mr. Reed was Chairman of the Board of ICT from November 1991 to
October 1993, and President of the Interactive Channel from 1994 to 1996. From
1986 to 1989, Mr. Reed was President of Reed & Associates, a Dallas-based real
estate brokerage and professional services firm, of which he is the sole
shareholder. Mr. Reed has conducted business through this firm from time to time
since 1989.
F. Paul Tigh has served as Chief Financial Officer and Treasurer since
July 1998. Mr. Tigh joined the Company in April 1998 as Vice President and
Corporate Controller. Prior to joining Source Media, Mr. Tigh was Chief
Financial Officer for Advanced Telemarketing Corporation. His previous
employment includes increasingly responsible positions with Scientific Atlanta,
Inc., Allied Signal, Inc. and Bendix Corporation.
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<PAGE> 13
Maryann Walsh has served as General Counsel of the Company since
January 1995 and Secretary of the Company since March 1995. Together with Mr.
Peters, she founded Information Express Co. and served as its Corporate Counsel
and Secretary. In 1981, she worked for a law firm in London, England and most
recently was with a law firm in Jakarta, Indonesia from 1989 through 1994. She
was also a counsel with Mobil Oil Corporation in New York City and Denver and
handled U.S. Supreme Court and federal court matters for the U.S. Department of
Justice.
Daniel D. Maitland has served as President of IT Network since October
1997, prior to which he had served as President of the Company's telephone
division since November 1996 and as an Executive Vice President of the Company
since September 1997. In 1986, Mr. Maitland founded BDR Audiotex, Inc., a
telephone information services company. In 1990, that company merged with
Perception Technology. Mr. Maitland became the Executive Vice President and
General Manager of Perception Electronic Publishing. In 1993, Perception
Technology merged with Brite Voice Systems.
W. Thomas Oliver has served as President of the Interactive Channel
since October 1997, prior to which he had served as President of the Company's
television division since June 1996 and as an Executive Vice President of the
Company since September 1997. Mr. Oliver was Executive Vice President of DMX
from 1994 to 1995; President and Chief Executive Officer of International
Cablecasting Technologies from 1987 to 1994; and a Senior Vice President of
Home Box Office from 1973 to 1987.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock has been quoted on The Nasdaq Stock Market
under the symbol "SRCM" since December 8, 1995. Prior to that, the Company's
common stock was quoted on the OTC Bulletin Board.
The following table sets forth the high and low closing sales prices
per share for the common stock for the periods indicated.
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
First Quarter
High $7.38 $14.44
Low 3.63 8.31
Second Quarter
High 10.06 21.63
Low 3.63 13.50
Third Quarter
High 12.00 32.25
Low 8.38 6.28
Fourth Quarter
High 13.88 19.00
Low 8.25 4.94
</TABLE>
On March 24, 1999, the last reported sale price of the common stock was
$15.00 per share. As of March 24, 1999, there were 167 record holders of the
common stock.
The Company has never paid cash dividends. Management intends to retain
any future earnings for the operation and expansion of the Company's business
and does not anticipate paying any cash dividends in the foreseeable future. In
addition, the indenture relating to the Company's Notes and the Certificate of
Designation relating to the Preferred Stock restrict the Company's ability to
pay cash dividends to the holders of its common stock.
13
<PAGE> 14
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
(In thousands, except per share data)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------
1994 1995 1996 1997 (4) 1998 (4)
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Monetary revenues $ 9,194 $ 9,342 $ 8,575 $ 12,387 $ 24,351
Nonmonetary revenues (1) 21,749 15,944 9,944 6,044 1,756
-------- -------- -------- -------- --------
Total revenues 30,943 25,286 18,519 18,431 26,107
Monetary cost of sales 5,248 4,937 3,485 8,611 12,673
Nonmonetary cost of sales (1) 21,749 15,944 9,944 6,044 1,756
-------- -------- -------- -------- --------
Total cost of sales 26,997 20,881 13,429 14,655 14,429
-------- -------- -------- -------- --------
Gross profit 3,946 4,405 5,090 3,776 11,678
Selling, general and administrative expenses 8,987 7,952 11,747 19,599 24,772
Amortization of intangible assets 1,684 1,031 1,031 4,987 6,320
Research and development expenses 2,706 3,750 6,331 3,680 3,410
Impairment of intangible assets 1,900 -- -- -- 25,936
-------- -------- -------- -------- --------
Operating loss (11,331) (8,328) (14,019) (24,490) (48,760)
Interest (income) expense, net 296 137 (174) 4,498 10,897
Other (income) expense (2) 1,230 (277) 10 (62) (27)
Charges related to financing incentives -- 1,581 -- -- --
-------- -------- -------- -------- --------
Net loss before extraordinary item (12,857) (9,769) (13,855) (28,926) (59,630)
Extraordinary loss - extinguishment of debt -- -- -- 3,455 --
-------- -------- -------- -------- --------
Net loss (12,857) (9,769) (13,855) (32,381) (59,630)
Preferred stock dividends 1,621 833 -- 416 2,996
-------- -------- -------- -------- --------
Net loss attributable to common stockholders $(14,478) $(10,602) $(13,855) $(32,797) $(62,626)
======== ======== ======== ======== ========
Net loss per common share $ (3.22) $ (1.65) $ (1.39) $ (2.89) $ (5.21)
======== ======== ======== ======== ========
Weighted average common shares outstanding 4,498 6,413 9,935 11,354 12,012
======== ======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------------------------------------------------
1994 1995 1996 1997 1998
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents $ 127 $ 17,479 $ 4,303 $ 8,431 $ 11,662
Working capital (deficit) (7,608) 12,223 (466) 31,288 19,947
Total assets 8,219 24,195 15,897 113,502 56,589
Long-term debt and capital lease
obligations (including current portion) 653 219 4,720 100,000 100,000
Redeemable convertible preferred stock (3) 16,236 -- -- -- --
Senior PIK preferred stock -- -- -- 13,698 16,628
Total stockholders' equity (capital deficiency)(3) (21,965) 13,037 30 (12,408) (71,509)
</TABLE>
(1) Nonmonetary revenues and nonmonetary cost of sales associated with
barter transactions are included in the consolidated statements of
operations at the estimated fair values of advertising time and
information content received. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and Note 2 -
Significant Accounting Policies of Notes to the Consolidated Financial
Statements.
(2) Includes $1,479,000 of expenses related to a discontinued public
offering for the year ended December 31, 1994.
(3) All of the outstanding redeemable convertible preferred stock was
converted to common stock as part of the Merger. See Note 1 - Company
Description and History in Notes to the Consolidated Financial
Statements.
(4) See MD&A and Footnote 2 and Footnote 5 regarding acquisitions and
impairment of intangibles.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Source Media operates through its subsidiaries in two business
segments: IT Network and Interactive TV. The Interactive TV business includes
the Interactive Channel, Inc. and Interactive Channel Technologies Inc.
14
<PAGE> 15
IT Network sells advertising and related support services to clients
who sponsor a promotional message with interactive content supplied or otherwise
managed by IT Network. IT Network's products and services are distributed
primarily through the Company's Publisher Partners which include over 500 Yellow
Page directories with distribution of over 100 million households and more than
200 daily newspapers with aggregate circulation of over 20 million. IT Network's
products and services are available in over 150 Dominant Market Areas (DMAs)
across North America, Hawaii and the Caribbean. Products and services are also
promoted and distributed over radio, television and the Internet.
The Company's Interactive TV business consists of the combined efforts
of the Interactive Channel and ICT subsidiaries. The Company has designed and is
developing proprietary software and interactive programming services that can
enable digital, two-way television systems equipped with digital (or advanced
analog) set-top boxes to deliver two-way, interactive programming with the touch
of a set-top remote or with the use of a wireless keyboard.
On January 14, 1997, the Company acquired all of the outstanding shares
that it did not already own of ICT in exchange for 1,390,000 shares of the
Company's common stock, making ICT a wholly-owned subsidiary of the Company.
Holdings owns all the patents and the proprietary technology utilized by the
Company for the Interactive Channel. ICT developed the Company's patented
technology 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.
On October 30, 1997, the Company purchased certain of the electronic
publishing assets of Brite for $35.6 million and certain of the assets of VNN, a
unit of Tribune Company, for $9.0 million. Throughout the second quarter of
1998, a significant portion of the customer contracts purchased in the Brite
acquisition were cancelled or not renewed. As a result, the Company reviewed the
value assigned to the contract rights and certain related intangible assets
acquired in the Brite purchase and found them, along with the goodwill
associated with the Brite acquisition, to be impaired, resulting in a write-off
of $25.9 million in the second quarter of 1998.
On February 11, 1999 the Company and Prevue executed a Letter of Intent
to enter into a joint venture ("Newco") to exploit the Company's Interactive TV
business. The Letter of Intent is subject to the execution of definitive
documentation, including representations and warranties, covenants and
conditions to closing. There can be no assurance that the Company and Prevue
will be able to agree on the form of such definitive documents or that, if
agreed upon, the transaction will be consummated.
YEARS ENDED DECEMBER 31, 1998 AND 1997
Monetary Revenues increased 97% to $24.4 million for the year ended
December 31, 1998 from $12.4 million for the year ended December 31, 1997. The
net increase of $12.0 million was attributable to increases of $5.8 million in
the Company's voice information services related to service contracts acquired
from Brite and VNN and $6.2 million from growth in the Company's existing
advertising sales business. The introduction of the Company's Yellow Page tab
product, the expansion of the LocalSource(SM) products, re-entry into the
Ameritech markets and further expansion of the Company's sales force to increase
sales in other existing markets is attributable for $3.9 million of the
advertising sales growth. The remaining advertising sales growth resulted from
certain new advertising agreements that earned approximately $2.3 million in
revenue for the year ended December 31, 1998. Under the new advertising
agreements, revenue from print advertising is earned at the time of the
directory distribution while revenue for services agreements and prior
advertising agreements is earned and recognized over the term of the contract.
Nonmonetary revenues and nonmonetary cost of sales declined 71% to $1.8
million for the year ended December 31, 1998 from $6.0 million for the year
ended December 31, 1997 as the Company reevaluates its volume of barter
business. Nonmonetary sales account for 7% of revenues in 1998 compared to 33%
of revenues in 1997.
Monetary cost of sales increased 47% to $12.7 million for the year
ended December 31, 1998 from $8.6 million for the year ended December 31, 1997.
This increase resulted from (i) $3.5 million in Yellow Page acquisition costs
(purchased yellow pages and tabs as well as revenue shared with publishers) due
to the increase in advertising sales, (ii) $3.4 million of operating expenses
primarily related to support new services acquired in the fourth quarter of 1997
from Brite and VNN as well as the new LocalSource(SM) and tab products and (iii)
$0.3 million for expenses associated with a failure of the Galaxy IV satellite.
These increases were offset by
15
<PAGE> 16
decreased expenses in 1998 of $2.0 million related to a 1997 write-off of
certain analog assets and related electronic components and $1.1 million
primarily due to decreased headcount at Interactive Channel associated with the
termination of the Colorado Springs analog pilot.
Selling, general and administrative expenses, including amortization
of intangible assets increased 26% to $31.1 million for the year ended December
31, 1998 from $24.6 million for the year ended December 31, 1997. This increase
resulted from (i) $4.9 million of expenses incurred by IT Network primarily to
support new services and advertising contracts acquired from Brite and VNN as
well as its new LocalSource(SM) and tab products, (ii) $2.1 million of non-cash
variable compensation expense for certain stock options granted to employees in
excess of shares authorized, (iii) $0.5 million in a non-cash legal settlement,
(iv) $0.9 million of bad debt write-offs primarily in connection with services
provided to customers acquired as part of the Brite and VNN acquisitions, and
(v) $1.9 million of amortization of certain contract rights and goodwill
acquired from Brite and VNN during the 4th quarter of 1997. These increases were
offset by decreases of $0.6 million in amortization expense at ICT and $3.2
million in television related expenses, primarily related to the termination of
operations in our analog markets.
Impairment of intangible assets of $25.9 million resulted from a
reduction in the carrying value of intangible assets recorded as part of the
acquisition of Brite and VNN. Subsequent to the acquisition, the Company learned
that former Brite and IT Network employees had formed a company to service many
of the former Brite customers. As a result, several customers canceled or did
not renew their contracts with IT Network. The Company reviewed the valuation of
the acquired assets recorded at the time of acquisition and found the assets
were impaired. As a result of the financial analysis of the expected discounted
future cash flows of the remaining customer base, the Company recorded a $25.9
million non-cash write-down of the Brite contract rights, non-compete agreement
and goodwill in the second quarter of 1998.
Research and Development expenses declined 7% to $3.4 million for the
year ended December 31, 1998 from $3.7 million for the year ended December 31,
1997. The decrease of $0.3 million is reflective of less spending in 1998 due to
the completion of development of an analog chip and set-top box.
Other income and expenses. Net interest expense was $10.9 million for
the year ended December 31, 1998 compared to net interest expense of $4.5
million for the year ended December 31, 1997. The increase of $6.4 million is
primarily due to the interest payable on the $100 million of debt financing
completed by the Company in October 1997 and described in detail in the Notes to
the Financial Statements.
YEARS ENDED DECEMBER 31, 1997 AND 1996
Monetary revenues increased 44% to $12.4 million for the year ended
December 31, 1997 from $8.6 million for the year ended December 31, 1996. The
net increase of $3.8 million was the result of an increase of (i) $3.1 million
attributable to the Company's voice information services related to new service
contracts acquired from Donnelly and GTE, (ii) $1.9 million attributable to
contracts acquired from Brite and VNN, and (iii) $0.3 million attributable to
the introduction of the Company's LocalSource(SM) product. These increases were
partially offset by declines of (i) $0.7 million attributable to ICT, (ii) $0.6
million attributable to the printed publications, and (iii) $0.2 million
attributable to the Company's consumer tips service.
The decline in Yellow Pages monetary revenues primarily reflects the
termination of distribution in 20 DMAs, 12 of which were located in the
Ameritech region, five within the Southwestern Bell region, and three of which
were located within the DonTech region. Total monetary revenues in the 20
terminated DMAs were $0.2 million for the year ended December 31, 1997 compared
with $1.7 million for the year ended December 31, 1996. This decline was
partially offset by increases of $0.6 million related to 12 new DMAs and $0.3
million in the Company's other 39 existing DMAs.
The decrease in ICT's revenues 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.
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% to $6.0
million for the year ended December 31, 1997 from $9.9 million for the year
ended December 31, 1996. Substantially all of this $3.9 million decline in
nonmonetary revenues and nonmonetary cost of sales occurred because of the
termination of distribution agreements in certain DMAs and because, in other
16
<PAGE> 17
DMAs, the Company reduced the amount of space devoted to information provided
by media sponsors and, accordingly, renewed its barter contracts with such media
sponsors for lesser amounts of promotional advertising.
Monetary cost of sales increased 147% to $8.6 million for the year
ended December 31, 1997 from $3.5 million for the year ended December 31, 1996.
This increase resulted from (i) operating personnel salaries, depreciation
expense, and various other operating expenses totaling $2.2 million attributable
to Interactive Channel operations in Colorado Springs and Denton, (ii) a $2.0
million write-off of certain analog assets and related electronic components in
connection with the Company's decision to pursue a digital set-top box strategy,
and (iii) increased operating personnel salaries and various other operating
expenses totaling $0.9 million incurred by IT Network to support new services
and advertising contracts acquired from Donnelly, GTE, Brite and VNN as well as
its new LocalSource(SM) product.
Selling, general and administrative expenses, including amortization of
intangible assets increased 92% to $24.6 million for the year ended December 31,
1997 from $12.8 million for the year ended December 31, 1996. This increase
resulted from (i) increases of certain programming, personnel salaries,
subscriber acquisition, travel and various other Interactive Channel expenses
totaling $5.0 million, (ii) increased customer service, sales, marketing and
administrative expenses incurred by IT Network to support new services and
advertising contracts acquired from Donnelly, GTE, Brite and VNN as well as its
new LocalSource(SM) product, (iii) costs associated with, and settlement of, a
legal dispute in 1997, and (iv) a $0.3 million write-off of certain analog
assets. Amortization of intangible assets increased by $4.0 million in 1997 as a
result of the amortization of patents related to the Company's acquisition of
the remaining shares of ICT during 1997 as well as the amortization of certain
contract rights and goodwill acquired from Donnelly, GTE, Brite and VNN.
Research and development expenses declined 42% to $3.7 million for the
year ended December 31, 1997 from $6.3 million for the year ended December 31,
1996. This decrease reflects lower Interactive Channel development expenses
following the commercial introduction of Interactive Channel.
Other income and expenses. Net interest expense was $4.5 million for
the year ended December 31, 1997 compared with net interest income of $0.2
million in 1996. Net interest expense in 1997 consisted of (i) interest expense
on higher debt balances outstanding during 1997, and (ii) 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. In 1996, net
interest income was generated from the proceeds from a public offering of the
Company's common stock in December 1995.
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
IT Network and develop, conduct trials and commercially launch Interactive TV.
As of December 31, 1998, the Company had an accumulated deficit of $148.9
million and had used cumulative net cash in operations of $76.0 million. The
difference at December 31, 1998, between the accumulated deficit and cumulative
net cash used in operations since inception was attributable primarily to
nonmonetary charges related to financing incentives and extinguishment of debt,
variable compensation expense, write-downs of analog set-top boxes and
intangible assets, depreciation and amortization and other non-cash expenses. As
a result of the October 1997 Brite and VNN acquisitions, the Company has
experienced growth in its revenues, gross margins, and operating expenses.
However, the effect of the lost customers associated with the Brite acquisition
will continue to have a negative impact on the Company's revenues and
profitability. The Company will continue to incur operating losses at least
through 1999, although it expects that cash used in IT Network operations
excluding related interest expense will decrease going forward as a result of
other growth initiatives. Any launch of the Company's television products and
services may require additional expenditures, which may require the Company to
raise additional capital.
Closing the joint venture with Prevue will provide both immediate and
long-term liquidity benefits and potential liquidity risks to the Company: (i)
at closing, the Interactive TV research and development costs and certain other
costs will become costs of Newco; (ii) at closing, Prevue will pay the Company
$12.0 million cash for 842,105 shares of common stock; (iii) at closing, Prevue
will receive warrants which they may exercise at any time within five years to
buy approximately 14.2 million shares of the Company common stock at $14.25 per
share. If fully exercised, these warrants will result in proceeds of
approximately $200 million and give Prevue an approximate 40% ownership of the
Company. (iv) The Company may face capital calls for Newco and has committed to
a proportionate share of the second $10.0 million of funding and may face
dilution for capital calls it doesn't meet. Also, in connection with the
proposed transaction with Prevue, the Company may face liquidated damages upon
the occurrence of certain events more fully described in "Business - Proposed
Transaction".
17
<PAGE> 18
Since its inception, the Company has financed its operations primarily
through an aggregate $156.6 million raised from various financing activities,
including the incurrence of debt and issuance of the Company's common stock and
preferred stock. In October 1997, the Company issued $100.0 million of its Notes
and $20.0 million of Preferred Stock. The interest escrow account created
pursuant to the indenture has been and will be used to fund the first four
interest payments on the Notes. Interest payments from the interest escrow
account were made on May 1, 1998 and November 1, 1998. The Company's primary
source of liquidity is its cash, cash equivalents and short-term investments,
which totaled $23.4 million at December 31, 1998. This cash position consists of
$11.7 million held in escrow for debt payments, and $11.7 million of operating
cash. The Company's first interest payment not currently held in escrow is due
May 1, 2000.
The Company currently 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 the Interactive Channel, ICT,
and IT Network through the fourth quarter of 1999.
The Company's future capital requirements will depend on many factors,
including, but not limited to the following factors, some of which are outside
the Company's control: (i) the operating results of IT Network, including the
Company's ability to successfully integrate its acquired businesses into its
existing business, and to retain and grow its customer base, (ii) the success
and timing of the development, introduction and deployment of the Interactive
Channel, (iii) the extent to which the Company is able to generate revenues from
licensing its proprietary technology, (iv) the number of file servers and other
equipment which the Company purchases in support of the Interactive Channel, (v)
the levels of advertising expenditures necessary to increase awareness of the
Interactive Channel, (vi) the extent of market acceptance of the Company's
products, (vii) potential acquisitions or asset purchases, (viii) the deployment
of digital set-top boxes incorporating the Company's technology, and (ix)
competitive factors.
YEAR 2000 DISCLOSURE
The Year 2000 issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Any of the
Company's computer programs or hardware that have date-sensitive software or
embedded chips may recognize a date using "00" as the year 1900 rather than the
year 2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary inability
to process transactions, send invoices, or engage in similar normal business
activities.
Based on recent assessments, the Company determined that it will be
required to modify or replace portions of its software and certain hardware so
that those systems will properly utilize dates beyond December 31, 1999. The
Company presently believes that with modifications or replacements of existing
software and certain hardware, the Year 2000 issue can be mitigated. However, if
such modifications and replacements are not made, or are not completed in a
timely manner, the Year 2000 issue could have a material impact on the
operations of the Company.
The Company's plan to resolve the Year 2000 issue involves the
following four phases: assessment, remediation, testing and implementation. To
date, the Company has completed its initial assessment of all systems that could
be significantly affected by the Year 2000. The Company's three operating
subsidiaries: ICT, Interactive Channel and IT Network as well as the Corporate
unit were included in the assessment. The assessment indicated that most of the
Company's significant information technology systems could be affected. That
assessment also indicated that software and hardware (embedded chips) used in
the IT Network's interactive voice response systems also are at risk
(hereinafter referred to as operating systems). In addition, the Company is
gathering information about the Year 2000 compliance status of its significant
suppliers and subcontractors and is continuing to monitor their compliance.
Regarding its information technology, the Company is approximately 80%
complete on the remediation phase and expects to complete software reprogramming
and replacement for all systems no later than October 31, 1999. Once software is
reprogrammed or replaced for a system, the Company will begin testing and
implementation. These phases run concurrently for different systems. To date,
the Company has completed approximately 75% of its testing and has implemented
approximately 30% of its remediated systems. Completion of the testing phase for
all significant systems is expected by July 31, 1999, with all remediated
systems fully tested and implemented by October 31, 1999.
The Company has initiated the remediation phase of its operating
equipment. The remediation of operating equipment is significantly more
difficult than the remediation of the information technology systems because
some of the software operating systems are no longer supported by the
manufacturers of that equipment. Testing of this equipment is also more
difficult than the testing of the information technology systems; the Company is
approximately 30% complete with the testing of its remediated operating
equipment. Once testing is complete, the operating equipment will be ready for
immediate use. The Company expects to
18
<PAGE> 19
complete its remediation of operating equipment by July 31, 1999. Testing and
implementation of affected equipment is expected to be complete by October 31,
1999.
The Company is in the process of working with third party vendors to
ensure that the Company's systems that interface directly with third parties are
Year 2000 compliant by December 31, 1999. The Company has completed
approximately 85% of its remediation efforts on these systems and is
approximately 50% complete with the testing phase. Testing of all significant
systems is expected no later than July 31, 1999. Implementation is approximately
50% complete and is expected to be completed by May 31, 1999.
The Company is querying its significant suppliers and subcontractors
that do not share information systems with the Company (external agents). To
date, the Company is not aware of any external agent with a Year 2000 issue that
would materially impact the Company's results of operations, liquidity, or
capital resources. However, the Company has no means of ensuring that external
agents will be Year 2000 ready. The inability of external agents to complete
their Year 2000 resolution process in a timely manner could materially impact
the Company. The effect of non-compliance by external agents is not
determinable.
The Company will utilize both internal and external resources to
reprogram, or replace, test, and implement the software and operating equipment
for Year 2000 modifications. The total cost of the Year 2000 project is
estimated at $1.4 million and is being funded through operating cash flows. To
date, the Company has incurred approximately $0.2 million, related to all phases
of the Year 2000 project. Of the total remaining project costs, approximately
$1.0 million is attributable to the purchase of new software the operating
equipment, which will be capitalized. The remaining $0.2 million relates to
repair of hardware and software that will be expensed as incurred.
Management of the Company believes it has an effective program in place
to resolve the Year 2000 issue in a timely manner. The Company has not yet
completed all necessary phases of the Year 2000 program. There can be no
assurance that the Company's efforts to solve its potential Year 2000 problems
will be successful, or even partially successful. In the event that the Company
does not complete any additional phases, the Company may be unable to take
customer orders, provide services and products, invoice customers or collect
payments. In addition, disruptions in the economy generally resulting from Year
2000 issues could also materially adversely affect the Company. The Company
could be subject to litigation for computer systems product failure, equipment
shutdown or failure to properly date business records. The amount of potential
liability and lost revenue cannot be reasonably estimated at this time.
The Company has contingency plans for certain critical applications and
is working on such plans for others. These contingency plans involve manual
workarounds, telecommunication alternatives, staff adjustments and other
appropriate actions.
FACTORS THAT MAY AFFECT FUTURE RESULTS
This Management's Discussion and Analysis of Financial Condition and
Results of Operations includes certain forward-looking statements of the Company
including future market trends, estimates regarding the economy and the
information service industry in general and key performance indicators which
impact the Company. In developing any forward-looking statements, the Company
makes a number of assumptions including expectations for continued market
growth, anticipated revenue and gross margin levels, and cost savings and
efficiencies. If the industry's or the Company's performance differs materially
from these assumptions or estimates, the Company's actual results could vary
significantly from the estimated performance reflected in any forward-looking
statements. Accordingly, forward-looking statements should not be relied upon as
a prediction of actual results.
NET OPERATING LOSS CARRYFORWARDS
At December 31, 1998, Holdings had net operating loss carryforwards of
approximately $87.4 million for U.S. Federal income tax purposes, which begin to
expire in 2003. See Note 11 - Income Taxes of Notes to Consolidated Financial
Statements included elsewhere herein. 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 a portion of the net operating losses is limited to approximately $9.0
million in a given year.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to changes in interest rates related primarily
to its Notes and Preferred Stock arrangements. Under
19
<PAGE> 20
its current policies, the Company does not use interest rate derivative
instruments to manage exposure to interest rate changes. At December 31, 1998,
the Company had Notes outstanding of $100.0 million, due November 1, 2004, which
bears interest at a fixed rate of 12% and Preferred Stock outstanding of $22.8
million due November 1, 2007, which bears interest at a fixed rate of 13 1/2%.
The fair value of the Notes and Preferred Stock at December 31, 1998 was
approximately $70.0 million and $16.4 million, respectively, based upon dealer
quoted market prices.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Report of Independent Auditors, and the consolidated financial
statements of the Company and the notes thereto appear on pages 23 through 42 of
this Report.
ITEM 9. DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
Certain information with respect to persons who are or may be deemed to
be executive officers of the Company is set forth under the caption "Executive
Officers of the Company" in Part I of this report. The sections entitled
"Election of Directors" and "Section 16(a) Beneficial Ownership Reporting
Compliance" appearing in the Company's proxy statement for the 1999 annual
meeting of stockholders sets forth certain information with respect to the
executive officers and directors of the Company and are incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION
The section entitled "Executive Compensation" appearing in the
Company's proxy statement for the 1999 annual meeting of stockholders sets forth
certain information with respect to the compensation of management of the
Company and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF BENEFICIAL OWNERS AND MANAGEMENT
The section entitled "Security Ownership of Certain Beneficial Owners
and Management" appearing in the Company's proxy statement for the 1999 annual
meeting of stockholders sets forth certain information with respect to the
ownership of the Company's common stock and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
The section entitled "Certain Transactions" appearing in the Company's
proxy statement for the 1999 annual meeting of stockholders sets forth certain
information with respect to certain business relationships and transactions
between the Company and its directors and officers and is incorporated herein by
reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this report:
(1) Financial Statements included in Item 8 herein:
Report of Independent Auditors
Covered by Report of Independent Auditors:
Consolidated Balance Sheets at December 31, 1997 and 1998
Consolidated Statements of Income for the years ended December
31, 1996, 1997, 1998
Consolidated Statements of Stockholders' Equity for the years
ended December 31, 1996, 1997, 1998
Consolidated Statements of Cash Flows for the years ended
December 31, 1996, 1997, 1998
20
<PAGE> 21
Notes to Consolidated Financial Statements
(2) Financial Statement Schedules included in Item 8 herein:
All schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are presented in
the consolidated financial statements or are not required under the
related instructions or are inapplicable or immaterial in relation to
the consolidated financial statements and, therefore, have been
omitted.
(3) Exhibits:
The information required by this Item 14(a)(3) is set forth in the
Index to Exhibits accompanying this Annual Report on Form 10-K.
(b) Reports on Form 8-K filed during the quarter ended December 31, 1998:
None.
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<PAGE> 22
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) of the
Securities Exchange Act of 1934, Source Media, Inc. has duly caused this Annual
Report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: March 30 , 1999 SOURCE MEDIA, INC.
--------------
By /S/ TIMOTHY P. PETERS
-----------------------------------
Timothy P. Peters
Chairman of the Board, Chief Executive
Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Annual Report has been signed by the following persons in the capacities
and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/S/ TIMOTHY P. PETERS Chairman of the Board and Chief Executive Officer March 30, 1999
- ----------------------------------- (Principal Executive Officer) -------------
Timothy P. Peters
/S/ F. PAUL TIGH Chief Financial Officer and Treasurer March 30, 1999
- ----------------------------------- (Principal Financial and Accounting Officer) -------------
F. Paul Tigh
/S/ JOHN J. REED President and Director March 30, 1999
- ----------------------------------- -------------
John J. Reed
/S/ MICHAEL S. WILLNER Director March 30, 1999
- ----------------------------------- -------------
Michael S. Willner
/S/ JAMES L. GREENWALD Director March 30, 1999
- ----------------------------------- -------------
James L. Greenwald
/S/MICHAEL J. MAROCCO Director March 30, 1999
- ----------------------------------- -------------
Michael J. Marocco
/S/ ROBERT H. ALTER Director March 30, 1999
- ----------------------------------- -------------
Robert H. Alter
/S/ BARRY RUBENSTEIN Director March 30, 1999
- ----------------------------------- -------------
Barry Rubenstein
</TABLE>
22
<PAGE> 23
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders of Source Media, Inc.
We have audited the accompanying consolidated balance sheets of Source Media,
Inc. (the Company) as of December 31, 1997 and 1998, and the related
consolidated statements of operations, stockholders' equity (capital
deficiency), and cash flows for each of the three years in the period ended
December 31, 1998. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Source Media,
Inc., at December 31, 1997 and 1998, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
Dallas, Texas
February 19, 1999
23
<PAGE> 24
SOURCE MEDIA, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1998
------------- -------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 8,430,941 $ 11,661,703
Short-term investments 15,615,419 --
Restricted investments 11,709,921 11,715,784
Trade accounts receivable, less allowance
for doubtful accounts of $153,694 and $387,330
in 1997 and 1998, respectively 2,796,241 3,595,788
Deferred expenses 990,687 446,788
Prepaid expenses and other current assets 843,005 937,492
------------- -------------
Total current assets 40,386,214 28,357,555
Property and equipment:
Production equipment 5,693,939 6,050,284
Computer equipment 2,652,103 3,272,883
Other equipment 753,883 1,149,886
Furniture and fixtures 523,516 660,167
------------- -------------
9,623,441 11,133,220
Accumulated depreciation 4,193,484 6,733,398
------------- -------------
Net property and equipment 5,429,957 4,399,822
Intangible assets:
Patents 14,942,465 14,944,242
Goodwill 22,372,837 6,698,137
Contract rights 24,487,000 11,933,377
------------- -------------
61,802,302 33,575,756
Accumulated amortization 10,528,869 14,556,638
------------- -------------
Net intangible assets 51,273,433 19,019,118
Restricted investments 11,090,574 --
Other non-current assets 5,321,848 4,812,584
------------- -------------
Total assets $ 113,502,026 $ 56,589,079
============= =============
</TABLE>
24
<PAGE> 25
SOURCE MEDIA, INC.
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDER'S EQUITY (CAPITAL DEFICIENCY)
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1998
------------- -------------
<S> <C> <C>
Current liabilities:
Trade accounts payable $ 1,654,404 $ 2,500,962
Accrued interest 2,066,667 2,000,000
Accrued payroll 150,062 539,889
Other accrued liabilities 1,202,665 1,619,464
Unearned income 4,024,164 1,750,202
------------- -------------
Total current liabilities 9,097,962 8,410,517
Long-term debt 100,000,000 100,000,000
Minority interests in consolidated subsidiaries 3,839,552 3,839,552
Note receivable and accrued interest from minority
stockholder, net of discount of $95,437 and
$53,723 in 1997 and 1998, respectively (723,645) (780,359)
------------- -------------
3,115,907 3,059,193
Senior redeemable payment-in-kind (PIK) preferred stock,
$25 liquidation preference, $.001 par value, net of
discount
Authorized shares - 1,000,000 and 1,712,000 and
800,000 and 913,632 shares issued and outstanding in
in 1997 and 1998, respectively 13,696,799 16,627,978
Stockholders' equity (capital deficiency):
Common stock, $.001 par value:
Authorized shares - 50,000,000 and
11,969,039 and 13,021,765 shares issued in 1997
and 1998, respectively 11,969 13,022
Less treasury stock, at cost - 410,963 and 280,425 shares in
1997 and 1998, respectively (4,075,127) (2,769,726)
Capital in excess of par value 81,066,822 80,268,950
Accumulated deficit (89,313,113) (148,943,329)
Notes receivable and accrued interest
from stockholders (99,193) (77,526)
------------- -------------
Total stockholders' equity (capital deficiency) (12,408,642) (71,508,609)
------------- -------------
Total liabilities and stockholders' equity (capital deficiency) $ 113,502,026 $ 56,589,079
============= =============
</TABLE>
See accompanying notes.
25
<PAGE> 26
SOURCE MEDIA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
Monetary revenues $ 8,574,823 $ 12,387,459 $ 24,351,325
Nonmonetary revenues 9,944,082 6,043,859 1,755,546
------------ ------------ ------------
Total revenues 18,518,905 18,431,318 26,106,871
Monetary cost of sales 3,485,045 8,611,267 12,673,541
Nonmonetary cost of sales 9,944,082 6,043,859 1,755,546
------------ ------------ ------------
Total cost of sales 13,429,127 14,655,126 14,429,087
------------ ------------ ------------
Gross profit 5,089,778 3,776,192 11,677,784
Selling, general and administrative expenses 11,747,155 19,599,557 24,771,932
Impairment of intangible assets -- -- 25,935,715
Amortization of intangible assets 1,031,337 4,987,099 6,320,375
Research and development expenses 6,330,745 3,679,786 3,409,508
------------ ------------ ------------
19,109,237 28,266,442 60,437,530
------------ ------------ ------------
Operating loss (14,019,459) (24,490,250) (48,759,746)
Interest expense 614,037 5,234,433 12,830,302
Interest income (788,629) (736,638) (1,932,577)
Other expense (income) (36,173) (53,344) (27,255)
Minority interest in earnings (losses) of consolidated
subsidiaries 46,475 (8,970) --
------------ ------------ ------------
Net loss before extraordinary item (13,855,169) (28,925,731) (59,630,216)
Extraordinary loss - early extinguishment of debt -- 3,455,551 --
------------ ------------ ------------
Net loss (13,855,169) (32,381,282) (59,630,216)
Preferred stock dividends -- 416,129 2,995,869
------------ ------------ ------------
Net loss attributable to common stockholders $(13,855,169) $(32,797,411) $(62,626,085)
============ ============ ============
Basic and diluted net loss per common share:
Net loss attributable to common stockholders
before extraordinary item $ (1.39) $ (2.59) $ (5.21)
Extraordinary item -- $ (0.30) --
------------ ------------ ------------
Net loss attributable to common stockholders $ (1.39) $ (2.89) $ (5.21)
============ ============ ============
Weighted average common shares outstanding 9,935,455 11,354,203 12,011,906
============ ============ ============
</TABLE>
See accompanying notes.
26
<PAGE> 27
SOURCE MEDIA, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY)
<TABLE>
<CAPTION>
CAPITAL IN
COMMON STOCK TREASURY EXCESS OF ACCUMULATED
SHARES AMOUNT STOCK PAR VALUE DEFICIT
---------- --------- ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1995 10,303,556 $ 10,304 $ (3,515,563) $ 59,955,392 $ (43,076,663)
Issuance of common stock upon exercise of
stock options 23,485 23 -- 141,777 --
Issuance of warrant with First Tranche Note -- -- -- 745,830 --
Repayment of notes receivable and accrued
interest from stockholder through surrender
of common stock -- -- (242,078) -- --
Other -- -- -- (27,214) --
Net loss -- -- -- -- (13,855,169)
---------- --------- ------------ ------------- -------------
BALANCE AT DECEMBER 31, 1996 10,327,041 10,327 (3,757,641) 60,815,785 (56,931,832)
========== ========= ============ ============= =============
Issuance of common stock upon exercise of
stock options 219,275 219 (317,486) 1,352,194 --
Acquisition of remaining minority interest in
ICT 1,389,723 1,390 -- 10,384,280 --
Issuance of warrants for services provided -- -- -- 279,571 --
Issuance of warrants with Aggregate Tranche
Notes -- -- -- 2,823,091 --
Issuance of warrants associated with Units -- -- -- 5,529,000 --
Other 33,000 33 -- 299,030 --
Net loss -- -- -- -- (32,381,281)
Preferred Stock Dividends -- -- -- (416,129) --
---------- --------- ------------ ------------- -------------
BALANCE AT DECEMBER 31, 1997 11,969,039 11,969 (4,075,127) 81,066,822 (89,313,113)
========== ========= ============ ============= =============
Issuance of common stock upon exercise of
stock options 93,779 94 -- 640,944 --
Issuance of stock for legal settlements -- -- 866,876 (243,526) --
Issuance of stock for employee stock plan -- -- 438,525 (253,192) --
Exercise of warrants 958,947 959 -- -- --
Stock Compensation -- -- -- 2,053,771 --
Other -- -- -- -- --
Net loss -- -- -- -- (59,630,216)
Preferred Stock Dividends -- -- -- (2,995,869) --
---------- --------- ------------ ------------- -------------
BALANCE AT DECEMBER 31, 1998 13,021,765 $ 13,022 $ (2,769,726) $ 80,268,950 $(148,943,329)
========== ========= ============ ============= =============
</TABLE>
<TABLE>
<CAPTION>
NOTES TOTAL
RECEIVABLE STOCKHOLDERS'
FROM EQUITY (CAPITAL
STOCKHOLDERS DEFICIENCY)
----------- ------------
<S> <C> <C>
BALANCE AT DECEMBER 31, 1995 $ (301,575) $ 13,071,895
Issuance of common stock upon exercise of
stock options -- 141,800
Issuance of warrant with First Tranche Note -- 745,830
Repayment of notes receivable and accrued
interest from stockholder through surrender
of common stock 242,078 --
Other (50,694) (77,908)
Net loss -- (13,855,169)
----------- ------------
BALANCE AT DECEMBER 31, 1996 (110,191) 26,448
=========== ============
Issuance of common stock upon exercise of
stock options -- 1,034,927
Acquisition of remaining minority interest in
ICT -- 10,385,670
Issuance of warrants for services provided -- 279,571
Issuance of warrants with Aggregate Tranche
Notes -- 2,823,091
Issuance of warrants associated with Units -- 5,529,000
Other 10,998 310,061
Net loss -- (32,381,281)
Preferred Stock Dividends -- (416,129)
----------- ------------
BALANCE AT DECEMBER 31, 1997 (99,193) (12,408,642)
=========== ============
Issuance of common stock upon exercise of
stock options -- 641,038
Issuance of stock for legal settlements -- 623,350
Issuance of stock for employee stock plan -- 185,333
Exercise of warrants -- 959
Stock Compensation -- 2,053,771
Other 21,667 21,667
Net loss -- (59,630,216)
Preferred Stock Dividends -- (2,995,869)
----------- ------------
BALANCE AT DECEMBER 31, 1998 $ (77,526) $(71,508,609)
=========== ============
</TABLE>
See accompanying notes.
27
<PAGE> 28
SOURCE MEDIA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1996 1997 1998
------------ ------------- ------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss ($13,855,169) ($ 32,381,282) ($59,630,216)
Adjustments to reconcile net loss to net cash used in
operating activities:
Impairment of intangible assets -- -- 25,935,715
Depreciation 906,982 2,313,692 2,539,914
Amortization of intangible assets 1,031,337 4,987,099 6,320,375
Stock Compensation -- -- 2,053,771
Write-off of analog set-top boxes -- 1,999,339 --
Non-cash interest expense 589,990 2,969,179 832,716
Non-cash interest income -- -- (981,955)
Provision for losses on accounts receivable 82,269 194,731 1,076,753
Extinguishment of debt -- 3,455,551 --
Warrants issued for services provided -- 279,571 --
Issuance of common stock in litigation settlement -- 299,063 623,350
Other, net (12,978) 260,382 (61,714)
Changes in operating assets and liabilities:
Trade accounts receivable 37,892 (2,034,894) (1,876,300)
Prepaid expenses and other current assets (274,967) 324,196 (94,487)
Deferred expenses 159,574 (260,868) 543,899
Trade accounts payable and accrued liabilities (518,287) 312,463 1,586,517
Accrued interest -- 1,893,604 --
Unearned income (748,713) 47,920 (2,273,962)
------------ ------------- ------------
Net cash used in operating activities (12,602,070) (15,340,254) (23,405,624)
INVESTING ACTIVITIES
Capital expenditures (2,678,970) (2,674,729) (1,509,779)
Redemption of short-term investments -- -- 27,682,085
Restricted investments (611,182) (22,189,313) --
Acquisition of equipment and contract rights (1,200,000) (1,350,000) --
Purchase of short-term investments -- (15,615,419) --
Interactive Channel Technologies acquisition costs (645,984) -- --
Acquisition of Brite -- (35,550,000) --
Acquisition of VNN -- (9,000,000) --
Capitalized acquisition costs -- (262,352) --
Other (47,998) -- --
------------ ------------- ------------
Net cash provided by (used in) investing activities (5,184,134) (86,641,813) 26,172,306
FINANCING ACTIVITIES
Net proceeds from issuance of long-term debt 4,606,163 94,548,351 --
Net proceeds from issuance of Second Tranche Notes -- 13,922,625 --
Payments on debt -- (21,986,792) --
Net proceeds from issuance of preferred stock and warrants -- 18,809,670 --
Proceeds from issuance of common stock upon exercise
of stock options 141,800 1,034,927 641,997
Other (138,039) (218,716) (177,917)
------------ ------------- ------------
Net cash provided by financing activities 4,609,924 106,110,065 464,080
Net increase (decrease) in cash and cash equivalents (13,176,280) 4,127,998 3,230,762
Cash and cash equivalents at beginning of period 17,479,223 4,302,943 8,430,941
------------ ------------- ------------
Cash and cash equivalents at end of period $ 4,302,943 $ 8,430,941 $ 11,661,703
============ ============= ============
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest on long-term debt $ 24,047 $ 285,671 $ 12,066,000
============ ============= ============
</TABLE>
See accompanying notes.
28
<PAGE> 29
SOURCE MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. COMPANY DESCRIPTION AND HISTORY
Source Media, Inc. (the "Company") operates through its subsidiaries
SMI Holdings, Inc. ("Holdings"), IT Network, Inc. ("IT Network"), Interactive
Channel, Inc. ("Interactive Channel"), and Interactive Channel Technologies
Inc. ("ICT") in two business segments: IT Network and Interactive TV.
IT Network sells advertising and related support services to clients
who sponsor a promotional message with interactive content supplied or otherwise
managed by IT Network. IT Network's products and services are distributed
primarily through the Company's Publisher Partners which include Yellow Page
directories and daily newspapers. IT Network's products and services are
available in North America, Hawaii and the Caribbean. Products and services are
also promoted and distributed over radio, television and the Internet.
The Company's Interactive TV business consists of the combined efforts
of the Interactive Channel and ICT subsidiaries. The Company has designed and is
developing proprietary software and interactive programming services that can
enable digital, two-way television systems equipped with digital (or advanced
analog) set-top boxes to deliver two-way, interactive programming with the touch
of a set-top remote or the use of a wireless keyboard.
Holdings (formerly known as IT Network) was incorporated on July 19,
1988, as a Colorado corporation and subsequently, on July 23, 1991,
reincorporated in Texas. On June 23, 1995, Holdings merged (the "Merger") into a
wholly-owned subsidiary of HB Communications Acquisition Corp. ("HBAC").
Pursuant to the Merger agreement, Holdings' outstanding common stock and
preferred stock were converted into an aggregate 6,696,992 shares of the
Company's common stock. In connection with the Merger, HBAC changed its name to
Source Media, Inc.
On February 11, 1999 the Company and Prevue Ventures, Inc. and its
parent, United Video Satellite Group, Inc. (collectively, "Prevue") executed a
Letter of Intent to form a joint venture ("Newco") to exploit the Company's
Interactive TV line of business. The Letter of Intent is subject to the
execution of definitive documentation, including representations and warranties,
covenants and conditions to closing. There can be no assurance that the Company,
Prevue and United Video will be able to agree on the form of such definitive
documents or that, if agreed upon, the transaction will be consummated. See Note
3 - Commitments and Contingencies.
2. SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of the
Company, its wholly-owned subsidiaries Holdings, IT Network, Interactive
Channel; and Holdings' wholly-owned Canadian subsidiaries, ICT and 997758
Ontario Inc. ("997758"). All material intercompany amounts and transactions have
been eliminated. Certain amounts from prior year financial statements have been
reclassified to conform to the current year's presentation.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Minority Interests in Consolidated Subsidiaries
Minority interests in consolidated subsidiaries represent the minority
stockholders' proportionate shares of the equity of 997758 and ICT. At December
31, 1997 and 1998, the Company owned 100% of the voting Class X shares of
997758, while an individual owned 100% of the Class Y nonvoting shares of
997758, as more fully discussed in Note 8 - Stock Options, Warrants, Employee
Stock Purchase Plan and Retirement Plan. At December 31, 1996, the Company owned
approximately 51% of ICT's capital stock, representing approximately 74% voting
control. In January 1997, the Company completed an arrangement whereby it
acquired the remaining shares of ICT, as more fully discussed in Note 5 -
Acquisitions.
29
<PAGE> 30
Cash and Cash Equivalents
The Company classifies all highly liquid investments with original
maturities of three months or less to be cash equivalents. These investments are
recorded at cost, which approximates market.
Monetary Revenue Recognition
IT Network earns monetary revenues by selling advertising and related
support services to clients who sponsor a promotional message with interactive
content supplied primarily by IT Network. The products and services are
distributed primarily through certain Regional Bell Operating Companies or their
affiliates or other Publisher Partners. Monetary revenues and associated costs
relating to print ads appearing in Yellow Pages are recognized at the time of
distribution by the Directory Publishers. For certain contracts, where an
obligation exists to service the advertisement for the contract period, a
portion of the revenue is deferred and amortized on a straight-line basis over
the term of the respective contracts, beginning at the time of the annual
distribution of the applicable local Yellow Pages directory, or at the
applicable contract start date, if later, and continuing to the end of the term
of the respective contracts, which is typically from 3 to 12 months. The
Company also earns monetary revenues from sales of voice information services
to certain Publisher Partners. Monetary revenues relating to non-Yellow Pages
products are also recognized as the services are performed.
Nonmonetary Revenue Recognition
In many of its markets, IT Network has entered into nonmonetary barter
agreements with local television and radio stations. These media sponsors
provide IT Network with advertising time on their stations and update local
news, weather and sports programming in exchange for promotional messages and
print advertisements. 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.
Nonmonetary revenues and cost of sales are recognized on a
straight-line basis over the terms of the respective contracts. The Company was
obligated to provide future services and was entitled to receive future
advertising and information content of $0.3 million and $2.0 million at December
31, 1998 and 1997, respectively.
Property and Equipment
Property and equipment are recorded at cost. Depreciation is computed
using the straight-line method over the estimated useful lives of the assets.
Computer equipment is depreciated over a three-year period. Production and other
equipment are depreciated over a five-year period. Furniture and fixtures are
depreciated over a seven-year period.
The Company continually evaluates the propriety of the carrying value
of property and equipment to determine whether current events and circumstances
warrant adjustment to the carrying value of the assets. As a result of this
periodic evaluation and in light of the Company's decision to discontinue its
analog set-top box strategy in favor of a digital set-top box strategy, in 1997,
the Company recorded a write-down of the remaining net book value of its analog
set-top boxes in the amount of $2.0 million which was charged to monetary cost
of sales.
Intangible Assets
Intangible assets are amortized using the straight-line method over the
following estimated useful lives: patents - five years; contract rights - three
to seven years; and goodwill - five years.
The carrying value of intangible assets is reviewed for impairment
whenever events or changes in circumstances indicate that there may be an
impairment. If the review indicates that any of the intangibles will not be
recoverable, as determined by an analysis of undiscounted cash flows, the
intangible asset will be reduced to its estimated fair value. Subsequent to the
Brite acquisition, (see Note 5 - Acquisitions) the Company learned that former
Brite and IT Network employees had formed a company to service many of these
former Brite clients. As a result, several former Brite customers canceled or
did not renew their contracts with IT Network. The Company reviewed the
valuation of the acquired assets recorded at the time of the acquisition, and
found these assets to be impaired. As a result of the financial analysis of the
expected discounted future cash flows of the remaining customer base, the
Company recorded a $25.9 million ($2.16 per share) non-cash write-down of the
Brite contract rights, non-compete agreement and goodwill in the second quarter
of 1998.
30
<PAGE> 31
Advertising Costs
The Company expenses the costs of advertising as incurred. Advertising
expenses were $1.3 million, $0.4 million and $0.4 million for the years ended
December 31, 1996, 1997 and 1998, respectively.
Translation of Foreign Currencies
The financial positions and results of operations of ICT and 997758 are
measured using local currency (Canadian dollar) as the functional currency.
Assets and liabilities of these subsidiaries are translated at the exchange rate
in effect at each balance sheet date. Statement of operations accounts are
translated at the average rate of exchange prevailing during the year.
Translation adjustments and foreign currency gains and losses have not been
significant and accordingly, have not been separately presented.
Computation of Net Loss Per Common Share
Net loss per common share is calculated in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share". Dilutive
earnings per share has not been presented because the options and warrants are
anti-dilutive.
Stock Options
The Company accounts for employee and director stock option grants in
accordance with Accounting Principles Board Opinion No. 25, "Accounting For
Stock Issued to Employees" ("APB 25") and related Interpretations. Under APB 25,
no compensation expense is recognized for stock option grants to employees and
directors if the exercise price of the Company's stock option grants is at or
above the fair market value of the underlying stock on the date of grant as more
fully described in Note 8 - Stock Options, Warrants, Employee Stock Purchase
Plan and Retirement Plan.
On January 2, 1998, the Company granted stock options to its employees.
The options fully vest on January 2, 2004. If certain target stock prices are
met, the vesting accelerates. As a portion of the underlying shares for these
options had not been authorized by the common stockholders at the date of grant,
the portion of unauthorized options were treated as a variable compensation plan
through July 28, 1998, when the stockholders authorized the shares. The Company
has recognized stock compensation expense of $2.1 million in selling, general
and administrative expense for the year ended December 31, 1998.
3. COMMITMENTS AND CONTINGENCIES
In October 1998, the Company settled all litigation in Ontario,
Canada, in connection with Marvin Lerch, the former Chief Executive Officer
and a former shareholder of ICT and certain of his relatives, also former
ICT shareholders. The settlement resolved all litigation by Lerch and his
family members against the Company, certain executive officers and a former
director of ICT. Under the terms of the settlement, the parties agreed to
dismiss all actions, and the Company agreed to transfer a total of 87,500
shares of the Company's common stock to the plaintiffs. The Company recorded
an additional expense of $.5 million in the fourth quarter of 1998
reflecting this settlement.
On May 11, 1998, ICT and Holdings filed an action in U.S. District
Court for the District of Delaware against WorldGate Communications, Inc.
("WorldGate") alleging that WorldGate has infringed four of the Company's
patents. Each party has filed a Motion to Dismiss certain claims and no date
has been set for a hearing by the district court. The Company intends to
aggressively defend its patents.
In July 1998, the Company initiated an action in the Western District
of Michigan federal court against a former employee of Brite, Michael Shell
("Shell") and three companies (Interactive Media Services, Inc., Interactive
Information Services, LLC, and Talking Directories, Inc. ("TDI")), alleging
copyright infringement and breach of contract. On October 14, 1998, the
federal judge issued a preliminary injunction in favor of the Company
enjoining the competitors from, among other things, selling, licensing,
distributing or reproducing works derived from the Company's information. On
December 2, 1998, the Company filed a Motion for Further Preliminary
Injunctive Relief in Michigan federal court against the same companies
involved in the first action. The action for Further Relief is based on
alleged copyright infringement by the defendant companies of the Company's
proprietary satellite software used to transmit the Company's voice
information to its customers' receiving systems. A trial date has been set
for November 8, 1999. The Company is also involved in certain litigation in
federal and state courts in Kansas related to tortious interference with the
Company's contractual relationships with customers and to violations of
non-compete agreements by former employees of IT Network. The Company
intends to aggressively pursue all of these cases.
On January 11, 1999, Brite Voice Systems, Inc. ("Brite") filed a
lawsuit against IT Network and Source in the United States District Court of
the District of Kansas. Brite alleges three claims: (1) breach of a
September 1997 Asset Purchase Agreement for which Brite seeks recovery of
alleged damages of approximately $112,000; (2) breach of an October 1997
Lease and Service Agreement in connection with such Asset Purchase
Agreement, for which Brite seeks recovery of alleged damages of
approximately $30,000; and (3) a declaratory judgment with respect to all
indemnity claims for which IT Network has provided Brite notice pursuant to
the Asset Purchase Agreement. The Company is required to respond by April
26, 1999, and intends to vigorously defend itself and to assert
counterclaims.
On August 21, 1998, the first of fourteen class action cases was filed
against the Company and certain officers and directors in federal court in
the Northern District of Texas. The litigation is pursuant to the provisions
of the Private Securities Litigation Reform Act of 1995. The federal court
has appointed three firms collectively as the lead counsel, and on March 3,
1999 the plaintiffs filed a Consolidated and Amended Class Action Complaint
to which a response is due by April 19, 1999. The Company believes that all
of these cases are without merit and will vigorously defend itself and its
officers and directors.
On October 6, 1998, Advanced Interactive, Inc. filed a complaint in
U.S. District Court for the Northern District of Illinois, Eastern Division,
against ICT and the following other companies: Matsushita Electric
Corporation, Matsushita Electric Industrial Co., Ltd., Sharp Electronics
Corp., Sharp Corp., Thomson Consumer Electronics, Toshiba Consumer Products,
Inc., Toshiba America, Inc., Toshiba Corporation, General Instruments Corp.,
Scientific Atlanta, Inc., ATI Technologies, Inc., ADS Technologies Inc.,
Gateway 2000, Inc., STB Systems, Inc., Hauppauge Computer Works, Inc., WebTV
Networks, Inc. and WorldGate Communications, Inc. (collectively the
"Defendants"). Advanced Interactive alleges that ICT infringed two claims of
one of its patents by manufacturing, using and/or selling or offering to
sell "Sourceware(TM) ChannelLink(TM)". The same allegation is made against each
Defendant for its particular product or service. The Plaintiff seeks
damages, but makes no claims against ICT's or any other Defendant's patents.
ICT, and each of the Defendants, have filed an Answer and seek to
collectively join the Motion for Partial Summary Judgment submitted by
Matsushita Electric Corporation of America, Sharp Electronics Corp., Sharp
Corp. and the Toshiba Defendants. The court has not yet considered the
Defendant's collective Motion for Partial Summary Judgment. The Company
believes this case is totally without merit and intends to vigorously defend
itself.
31
<PAGE> 32
In addition, the Company is aware of certain claims against the Company
that have not developed into litigation, or if they have, are dormant, and in
any case are not expected to have a material adverse affect on the Company.
Further, the Company is party to ordinary routine litigation, none of which is
expected to have a material adverse effect on the Company's results of
operations or its financial condition.
On February 11, 1999, the Company signed a Letter of Intent with Prevue
to enter into a joint venture, Newco. Under the terms of the Letter of Intent,
if either the Company or Prevue fails to use its good faith commercially
reasonable efforts as such, the other has agreed to pay as liquidated damages
$3.0 million plus out-of-pocket costs and expenses associated with due
diligence and negotiation. In addition, the Company has agreed to pay such
liquidated damages and costs and expenses if it breaches the exclusivity
agreement prior to execution of definitive documents and, within 240 days after
the execution of the Letter of Intent, enters into a significant transaction
with a third party. If the transaction is not consummated after the execution
of definitive documents as a result of the Company's breach of the exclusivity
agreement and the Company enters into a significant transaction with a third
party within one year after the execution of the Letter of Intent, in addition
to a non-exclusive licenses grant, the Company would be required to pay Prevue
as liquidated damages $10.0 million plus out-of-pocket costs and expenses,
provide for two Prevue representatives on a seven-member Board of Directors of
the Company and issue to Prevue five-year warrants to acquire 3,208,700 shares
of the Company's common stock at an exercise price of $7.125 per share.
4. SHORT-TERM AND RESTRICTED INVESTMENTS
The Company held certain short-term investments in 1997, which
consisted of securities that management held to maturity. In 1998, all
investments are highly liquid investments with maturities of three months or
less and, therefore, are classified as cash equivalents.
In connection with the October 1997 offering of Senior Secured Notes,
as more fully described in Note 6 - Long Term Debt, the Company placed
approximately $22.6 million of the net proceeds from the offering, representing
funds sufficient, together with interest thereon, to pay the first four interest
payments on the Senior Secured Notes, into an Interest Escrow Account (the
Escrow Account) for the benefit of the holders of the Senior Secured Notes. As
of December 31, 1998, the Escrow Account, including accrued interest, totaled
$11.7 million. Until disbursed in accordance with the Escrow and Disbursement
Agreement relating to the Escrow Account, the Escrow Account is designed to
secure a portion of the Company's obligations under the Senior Secured Notes.
Funds will be disbursed from the Escrow Account only to pay interest on the
Notes and, upon certain repurchases or redemptions of the Senior Secured Notes,
to pay principal of and premium, if any, thereon. Management has the intent and
ability to hold the securities in the Escrow Account to maturity. These
investments are carried at amortized cost and are summarized as follows on
December 31, 1998:
<TABLE>
<CAPTION>
Gross Unrealized
(In thousands) Amortized Cost Gains Fair Value
------------- -------------- -------------- --------------
<S> <C> <C> <C>
U.S. Government agencies $ 5,806 $ 28 $ 5,834
Corporate obligations 5,910 10 5,920
-------------- -------------- --------------
Restricted investments $ 11,716 $ 38 $ 11,754
============== ============== ==============
</TABLE>
Security fair values are based on market prices or dealer quotes. All
securities mature in 1999.
5. ACQUISITIONS
In October 1996, the Company acquired certain voice information assets
from The Reuben H. Donnelly Corporation (Donnelly) for an aggregate purchase
price of $0.8 million. In connection therewith, the Company executed a services
agreement with a three year minimum term under which Donnelly is obligated to
pay the Company a minimum of $3.2 million over the term of the agreement and the
Company is assuming Donnelly's operating responsibilities for its voice
information services business. The Donnelly asset acquisition has been accounted
for as the purchase of equipment and contract rights and the purchase price was
allocated to the assets based on the estimated fair values at the date of
acquisition.
32
<PAGE> 33
In December 1996, the Company acquired certain voice information
servicing assets from GTE Directories Corporation (GTE) for an aggregate
purchase price of $1.8 million. GTE and the Company executed sales agency and
services agreements with a three year minimum term under which the parties have
agreed to share revenues. The Company assumed operating responsibilities for
GTE's voice information services business. The Company has guaranteed GTE a
minimum of approximately $3.7 million as its percentage of shared revenues over
the term of the agreement with minimum annual targets. If the Company pays the
minimum required amount to GTE under the sales agency agreement, then pursuant
to the services agreement, GTE will pay the Company a minimum of approximately
$0.7 million for services rendered in the final year of the agreement. Through
December 31, 1998 the Company has shared $1.7 million of revenues under
this agreement. Assuming the 1999 target is met, it is expected that any
shortfall of advertising sales in previous years will be offset by the amount
received as the minimum payment from GTE under the final settlement terms of the
service agreements; however, should the Company not meet the minimum revenue
target it may be liable to GTE for such shortfall. The GTE asset acquisition has
also been accounted for as the purchase of equipment and contract rights and the
purchase price was allocated to the assets based on the estimated fair values at
the date of acquisition.
In January 1997, the Company acquired all of the outstanding shares of
ICT held by minority interest shareholders in exchange for 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. Cash expenses related to the acquisition were
approximately $0.8 million. 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.
On October 30, 1997, the Company acquired certain of the electronic
publishing assets of Brite Voice Systems, Inc. (Brite) for a purchase price of
approximately $35.6 million. The Brite acquisition has been accounted for by the
purchase method of accounting and the purchase price was allocated to equipment,
contract rights and goodwill based on the estimated fair values of the assets at
the date of acquisition. (See Note 2 - Significant Accounting Policies for a
description of events subsequent to the date of acquisition.)
Also on October 30, 1997, the Company acquired certain of the assets of
Voice News Network, Inc. (VNN), a subsidiary of Tribune Media Services, Inc., a
unit of Tribune Company, for a purchase price of $9.0 million. The VNN
acquisition has been accounted for by the purchase method of accounting and the
purchase price was allocated to equipment, contract rights and goodwill based on
the estimated fair values of the assets at the date of acquisition.
The operating results of Brite and VNN are included in the Company's
results from the date of acquisition. The following represents the unaudited pro
forma results of operations as if the acquisitions of ICT, Brite and VNN had
occurred on January 1, 1996, after giving effect to certain adjustments,
including minority interest in earnings (losses) of consolidated subsidiaries,
interest expense, preferred stock dividends and amortization of intangibles
resulting from the allocation of the purchase price.
<TABLE>
<CAPTION>
Year Ended December 31,
1996 1997
------------ ------------
(In thousands, except per share amount)
<S> <C> <C>
Total revenues $ 30,356 $ 31,637
Operating loss (20,574) (28,789)
Net loss (32,552) (40,778)
Net loss attributable to common stockholders $ (35,187) $ (43,904)
Net loss per common share $ (3.11) $ (3.87)
</TABLE>
Pro forma results presented above are not necessarily indicative of what
actually would have occurred if the acquisitions had been consummated as of
January 1, 1996, and are not intended to be a projection of future results or
trends.
6. LONG-TERM DEBT
On April 3, 1996, the Company issued a senior note (the First Tranche
Note) in the principal amount of $5.0 million and a
33
<PAGE> 34
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 $0.3 million and $0.4 million,
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 at the date of issuance of the First Tranche Warrant of $0.7 million 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%.
On April 9, 1997, the Company received cash proceeds of $15.0 million
upon the issuance of additional senior notes (the "Second Tranche Notes") in the
principal amount of $15.0 million and warrants (the "Second Tranche Warrants")
which entitled 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. The estimated fair market value of the
Second Tranche Warrants of $1.7 million at the date of issuance was credited to
capital in excess of par value and the Second Tranche Notes were recorded at a
corresponding discount. The discount on the Second Tranche Notes was being
amortized to interest expense using the effective interest rate method over the
stated terms of the Second Tranche Notes resulting in an effective interest rate
of 15.4%. 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 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. On
September 30, 1997 the interest due was paid through the issuance of additional
notes, with terms identical to those of the Second Tranche Notes, in the amount
of approximately $1.3 million and warrants to purchase approximately 165,000
shares of common stock in payment of the interest accrued on the Aggregate First
Tranche Notes and the Second Tranche Notes. The estimated fair market values of
the notes and warrants issued in lieu of a cash interest payment on September
30, 1997 were approximately $1.1 million and $1.1 million, respectively, which
were recorded as interest expense during 1997.
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 warrants. The extinguishment resulted in a loss of approximately $0.3
million, which was included in other (income) expense during the second quarter
of 1997.
In connection with the issuance of the Senior Secured Notes (the
"Senior Secured Notes", or the "Notes"), the Company used $22.2 million of the
proceeds received to pay off the amended Aggregate First Tranche Notes and the
Second Tranche Notes, including accrued interest thereon, and the 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 Second Tranche Notes and
unamortized issuance costs which were recorded as an extraordinary item in 1997.
The proceeds were also used in part to complete the Company's acquisitions of
certain assets more fully described in Note 5 - Acquisitions.
On October 30, 1997, the Company issued Senior Secured Notes in the
principal amount of $100 million, which bear interest at the rate of 12% per
annum through November 1, 2004. Interest on the Notes is payable semi-annually
on May 1 and November 1 of each year commencing on May 1, 1998, to holders of
record at the close of business on April 15th or October 15th immediately
preceding the interest payment date. The Company placed approximately $22.6
million of the net proceeds from the offering, representing funds sufficient,
together with interest thereon, to pay the first four interest payments on the
Notes, into the Escrow Account. Interest payments of $12.1 million were made in
1998. As discussed in Note 4 - Short-term and Restricted Investments, $11.7
million remains in escrow at December 31, 1998 to pay the interest due in 1999.
The Notes are fully and unconditionally guaranteed, jointly and
severally, by each of the Company's subsidiaries (the "Subsidiary Guarantors").
The guarantees are senior obligations of the Subsidiary Guarantors and are
secured by substantially all of the assets of the Subsidiary Guarantors. The
guarantees rank pari passu in right of payment with all existing and future
senior indebtedness of the Subsidiary Guarantors and rank senior in right of
payment to all existing and future subordinated obligations of the Subsidiary
Guarantors. The guarantees may be released upon the occurrence of certain
events. The guarantee executed by IT Network contains a covenant that restricts
payments of dividends on its capital stock to an amount sufficient to cover debt
service on the Notes, redemptions or repurchases of the Notes or the Preferred
Stock, dividends on the Preferred Stock and corporate overhead. The assets of
Source consist solely of investments in its subsidiaries and invested proceeds
from the Notes and the Senior PIK Preferred Stock and related warrants.
Financial statements for the Subsidiary Guarantors and the parent, Source Media,
Inc. are not presented because management has determined that they would not be
material to investors.
34
<PAGE> 35
Except as described below, the Company may not redeem the Notes prior
to November 1, 2001. On or after such date, the Company may redeem the Notes, in
whole or in part, at any time, at various redemption prices set forth in the
indenture governing the sale of the Notes, together with accrued and unpaid
interest, if any, to the date of redemption. In addition, at any time and from
time to time on or prior to November 1, 2000, the Company may, subject to
certain requirements, redeem up to 35% of the aggregate principal amount of the
Notes with the cash proceeds of one or more equity offerings at a redemption
price equal to 112% of the principal amount to be redeemed, together with
accrued and unpaid interest, if any, to the date of redemption, provided, that,
at least $65.0 million of the aggregate principal amount of the Notes remain
outstanding immediately after each such redemption. The Notes are not subject to
any sinking fund requirement. Upon the occurrence of a change in control, the
Company will be required to make an offer to repurchase the Notes at a price
equal to 101% of the principal amount thereof, together with accrued and unpaid
interest, if any, to the date of the repurchase. The indenture contains certain
covenants including, but not limited to, limitations on indebtedness, restricted
payments, liens, restrictions on distributions from restricted subsidiaries,
sales of assets and subsidiary stock, affiliate transactions, issuances of
capital stock of restricted subsidiaries and sale/leaseback transactions. As of
December 31, 1998, the dealer quoted value of a Note was $0.70 per dollar
resulting in an aggregate fair market value of approximately $70.0 million.
7. SENIOR PIK PREFERRED STOCK
On October 30, 1997, the Company issued 800 units (the Units) for an
aggregate purchase price of $20 million, each Unit consisting of 1,000 shares of
non-voting Senior Preferred Stock (the "Preferred Stock") with a liquidation
preference of $25.00 per share and 558.75 warrants (the "October 1997 Warrants")
to purchase one share of the Company's common stock at a purchase price of $0.01
per share. In the aggregate, the October 1997 Warrants represent the right to
purchase 447,000 shares of common stock. The Units were sold in connection with
the Company's acquisitions of certain assets more fully described in Note 5 -
Acquisitions.
Dividends on the Preferred Stock are payable quarterly on each February
1, May 1, August 1 and November 1, commencing February 1, 1998, at a rate of 13
1/2% of the liquidation preference per share. At the Company's option, on any
dividend payment date occurring on or prior to November 1, 2002 dividends may be
paid either in cash or by the issuance of additional shares of Preferred Stock
with a liquidation preference equal to the amount of such dividends; thereafter,
dividends will be paid in cash. The certificate of designation governing the
sale of the Units limits the amount of cash dividends that may be paid on the
Preferred Stock. At any time and from time to time on or prior to November 1,
2000, the Company may, subject to certain requirements, redeem up to 35% of the
aggregate liquidation value of the Preferred Stock with the cash proceeds of one
or more equity offerings at a redemption price equal to 113 1/2% of the
liquidation preference thereof, plus accumulated dividends, on the date of
redemption. After November 1, 2000 and prior to November 1, 2002, the Preferred
Stock is not redeemable. On or after November 1, 2002, the Company may redeem
the Preferred Stock, in whole or in part, at any time, at various redemption
prices, plus accumulated and unpaid dividends, to the date of redemption. Upon
the occurrence of a change in control, the Company will be required to make an
offer to purchase the outstanding shares of the Preferred Stock at a price equal
to 101% of the liquidation preference thereof, plus accumulated and unpaid
dividends, to the date of purchase. The Preferred Stock will be subject to
mandatory redemption in whole on November 1, 2007, at a price equal to 100% of
the then effective liquidation preference thereof, plus, without duplication,
all accrued and unpaid dividends to the date of redemption. The certificate of
designation contains certain covenants including, but not limited to,
limitations on indebtedness, restricted payments, affiliate transactions,
issuances of capital stock of restricted subsidiaries and sale/leaseback
transactions.
The Preferred Stock ranks senior to all classes of common stock and to
each other class of capital stock or series of preferred stock with respect to
dividend rights and rights on liquidation, winding-up and dissolution of the
Company. The Preferred Stock is non-voting except in certain circumstances. The
Company may not authorize any new class of preferred stock that ranks senior or
pari passu to the Preferred Stock without the approval of the holders of at
least a majority of the shares of Preferred Stock then outstanding, voting or
consenting, as the case may be, as one class, provided, however, that the
Company can issue additional shares of Preferred Stock to satisfy dividend
payments on outstanding shares of Preferred Stock; and further provided that the
Company can issue shares of preferred stock ranking pari passu with the
Preferred Stock if after giving effect thereto, the Consolidated Coverage Ratio,
as defined in the certificate of designation, is greater than 1.7 to 1.0.
The estimated fair market value of the October 1997 Warrants, which was
estimated to be approximately $5.5 million, was credited to capital in excess of
par value and the Preferred Stock was recorded at a corresponding discount.
Additionally, $1.2 million of issuance costs were recorded on the Preferred
Stock. The discount and issuance costs on the Preferred Stock are being accreted
as additional preferred stock dividends using the effective dividend rate method
over a ten year period, resulting in an effective dividend rate of 19.9%. As of
December 31, 1998, the dealer quoted fair market value of the preferred stock
was $18.00 per share for an aggregate value of $16.4 million.
35
<PAGE> 36
During 1998, the quarterly dividends due on the Preferred Stock were
paid through the issuance of additional Preferred Stock having a total
liquidation preference of $2.8 million with terms identical to those of the
Preferred Stock. The estimated fair market value of the stock issued in lieu of
a cash payment on the respective dividend dates totaled $2.4 million which was
recorded as preferred stock dividends.
8. STOCK OPTIONS, WARRANTS, EMPLOYEE STOCK PURCHASE PLAN AND RETIREMENT
PLAN
Stock Options
In 1995 the Company adopted the 1995 Performance Equity Plan (the
Equity Plan). The Equity Plan provides for the grant of options to purchase
shares of the Company's common stock to employees, officers, directors, and
consultants of the Company and its subsidiaries, including Holdings, IT Network
and Interactive Channel. Options granted pursuant to the Equity Plan have a term
of ten years from the date of grant and generally vest over four or five years.
The Equity Plan, as amended, authorizes the granting of awards (stock options,
stock appreciation rights, restricted stock, deferred stock, stock reload
options, and other stock-based awards, as defined), the exercise of which would
allow up to an aggregate of 1,975,000 shares of the Company's common stock to be
acquired.
In 1989, the Company established a qualified incentive employee stock
option plan. Options granted in 1989 and 1990 have a term of ten years from the
date of grant and vested over a three year period. During 1991 and 1993, the
Company established additional qualified incentive employee stock option plans
whereby granted options have a term of ten years from the date of grant and vest
over a five year period. The Company does not intend to grant any additional
options under these plans and, accordingly, all remaining options available for
grant under such plans are assumed to be canceled.
The following table is a summary of stock option activity under the
employee stock option plans during the years ended December 31, 1996, 1997, and
1998:
<TABLE>
<CAPTION>
OPTIONS AVAILABLE SHARES UNDER AGGREGATE OPTIONS OR EXERCISE WEIGHTED AVERAGE
EMPLOYEE STOCK OPTION ACTIVITY FOR GRANT OPTION PRICE PRICE PER SHARE EXERCIE PRICE PER SHARE
------------ ------------ ------------ ---------------- -----------------------
<S> <C> <C> <C> <C> <C>
Balance at December 31,1995 358,999 348,609 $ 3,271,718 $0.74-$11.50 $ 9.39
Options authorized 400,000 -- -- -- --
Options granted (775,224) 775,224 7,181,190 8.25-10.50 9.26
Options exercised -- (23,485) (141,796) 0.74-9.77 6.04
Options canceled - 1995 Plan 16,225 (16,225) (169,731) 8.25-11.12 10.46
Options canceled - Other plans -- (22,379) (217,980) 3.72-9.77 9.74
------------ ------------ ------------ ------------- -------------
Balance at December 31,1996 -- 1,061,744 9,923,401 0.74-11.50 9.35
Options authorized 500,000 -- -- -- --
Options granted (176,000) 176,000 1,280,700 6.41-13.31 7.28
Options exercised -- (90,803) (758,755) 0.74-10.40 8.36
Options canceled - 1995 Plan 149,324 (149,324) (1,376,794) 6.41-11.12 9.22
Options canceled - Other plans -- (21,910) (204,820) 3.72-9.77 9.35
------------ ------------ ------------ ------------- -------------
Balance at December 31,1997 473,324 975,707 8,863,732 0.74-13.31 9.08
Options authorized 575,000 -- -- -- --
Options granted (1,068,201) 1,068,201 9,357,781 6.28-14.00 8.76
Options exercised -- (51,888) (469,317) 0.74-11.12 9.04
Options canceled - 1995 Plan 38,653 (38,653) (353,452) 6.41-11.12 9.14
Options canceled - Other Plan -- (9,898) (96,272) 3.72-9.77 9.73
------------ ------------ ------------ ------------- -------------
BALANCE AT DECEMBER 31, 1998 18,776 1,943,469 $ 17,302,472 $3.72-$14.00 $ 8.90
============ ============ ============ ============= =============
</TABLE>
During 1995, the Company adopted the 1995 Nonqualified Stock Option
Plan for Non-Employee Directors (the "Directors' Plan"). The Directors' Plan
provides for the automatic annual grant to each non-employee director of the
Company an option to purchase 3,000 shares of common stock. Options granted
under the Directors' Plan have an exercise price equal to the fair market value
of the common stock on the date of grant and are exercisable at any time from
the date of grant until the fifth anniversary
36
<PAGE> 37
thereof. The Directors' Plan, as amended on May 21, 1997, provides for the grant
of options to purchase up to 300,000 shares of common stock. The following table
is a summary of stock option activity under the Directors' Plan during the years
ended December 31, 1996, 1997, and 1998:
<TABLE>
<CAPTION>
OPTIONS SHARES WEIGHTED AVERAGE
DIRECTORS' PLAN STOCK OPTION AVAILABLE UNDER AGGREGATE OPTION OR EXERCISE EXERCISE PRICE
ACTIVITY FOR GRANT OPTION PRICE PRICE PER SHARE PER SHARE
- ---------------------------- -------------- -------------- -------------- ----------------- --------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1995 78,000 12,000 $ 130,650 $ 10.89 $ 10.89
Options granted (18,000) 18,000 187,650 10.43 10.43
-------------- -------------- -------------- -------------- --------------
Balance at December 31, 1996 60,000 30,000 318,300 10.43-10.89 10.61
Options authorized 50,000 -- -- -- --
Options granted (15,000) 15,000 88,650 5.91 5.91
-------------- -------------- -------------- -------------- --------------
Balance at December 31, 1997 95,000 45,000 406,950 5.91-10.89 9.04
Options granted (33,000) 33,000 617,670 13.77-22.84 18.72
Options exercised -- (6,000) (63,938) 10.43-10.89 10.66
-------------- -------------- -------------- -------------- --------------
Balance at December 31, 1998 62,000 72,000 $ 960,682 $5.91-$22.84 $ 13.34
============== ============== ============== ============== ==============
</TABLE>
Pursuant to an agreement, each of the 176,958 options for ICT common
shares outstanding at the effective time of the acquisition of the remaining
minority interest of ICT was exchanged for an option (a "Replacement Option") to
purchase shares of common stock. During 1998, 35,891 Replacement Options were
exercised at a weighted average exercise price of $4.11. As of December 31,
1998, the remaining options represent the right to purchase 35,891 shares of
common stock at a weighted average exercise price of $4.12 per share.
Certain additional information for all outstanding options as of
December 31, 1998, is being presented based on a range of exercise prices as
follows
<TABLE>
<CAPTION>
EXERCISE PRICES
$3.72-$4.15 $5.91-$14.00 $22.84
----------- ------------ -----------
<S> <C> <C> <C>
Number of outstanding options 35,958 1,997,402 18,000
Weighted average exercise price of outstanding options $ 4.12 $ 8.94 $ 22.84
Weighted average remaining life 7.4 years 8.4 years 9.6 years
Number of options exercisable 35,958 705,055 18,000
Weighted average exercise price of options exercisable $ 4.12 $ 9.36 $ 22.84
</TABLE>
As required by the Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("FAS 123"), pro forma information
regarding net loss and loss per share has been determined as if the Company had
accounted for employee and director stock options granted subsequent to December
31, 1994 under the fair value method provided for under FAS 123. The fair value
for the stock options granted to directors, officers and key employees of the
Company on or after January 1, 1995 was estimated at the date of the grant using
the Black-Scholes option pricing model with the following weighted-average
assumptions:
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Risk-free interest rate 6.39% 6.21% 5.31%
Expected dividend yield 0.00% 0.00% 0.00%
Expected volatility 30% 30% 76%
Expected lives 4.0 years 4.0 years 2.7 years
</TABLE>
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
The weighted-average fair value of stock options granted during the
years ended December 31, 1996, 1997 and 1998 was $2.34, $2.55 and $4.50,
respectively. For purposes of the pro forma disclosures, the estimated fair
value of stock options granted from January 1, 1995 through December 31, 1998
have been amortized to expense over the vesting period. The Company's pro forma
information for FAS 123 follows (in thousands, except for loss per common share
information):
37
<PAGE> 38
<TABLE>
<CAPTION>
1996 1997 1998
-------- -------- --------
<S> <C> <C> <C> <C>
Net loss attributable to common stockholders As reported $ 13,855 $ 32,797 $ 62,626
Pro forma $ 14,411 $ 33,471 $ 64,271
Net loss per common share As reported $ 1.39 $ 2.89 $ 5.21
Pro forma $ 1.45 $ 2.95 $ 5.35
</TABLE>
Because FAS 123 is applicable only to options and stock-based awards
granted subsequent to December 31, 1994, its pro forma effect will not be fully
reflected until 1999.
Warrants
The Company has issued warrants for the purchase of shares of its
common stock from time to time in connection with various financing transactions
and for advisory and consulting services provided to the Company. The majority
of the warrants provide for registration rights. As of December 31, 1998,
outstanding warrants for the purchase of common stock of the Company were:
<TABLE>
<CAPTION>
SHARES ISSUABLE EXERCISE PRICE
UPON EXERCISE PER SHARE EXPIRATION DATE
------------- --------- ---------------
<S> <C> <C>
1,034,687 $ 6.00 May 2000
200,000 6.41 May 2000
2,326,500(1) 11.00 June 2000
83,085 10.80 February 2001
252,676 10.50 December 2002
1,335,924 6.00 March 2004
25,000(1) 11.00 June 2005
37,748 4.38 June 2007
447,000 0.01 November 2007
---------
5,742,620
=========
</TABLE>
(1) In the event the sales price of the Company's common stock equals or
exceeds $20.00 per share for 20 consecutive trading days, the Company
will have the right to redeem warrants representing 2,351,500 common
shares upon 20 days written notice at a price of $11.00 per share.
997758 Class Y Stock Exchange Rights
On September 24, 1992, the Company's subsidiary, 997758, entered into
an agreement with an individual to issue shares of 997758's nonvoting Class Y
shares in exchange for Class A Subordinate Voting Shares and Class B Multiple
Voting Shares of ICT owned by such individual. The individual has the right at
any time through February 14, 2000, to exchange any or all of the Class Y shares
of 997758 for up to an aggregate of 206,376 shares of the Company's common
stock. Each exercise of the exchange rights shall include at least Cdn $150,000
in value of Class Y shares of 997758 being exchanged for the Company's common
stock.
38
<PAGE> 39
Shares Reserved for Future Issuance
As of December 31, 1998, common shares reserved for future issuance
were as follows:
<TABLE>
<CAPTION>
NUMBER OF
SECURITY RESERVED SHARES
-------- ---------------
<S> <C>
Warrants ........................... 5,742,620
Stock options ...................... 2,132,136
Employee stock purchase plan ....... 57,557
997758 Class Y Stock exchange rights 206,376
---------
8,138,689
=========
</TABLE>
Employee Stock Purchase Plan and Retirement Plan
During July 1996, the Company's Board of Directors adopted the Employee
Stock Purchase Plan (the "Plan"), which was approved by the Company's
stockholders at the 1997 annual meeting. Under the Plan, eligible employees may
purchase shares of the Company's common stock at a discount through voluntary
monthly payroll deductions with a maximum contribution being 10% of an eligible
employee's salary, beginning in September 1996. Semi-annually, on June 30 and
December 31, participant account balances are used to purchase shares at the
lesser of 85 percent of the fair market value of the common stock on either the
first or last day of the subscription period. In connection with the Plan, the
Company has set aside 100,000 shares of common stock held in treasury. On June
30, 1998 and December 31, 1998, 11,595 shares and 7,055 shares of common stock
were purchased by employees at prices of $7.38 per share and $14.13 per share,
respectively.
The Company sponsors a defined contribution plan covering substantially
all employees; the plan is qualified under Section 401(k) of the Internal
Revenue Code. Under the provisions of the plan, eligible participating employees
may elect to contribute up to the maximum amount of tax deferred contribution
allowed by the Internal Revenue Code.
Anti-Dilution Provisions
Certain of the warrants to purchase common stock contain anti-dilution
provisions whereby the exercise price and the number of shares exercisable
pursuant to the warrants may be adjusted from time to time upon the occurrence
of certain events. In connection with such provisions, warrants to purchase
1,034,687 shares of common stock at a purchase price of $7.44 per share were
adjusted to provide for the purchase of the same number of shares at a purchase
price of $6.00 per share, and warrants to purchase 28,302 shares of common stock
at a purchase price of $10.60 per share were adjusted to provide for the
purchase of 68,498 shares at a purchase price of $4.38 per share upon the
issuance of common stock in connection with the ICT acquisition discussed in
Note 5 - Acquisitions and the amendment to the First Tranche Warrant and
issuance of the Second Tranche Warrants discussed in Note 6 - Long-Term Debt,
respectively.
9. NOTES RECEIVABLE FROM STOCKHOLDERS
On May 20, 1993, the Company loaned $0.8 million to the individual
holding Class Y shares of 997758, which note is secured by the individual's
holdings in 997758 and bears interest at a rate per annum of 2%, payable
quarterly. The unpaid principal and interest become due on May 20, 2000. At that
time, the Company recorded a discount to reflect the difference between the
actual interest rate and a reasonable market rate (10%) and increased goodwill
accordingly. The note and accrued interest, net of the unamortized discount of
$0.1 million and $0.1 million as of December 31, 1997 and 1998, respectively,
are reflected as a reduction of minority interests in the accompanying
consolidated balance sheet.
On June 30, 1993, the Company loaned $0.1 million to an officer,
director and stockholder. This loan bears interest at the rate of 10% per annum,
with the principal amount and accrued interest due and payable on May 31, 1999.
Payment of the note is secured by a pledge of 6,719 shares of common stock.
Amounts outstanding, including accrued interest, are included in stockholders'
equity (capital deficiency) in the accompanying consolidated balance sheets.
10. LEASES
The Company leases office space and various office equipment under
operating leases. Rent expense was $0.5 million, $0.9 million and $1.1 million
for the years ended December 31, 1996, 1997, and 1998, respectively.
39
<PAGE> 40
At December 31, 1998, aggregate amounts of future minimum payments
under lease commitments are as follows:
<TABLE>
<CAPTION>
Operating Leases
(In thousands)
<S> <C>
1999 $ 819
2000 698
2001 282
2002 4
2003 6
------
Total future minimum lease payments $1,809
======
</TABLE>
11. INCOME TAXES
For the years ended December 31, 1996, 1997 and 1998, the Company had
no provision or benefit for income taxes because the deferred benefit from the
operating losses was offset by an increase in the valuation allowance of $5.6
million, $4.1 million and $18.3 million, respectively. Significant components of
the Company's deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
1997 1998
------------ ------------
<S> <C> <C>
Deferred tax liabilities:
Tax over book depreciation $ (548,386) $ (523,243)
Other (11,156) (7,706)
------------ ------------
Total deferred tax liabilities (559,542) (530,949)
Deferred tax assets
Net operating loss carryforwards 24,136,650 32,431,574
Investment tax credits 801,712 488,025
Unearned income 1,491,716 787,065
Book over tax amortization of intangibles 414,831 10,420,726
Reserve for fixed asset impairment 739,763 739,763
Accrued expenses 61,248 927,397
Other 56,967 143,312
------------ ------------
Total deferred tax assets 27,702,887 45,937,862
Valuation allowance for deferred tax assets (27,143,345) (45,406,913)
------------ ------------
Net of valuation allowance 559,542 530,949
------------ ------------
Net deferred tax asset $ -- $ --
============ ============
</TABLE>
At December 31, 1998, the Company had net operating loss carryforwards
of approximately $87.4 million for United States income tax purposes, that
expire in 2003 through 2018, which may be used to reduce future United States
taxable income. The Tax Reform Act of 1986 imposes limitations on the use of net
operating loss carryforwards if certain stock ownership changes occur. An
ownership change occurred that will cause utilization of a portion of the
Company's net operating losses to be limited to approximately $9.0 million in a
given year.
At December 31, 1998, ICT had net operating loss carryforwards for
Canadian income tax purposes of approximately Cdn $0.3 million, expiring in 1999
through 2003, which may be used to reduce future Canadian taxable income of ICT.
ICT also has available at December 31, 1998 investment tax credits totaling Cdn
$0.8 million, expiring in 1999 through 2002. At December 31, 1998, ICT had net
operating loss carryforwards for Ontario Provincial income tax purposes of
approximately Cdn $0.1 million, expiring in 2002 through 2003, which may be used
to reduce future Ontario taxable income of ICT.
Certain transactions between ICT and its subsidiaries in March 1997
resulted in taxable income of approximately $7.0 million in the United States
and Canada and the utilization of net operating losses in both countries in
1997. Certain transactions between ICT and its subsidiaries in 1998 resulted in
utilization of approximately Cdn $4.0 million of Canadian net operating loss
carryforwards.
12. CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMERS
The Company performs ongoing credit evaluations of its customers and
does not require collateral. Overall concentrations of credit risk with respect
to receivables, except for the customers discussed below, are limited because of
the large number of customers
40
<PAGE> 41
in the Company's customer base, the relatively small dollar amount of individual
customer balances and their dispersion across many different industries and
geographic areas. The Company maintains an allowance for doubtful accounts which
was $0.4 million and $0.2 million as of December 31, 1998 and 1997,
respectively, to reserve for potential credit losses, which have historically
been within management's expectations.
As of December 31, 1998 and 1997, balances due from BellSouth
Advertising and Publishing represented 21% and 22%, respectively, of the
Company's accounts receivable. No other customer represented more than 10% of
the Company's accounts receivable as of December 31, 1998 or 1997.
For the year ended December 31, 1998, a major customer accounted for
12% of monetary revenues. For the year ended December 31, 1997, a major customer
accounted for 11% of the monetary revenues while another major customer
accounted for 10% of monetary revenues. No other customer accounted for greater
than 10% of monetary revenues for any of the three years ended December 31,
1998.
13. MANAGEMENT PLANS
The Company has reported a net loss of approximately $59.6 million for
the year ended December 31, 1998, incurred accumulated losses from inception to
December 31, 1998 aggregating to approximately $148.9 million, and reported
negative cash flows from operations for the year ended December 31, 1998 of
approximately $23.4 million and a capital deficiency of $71.5 million. The
Company's 1999 operating plan contemplates focusing activities to expand
revenues at the Company's IT Network division and successfully launch its
VirtualModem(TM) and Interactive Channel products. Based on its plan, management
expects to be able to meet its current maturing obligations through the end of
1999; however, there can be no assurance that the Company will be successful in
its attempt to expand monetary revenues, successfully launch its
VirtualModem(TM) and Interactive Channel products, secure additional financing,
or consummate a strategic alternative. Since the development of the 1999
operating plan, the Company executed a Letter of Intent with Prevue. Management
intends to finalize the Prevue transaction. If management's plans are not
successful, management may not be able to secure additional financing or
consummate a strategic alternative that would provide adequate working capital
to meet the requirements of existing obligations beginning in 2000.
14. SEGMENT REPORTING
The Company adopted Statement of Financial Accounting Standards No.
131, "Disclosures about Segments of an Enterprise and Related Information:"
("SFAS 131") in the year ended December 31, 1998.
In accordance with SFAS 131, the Company has identified two reportable
operating segments, IT Network and Interactive TV, for disclosure purposes.
These two segments are regularly reviewed by the Company's management for
determination of the allocation of resources to these businesses.
IT Network sells advertising and related support services to clients
who sponsor a promotional message with interactive content supplied primarily by
IT Network.
Interactive TV has designed and is developing proprietary software and
interactive programming services that can enable digital, two-way television
systems equipped with digital (or advanced analog) set-top boxes to deliver
two-way, interactive programming with the touch of a set-top remote or the use
of a wireless keyboard.
The total revenues, expenses and assets by reportable operating
segments are used in the Company's operations and do not include general
corporate overhead and assets not allocated to the operating units. These assets
and expenses have been separately disclosed for reconciliation purposes.
41
<PAGE> 42
The following are operating results and certain other information by
business segment:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1996 1997 1998
--------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Monetary revenues:
IT Network $ 7,543 $ 12,082 $ 24,244
Interactive TV 1,032 305 107
--------- --------- ---------
Total monetary revenues $ 8,575 $ 12,387 $ 24,351
========= ========= =========
Nonmonetary revenues:
IT Network $ 9,944 $ 6,044 $ 1,756
Interactive TV -- -- --
--------- --------- ---------
Total nonmonetary revenues $ 9,944 $ 6,044 $ 1,756
========= ========= =========
Net revenues:
IT Network $ 17,487 $ 18,126 $ 26,000
Interactive TV 1,032 305 107
--------- --------- ---------
Total net revenues $ 18,519 $ 18,431 $ 26,107
========= ========= =========
Operating loss:
IT Network $ (301) $ (163) $ (29,475)
Interactive TV (10,311) (19,892) (11,325)
Corporate (3,407) (4,435) (7,960)
--------- --------- ---------
Total operating loss $ (14,019) $ (24,490) $ (48,760)
========= ========= =========
Identifiable assets:
IT Network $ 6,482 $ 51,374 $ 19,408
Interactive TV 4,166 9,959 8,401
Corporate 5,249 52,169 28,780
--------- --------- ---------
Total identifiable assets $ 15,897 $ 113,502 $ 56,589
========= ========= =========
Depreciation and amortization:
IT Network $ 361 $ 2,835 $ 5,684
Interactive TV 1,577 6,465 2,925
Corporate -- -- 251
--------- --------- ---------
Total depreciation and
amortization $ 1,938 $ 9,300 $ 8,860
========= ========= =========
Capital expenditures:
IT Network $ 591 $ 2,838 $ 993
Interactive TV 2,088 1,944 432
Corporate -- -- 85
--------- --------- ---------
Total capital expenditures $ 2,679 $ 4,782 $ 1,510
========= ========= =========
</TABLE>
15. SUBSEQUENT EVENTS
On February 11, 1999, the Company and Prevue executed a Letter of
Intent to enter into a joint venture, Newco. The Letter of Intent is subject to
the execution of definitive documentation, including representations and
warranties, covenants and conditions to closing. There can be no assurance that
the Company, Prevue and United Video will be able to agree on the form of such
definitive documents or that, if agreed upon, the transaction will be
consummated. See discussion of contingencies related to the Letter of Intent in
Note 3 - Commitments and Contingencies.
42
<PAGE> 43
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
Number Description
------ -----------
<S> <C>
3.1 Restated Certificate of Incorporation, as amended (filed as Exhibit 3.1
to the Company's Registration Statement on Form S-1, as amended (No.
33-97564), and incorporated herein by reference).
3.2 Bylaws (filed as Exhibit 3.2 to HBAC Registration Statement on Form
S-1, as amended (No. 33-62606), and incorporated herein by reference).
4.1 Form of Common Stock Certificate (filed as Exhibit 4.1 to the Company's
Registration Statement on Form S-1 (No. 33-97564), and incorporated
herein by reference).
4.2 Certificate of Designations for Senior PIK Preferred Stock (filed as
Exhibit 4.2 to the Company's current report on Form 8-K dated October
30, 1997, and incorporated herein by reference).
4.3 Indenture dated as of October 30, 1997 between Source Media, Inc. and
U.S. Trust Company of Texas, N.A. (filed as Exhibit 4.1 to the
Company's current report on Form 8-K dated October 30, 1997, and
incorporated herein by reference).
4.4 Warrant Agreement dated as of October 30, 1997 between Source Media,
Inc. and ChaseMellon Shareholder Services (filed as Exhibit 4.3 to the
Company's current report on Form 8-K dated October 30, 1997, and
incorporated herein by reference).
</TABLE>
<PAGE> 44
<TABLE>
<S> <C>
10.1 Development and Licensing Agreement dated as of April 1, 1995 between
IT Network, Inc., Source Media, Inc., ICT Inc., Cable Share
International Inc., ICT (U.S.) Limited and ICT B.V. ("Development and
Licensing Agreement") (filed as Exhibit 10.22 to the Company's Annual
Report on Form 10-K for the Year Ended December 31, 1995, and
incorporated herein by reference).
10.1.1 First Amendment to the Development and Licensing Agreement, dated
October 31, 1996.
10.1.2 Second Amendment to the Development and Licensing Agreement dated
March 17, 1997.
10.1.3 Third Amendment to the Development and Licensing Agreement, dated
October 24, 1997.
10.2 Interactive Television License Agreement between IT Network, Inc., ICT
(U.S.) Limited and ICT Inc., dated June 11, 1992 (filed as Exhibit
10.40 to HBAC's Registration Statement on Form S-4 (No. 33-90482), and
incorporated herein by reference).
10.3 Interactive Channel Distribution Agreement dated November 16, 1995
between IT Network, Inc. and Cablevision Systems Corporation (filed as
Exhibit 99.2 to the Company's Current Report on Form 8-K filed January
30, 1996, and as amended on March 19, 1996, and incorporated herein by
reference).
10.4 Interactive Cable Agreement between IT Network, Inc. and Marcus Cable
Associates, L.P. (formerly known as Sammons Communications, Inc.),
dated June 4, 1993 (filed as Exhibit 10.53 to HBAC's Registration
Statement on Form S-4 (No. 33-90482), and incorporated herein by
reference).
10.5 Contribution Agreement between National Research Council Canada and ICT
Inc. (filed as Exhibit 10.54 to HBAC's Registration Statement on Form
S-4 (No. 33-90482), and incorporated herein by reference).
</TABLE>
<PAGE> 45
<TABLE>
<S> <C>
10.6 Stock Purchase Warrant dated April 13, 1996 between Northstar Advantage
High Total Return Fund and the Company (filed as Exhibit 10.3 to the
Company's Quarterly Report on Form 10-Q for the Quarter Ended March 31,
1996, and incorporated herein by reference).
10.7 Registration Rights Agreement dated April 3, 1996 between Northstar
Advantage High Total Return Fund and the Company (filed as Exhibit 10.4
to the Company's Quarterly Report on Form 10-Q for the Quarter Ended
March 31, 1996, and incorporated herein by reference).
10.8 License Agreement dated June 6, 1996 between WinStar New Media Co.,
Inc. and the Company (filed as Exhibit 10.2 to the Company's Quarterly
Report on Form 10-Q for the Quarter Ended June 30, 1996, and
incorporated herein by reference).
10.9 Charter Affiliation Agreement between Century Communications
Corporation and the Company (filed as Exhibit 10.1 to the Company's
Current Report on Form 8-K filed April 23, 1996, and incorporated
herein by reference).
</TABLE>
<PAGE> 46
<TABLE>
<S> <C>
10.10 Arrangement Agreement dated November 13, 1996 between the Company and
ICT. (filed as Exhibit 10.18 to the Company's Registration Statement
on Form S-1, (No. 33-16883), subsequently withdrawn, and incorporated
herein by reference).
10.11 Form of Plan of Arrangement. (filed as Exhibit 10.19 to the Company's
Registration Statement on Form S-1 (No. 33-16883), subsequently
withdrawn, and incorporated herein by reference).
10.12 Stock Purchase Warrant dated as of April 9, 1996 between the Company
and Northstar (filed as Exhibit 10.29 to the Company's Annual Report on
Form 10-K for the Year Ended December 31, 1996, and incorporated by
reference herein).
10.13 Amended and Restated Stock Purchase Warrant dated as of April 9, 1997
between the Company and Northstar (filed as Exhibit 10.30 to the
Company's Annual Report on Form 10-K for the Year Ended December 31,
1996, and incorporated by reference herein).
10.14 Amended and Restated Registration Rights Agreement dated as of April 9,
1997 among the Company and Northstar, Zeneca, McConnell, ICI and
Delaware (filed as Exhibit 10.35 to the Company's Annual Report on Form
10-K for the Year Ended December 31, 1996, and incorporated by
reference herein).
10.15 Management Lock-Up and Voting Agreement dated as of April 9, 1997 among
each of the persons named on Schedule I thereto, the Company and
Northstar, Zeneca, McConnell, ICI and Delaware (filed as Exhibit 10.40
to the Company's Annual Report on Form 10-K for the Year Ended December
31, 1996, and incorporated by reference herein).
10.16 Asset Purchase Agreement dated September 23, 1997 between IT Network,
Inc. and Brite Voice Systems, Inc. (filed as Exhibit 2.1 to the
Company's current report on Form 8-K dated October 30, 1997, and
incorporated by reference herein).
10.17* 1995 Performance Equity Plan, as amended and restated effective as of
June 10, 1998.
10.18* 1995 Nonqualified Stock Option Plan for Non-employee Directors (filed
as Exhibit 10.32 to Source Media's Registration Statement on Form S-1,
(No. 33-90482), and incorporated by reference herein).
</TABLE>
<PAGE> 47
<TABLE>
<S> <C>
10.19 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 Company's current report on Form 8-K dated
October 30, 1997, and incorporated by reference herein).
10.20 Asset Purchase Agreement dated September 30, 1997 between Source Media,
Inc. and Voice News Network, Inc. (filed as Exhibit 2.3 to the
Company's current report on Form 8-K dated October 30, 1997, and
incorporated by reference herein).
10.21 Preferred Stock Registration Rights Agreement dated October 30, 1997
between Source Media, Inc. and Natwest Capital Markets Limited and
Prudential Securities Incorporated (filed as Exhibit 10.2 to the
Company's current report on Form 8-K dated October 30, 1997, and
incorporated by reference herein).
10.22 Exchange and Registration Rights Agreement for Senior Secured Notes
dated September 30, 1997 between Source Media, Inc. and Natwest Capital
Markets Limited and Prudential Securities Incorporated (filed as
Exhibit 10.1 to the Company's current report on Form 8-K dated
October 30, 1997, and incorporated by reference herein).
10.23 Form of Guarantee for domestic subsidiaries (filed as Exhibit 10.29 to
the Company's Registration Statement on Form S-4 (No. 333-42017), and
incorporated by reference herein).
10.24 Form of Guarantee for foreign subsidiaries (filed as Exhibit 10.30 to
the Company's Registration Statement on Form S-4 (No. 333-42017), and
incorporated by reference herein).
</TABLE>
<PAGE> 48
<TABLE>
<S> <C>
21 Subsidiaries.
23 Consent of Ernst & Young LLP.
27 Financial Data Schedule.
</TABLE>
* Management contract or compensatory plan
<PAGE> 1
EXHIBIT 10.1.1
FIRST AMENDMENT TO
DEVELOPMENT AND LICENSING AGREEMENT
THIS AGREEMENT ("Amendment") to the Development and Licensing Agreement dated
April 1, 1995 ("Agreement") among IT NETWORK, INC., a wholly-owned subsidiary
of Source Media, Inc., and a Texas Corporation located at Suite 1000, 8140
Walnut Hill Lane, Dallas, Texas 75231 ("ITN") and CABLESHARE, INC., an Ontario
corporation, with its office at 150 Dufferin Avenue, Suite 906, London, Ontario
N684N6 ("Cableshare Cda"), CABLESHARE INTERNATIONAL, INC., a Barbadian
corporation with its office in Bridgetown, Barbados ("Cableshare Barbados"),
CABLESHARE (U.S.) LIMITED, an Illinois corporation with its office in Chicago,
Illinois ("Cableshare U.S.") and CABLESHARE B.V., a Netherlands corporation
with its office in Amsterdam ("Cableshare B.V."), (collectively "Cableshare")
is entered into this 31st day of October, 1996.
WHEREAS, by its terms, the Agreement will expire on December 31, 1996; and
WHEREAS, ITN and Cableshare wish to modify certain terms and conditions of the
Agreement and to extend the Agreement beyond December 31, 1996.
NOW THEREFORE, in consideration of the mutual promises and conditions set forth
in this Agreement ITN and Cableshare hereby agree as follows:
1. Article 1.1(f) of the Agreement is amended in its entirety as follows:
"Effective Date means October 31, 1996."
2. ITN and Cableshare mutually agree that the execution of this Amendment is a
"written notice of renewal" under Article 2.1 of the Agreement. Furthermore,
Article 2.1 of the Agreement is amended in its entirety as follows:
"This Agreement shall commence on the Effective Date and shall continue until
March 31, 1997. This term may be renewed for successive terms at the option
of ITN and Cableshare by the delivery of written notice of renewal signed by
ITN to Cableshare followed by the return by Cableshare to ITN of such notice
of renewal signed by Cableshare prior to the date upon which this agreement
would otherwise expire. Each such renewal shall be on the same terms and
conditions contained in this Agreement, except as otherwise mutually agreed
by the Parties."
3. Article 7.3 of the Agreement is amended in its entirety as follows:
"ITN and Cableshare acknowledge that although the Projects have not been
completed, ITN has paid and Cableshare has received all amounts for Project
Funding due under Article 7.3 of the Agreement. For continuing work on the
Projects and for additional work requested by ITN and accepted by Cableshare
and identified by the Parties as a "Project", ITN will pay Cableshare a total
of US$300,000 each month by payment of
<PAGE> 2
U.S. $150,000 on the 15th and on the last business day of each month which
payments will begin on October 31, 1996 and end on March 31, 1997.
4. Article 7.1 is amended by adding the following:
"Projects' identified in writing by ITN and Cableshare under Article 7.3 of
the Amendment shall be considered "Projects" under the Agreement".
5. All terms and conditions of the Agreement not modified by this Amendment
remain in effect as set forth in the Agreement. Only the provisions
modified by this Amendment are modified in the Agreement.
6. This Agreement may be executed in one or more counterparts, each of which
shall be deemed an original and all of which, taken together, shall
constitute one and the same instrument.
IN WITNESS WHEREOF, the Parties have duly executed this Amendment as of the
day and year first above written.
IT NETWORK, INC.
Per: /s/ ILLEGIBLE
-------------------------
Title: Chief Financial Officer
-----------------------
SOURCE MEDIA, INC.
Per: /s/ ILLEGIBLE
-------------------------
Title: ILLEGIBLE
-----------------------
CABLESHARE, INC.
Per: /s/ ILLEGIBLE
-------------------------
Title: President & CEO
------------------------
CABLESHARE
INTERNATIONAL INC. CABLESHARE (U.S.) LIMITED
Per: Per: /s/ ILLEGIBLE
------------------------- ----------------------
Title: Title: President
------------------------ ---------------------
<PAGE> 1
EXHIBIT 10.1.2
SECOND AMENDMENT TO
DEVELOPMENT AND LICENSING AGREEMENT
THIS AMENDMENT ("Second Amendment") to the Development and Licensing Agreement
dated April 1, 1995 ("Agreement") among IT NETWORK, INC., a wholly-owned
subsidiary of Source Media, Inc., and a Texas corporation located at Suite 1000,
8140 Walnut Hill Lane, Dallas. Texas 75231 ("ITN") and INTERACTIVE CHANNEL
TECHNOLOGIES, INC., formerly known as Cableshare, Inc., an Ontario corporation
with its office at 150 Dufferin Avenue, Suite 906, London, Ontario N684N6
("ICT"), CABLE SHARE INTERNATIONAL, INC., a Barbados corporation with its office
in Bridgetown, Barbados ("Cableshare Barbados"), CABLESHARE (U.S.) LIMITED, an
Illinois corporation with its office in Chicago, Illinois ("Cableshare U.S.")
and CABLESHARE B.V., a Netherlands corporation with its office in Amsterdam,
Netherlands ("Cableshare B.V.") (ICT, Cableshare Barbados, Cableshare U.S. and
Cableshare B.V. collectively "the ICT Companies") is entered into this 17th day
of March, 1997.
WHEREAS, according to the First Amendment to Development and Licensing
Agreement, entered into October 31, 1996 between ITN and the ICT Companies (the
"First Amendment"), the Agreement was amended to expire on March 31, 1997; and
WHEREAS, ITN and the ICT Parties wish to modify certain terms and conditions
set forth in the Agreement and to extend the Agreement, as amended by the First
Amendment, beyond March 31, 1997.
NOW THEREFORE, in consideration of the mutual promises and conditions set
forth in this Second Amendment, ITN and the ICT Companies agree as follows:
1. ITN and the ICT Companies mutually agree that the execution of this
Second Amendment is a "written notice of renewal under Article 2.1 of
the Agreement" and a return receipt of signed notice of renewal.
Furthermore, Article 2.1 of the Agreement is amended in its entirety
as follows:
"This Agreement shall commence on the Effective Date and shall continue
until June 1, 2002. This term may be renewed for successive five-year
terms at the option of ITN and the ICT Companies by the delivery of
written notice of renewal signed by ITN to the ICT Companies followed
by the return by the ICT Companies to ITN of such notice of renewal
signed by the ICT Companies prior to the date upon which this Agreement
would otherwise expire. Each such renewal shall be on the same terms
and conditions contained in this Agreement except as otherwise
mutually agreed by the Parties."
<PAGE> 2
2. Article 5.4 - Other Sales - shall be amended by adding at the end of
the present paragraph the following:
"If the chief executive officer of Cableshare and Scott Bedford (or
such other person designated for such purpose by ITN) do not, or are
not able to, settle the amount of the payments, the payments shall be
an amount equivalent to five percent (5%) of the Revenue from the
transaction (as "Revenue" is defined in the Existing License Agreement)
provided that such five percent (5%) amount is not more than a rate
charged any other customer for a license on similar terms and
conditions."
3. All terms and conditions of the Agreement and the First Amendment not
modified by this Second Amendment remain in effect as set forth in the
Agreement and the First Amendment.
4. This Second Amendment may be executed in one or more counterparts, each
of which shall be deemed an original and all of which, taken together
shall constitute one and the same instrument.
IN WITNESS WHEREOF, the Parties have duly executed this Second Amendment as of
the day and year first above written.
IT NETWORK, INC. SOURCE MEDIA, INC.
Per: /s/ [ILLEGIBLE] Per: /s/ [ILLEGIBLE]
------------------------- ------------------------------
Title: Secretary Title: Chief Financial Officer
----------------------- and Treasurer
---------------------------
INTERACTIVE CHANNEL TECHNOLOGIES, INC.
Per: /s/ [ILLEGIBLE]
-------------------------
Title: Secretary
-----------------------
CABLESHARE, B.V. CABLE SHARE INTERNATIONAL, INC.
Per: /s/ [ILLEGIBLE] - Director Per: /s/ [ILLEGIBLE]
-------------------------- ------------------------------
Title: [ILLEGIBLE- - Director Title: Secretary
------------------------ ---------------------------
CABLESHARE (U.S.) LIMITED
Per: /s/ [ILLEGIBLE]
-------------------------
Title: Secretary
-----------------------
<PAGE> 1
EXHIBIT 10.1.3
THIRD AMENDMENT TO
DEVELOPMENT AND LICENSING AGREEMENT
THIS AMENDMENT ("Third Amendment") to the Development and Licensing Agreement
dated April 1, 1995, ("Agreement") among IT NETWORK, INC., a wholly-owned
subsidiary of Source Media, Inc., and a Texas corporation located at Suite 1000,
8140 Walnut Hill Lane, Dallas, Texas 75231 ("ITN") and INTERACTIVE CHANNEL
TECHNOLOGIES, INC., formerly known as Cableshare, Inc., an Ontario corporation
with its office at 150 Dufferin Avenue, Suite 906, London, Ontario N684N6
("ICT"), CABLE SHARE INTERNATIONAL, INC., a Barbados corporation with its office
in Bridgetown, Barbados ("Cableshare Barbados"), CABLESHARE (U.S.) LIMITED, an
Illinois corporation with its office in Chicago, Illinois ("Cableshare U.S.")
and CABLESHARE B.V., a Netherlands corporation with its office in Amsterdam,
Netherlands ("Cableshare B.V.") (ICT, Cableshare Barbados, Cableshare U.S., and
Cableshare B.V. collectively "the ICT Companies") is entered into this 24th day
of October, 1997.
WHEREAS, the Parties entered into the First Amendment to the Development and
Licensing Agreement between ITN and the ICT Companies on October 31, 1996,
("First Amendment") and entered into the Second Amendment to the Development and
Licensing Agreement between ITN and the ICT Companies on March 17, 1997,
("Second Amendment");
WHEREAS, according to the Second Amendment, the Agreement was amended to expire
on June 1, 2002;
WHEREAS, ITN and the ICT Parties wish to modify certain terms and conditions set
forth in the Agreement and to extend the Agreement, as amended by the Second
Amendment, beyond June 1, 2002.
NOW THEREFORE, in consideration of the mutual promises and conditions set forth
in this Third Amendment, ITN and the ICT Companies agree as follows:
1. ITN and the ICT Companies mutually agree that the execution of this
Third Amendment is a "written notice of renewal under Article 2.1 of the
Agreement" and a return receipt of signed notice of renewal. Furthermore,
Article 2.1 of the Agreement is amended in its entirety as follows:
"This Agreement shall commence on the Effective Date and shall continue
until November 1, 2004. This term may be renewed for successive
five-year terms at the option of ITN and the ICT Companies by the
delivery of written notice of renewal signed by ITN to the ICT
Companies followed by the return by the ICT Companies to ITN of such
notice of renewal signed by the ICT Companies prior to the date upon
which this Agreement would otherwise expire. Each such renewal shall be
on the same terms and conditions contained in this Agreement, except as
otherwise mutually agreed by the Parties."
2. All terms and conditions of the Agreement, the First Amendment and the
Second Amendment not modified by this Third Amendment remain in effect as set
forth in the Agreement, the First Amendment and the Second Amendment.
<PAGE> 2
3. This Third Amendment may be executed in one or more counterparts, each
of which shall be deemed an original and all of which, taken together, shall
constitute one and the same instrument.
IN WITNESS WHEREOF, the Parties have duly executed this Third Amendment as of
the day and year first above written.
IT NETWORK, INC. SOURCE MEDIA, INC.
Per: /s/ [ILLEGIBLE] Per: /s/ [ILLEGIBLE]
-------------------------- -----------------------------------------
Title: Secretary Title: Chief Financial Officer and Treasurer
------------------------ --------------------------------------
INTERACTIVE CHANNEL TECHNOLOGIES,
INC.
Per: /s/ [ILLEGIBLE]
--------------------------
Title: Secretary
------------------------
CABLESHARE, B.V. CABLE SHARE INTERNATIONAL, INC.
Per: /s/ [ILLEGIBLE] Per: /s/ [ILLEGIBLE]
-------------------------- -----------------------------------------
Title: Director Title: Secretary
------------------------ ---------------------------------------
Per: /s/ [ILLEGIBLE]
--------------------------
Title: Director
------------------------
CABLESHARE (U.S.) LIMITED
Per: /s/ [ILLEGIBLE]
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Title: Secretary
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EXHIBIT 10.17
SOURCE MEDIA, INC.
1995 Performance Equity Plan
AS AMENDED AND RESTATED EFFECTIVE AS OF JUNE 10, 1998
Section 1. Purpose; Definitions.
1.1 Purpose. The purpose of the Source Media, Inc. ("Company") 1995
Performance Equity Plan, as amended and restated ("Plan"), is to enable the
Company to offer to the key employees, officers, directors and consultants of
the Company and its Subsidiaries whose past, present and/or potential
contributions to the Company and its Subsidiaries have been, are or will be
important to the success of the Company and its Subsidiaries, an opportunity to
acquire a proprietary interest in the Company. The various types of long-term
incentive awards which may be provided under the Plan will enable the Company to
respond to changes in compensation practices, tax laws, accounting regulations
and the size and diversity of its businesses.
1.2 Definitions. For purposes of the Plan, the following terms shall be
defined as set forth below:
"Agreement" means the agreement between the Company and the Holder
setting forth the terms and conditions of an award under the Plan.
"Award" means an award of Stock under the Plan.
"Board" means the Board of Directors of the Company.
"Code" means the Internal Revenue Code of 1986, as amended from time to
time, and any successor thereto and the regulations promulgated thereunder.
"Committee" means the Compensation Committee of the Board or any other
committee of the Board, which the Board may designate to administer the Plan or
any portion thereof. If no Committee is so designated, then all references in
this Plan to "Committee" shall mean the Board.
"Common Stock" means the Common Stock of the Company, par value $.001
per share.
"Company" means Source Media, Inc., a Delaware corporation
"Deferred Stock" means Stock to be received, under an award made
pursuant to Section 9 below, at the end of a specified deferral period.
"Disability" means incapacity by illness or other disability from
performing usual employment obligations for a period in excess of 240 days
(whether or not consecutive) or 120 days consecutively, as the case may be,
during any twelve month period.
"Effective Date" means the date set forth in Section 12.
"Fair Market Value", unless otherwise required by any applicable
provision of the Code or any regulations issued thereunder, means, as of any
given date: (i) if the Common Stock is listed on a national securities exchange
or quoted on the Nasdaq National Market or Nasdaq SmallCap Market, the last sale
price of the Common Stock in the principal trading market for the Common Stock
on the date of grant of an award hereunder, as reported by the exchange or
Nasdaq, as the case may be; (ii) if the Common Stock is not listed on a national
securities exchange or quoted on the Nasdaq National Market or Nasdaq SmallCap
Market, but
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is traded in the over-the-counter market, the closing bid price for the
Common Stock on the date of grant of an award hereunder for which such
quotations are reported by the National Quotation Bureau, Incorporated
or similar publisher of such quotations; and (iii) if the fair market
value of the Common Stock cannot be determined pursuant to clause (i)
or (ii) above, such price as the Committee shall determine, in good
faith.
"Holder" means a person who has received an award under the
Plan.
"Incentive Stock Option" means any Stock Option intended to be
and designated as an "incentive stock option" within the meaning of
Section 422 of the Code.
"Non-Qualified Stock Option" means any Stock Option that is
not an Incentive Stock Option.
"Other Stock-Based Award" means an award under Section 10
below that is valued in whole or in part by reference to, or is
otherwise based upon, Stock.
"Parent" means any present or future parent corporation of the
Company, as such term is defined in Section 424(e) of the Code.
"Plan" means the Source Media, Inc. 1995 Performance Equity
Plan, as amended and restated and as hereinafter amended from time to
time.
"Restricted Stock" means Stock, received under an award made
pursuant to Section 8 below, that is subject to restrictions under said
Section 8.
"Rule 16b-3" means Rule 16b-3 of the General Rules and
Regulations under the Exchange Act, as in effect from time to time.
"SAR Value" means the excess of the Fair Market Value of one
share of Common Stock over the exercise price per share specified in a
related Stock Option in the case of a Stock Appreciation Right granted
in tandem with a Stock Option and the Stock Appreciation Right price
per share in the case of a Stock Appreciation Right awarded on a free
standing basis, in each case multiplied by the number of shares in
respect of which the Stock Appreciation Right shall be exercised, on
the date of exercise.
"Stock" means the Common Stock of the Company, par value $.001
per share.
"Stock Appreciation Right" means the right, pursuant to an
award granted under Section 7 hereof, to recover an amount equal to the
SAR Value.
"Stock Option" or "Option" means any option to purchase shares
of Stock which is granted pursuant to the Plan.
"Stock Reload Option" means any option granted under Section
6.3 as a result of the payment of the exercise price of a Stock Option
and/or the withholding tax related thereto in the form of Stock owned
by the Holder or the withholding of Stock by the Company.
"Subsidiary" means any present or future subsidiary
corporation of the Company, as such term is defined in Section 424(f)
of the Code.
"Tandem Stock Appreciation Right" means a Stock Appreciation
Right granted in tandem with all or part of any Stock Option granted
under the Plan.
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SECTION 2. ADMINISTRATION.
2.1 Committee Membership. The Plan shall be administered by a
Committee. Committee members shall serve for such term as the Board may in each
case determine, and shall be subject to removal at any time by the Board. It is
the intent of the Board that the Plan qualify under Rule 16b-3 promulgated under
the Securities Exchange Act of 1934 ("Exchange Act"). To that end, unless
otherwise determined by the Board, each Committee member shall be a
"disinterested person" (i.e., a director who has not, during the one year prior
to service as an administrator of the Plan, or during such service, received a
grant or award of equity securities of the Company pursuant to the Plan or any
other plan of the Company or any of its affiliates). The membership of the
Committee shall at all times be comprised of persons so as not to adversely
affect the compliance of the Plan with the requirements of Rule 16b-3 under the
Exchange Act or with the requirements of any other applicable law, rule or
regulation.
2.2 Powers of Committee. The Committee shall have full authority,
subject to Section 4 hereof, to award, pursuant to the terms of the Plan: (i)
Stock Options, (ii) Stock Appreciation Rights, (iii) Restricted Stock, (iv)
Deferred Stock, (v) Stock Reload Options and/or (vi) Other Stock-Based Awards.
For purposes of illustration and not of limitation, the Committee shall have the
authority (subject to the express provisions of this Plan):
(a) to select the key employees, officers, directors and
consultants of the Company or any Subsidiary to whom Stock Options,
Stock Appreciation Rights, Restricted Stock, Deferred Stock, Reload
Stock Options and/or Other Stock-Based Awards may from time to time be
awarded hereunder;
(b) to determine the terms and conditions, not inconsistent
with the terms of the Plan, of any award granted hereunder (including,
but not limited to, number of shares, share price, any restrictions or
limitations, and any vesting, exchange, surrender, cancellation,
acceleration, termination, exercise or forfeiture provisions, as the
Committee shall determine);
(c) to determine any specified performance goals or such other
factors or criteria which need to be attained for the vesting of an
award granted hereunder;
(d) to determine the terms and conditions under which awards
granted hereunder are to operate on a tandem basis and/or in
conjunction with or apart from other equity awarded under this Plan and
cash awards made by the Company or any Subsidiary outside of this Plan;
(e) to permit a Holder to elect to defer a payment under the
Plan under such rules and procedures as the Committee may establish,
including the crediting of interest on deferred amounts denominated in
cash and of dividend equivalents on deferred amounts denominated in
Stock;
(f) to determine the extent and circumstances under which
Stock and other amounts payable with respect to an award hereunder
shall be deferred which may be either automatic or at the election of
the Holder; and
(g) to substitute (i) new Stock Options for previously granted
Stock Options, which previously granted Stock Options have higher
option exercise prices and/or contain other less favorable terms, and
(ii) new awards of any other type for previously granted awards of the
same type, which previously granted awards are upon less favorable
terms.
2.3 Interpretation of Plan.
(a) Committee Authority. Subject to Sections 4.2 (b) and 11
hereof, the Committee shall have the authority to adopt, alter and
repeal such administrative rules, guidelines and practices governing
the Plan as it shall, from time to time, deem advisable, to interpret
the terms and provisions of the Plan and any award
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issued under the Plan (and to determine the form and substance of all
Agreements relating thereto), and to otherwise supervise the
administration of the Plan. Subject to Section 11 hereof, all decisions
made by the Committee pursuant to the provisions of the Plan shall be
made in the Committee's sole discretion and shall be final and binding
upon all persons, including the Company, its Subsidiaries and Holders.
Determinations by the Committee under the Plan relating to the form,
amount and terms and conditions of awards need not be uniform, and may
be made selectively among persons who receive or are eligible to
receive awards under the Plan, whether or not such persons are
similarly situated.
(b) Incentive Stock Options. Anything in the Plan to the
contrary notwithstanding, no term or provision of the Plan relating to
Incentive Stock Options (including but limited to Stock Reload Options
or Tandem Stock Appreciation Rights granted in conjunction with an
Incentive Stock Option) or any Agreement providing for Incentive Stock
Options shall be interpreted, amended or altered, nor shall any
discretion or authority granted under the Plan be so exercised, so as
to disqualify the Plan under Section 422 of the Code, or, without the
consent of the Holder(s) affected, to disqualify any Incentive Stock
Option under such Section 422.
SECTION 3. STOCK SUBJECT TO PLAN
3.1 Number of Shares. The total number of shares of Common Stock
reserved and available for distribution under the Plan shall be one million nine
hundred seventy-five thousand (1,975,000) shares. Shares of Stock under the Plan
may consist, in whole or in part, of authorized and unissued shares or treasury
shares. If any shares of Stock that have been granted pursuant to a Stock Option
cease to be subject to a Stock Option, or if any shares of Stock that are
subject to any Stock Appreciation Right, Restricted Stock, Deferred Stock award,
Reload Stock Option or Other Stock-Based Award granted hereunder are forfeited
or any such award otherwise terminates without a payment being made to the
Holder in the form of Stock, such shares shall again be available for
distribution in connection with future grants and awards under the Plan. Only
net shares issued upon a stock-for-stock exercise (including stock used for
withholding taxes) shall be counted against the number of shares available under
the Plan.
3.2 Adjustment Upon Changes in Capitalization, Etc. In the event of any
merger, reorganization, consolidation, recapitalization, dividend (other than a
cash dividend), stock split, reverse stock split, or other change in corporate
structure affecting the Stock, such substitution or adjustment shall be made in
the aggregate number of shares reserved for issuance under the Plan, in the
number and exercise price of shares subject to outstanding Options, in the
number of shares and Stock Appreciation Right price relating to Stock
Appreciation Rights, and in the number of shares subject to, and in the related
terms of, other outstanding awards (including but not limited to awards of
Restricted Stock, Deferred Stock, Reload Stock Options and Other Stock-Based
Awards) granted under the Plan as may be determined to be appropriate by the
Committee in order to prevent dilution or enlargement of rights, provided that
the number of shares subject to any award shall always be a whole number.
SECTION 4. ELIGIBILITY.
4.1 General. Awards may be made or granted to key employees, officers,
directors and consultants of the Company or any of its Subsidiaries who are
deemed to have rendered or to be able to render significant services to the
Company or its Subsidiaries and who are deemed to have contributed or to have
the potential to contribute to the success of the Company or any of its
Subsidiaries. No Incentive Stock Option shall be granted to any person who is
not an employee of the Company or a Subsidiary at the time of grant.
4.2 Awards and Grants.
(a) The granting of Stock Options and Awards under the Plan
shall be determined by a Committee of two or more directors of the
Company, of which all members shall be disinterested persons, as
described in
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Section 2.1 hereof. No grants or awards will be made to any person
whose eligibility under the Plan would adversely affect the compliance
of the Plan with the requirements of Rule 16b-3.
(b) This Section 4.2 shall not be amended more than once every
six months, other than to comport with any changes in the Code or the
Employment Retirement Income Security Act, or the rules and regulations
promulgated thereunder.
SECTION 5. GENERAL TERMS AND CONDITIONS.
5.1 General. With respect to the award or grant of any (i) Stock
Options, (ii) Stock Appreciation Rights, (iii) Restricted Stock, (iv) Deferred
Stock, (v) Stock Reload Options and/or (vi) Other Stock-Based Awards, the
following terms and conditions shall apply:
(a) Transferability:
(i) Incentive Stock Options: Any Stock Option issued
pursuant to and intended to be an Incentive Stock Option under
the Plan shall not be transferable by the Holder other than by
will or the laws of descent and distribution.
(ii) Non-Qualified Stock Options: Any Stock Option
issued pursuant to the Plan which is not intended to qualify
as an Incentive Stock Option, shall not be transferable by the
Holder other than by will or the laws of descent and
distribution; provided, however, should Rule 16b-3 so permit,
such Stock Option may also be transferred, for no
consideration, by the Holder to the following transferees
("Transferee"):
(A) a member of the Holder's immediate
family. For purposes of this section, "immediate
family" shall include only brothers and sisters
(whether by the whole or half blood) spouse, parents,
and natural or adopted siblings,
(B) a trust for the benefit of members of
the Holder's immediate family, or
(C) a partnership whose only partners are
members of the Holder's immediate family,
if the Transferee shall agree to be subject to the same
restrictions and conditions as relate to the Holder pursuant
to the Plan.
(b) Change in Control. In the event of a Change in Control (as
defined below), all options to the extent not then currently
exercisable shall become immediately exercisable in full.
As used in this Plan, a "Change in Control" shall be deemed to occur
(i) when the Company acquires actual knowledge that any person, as such term is
used in the Exchange Act, including Section 14(d)(2) thereof, (other than (a)
any employee benefit plan established or maintained by the Company or any of its
Subsidiaries, and (b) any person who is deemed to be the beneficial owner of any
securities of the Company to which any person in clause (a) above is and remains
a beneficial owner, including, without limitation, any person that is a member
of a group (as defined in said Section 14(d)(2) of the Exchange Act) in which
any person defined in clause (a) above is also a member) is or becomes the
beneficial owner (as defined in Rule 13d-3 of the Exchange Act), directly or
indirectly, of securities of the Company representing 25% or more of the
combined voting power of the Company's then outstanding securities, (ii) upon
the first purchase of the Company's Common Stock pursuant to a tender or
exchange offer (other than a tender or exchange offer made by the Company or an
employee benefit plan established or maintained by the Company or any of its
subsidiaries), (iii) upon the approval by the Company's stockholders of (A) a
merger or consolidation of the Company with or into another corporation (other
than a merger or consolidation in which the
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Company is the surviving corporation and which does not result in any capital
reorganization or reclassification or other change in the Company's then
outstanding shares of Common Stock), (B) a sale or disposition of all or
substantially all of the Company's assets or (C) a plan of liquidation or
dissolution of the Company, or (iv) if during any period of two (2) consecutive
years, individuals who at the beginning of such period constitute the Board of
Directors of the Company cease for any reason to constitute at least two-thirds
thereof, unless the election or nomination for the election by the Company's
stockholders of each new director was approved by a vote of at least two-thirds
of the directors then still in office who were directors at the beginning of the
period.
SECTION 6. STOCK OPTIONS.
6.1. Grant and Exercise. Stock Options granted under the Plan may be of
two types: (i) Incentive Stock Options and (ii) Non-Qualified Stock Options. Any
Stock Option granted under the Plan shall contain such terms, not inconsistent
with this Plan, or with respect to Incentive Stock Options, the Code, as the
Committee may from time to time approve. The Committee shall have the authority
to grant Incentive Stock Options, Non-Qualified Stock Options, or both types of
Stock Options and may be granted alone or in addition to other awards granted
under the Plan. To the extent that any Stock Option intended to qualify as an
Incentive Stock Option does not so qualify, it shall constitute a separate
Non-Qualified Stock Option. An Incentive Stock Option may only be granted within
the ten year period commencing from the Effective Date and may only be exercised
within ten years of the date of grant (or five years in the case of an Incentive
Stock Option granted to an optionee ("10% Stockholder") who, at the time of
grant, owns Stock possessing more than 10% of the total combined voting power of
all classes of stock of the Company or a Parent or Subsidiary.
6.2. Terms and Conditions. Stock Options granted under the Plan shall
be subject to the following terms and conditions:
(a) Exercise Price. The exercise price per share of Stock
purchasable under a Stock Option shall be determined by the Committee
at the time of grant and may be less than 100% of the Fair Market Value
of the Stock as defined above; provided, however, that the exercise
price of an Incentive Stock Option shall not be less than 100% of the
Fair Market Value of the Stock (110%, in the case of a 10%
Stockholder).
(b) Option Term. Subject to the limitations in Section 6.1,
the term of each Stock Option shall be fixed by the Committee.
(c) Exercisability. Subject to Section 5.1 (a) hereinabove,
Stock Options shall be exercisable at such time or times and subject to
such terms and conditions as shall be determined by the Committee. If
the Committee provides, in its discretion, that any Stock Option is
exercisable only in installments, i.e., that it vests over time, the
Committee may waive such installment exercise provisions at any time at
or after the time of grant in whole or in part, based upon such factors
as the Committee shall determine.
(d) Method of Exercise. Subject to whatever installment,
exercise and waiting period provisions are applicable in a particular
case, Stock Options may be exercised in whole or in part at any time
during the term of the Option, by giving written notice of exercise to
the Company specifying the number of shares of Stock to be purchased.
Such notice shall be accompanied by payment in full of the purchase
price, which shall be in cash or, unless otherwise provided in the
Agreement, in shares of Stock (including Restricted Stock and other
contingent awards under this Plan) or, partly in cash and partly in
such Stock, or such other means which the Committee determines are
consistent with the Plan's purpose and applicable law. Cash payments
shall be made by wire transfer, certified or bank check or personal
check, in each case payable to the order of the Company; provided,
however, that the Company shall not be required to deliver certificates
for shares of Stock with respect to which an Option is exercised until
the Company has confirmed the receipt of good and available funds in
payment of the purchase price thereof. Payments in the form of Stock
shall be valued at the Fair Market Value of a share of Stock on the
date prior to the date of exercise. Such payments shall be made by
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delivery of stock certificates in negotiable form which are effective
to transfer good and valid title thereto to the Company, free of any
liens or encumbrances. Subject to the terms of the Agreement, the
Committee may, in its sole discretion, at the request of the Holder,
deliver upon the exercise of a Non-Qualified Stock Option a combination
of shares of Deferred Stock and Common Stock; provided that,
notwithstanding the provisions of Section 9 of the Plan, such Deferred
Stock shall be fully vested and not subject to forfeiture. A Holder
shall have none of the rights of a stockholder with respect to the
shares subject to the Option until such shares shall be transferred to
the Holder upon the exercise of the Option.
(e) Termination by Reason of Death. If a Holder's employment
by the Company or a Subsidiary terminates by reason of death, any Stock
Option held by such Holder, unless otherwise determined by the
Committee at the time of grant and set forth in the Agreement, shall be
fully vested and may thereafter be exercised by the legal
representative of the estate or by the legatee of the Holder under the
will of the Holder, for a period of one year (or such other greater or
lesser period as the Committee may specify at grant) from the date of
such death or until the expiration of the stated term of such Stock
Option, whichever period is the shorter.
(f) Termination by Reason of Disability. If a Holder's
employment by the Company or any Subsidiary terminates by reason of
Disability, any Stock Option held by such Holder, unless otherwise
determined by the Committee at the time of grant and set forth in the
Agreement, shall be fully vested and may thereafter be exercised by the
Holder for a period of one year (or such other greater or lesser period
as the Committee may specify at the time of grant) from the date of
such termination of employment or until the expiration of the stated
term of such Stock Option, whichever period is the shorter.
(g) Other Termination. Subject to the provisions of Section
13.3 below and unless otherwise determined by the Committee at the time
of grant and set forth in the Agreement, if a Holder is an employee of
the Company or a Subsidiary at the time of grant and if such Holder's
employment by the Company or any Subsidiary terminates for any reason
other than death or Disability, the Stock Option shall thereupon
automatically terminate, except that if the Holder's employment is
terminated by the Company or a Subsidiary without cause or due to
retirement from active employment with the Company or any Subsidiary on
or after age 65, then the portion of such Stock Option which has vested
on the date of termination of employment may be exercised for the
lesser of three months after termination of employment or the balance
of such Stock Option's term.
(h) Additional Incentive Stock Option Limitation. In the case
of an Incentive Stock Option, the amount of aggregate Fair Market Value
of Stock (determined at the time of grant of the Option) with respect
to which Incentive Stock Options are exercisable for the first time by
a Holder during any calendar year (under all such plans of the Company
and its Parent and Subsidiaries) shall not exceed $100,000.
(i) Buyout and Settlement Provisions. The Committee may at any
time offer to buy out a Stock Option previously granted, based upon
such terms and conditions as the Committee shall establish and
communicate to the Holder at the time that such offer is made.
(j) Stock Option Agreement. Each grant of a Stock Option shall
be confirmed by, and shall be subject to the terms of, the Agreement
executed by the Company and the Holder.
6.3. Stock Reload Option. The Committee may also grant to the Holder
(concurrently with the grant of an Incentive Stock Option and at or after the
time of grant in the case of a Non-Qualified Stock Option) a Stock Reload Option
up to the amount of shares of Stock held by the Holder for at least six months
and used to pay all or part of the exercise price of an Option and, if any,
withheld by the Company as payment for withholding taxes. Such Stock Reload
Option shall have an exercise price of the Fair Market Value as of the date of
the Stock Reload Option grant.
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Unless the Committee determines otherwise, a Stock Reload Option may be
exercised commencing one year after it is granted and shall expire on the date
of expiration of the Option to which the Stock Reload Option is related.
SECTION 7. STOCK APPRECIATION RIGHTS.
7.1. Grant and Exercise. Stock Appreciation Rights may be granted in
tandem with (i.e., Tandem Stock Appreciation Right) or in conjunction with all
or part of any Stock Option granted under the Plan or may be granted on a
free-standing basis. In the case of a Non-Qualified Stock Option, a Tandem Stock
Appreciation Right may be granted either at or after the time of the grant of
such Non-Qualified Stock Option. In the case of an Incentive Stock Option, a
Tandem Stock Appreciation Right may be granted only at the time of the grant of
such Incentive Stock Option.
7.2. Terms and Conditions. Stock Appreciation Rights shall be subject
to the following terms and conditions:
(a) Exercisability. Tandem Stock Appreciation Rights shall be
exercisable only at such time or times and to the extent that the Stock
Options to which they relate shall be exercisable in accordance with
the provisions of Section 6 hereof and this Section 7 and may be
subject to the Code with respect to related Incentive Stock Options and
such additional limitations on exercisability as shall be determined by
the Committee and set forth in the Agreement. Other Stock Appreciation
Rights shall be exercisable at such time or times and subject to such
terms and conditions as shall be determined by the Committee and set
forth in the Agreement.
(b) Termination. A Tandem Stock Appreciation Right shall
terminate and shall no longer be exercisable upon the termination or
exercise of the related Stock Option, except that, unless otherwise
determined by the Committee at the time of grant, a Tandem Stock
Appreciation Right granted with respect to less than the full number of
shares covered by a related Stock Option shall not be reduced until
after the number of shares remaining under the related Stock Option
equals the number of shares covered by the Tandem Stock Appreciation
Right.
(c) Method of Exercise. A Tandem Stock Appreciation Right may
be exercised by a Holder by surrendering the applicable portion of the
related Stock Option. Upon such exercise and surrender, the Holder
shall be entitled to receive such amount in the form determined
pursuant to Section 7.2(d) below. Stock Options which have been so
surrendered, in whole or in part, shall no longer be exercisable to the
extent the related Tandem Stock Appreciation Rights have been
exercised.
(d) Receipt of SAR Value. Upon the exercise of a Stock
Appreciation Right, a Holder shall be entitled to receive up to, but
not more than, an amount in cash and/or shares of Stock equal to the
SAR Value with the Committee having the right to determine the form of
payment.
(e) Shares Affected Upon Plan. Upon the exercise of a Tandem
Stock Appreciation Right, the Stock Option or part thereof to which
such Tandem Stock Appreciation Right is related shall be deemed to have
been exercised for the purpose of the limitation set forth in Section 3
hereof on the number of shares of Common Stock to be issued under the
Plan, but only to the extent of the number of shares, if any, issued
under the Tandem Stock Appreciation Right at the time of exercise based
upon the SAR Value.
SECTION 8. RESTRICTED STOCK.
8.1. Grant. Shares of Restricted Stock may be awarded either alone or
in addition to other awards granted under the Plan. The Committee shall
determine the eligible persons to whom, and the time or times at which, grants
of Restricted Stock will be awarded, the number of shares to be awarded, the
price (if any) to be paid by the Holder,
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the time or times within which such awards may be subject to forfeiture
("Restriction Period"), the vesting schedule and rights to acceleration thereof,
and all other terms and conditions of the awards.
8.2. Terms and Conditions. Each Restricted Stock award shall be subject
to the following terms and conditions:
(a) Certificates. Restricted Stock, when issued, will be
represented by a stock certificate or certificates registered in the
name of the Holder to whom such Restricted Stock shall have been
awarded. During the Restriction Period, certificates representing the
Restricted Stock and any securities constituting Retained Distributions
(as defined below) shall bear a legend to the effect that ownership of
the Restricted Stock (and such Retained Distributions), and the
enjoyment of all rights appurtenant thereto, are subject to the
restrictions, terms and conditions provided in the Plan and the
Agreement. Such certificates shall be deposited by the Holder with the
Company, together with stock powers or other instruments of assignment,
each endorsed in blank, which will permit transfer to the Company of
all or any portion of the Restricted Stock and any securities
constituting Retained Distributions that shall be forfeited or that
shall not become vested in accordance with the Plan and the Agreement.
(b) Rights of Holder. Restricted Stock shall constitute issued
and outstanding shares of Common Stock for all corporate purposes. The
Holder will have the right to vote such Restricted Stock, to receive
and retain all regular cash dividends and other cash equivalent
distributions as the Board may in its sole discretion designate, pay or
distribute on such Restricted Stock and to exercise all other rights,
powers and privileges of a holder of Common Stock with respect to such
Restricted Stock, with the exceptions that (i) the Holder will not be
entitled to delivery of the stock certificate or certificates
representing such Restricted Stock until the Restriction Period shall
have expired and unless all other vesting requirements with respect
thereto shall have been fulfilled; (ii) the Company will retain custody
of the stock certificate or certificates representing the Restricted
Stock during the Restriction Period; (iii) other than regular cash
dividends and other cash equivalent distributions as the Board may in
its sole discretion designate, pay or distribute, the Company will
retain custody of all distributions ("Retained Distributions") made or
declared with respect to the Restricted Stock (and such Retained
Distributions will be subject to the same restrictions, terms and
conditions as are applicable to the Restricted Stock) until such time,
if ever, as the Restricted Stock with respect to which such Retained
Distributions shall have been made, paid or declared shall have become
vested and with respect to which the Restriction Period shall have
expired; (iv) a breach of any of the restrictions, terms or conditions
contained in this Plan or the Agreement or otherwise established by the
Committee with respect to any Restricted Stock or Retained
Distributions will cause a forfeiture of such Restricted Stock and any
Retained Distributions with respect thereto.
(c) Vesting; Forfeiture. Upon the expiration of the
Restriction Period with respect to each award of Restricted Stock and
the satisfaction of any other applicable restrictions, terms and
conditions (i) all or part of such Restricted Stock shall become vested
in accordance with the terms of the Agreement, and (ii) any Retained
Distributions with respect to such Restricted Stock shall become vested
to the extent that the Restricted Stock related thereto shall have
become vested. Any such Restricted Stock and Retained Distributions
that do not vest shall be forfeited to the Company and the Holder shall
not thereafter have any rights with respect to such Restricted Stock
and Retained Distributions that shall have been so forfeited.
SECTION 9. DEFERRED STOCK.
9.1. Grant. Shares of Deferred Stock may be awarded either alone or in
addition to other awards granted under the Plan. The Committee shall determine
the eligible persons to whom and the time or times at which grants of Deferred
Stock shall be awarded, the number of shares of Deferred Stock to be awarded to
any person, the duration of the period ("Deferral Period") during which, and the
conditions under which receipt of the shares will be deferred, and all the other
terms and conditions of the awards.
9
<PAGE> 10
9.2. Terms and Conditions. Each Deferred Stock award shall be subject
to the following terms and conditions:
(a) Certificates. At the expiration of the Deferral Period (or
the Additional Deferral Period referred to in Section 9.2(c) below,
where applicable), share certificates shall be delivered to the Holder,
or his legal representative, representing the number equal to the
shares covered by the Deferred Stock award.
(b) Vesting; Forfeiture. Upon the expiration of the Deferral
Period (or the Additional Deferral Period, where applicable) with
respect to each award of Deferred Stock and the satisfaction of any
other applicable limitations, terms or conditions, such Deferred Stock
shall become vested in accordance with the terms of the Agreement. Any
Deferred Stock that does not vest shall be forfeited to the Company and
the Holder shall not thereafter have any rights with respect to such
Deferred Stock that has been so forfeited.
(c) Additional Deferral Period. A Holder may request to, and
the Committee may at any time, defer the receipt of an award (or an
installment of an award) for an additional specified period or until a
specified event ("Additional Deferral Period"). Subject to any
exceptions adopted by the Committee, such request must generally be
made at least one year prior to expiration of the Deferral Period for
such Deferred Stock award (or such installment).
SECTION 10. OTHER STOCK-BASED AWARDS.
10.1. Grant and Exercise. Other Stock-Based Awards may be awarded,
subject to limitations under applicable law, that are denominated or payable in,
valued in whole or in part by reference to, or otherwise based on, or related
to, shares of Common Stock, as deemed by the Committee to be consistent with the
purposes of the Plan, including, without limitation, purchase rights, shares of
Common Stock awarded which are not subject to any restrictions or conditions,
convertible or exchangeable debentures, or other rights convertible into shares
of Common Stock and awards valued by reference to the value of securities of or
the performance of specified Subsidiaries. Other Stock-Based Awards may be
awarded either alone or in addition to or in tandem with any other awards under
this Plan or any other plan of the Company.
10.2. Eligibility For Other Stock-Based Awards. The Committee shall
determine the eligible persons to whom and the time or times at which grants of
such Other Stock-Based Awards shall be made, the number of shares of Common
Stock to be awarded pursuant to such awards, and all other terms and conditions
of the awards.
10.3. Terms and Conditions. Each Other Stock-Based Award shall be
subject to such terms and conditions as may be determined by the Committee.
SECTION 11. AMENDMENT AND TERMINATION.
The Board may at any time, and from time to time, amend, alter, suspend
or discontinue any of the provisions of the Plan, but no amendment, alteration,
suspension or discontinuance shall be made which would impair the rights of a
Holder under any Agreement theretofore entered into hereunder, without his
consent.
SECTION 12. TERM OF PLAN.
12.1 Effective Date. The Plan, as amended and restated, shall be
effective as of June 10, 1998 ("Effective Date"), subject to the approval of the
Plan by the stockholders of the Company within one year after the Effective
Date. Any awards granted under the Plan after the Effective Date and prior to
such approval shall be effective when made (unless otherwise specified by the
Committee at the time of grant), but shall be conditioned upon, and subject to,
such approval of the Plan by the Company's stockholders and no awards shall vest
or otherwise become free of restrictions prior to such approval.
10
<PAGE> 11
12.2 Termination Date. Unless terminated by the Board, this Plan shall
continue to remain effective until such time no further awards may be granted
and all awards granted under the Plan are no longer outstanding. Notwithstanding
the foregoing, grants of Incentive Stock Options may only be made during the ten
year period following the Effective Date.
SECTION 13. GENERAL PROVISIONS.
13.1 Written Agreements. Each award granted under the Plan shall be
confirmed by, and shall be subject to, the terms of the Agreement executed by
the Company and the Holder. The Committee may terminate any award made under the
Plan if the Agreement relating thereto is not executed and returned to the
Company within 60 days after the Agreement has been delivered to the Holder for
his or her execution.
13.2 Unfunded Status of Plan. The Plan is intended to constitute an
"unfunded" plan for incentive and deferred compensation and the Company shall
not be required to segregate any assets in respect of the Plan. With respect to
any payments not yet made to a Holder by the Company, nothing contained herein
shall give any such Holder any rights that are greater than those of a general
creditor of the Company.
13.3 Employees.
(a) Engaging in Competition With the Company. In the event an
employee Holder terminates his employment with the Company or a
Subsidiary for any reason whatsoever, and within eighteen (18) months
after the date thereof accepts employment with any competitor of, or
otherwise engages in competition with, the Company or any Subsidiary,
the Committee, in its sole discretion, may require such Holder to
return to the Company the economic value of any award which was
realized or obtained (measured at the date of exercise, vesting or
payment) by such Holder at any time during the period beginning on that
date which is six months prior to the date of such Holder's termination
of employment with the Company or a Subsidiary.
(b) Termination for Cause. The Committee may, in the event a
Holder is terminated by the Company or a Subsidiary for cause, annul
any award granted under this Plan to such Holder and, in such event,
the Committee, in its sole discretion, may require such Holder to
return to the Company the economic value of any award which was
realized or obtained (measured at the date of exercise, vesting or
payment) by such Holder at any time during the period beginning on that
date which is six months prior to the date of such Holder's termination
of employment with the Company or a Subsidiary.
(c) No Right of Employment. Nothing contained in the Plan or
in any award hereunder shall be deemed to confer upon any Holder of the
Company or any Subsidiary any right to continued employment with the
Company or any Subsidiary, nor shall it interfere in any way with the
right of the Company or any Subsidiary to terminate the employment of
any of its employees or agents at any time.
13.4 Investment Representations. The Committee may require each person
acquiring shares of Stock pursuant to a Stock Option or other award under the
Plan to represent to and agree with the Company in writing that the Holder is
acquiring the shares for investment without a view to distribution thereof, or
to take any other action which may be required in order to comply with any
applicable state securities laws or regulations.
13.5 Indemnification. No member of the Board or the Committee, nor any
officer or employee of the Company acting on behalf of the Board or the
Committee, shall be personally liable for any action, determination or
interpretation taken or made with respect to the Plan, and all members of the
Board or the Committee and all officers or employees of the Company acting on
their behalf shall, to the extent permitted by law, be fully indemnified and
protected by the Company in respect of any such action, determination or
interpretation.
11
<PAGE> 12
13.6 Additional Incentive Arrangements. Nothing contained in the Plan
shall prevent the Board from adopting such other or additional incentive
arrangements as it may deem desirable, including, but not limited to, the
granting of Stock Options and the awarding of stock and cash otherwise than
under the Plan; and such arrangements may be either generally applicable or
applicable only in specific cases.
13.7 Withholding Taxes. Not later than the date as of which an amount
first becomes includible in the gross income of the Holder for Federal income
tax purposes with respect to any option or other award under the Plan, the
Holder shall pay to the Company, or make arrangements satisfactory to the
Committee regarding the payment of, any Federal, state and local taxes of any
kind required by law to be withheld or paid with respect to such amount. If
permitted by the Committee, tax withholding or payment obligations may be
settled with Common Stock, including Common Stock that is part of the award that
gives rise to the withholding requirement. The obligations of the Company under
the Plan shall be conditional upon such payment or arrangements and the Company
or the Holder's employer (if not the Company) shall, to the extent permitted by
law, have the right to deduct any such taxes from any payment of any kind
otherwise due to the Holder from the Company or any Subsidiary.
13.8 Governing Law. The Plan and all awards made and actions taken
thereunder shall be governed by and construed in accordance with the laws of the
State of Texas (without regard to choice of law provisions).
13.9 Other Benefit Plans. Any award granted under the Plan shall not be
deemed compensation for purposes of computing benefits under any retirement plan
of the Company or any Subsidiary and shall not affect any benefits under any
other benefit plan now or subsequently in effect under which the availability or
amount of benefits is related to the level of compensation (unless required by
specific reference in any such other plan to awards under this Plan).
13.10 Compliance with Rule 16b-3. With respect to persons subject to
Section 16 of the Exchange Act, transactions under this Plan are intended to
comply with all applicable conditions of Rule 16b-3 or its successors under the
Exchange Act. To the extent any provision of the Plan or action by the Committee
fails to so comply, it shall be deemed null and void, to the extent permitted by
law and deemed advisable by the Committee.
13.11 Non-Transferability. Except as otherwise expressly provided in
the Plan, no right or benefit under the Plan may be alienated, sold, assigned,
hypothecated, pledged, exchanged, transferred, encumbered or charged, and any
attempt to alienate, sell, assign, hypothecate, pledge, exchange, transfer,
encumber or charge the same shall be void.
13.12 Applicable Laws. The obligations of the Company with respect to
all Stock Options and awards under the Plan shall be subject to (i) all
applicable laws, rules and regulations and such approvals by any governmental
agencies as may be required, including, without limitation, the effectiveness of
a registration statement under the Securities Act of 1933, as amended, and (ii)
the rules and regulations of any securities exchange on which the Stock may be
listed.
13.13 Conflicts. If any of the terms or provisions of the Plan conflict
with the requirements of (with respect to Incentive Stock Options) Section 422
of the Code, then such terms or provisions shall be deemed inoperative to the
extent they so conflict with the requirements of said Section 422 of the Code.
Additionally, if this Plan does not contain any provision required to be
included herein under Section 422 of the Code, such provision shall be deemed to
be incorporated herein with the same force and effect as if such provision had
been set out at length herein.
13.14 Non-Registered Stock. The shares of Stock being distributed under
this Plan have not been registered under the Securities Act of 1933, as amended
("1933 Act"), or any applicable state or foreign securities laws and the Company
has no obligation to any Holder to register the Stock or to assist the Holder in
obtaining an exemption from the various registration requirements, or to list
the Stock on a national securities exchange.
12
<PAGE> 1
EXHIBIT 21
ITEM NO. 21 SUBSIDIARIES OF ORGANIZATION
SMI Holdings, Inc. Texas
IT Network, Inc. Delaware
Interactive Channel, Inc. Delaware
Interactive Channel Technologies Inc. Ontario, Canada
997758 Ontario Inc. Ontario, Canada
Cable Share International Inc. Barbados
Cableshare B.V. Netherlands
Cableshare (U.S.) Limited Illinois
1229501 Ontario Inc. Ontario, Canada
<PAGE> 1
EXHIBIT 23
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
pertaining to the 1989, 1991 and 1993 stock option plans and the 1995
performance equity plan, (Form S-8 No. 33-00142), (Form S-8 No. 33-00144),
Employee Stock Purchase Plan (Form S-8 No. 333-30197), 1995 Nonqualified Stock
Option Plan for Non-Employee Directors and certain nonqualified stock options
(Form S-8 No. 333-31439), Senior PIK Preferred Stock (Form S-4 No. 333-42017),
Senior Secured Notes (Form S-4 No. 333-42037), and Registration of shares
underlying certain warrants (Form S-3 No. 333-50853) of our report dated
February 19, 1999, with respect to the consolidated financial statements of
Source Media, Inc. included in the Annual Report (Form 10-K) for the year ended
December 31, 1998.
/s/ ERNST & YOUNG LLP
Dallas, Texas
March 29, 1999
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