<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED
MARCH 31, 2000
COMMISSION FILE NUMBER 0-21894
SOURCE MEDIA, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 13-3700438
(STATE OF INCORPORATION) (I.R.S. EMPLOYER
IDENTIFICATION NUMBER)
5400 LBJ FREEWAY, SUITE 680
DALLAS, TEXAS 75240
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(972) 701-5400
(REGISTRANT'S TELEPHONE NUMBER)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING
THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS
REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS.
YES X NO
--- ---
NUMBER OF SHARES OF COMMON STOCK OUTSTANDING AT MAY 10, 2000: 16,202,092
<PAGE> 2
SOURCE MEDIA, INC.
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2000
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION
Page Number
-----------
<S> <C>
Item 1. Consolidated Financial Statements of Source Media, Inc.
Consolidated Balance Sheets of Source Media, Inc. (Unaudited)
December 31, 1999 and March 31, 2000 3-4
Consolidated Statements of Operations of Source Media, Inc. (Unaudited)
Three months ended March 31, 1999 and 2000 5
Consolidated Statements of Cash Flows of Source Media, Inc. (Unaudited)
Three months ended March 31, 1999 and 2000 6
Consolidated Statements of Stockholders' Equity (Capital Deficiency)
of Source Media, Inc. (Unaudited) 7
Notes to Consolidated Financial Statements of Source Media,
Inc. (Unaudited) 8-15
Financial Statements of SourceSuite LLC
Balance Sheet of SourceSuite LLC (Unaudited) March 31, 2000 16
Statement of Operations of SourceSuite LLC (Unaudited)
Period from Inception (March 3, 2000) to March 31, 2000 17
Statement of Cash Flows of SourceSuite LLC (Unaudited)
Period from Inception (March 3, 2000) to March 31, 2000 18
Statement of Members' Equity of SourceSuite, LLC (Unaudited) March 31, 2000 19
Notes to Financial Statements of SourceSuite LLC (Unaudited)
Period from Inception (March 3, 2000) to March 31, 2000 20-22
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 23-27
Item 3. Quantitative and Qualitative Disclosures About Market Risk 27
PART II. OTHER INFORMATION
Item 1. Legal Proceedings N/A
Item 2. Changes in Securities and Use of Proceeds N/A
Item 3. Defaults Upon Senior Securities N/A
Item 4. Submission of Matters to a Vote of Security Holders 28
Item 5. Other Information N/A
Item 6. Exhibits and Reports on Form 8-K 28
</TABLE>
2
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SOURCE MEDIA, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
(IN THOUSANDS)
(Unaudited)
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1999 2000
------------ ------------
<S> <C> <C>
Current Assets:
Cash and cash equivalents $ 10,910 $ 14,004
Short-term investments 2,500 --
Restricted investments 5,997 6,080
Trade accounts receivable, less allowance for doubtful
accounts of $605 and $471 in 1999 and 2000, respectively 1,643 2,086
Related party receivables 1,458 530
Prepaid expenses and other current assets 1,068 1,244
Investment in securities available for sale -- 55,597
------------ ------------
Total current assets 23,576 79,541
Property and equipment:
Production equipment 4,511 4,355
Computer equipment 3,612 3,450
Other equipment 1,612 2,618
Furniture and fixtures 656 656
------------ ------------
10,391 11,079
Accumulated depreciation 7,957 9,183
------------ ------------
Net property and equipment 2,434 1,896
Intangible assets:
Goodwill 3,688 3,688
Contract rights 11,933 11,933
------------ ------------
15,621 15,621
Accumulated amortization 6,119 6,649
------------ ------------
Net intangible assets 9,502 8,972
Investment in joint venture 18,669 4,626
Other non-current assets 3,835 3,628
------------ ------------
Total assets $ 58,016 $ 98,663
============ ============
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
3
<PAGE> 4
SOURCE MEDIA, INC.
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY)
(IN THOUSANDS)
(Unaudited)
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1999 2000
------------ ------------
<S> <C> <C>
Current Liabilities:
Trade accounts payable $ 955 $ 1,102
Accrued interest 1,991 4,878
Accrued payroll 591 627
Other accrued liabilities 3,706 3,642
Unearned income 1,925 2,459
------------ ------------
Total current liabilities 9,168 12,708
Long-term debt 96,250 96,250
Minority interests in consolidated subsidiaries 3,840 3,840
Note receivable and accrued interest from minority stockholder,
net of discount of $12 and $5 in 1999 and 2000, respectively (837) (848)
------------ ------------
3,003 2,992
Senior redeemable payment-in-kind (PIK) preferred
stock, $25 dollar per share liquidation preference, $.001 par value,
net of discount
Authorized shares - 1,712; Issued and outstanding
shares 1,043 and 1,078 in 1999 and 2000, respectively 18,467 19,339
Non-participating preferred stock, $25 dollar per share liquidation
preference, $.001 par value; Authorized and issued - 1 single share
Stockholders' equity (capital deficiency):
Common stock, $.001 par value:
Authorized shares - 50,000; 16,278 and 16,456
issued and outstanding in 1999 and 2000, respectively 16 16
Less treasury stock, at cost - 268 and 268 shares in
1999 and 2000, respectively (2,647) (2,647)
Capital in excess of par value 120,883 121,083
Accumulated other comprehensive loss -- (31,841)
Accumulated deficit (187,124) (119,237)
------------ ------------
Total stockholders' equity (capital deficiency) (68,872) (32,626)
------------ ------------
Total liabilities and stockholders' equity (capital deficiency) $ 58,016 $ 98,663
============ ============
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
4
<PAGE> 5
SOURCE MEDIA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS THREE MONTHS
ENDED ENDED
MARCH 31, 1999 MARCH 31, 2000
-------------- --------------
<S> <C> <C>
Monetary revenues $ 4,943 $ 3,976
Nonmonetary revenues 409 660
-------------- --------------
Total revenues 5,352 4,636
Monetary cost of sales 2,697 2,340
Nonmonetary cost of sales 409 660
-------------- --------------
Total cost of sales 3,106 3,000
-------------- --------------
Gross profit 2,246 1,636
Selling, general and administrative expenses 5,550 3,843
Amortization of intangible assets 1,236 584
Research and development expenses 830 --
-------------- --------------
7,616 4,427
-------------- --------------
Operating loss (5,370) (2,791)
Interest expense 3,209 3,094
Interest income (282) (246)
Equity interest in losses of joint venture -- 1,583
Gain on sale of interest in joint venture -- (74,977)
Other expense (income) (2) (133)
-------------- --------------
Net income (loss) (8,295) 67,888
Preferred stock dividends 716 822
-------------- --------------
Net income (loss) attributable to common stockholders $ (9,011) $ 67,066
============== ==============
Other comprehensive income (loss):
Unrealized loss on available for sale securities -- (31,841)
-------------- --------------
Comprehensive Income (9,011) 35,225
============== ==============
Basic and diluted net loss per common share:
Net income (loss) per common share:
Basic $ (0.70) $ 4.17
Diluted $ (0.70) $ 3.72
Weighted average common shares outstanding:
Basic 12,830 16,086
Diluted 12,830 18,028
</TABLE>
See accompanying notes to Consolidated Financial Statements
5
<PAGE> 6
SOURCE MEDIA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS THREE MONTHS
ENDED ENDED
MARCH 31, 1999 MARCH 31, 2000
-------------- --------------
<S> <C> <C>
OPERATING ACTIVITIES
Net income (loss) $ (8,295) $ 67,888
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation 669 573
Amortization of intangible assets 1,236 530
Stock compensation 408 163
Non-cash interest expense 206 255
Non-cash interest income (154) (83)
Provision for losses on accounts receivable 150 134
Gain of sale of joint venture -- (74,977)
Equity investment in losses of joint venture -- 1,583
Other, net (15) --
Changes in operating assets and liabilities:
Trade accounts receivable 384 1,279
Related party receivable -- (928)
Prepaid expenses and other current assets (217) (183)
Deferred expenses 143 6
Trade accounts payable and accrued liabilities 2,044 3,006
Accrued interest -- (11)
Unearned income 46 534
-------------- --------------
Net cash used in operating activities (3,395) (231)
INVESTING ACTIVITIES
Capital expenditures (204) (34)
Redemption of short-term investments -- 2,500
Proceeds from sale of joint venture -- 4,392
Investment in SourceSuite LLC -- (4,392)
-------------- --------------
Net cash provided by (used in) investing activities (204) 2,466
FINANCING ACTIVITIES
Proceeds from issuance of common stock 1,273 858
Other -- 1
-------------- --------------
Net cash provided by financing activities 1,273 859
Net increase (decrease) in cash and cash equivalents (2,326) 3,094
Cash and cash equivalents at beginning of period 11,662 10,910
-------------- --------------
Cash and cash equivalents at end of period $ 9,336 $ 14,004
============== ==============
</TABLE>
See accompanying Notes to Consolidated Financial Statements
6
<PAGE> 7
SOURCE MEDIA, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY)
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
COMMON STOCK CAPITAL IN
----------------------- TREASURY EXCESS OF ACCUMULATED
SHARES AMOUNT STOCK PAR VALUE DEFICIT
-------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1999 16,278 $ 16 $ (2,647) $ 120,883 $ (187,124)
Issuance of common stock upon exercise of
stock options 178 -- -- 859 --
Stock compensation -- -- -- 163 --
Accumulated other comprehensive loss -- -- -- -- --
Net income -- -- -- -- 67,887
Preferred stock dividends -- -- -- (822) --
------ ------------ ------------ ------------ ------------
BALANCE AT MARCH 31, 2000 16,456 $ 16 $ (2,647) $ 121,083 $ (119,237)
====== ============ ============ ============ ============
</TABLE>
<TABLE>
<CAPTION>
TOTAL
STOCKHOLDERS'
Comprehensive EQUITY (CAPITAL
Loss DEFICIENCY)
------------- ---------------
<S> <C> <C>
BALANCE AT DECEMBER 31, 1999 $ -- $ (68,872)
Issuance of common stock upon exercise of
stock options -- 859
Stock compensation -- 163
Accumulated other comprehensive loss (31,841) (31,841)
Net income -- 67,887
Preferred stock dividends -- (822)
---------- ------------
BALANCE AT MARCH 31, 2000 $ (31,841) $ (32,626)
========== ============
</TABLE>
See accompanying Notes to Consolidated Financial Statements
7
<PAGE> 8
SOURCE MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Unless the context otherwise requires, all references to the "Company"
or "Source Media" include Source Media, Inc. and its wholly-owned operating
subsidiaries, IT Network, Inc. ("IT Network"), Interactive Channel, Inc.
("Interactive Channel"), SMI Holdings, Inc. ("Holdings"), and Interactive
Channel Technologies Inc., ("ICTI") and SourceSuite LLC ("SourceSuite"), a 50/50
joint venture with Insight Interactive LLC ("Insight"), a subsidiary of Insight
Communications Company, Inc.
1. Basis of Presentation
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and the instructions for Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, these financial statements
include all adjustments, consisting of normal recurring accruals, necessary to
present fairly the financial position, results of operations and cash flows of
the Company and its consolidated subsidiaries for the periods indicated.
Operating results for the three months ended March 31, 2000 are not necessarily
indicative of the results that may be expected for the year ended December 31,
2000. The balance sheet at December 31, 1999 has been derived from the audited
financial statements at that date. For further information, refer to the
consolidated financial statements and notes thereto included in the Company's
Annual Report on Form 10-K for the year ended December 31, 1999.
On March 3, 2000 Source Media and Insight sold their respective
interests in a joint venture to Liberate Technologies ("Liberate") in exchange
for the issuance of 886,000 shares of common stock in Liberate to both Source
Media and Insight. Prior to the sale of the joint venture, cash equal to the
value (as determined by an independent appraisal) of certain retained
businesses, consisting of the interactive programming guide and related content
business, was contributed by the joint venture to SourceSuite, of which Source
Media and Insight each own 50%. SourceSuite used these funds to purchase the
retained business from the joint venture, which comprised fixed assets with a
net book value of approximately $200,000 and certain accrued liabilities, for
$1.1 million.
The following represents the unaudited pro forma results of operations
for Source Media as if the joint venture with Insight, subsequent sale to
Liberate and formation of SourceSuite had occurred on January 1, 1999.
<TABLE>
<CAPTION>
Three Months Ended Three Months Ended
March 31, 1999 March 31, 2000
------------------ ------------------
<S> <C> <C>
Total revenues $ 5,310 $ 4,636
Operating loss (2,670) (2,791)
Net loss attributable to common stockholders (6,913) 68,152
Net loss per common share (0.54) 4.24
</TABLE>
2. Equity Investment in Joint Venture
The Company recorded its share of results of operations of its original
joint venture with Insight up to March 3, 2000 and records its share of
operating results of SourceSuite on the equity method in the Consolidated
Statement of Operations. The Company owns a 50% interest in SourceSuite which
provides interactive programming guide and television programming services.
SourceSuite is managed by the Company within the terms of the operating
agreement and the annual operating plan approved by the management committee.
Special actions by SourceSuite require approval of a four member management
committee with equal representation, by both
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<PAGE> 9
Source Media and Insight, on the management committee. The Operating Agreement
of SourceSuite restricts any distribution of equity to members for a period of
three years.
3. Computation of Net Loss Per Common Share
The Company computes net income (loss) per share in accordance with
SFAS No. 128, "Earnings Per Share" (SFAS No. 128). Under the provisions of SFAS
No. 128, basic net income (loss) per common share is computed by dividing net
income (loss) attributable to common stockholders by the weighted average
number of common shares outstanding. In computing diluted net income (loss) per
share, all options, warrants, and convertible securities are excluded if their
effect would be antidilutive.
The reconciliation between the numerator of Basic and Diluted net
income (loss) per common share is as follows:
<TABLE>
<CAPTION>
MARCH 31, MARCH 31,
1999 2000
---------- ----------
<S> <C> <C>
Numerator for basic and diluted
net income (loss) per share -
income available to common
stockholders $ (9,011) $ 67,066
======== ========
</TABLE>
The reconciliation between the denominator of Basic and Diluted net income
(loss) per common share is as follows:
<TABLE>
<CAPTION>
MARCH 31, MARCH 31,
1999 2000
---------- ----------
<S> <C> <C>
Denominator for basic net income (loss)
per share - weighted average shares 12,830 16,086
Effect of dilutive securities:
Employee stock options -- 366
Warrants -- 1,576
---------- ----------
Dilutive potential common shares -- 1,942
Denominator for diluted net income (loss)
per share - adjusted weighted average
shares and assumed conversions 12,830 18,028
========== ==========
Basic net income (loss) per share $(0.70) $4.17
=========== ==========
Diluted net income (loss) per share $(0.70) $3.72
=========== ==========
</TABLE>
4. Available for Sale Securities
Investment in securities available for sale are recorded at market
value as of the reporting date. Temporary declines in market value are charged
to shareholders' equity. Permanent declines in market value, if any, are
charged to earnings.
5. New Accounting Pronouncements
Financial Accounting Statement 133, Accounting for Derivative
Instruments and Hedging Activities was issued in June 1998, amended by FAS 137,
to be effective for all fiscal quarters of fiscal years beginning after June 15,
2000. The Company has not yet adopted or completed its assessment of the
implications of this statement. The Company is also considering the effects of
the SEC Staff Accounting Bulletin No. 101, Revenue Recognition. If the Company
were to change its current revenue recognition methodology, it would expect this
change in accounting policy to negatively impact revenues in 2000. Additionally,
the Company is evaluating the effects of FASB Interpretation 44, Accounting for
Certain Transactions Involving Stock Options. The Company has not yet adopted or
completed its assessment of this interpretation on our current practices.
6. Commitments and Contingencies
ICTI and Holdings filed a patent infringement suit against WorldGate
Communications, Inc. in federal district court in Delaware in May 1998. In June
1998, WorldGate filed a counterclaim against the plaintiffs and the Company for,
among other things, unfair competition, interference with contract and trade
secret misappropriation. The counterclaim defendants denied the allegations in
the counterclaim. The relevant patents and this litigation were assumed by
Liberate as part of the sale of the joint venture with Insight. Liberate agreed
to defend the Company against WorldGate's counterclaims.
On August 21, 1998, the first of fourteen class action complaints was
filed against the Company and certain of its present and former officers and
directors in the United States District Court for the Northern District of Texas
asserting violations of sections 10(b) and 20(a) of the Securities Exchange Act
of 1934 and Rule 10-b5 promulgated thereunder. The fourteen complaints were
consolidated into the first filed case. Plaintiffs filed an amended complaint on
March 3, 1999. The plaintiffs sought damages in an unspecified amount. On
November 12, 1999, the Court set a series of deadlines for the disposition of
the case ending with the trial set for October 2, 2000. The Company believes
this case is totally without merit and intends to vigorously defend itself and
its officers and directors.
9
<PAGE> 10
On October 6, 1998, Advanced Interactive, Inc. filed a complaint in
U.S. District Court for the Northern District of Illinois, Eastern Division,
against ICTI and the following companies: Matsushita Electric Corporation,
Matsushita Electric Industrial Co., Ltd., Sharp Electronics Corp., Sharp Corp.,
Thomson Consumer Electronics, Toshiba Consumer Products, Inc., Toshiba American,
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 ICTI 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 the patents of
ICTI or any other Defendant. ICTI, and each of the Defendants, have filed an
Answer and have collectively joined the Motion for Partial Summary Judgment
submitted by Matsushita Electric Corporation of America, Sharp Electronics
Corp., Sharp Corp. and the Toshiba Defendants. On May 12, 1999 the court denied
Advanced Interactive's Motion for summary Judgement of Infringement. On February
17, 2000, the court granted the Defendants' collective Motion for Partial
Summary Judgment on patent claims interpretation. This case was transferred to
the Company's joint venture with Insight in November 1999 and subsequently
became the responsibility of SourceSuite on March 3, 2000. 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.
The Company has employment agreements with two executives which expire
in 2001 and 2002. The agreements provide that the Company will pay a base salary
amount and grant stock options that vest over a set term to the employees. In
the event of a termination without cause, the Company remains obligated to make
certain payments as defined in the agreements.
7. Long-Term Debt
On October 30, 1997, the Company issued Senior Secured Notes (the
"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 into an
escrow account approximately $22.6 million of the net proceeds from the offering
of the Notes, representing funds sufficient, together with interest thereon, to
pay the first four interest payments on the Notes. Additionally, the Company
placed in escrow $6.0 million in November 1999 from the proceeds received in the
transaction with Insight to pay the May 2000 interest payment.
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<PAGE> 11
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 Company's
Senior PIK Preferred Stock (the "Preferred Stock"), dividends on the Preferred
Stock and corporate overhead. The assets of Source Media consist solely of
investments in its subsidiaries and SourceSuite and invested proceeds from the
Notes and the Preferred Stock and related warrants. Financial statements for the
Subsidiary Guarantors and Source Media, Inc., on an unconsolidated basis, are
not presented because management has determined that they would not be material
to investors. In conjunction with the formation of SourceSuite, the Company
pledged its membership units in SourceSuite as collateral to secure payments on
the Notes. On December 13, 1999, $3.75 million of Notes were tendered to the
Company and additional cash received in exchange for an exercise of warrants to
purchase shares of common stock.
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 terms 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
March 31, 2000, 96.25 million of notes were outstanding and the dealer quoted
value of a Note was $0.70 per dollar face value resulting in an aggregate fair
market value of the outstanding Notes of approximately $67.4 million.
8. 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 Preferred Stock
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<PAGE> 12
with a liquidation preference of $25.00 per share and 558.75 warrants (the
"October 1997 Warrants"). Each October 1997 Warrant entitles the holder 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.
Dividends on the Preferred Stock are payable quarterly on each February
1, May 1, August 1 and November 1, commencing February 1, 1998, at an annual
rate of 13 1/2% of the liquidation preference per share. At the Company's
option, any dividend payment occurring on or prior to November 1, 2002, 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
Preferred Stock 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
12
<PAGE> 13
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 March 31, 2000 the dealer quoted fair market value of the
preferred stock was $12 per share for an aggregate value of the outstanding
Preferred Stock of $12.9 million.
On February 1, 2000 the quarterly dividend due on the Preferred Stock
was paid through the issuance of additional Preferred Stock having a liquidation
preference of $0.9 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 February 1, 2000 was approximately $0.4 million, which was recorded
as preferred stock dividends.
9. Stock Based Compensation
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 $0.4 million and $0.2 million in
selling, general and administrative expense for the three months ended March 31,
1999 and 2000.
10. Equity in SourceSuite Joint Venture
On November 17, 1999 the Company completed the creation of a joint
venture with Insight to conduct the business of its former VirtualModem(TM) and
Interactive TV lines of business. The investment in the joint venture was
accounted for by the equity method. The Company contributed certain assets of
the "VirtualModem(TM)" and "Interactive Channel" products and businesses in
exchange for a 50% ownership in the joint venture. Insight contributed $13
million in cash to the joint venture in exchange for a 50% interest. On March 3,
2000, the joint venture conveyed its Interactive TV line of business to
SourceSuite and Source Media and Insight each transferred their interests in the
joint venture to Liberate in exchange for the issuance of 886,000 shares of
Liberate common stock and $4.4 million of cash.
The above transaction resulted in a gain of $75.0 million in the first
quarter. The gain was calculated based on the closing price of Liberate common
stock on March 3, 2000 (the closing date) of $98.6875 per share, net of our book
basis of $17.4 million. The Company has net operating loss carryforwards in
excess of the tax effect of this gain and, consequently, reports no current or
deferred income tax expense.
Assets contributed to SourceSuite have been valued based on an
independent appraisal of fair value and allocated to assets, liabilities and
goodwill.
The Company records amortization of the assets contributed to the joint
venture on its historical basis.
13
<PAGE> 14
Summary financial data of SourceSuite at March 31, 2000 is as follows (in
thousands):
<TABLE>
<S> <C>
ASSETS:
Current Assets ..................... $ 9,630
Property and Equipment, net ........ 192
Intangible assets, net ............. 969
------------
$ 10,791
============
LIABILITIES AND MEMBERS' EQUITY:
Current liabilities ................ $ 1,456
Members' equity .................... 9,335
------------
$ 10,791
NET LOSS:
Net loss ........................... $ (632)
============
</TABLE>
11. Segment Reporting
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.
The Interactive TV business had developed 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 Interactive TV business includes the results of the
Interactive Channel and ICTI subsidiaries and the Company's 50% equity interest
in the results of SourceSuite (and its predecessor joint venture with Insight)
from November 17, 1999.
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.
14
<PAGE> 15
<TABLE>
<CAPTION>
Three Months Ended March 31,
1999 2000
------------ ------------
(In Thousands)
<S> <C> <C>
Monetary revenues:
IT Network $ 4,901 $ 3,976
Interactive TV 42 --
------------ ------------
Total monetary revenues $ 4,943 $ 3,976
============ ============
Nonmonetary revenues:
IT Network $ 409 $ 660
Interactive TV -- --
------------ ------------
Total nonmonetary revenues $ 409 $ 660
============ ============
Net revenues:
IT Network $ 5,310 $ 4,636
Interactive TV 42 --
------------ ------------
Total net revenues $ 5,352 $ 4,636
============ ============
Operating loss:
IT Network $ (960) $ (1,246)
Interactive TV (2,700) (--)
Corporate (1,711) (1,545)
------------ ------------
Total operating loss $ (5,371) $ (2,791)
============ ============
Equity interest in loss of joint venture:
Interactive TV $ -- $ (1,583)
============ ============
</TABLE>
<TABLE>
<CAPTION>
December 31, 1999 March 31, 2000
----------------- ----------------
<S> <C> <C>
Identifiable assets:
IT Network $ 15,474 $ 14,495
Interactive TV 20,675 4,626
Corporate 21,867 79,542
---------------- ----------------
Total identifiable assets $ 58,016 $ 98,663
================ ================
Investment in joint venture:
Interactive TV $ 18,669 $ 4,626
================ ================
</TABLE>
12. Subsequent Events
During the week of May 8, 2000 the Company entered into a number of
agreements whereby it exchanged shares of common stock for shares of Preferred
Stock. The exchange ratio in each agreement was 1.2 shares of common stock for
1.0 shares of Preferred Stock. In this manner the Company has been able to
retire approximately 37% of the outstanding Preferred Stock. The Preferred Stock
has a liquidation preference of $25 per share.
On May 12, 2000, Liberate common stock closed at $30.37. Based on that
date, our unrealized loss on available for sale securities would have been $60.5
million.
15
<PAGE> 16
SOURCESUITE LLC
BALANCE SHEET
MARCH 31, 2000
(IN THOUSANDS)
<TABLE>
<S> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 8,848
Related party receivables 713
Prepaid expenses and other current assets 69
------------
Total current assets 9,630
Property and equipment:
Computer and production equipment 208
Accumulated depreciation 16
------------
Net property and equipment 192
Intangible assets:
Goodwill 969
------------
Total assets $ 10,791
============
LIABILITIES AND MEMBERS' EQUITY
Current Liabilities:
Accounts payable $ 156
Accrued liabilities 770
Payable to Source Media, Inc 530
------------
Total current liabilities 1,456
Members' equity, 1,000,000 units authorized and
outstanding 9,967
Accumulated deficit (632)
------------
Total members' equity 9,335
------------
Total liabilities and members' equity $ 10,791
============
</TABLE>
See accompanying Notes to Financial Statements.
16
<PAGE> 17
SOURCESUITE LLC
STATEMENT OF OPERATIONS
PERIOD OF INCEPTION (MARCH 3, 2000) THROUGH MARCH 31, 2000
(IN THOUSANDS)
<TABLE>
<S> <C>
Revenues $ --
Selling, general and administrative expenses 670
------------
Operating loss (670)
Interest income 38
------------
Net loss $ (632)
============
</TABLE>
See accompanying Notes to Financial Statements.
17
<PAGE> 18
SOURCESUITE LLC
STATEMENT OF CASH FLOWS
PERIOD OF INCEPTION (MARCH 3, 2000) THROUGH MARCH 31, 2000
(IN THOUSANDS)
<TABLE>
<S> <C>
OPERATING ACTIVITIES
Net Loss $ (632)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation 4
Changes in operating assets and liabilities:
Trade accounts receivable (7)
Prepaid expenses and other current assets (22)
Trade accounts payable and accrued liabilities 361
Related party payable 321
------------
Net cash provided by operating activities 25
INVESTING ACTIVITIES
Capital expenditures (7)
------------
Net cash used in investing activities (7)
Net increase in cash and cash equivalents 18
Cash and cash equivalents at beginning of period 8,830
------------
Cash and cash equivalents at end of period $ 8,848
============
</TABLE>
See accompanying Notes to Financial Statements
18
<PAGE> 19
SOURCESUITE LLC
STATEMENT OF MEMBERS' EQUITY
<TABLE>
<CAPTION>
MEMBERSHIP MEMBERS'
UNITS EQUITY
------------ ------------
(in thousands)
<S> <C> <C>
Membership units issued on March 3, 2000 1,000,000 $ 9,967
Net loss -- (632)
------------ ------------
March 31, 2000 1,000,000 $ 9,335
============ ============
</TABLE>
See accompanying Notes to Financial Statements.
19
<PAGE> 20
SOURCESUITE LLC
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM INCEPTION (MARCH 3, 2000) THROUGH MARCH 31, 2000
1. DESCRIPTION OF BUSINESS
SourceSuite LLC ("SourceSuite" or "Company"), a Delaware limited
liability company, was formed on March 3, 2000 as a 50/50 joint venture between
Source Media, Inc.("Source Media") and Insight Interactive, LLC ("Insight").
On November 17,1999 Source Media conveyed certain assets related to its
"VirtualModem(TM)" and "Interactive Channel" products and businesses and Insight
contributed $13 million in cash to a joint venture in exchange for each owning a
50% interest in that joint venture.
On March 3, 2000, Source Media and Insight sold their respective
interests in the joint venture to Liberate Technologies ("Liberate") in exchange
for the issuance of 886,000 shares of common stock in Liberate to both Source
Media and Insight. Prior to the sale of the joint venture, cash equal to the
value (as determined by an independent appraisal) of certain retained
businesses, consisting of the interactive programming guide and related content
business, was contributed by the joint venture to SourceSuite. SourceSuite used
these funds to purchase the retained business from the joint venture, which
comprised fixed assets with a net book value of approximately $200,000 and
certain accrued liabilities, for $1.1 million.
SourceSuite operates primarily in the United States with certain
technological development efforts performed in Canada by a Source Media
subsidiary, Interactive Channel Technologies, Inc. ("ICTI").
SourceSuite will continue the development of the proprietary software
contributed by Source Media and will provide 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.
Liberate provides SourceSuite without charge, specific software
development services for the Interactive TV products under a programming
services agreement. SourceSuite entered into a preferred content provider
agreement with Liberate which allows Liberate to offer pricing incentives to its
customers that use SourceSuite's local content services with the
VirtualModem(TM) products.
20
<PAGE> 21
2. ACCOUNTING POLICIES
Basis of Presentation
Assets contributed to the joint venture by Source Media have been
valued at the fair value on the date of contribution based on independent
appraisal and allocated to assets, liabilities and goodwill.
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.
Cash and Cash Equivalents
The Company classifies all highly liquid investments with original
maturities of three months or less as cash equivalents. These investments are
recorded at cost, which approximates market.
Computer and Production Equipment
Computer and production equipment are recorded at cost. Depreciation is
computed using the straight-line method over the estimated useful lives (three
to five years) of the assets.
Intangible Assets
Goodwill resulted from the difference between the cash received for the
fair value of the assets contributed to the joint venture and their recorded
values. Intangible assets are amortized using the straight-line method over an
estimated useful life of 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.
Comprehensive Income
There are no significant comprehensive income items, therefore,
comprehensive income is equal to net income and not separately shown on the
Statement of Operations.
3. INCOME TAXES
SourceSuite has experienced net operating losses from inception.
Accordingly, no provision for income taxes has been recorded. A valuation
allowance has been established to fully offset the deferred tax asset associated
with SourceSuite's net operating loss carryforwards.
21
<PAGE> 22
4. MEMBERS' EQUITY
Distribution of equity to members is restricted by the Company's
Operating Agreement for a period of three years.
5. RELATED PARTY TRANSACTIONS
As part of the joint venture agreement between Source Media and
Insight, Source Media manages the day to day operations of SourceSuite within
the terms of SourceSuite's operating plan. As part of this arrangement,
SourceSuite reimburses Source Media for the direct costs of the Interactive TV
business and certain overhead costs. These costs have been included in the
payable to related parties and are reimbursed to Source Media on a regular
basis. Additionally, SourceSuite purchases certain hardware on behalf of
Insight. These amounts are billed to Insight and included in related party
receivables.
6. COMMITMENTS AND CONTINGENCIES
Upon formation, SourceSuite assumed the responsibility for the
following litigation:
On October 6, 1998, Advanced Interactive, Inc. filed a complaint in
U.S. District Court for the Northern District of Illinois, Eastern Division,
against ICTI and the following companies: Matsushita Electric Corporation,
Matsushita Electric Industrial Co., Ltd., Sharp Electronics Corp., Sharp Corp.,
Thomson Consumer Electronics, Toshiba Consumer Products, Inc., Toshiba American,
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, Inc.
alleges that ICTI 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 the patents of
ICTI or any other Defendant. ICTI, and each of the Defendants, have filed an
Answer and have collectively joined the Motion for Partial Summary Judgment
submitted by Matsushita Electric Corporation of America, Sharp Electronics
Corp., Sharp Corp. and the Toshiba Defendants. On May 12, 1999 the court denied
Advanced Interactive Inc.'s Motion for summary Judgement of Infringement. On
February 17, 2000, the court granted the Defendants' collective Motion for
Partial Summary Judgment on patent claims interpretation. This case was
transferred to the joint venture between Source Media and Insight in November
1999 and was assumed by SourceSuite on March 3, 2000.
22
<PAGE> 23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Unless the context otherwise requires, all references to "we", "us" or
"our" include Source Media, Inc., its wholly-owned operating subsidiaries, IT
Network, Inc. ("IT Network"), Interactive Channel, Inc. ("Interactive Channel"),
SMI Holdings, Inc. ("Holdings"), and Interactive Channel Technologies Inc.
("ICTI"), and SourceSuite LLC, a 50/50 joint venture with Insight Interactive
LLC ("Insight"), a subsidiary of Insight Communications Company, Inc.
FORWARD LOOKING INFORMATION AND RISK FACTORS
We or our 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 our various filings with the
Securities and Exchange Commission. We wish 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.
We caution 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.
Among the factors that could cause actual results to differ materially
from our expectations are our high degree of leverage and our ability to service
debt, the need for additional financing, that we may not have sufficient
collateral to repay our indebtedness in full, the potential for a change of
control that would require us to purchase our notes and preferred stock,
historical and projected losses, access to channels on cable television systems
and uncertainty of subscriber acceptance, the uncertainty of a market for
interactive television, the availability of programming, the further technical
development needed to improve the economics of deploying interactive television
to multiple cable systems, a delay in the roll-out of digital set-top boxes,
competition within the industry, rapid technological advances that could render
our products obsolete or non-competitive, anti-takeover effects of our
shareholder rights plan, stock volatility, the market price of our common stock,
our ability to attract and retain key management personnel, government
regulation and other factors discussed from time to time in our Annual Report on
Form 10-K and other Securities and Exchange Commission filings.
23
<PAGE> 24
GENERAL
The following discussion should be read in conjunction with our
Consolidated Financial Statements and related notes which are included elsewhere
in this report.
We provide streaming media content and sell interactive advertising
that can be accessed over the telephone and the Internet. We also own a 50%
interest in SourceSuite LLC, a joint venture we manage, which provides
interactive cable television programming services, including a fully interactive
program guide, know as SourceGuide(TM), and an information entertainment
service, known as LocalSource(TM). We categorize these operations as our IT
Network business and our Interactive TV business.
We have experienced significant changes in our Interactive TV business
since the first quarter of 1999. In November 1999 we contributed this business
to a 50/50 joint venture with Insight. Insight contributed $13 million of equity
financing to the joint venture and purchased 842,105 shares of our common stock
for $12 million ($14.25 per share) and warrants to purchase 4,596,786 additional
share of our common stock at $20 per share. On March 3, 2000, we and Insight
sold our interests in the joint venture to Liberate Technologies ("Liberate") in
exchange for the issuance to each of us and Insight of 886,000 share of Liberate
common stock and $4.4 million of cash. Prior to the completion of the sale, the
joint venture transferred to SourceSuite its assets and properties not related
to the VirtualModem(TM) products and associated businesses. The interests in the
new joint venture were distributed to us and Insight, so that each became a 50%
owner of SourceSuite. Liberate thus acquired all patents and intellectual
property related to the VirtualModem(TM) products and businesses and granted
SourceSuite an exclusive license to use the patents necessary to its business.
SourceSuite's business is interactive television programming and services,
including SourceGuide(TM) and LocalSource(TM).
THREE MONTHS ENDED MARCH 31, 2000 AND 1999
Monetary revenues decreased 18% to $4.0 million for the three months
ended March 31, 2000 from $4.9 million for the same period in 1999. Traditional
advertising sales were down $1.0 million as we eliminated unprofitable newspaper
channels and reduced the number of small directory markets we serve. The lower
advertising sales were partially offset by $0.5 million of Internet advertising
and streaming audio sales. Information services revenues were down $0.5 million
from the prior year quarter primarily reflecting customers' late 1999 decisions
to not invest in Y2K equipment upgrades and the resultant termination of our
services.
Monetary cost of sales decreased 15% to $2.3 million for the three
months ended March 31, 2000 from $2.7 million for the same period in 1999 as a
result of a $0.3 million reduction in page costs related to the decreased
advertising sales.
Nonmonetary revenues and nonmonetary cost of sales increased 61% to
$0.7 million for the three months ended March 31, 2000. Nonmonetary sales
accounted for 14% of revenues for the three months ended March 31, 2000 compared
to 8% of revenues for the same period in 1999.
24
<PAGE> 25
Selling, general and administrative expenses decreased 31% to $3.8
million for the three months ended March 31, 2000 from $5.6 million for the same
period in 1999. The decrease is primarily due to $1.3 million of cost of the
Interactive TV operations transitioned to our joint venture with Insight,
decrease in non-cash variable compensation expense of $0.2 million and $0.5
million in cost reductions in other administrative expenses partially offset by
$10.2 million of severance payments.
Amortization of intangible assets decreased 53% to $0.6 million from
$1.2 million for the three months ended March 31, 2000 due to the transfer of
patents to our joint venture with Insight in 1999.
Research and development expenses were transferred to our joint venture
with Insight in November 1999, resulting in a decrease of $0.8 million compared
to the three months ended March 31, 1999.
Gain on sale of interest in joint venture includes $75.0 million of
gain recorded upon the sale of our interest in the joint venture with Insight to
Liberate.
Equity interest includes our share of the results of operations of
SourceSuite and its predecessor joint venture for the three months ended March
31, 2000, recorded using the equity method. The original joint venture was
formed November 17, 1999.
Interest expense decreased 4% to $3.1 million from $3.2 million for the
three months ended March 31, 2000 and 1999 due to a $3.75 million retirement of
bonds in December 1999. This expense is associated with a $100 million debt
financing completed by the Company in October 1997 and described in detail in
the Notes to Consolidated Financial Statements.
Interest income remained unchanged at $0.3 million for the three months
ended March 31, 2000 and 1999.
Preferred Stock dividends of $0.8 and $0.7 million for the three months
ended March 31, 2000 and 1999, relate to the $20 million Preferred Stock
financing completed by the Company in October 1997 and described in detail in
the Notes to Consolidated Financial Statements. Dividends are recorded at the
fair market value of the shares.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have experienced substantial operating losses and
net losses as a result of our efforts to develop, deploy and support our IT
Network business and to develop, conduct trials and commercially launch our
Interactive TV business. As of March 31, 2000, we had an accumulated deficit of
$119.2 million and had used cumulative net cash in operations of $102.9 million.
The difference at March 31, 2000, between the accumulated deficit and cumulative
net cash used in operations since inception was attributable primarily to
charges
25
<PAGE> 26
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.
We will continue to incur operating losses at least through 2000. Any
launch of our television products and services through SourceSuite may require
an additional capital contribution which may require us to raise additional
capital. On March 3, 2000, we sold our interest in the VirtualModem(TM) business
owned by our joint venture with Insight to Liberate for 886,000 shares of
Liberate common stock, 20% of which is immediately available for sale, with
nearly all of the remainder becoming available for sale after July 31, 2000. It
is expected that this liquidity will provide the necessary funding for expected
future capital requirements. The Liberate shares had an aggregate value of
approximately $87.4 million, based on the closing price of Liberate common stock
of $98.6875 per share on March 3, 2000. Liberate common stock is traded on the
Nasdaq Stock Market under the symbol "LBRT". As of May 12, 2000, the closing
price per share of the Liberate common stock was $30.37. In addition to the
Liberate common shares, we received from Liberate $4.4 million of working
capital adjustments, which we contributed to SourceSuite.
Since inception, we have financed our operations primarily with $156.6
million raised from various financing activities, including the incurrence of
debt and issuance of our common stock and preferred stock. In October 1997, we
issued $100.0 million of Notes and $20.0 million of Preferred Stock. The
interest escrow account created pursuant to the indenture governing the Notes
has been used to fund the first four interest payments on the Notes. Interest
payments from the interest escrow account were made on May 1, 1998, November 1,
1998, May 1, 1999 and November 1, 1999. Our primary source of liquidity is our
cash, cash equivalents and restricted investments which totaled $20.1 million at
March 31, 2000. This cash position consisted of $6.0 million held in escrow for
the May 1, 2000 interest payment and $14.1 million of cash available for
operations. Additionally, we have an investment of 886,000 shares of Liberate
common stock, 20% is immediately tradable and nearly all of the remainder
becomes tradable on August 1, 2000. Our first interest payment of $6 million,
not currently held in escrow, is due November 1, 2000.
We currently believe our resources will be sufficient to meet our
anticipated cash needs for working capital, required interest payments and other
capital expenditures related to the further development of our IT Network
business and capital requirements for SourceSuite through and beyond the fourth
quarter of 2000. Additionally, while we do not currently anticipate any capital
calls by the joint venture, we believe our resources are sufficient to meet any
capital calls through 2000.
Our future capital requirements will depend on many factors, including,
but not limited to the following factors, some of which are outside our control:
(i) the operating results of our IT Network business, including local
advertisers' willingness to purchase Internet based advertising; (ii) the
success and timing of the development, introduction and deployment of the
Interactive TV products; (iii) the extent of market acceptance of our products;
(iv) potential acquisitions or asset purchases; (v) the deployment of digital
set-top boxes incorporating technology that we are able to access; (vi)
competitive factors; and (vii) changes in the regulatory environment.
26
<PAGE> 27
EFFECT OF INFLATION
We believe that the effect of inflation has not had a material
effect on our business during the three month periods ended March 31, 1999 and
2000, respectively.
NET OPERATING LOSS CARRYFORWARDS
At December 31, 1999, we had net operating loss carryforwards of
approximately $124.5 million for U.S. Federal income tax purposes, which begin
to expire in 2003. The Internal Revenue Code of 1986, as amended, imposes
limitations on the use of net operating loss carryforwards if certain stock
ownership changes occur. An ownership change occurred in 1995 that caused
utilization of $23.1 million of our net operating losses incurred prior to the
ownership change to be limited to approximately $9.0 million in a given year.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We are exposed to changes in interest rates related primarily to our
Notes and Preferred Stock. Under our current policies, we do not use interest
rate derivative instruments to manage exposure to interest rate changes. At
March 31, 2000, we had Notes outstanding having an aggregate principal amount of
$96.3 million, due November 1, 2004, which bear interest at a fixed rate of 12%
and Preferred Stock outstanding having a liquidation preference of $27.0
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 March 31, 2000 was
approximately $67.4 million and $12.9 million, respectively, based upon dealer
quoted market prices.
We invest our cash balance in money market funds and commercial paper
rated A1, and P1, respectively. These securities are in U.S. dollars, with
maturities of six months or less, are held to maturity and are not owned for
trading purposes. Using this strategy, we have not experienced any losses due to
interest rate risk, market risk or foreign exchange risk on our commercial paper
investments, and we do not anticipate any such losses.
On March 3, 2000, we received 886,000 shares of Liberate common stock
in exchange for our interest in our joint venture with Insight. The closing
price per share of the Liberate common stock on March 3, 2000 was $98.6875,
giving us a total original investment in Liberate common stock of approximately
$87.4 million. We are restricted from calling, pledging and otherwise
transferring the economic consequences of ownership of 80% of the Liberate
common stock until after July 31, 2000. The remaining 20% is unrestricted. We
face the market risk associated with price fluctuations of the Liberate common
stock until such time as we sell or hedge the stock. As of May 12, 2000, the
closing price per share of the Liberate common stock was $30.37.
27
<PAGE> 28
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings
Reference is made to our Annual Report on Form 10-K for the year ended
December 31, 1999 for a discussion of certain litigation.
Item 2 - Changes in Securities and Use of Proceeds - not applicable
Item 3 - Defaults Upon Senior Securities - not applicable
Item 4 - Submission of Matters to a Vote of Security Holders
On January 19, 2000, we solicited the consents of the holders of the
Notes to amend the provisions of the indenture governing the Notes to allow the
transaction with Liberate. On the same date, we solicited the consents of the
holders of the Preferred Stock to amend the provisions of the certificate of
designation governing the Preferred Stock to allow the transaction with
Liberate. Holders of $85,090,000 principal amount of the Notes, representing
88.4% of the Notes outstanding, gave their consent to the amendment of the
indenture. Holders of 1,008,582 shares of Preferred Stock, representing 96.7% of
the Preferred Stock outstanding, gave their consent to the amendment of the
certificate of designation.
Item 5 - Other Information -- none
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 27 - Financial Data Schedule
(b) Reports on Form 8-K during the three months ended March 31, 2000.
None.
28
<PAGE> 29
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
SOURCE MEDIA, INC.
(Registrant)
Date: May 15, 2000 By: /s/ PAUL TIGH
---------------------------------------
Paul Tigh
Chief Financial Officer and Treasurer
(Principal Financial Officer and
Duly Authorized Officer)
<PAGE> 30
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description
------ -----------
<S> <C>
27 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-START> JAN-01-2000
<PERIOD-END> MAR-31-2000
<CASH> 14,004
<SECURITIES> 6,080
<RECEIVABLES> 2,616
<ALLOWANCES> 471
<INVENTORY> 0
<CURRENT-ASSETS> 79,541
<PP&E> 11,079
<DEPRECIATION> 9,183
<TOTAL-ASSETS> 98,663
<CURRENT-LIABILITIES> 12,708
<BONDS> 96,250
19,339
0
<COMMON> 18
<OTHER-SE> (32,644)
<TOTAL-LIABILITY-AND-EQUITY> 98,663
<SALES> 4,636
<TOTAL-REVENUES> 4,636
<CGS> 3,000
<TOTAL-COSTS> 3,000
<OTHER-EXPENSES> 4,427
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 3,094
<INCOME-PRETAX> 67,888
<INCOME-TAX> 0
<INCOME-CONTINUING> 67,888
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 67,066
<EPS-BASIC> 4.17
<EPS-DILUTED> 3.71
</TABLE>
