<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
AMENDMENT NO. 1
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED
JUNE 30, 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 AUGUST 7, 2000: 17,151,565
1
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SOURCE MEDIA, INC.
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2000
The following items of our Quarterly Report on Form-10Q for the fiscal
quarter ended June 30, 2000 are hereby amended. Each such item is set forth
herein in its entirety, as amended:
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page Number
-----------
<S> <C> <C>
Item 1. Consolidated Financial Statements of Source Media, Inc.
Consolidated Balance Sheets of Source Media, Inc. (Unaudited)
December 31, 1999 and June 30, 2000 3-4
Consolidated Statements of Operations of Source Media, Inc. (Unaudited)
Three and six months ended June 30, 1999 and 2000 5
Consolidated Statements of Cash Flows of Source Media, Inc. (Unaudited)
Six months ended June 30, 1999 and 2000 6
Consolidated Statements of Stockholder's Equity (Capital Deficiency)
of Source Media, Inc. (Unaudited) June 30, 2000 7
Notes to Consolidated Financial Statements of Source Media,
Inc. (Unaudited) 8-17
Financial Statements of SourceSuite LLC
Balance Sheet of SourceSuite LLC (Unaudited) June 30, 2000 18
Statement of Operations of SourceSuite LLC (Unaudited)
Three months ended June 30, 2000 and Period from Inception
(March 3, 2000) to June 30, 2000 19
Statement of Cash Flows of SourceSuite LLC (Unaudited)
Period from Inception (March 3, 2000) to June 30, 2000 20
Statement of Members' Equity of SourceSuite LLC (Unaudited)
June 30, 2000 21
Notes to Financial Statements of SourceSuite LLC (Unaudited)
Period from Inception (March 3, 2000) to June 30, 2000 22-24
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 25-30
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 31
</TABLE>
2
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SOURCE MEDIA, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1999 2000
------------ --------
<S> <C> <C>
Current Assets:
Cash and cash equivalents $ 10,910 $ 13,798
Short-term investments 2,500 --
Restricted investments 5,997 349
Trade accounts receivable, less allowance for doubtful
accounts of $605 and $616 in 1999 and 2000 respectively 1,643 1,464
Related party receivables 1,458 1,071
Prepaid expenses and other current assets 1,068 1,021
Investment in securities available for sale -- 25,971
-------- --------
Total current assets 23,576 43,674
Property and equipment:
Production equipment 4,511 4,372
Computer equipment 3,612 3,459
Other equipment 1,612 2,617
Furniture and fixtures 656 656
-------- --------
10,391 11,104
Accumulated depreciation 7,957 9,553
-------- --------
Net property and equipment 2,434 1,551
Intangible assets:
Goodwill 3,688 3,688
Contract rights 11,933 11,933
-------- --------
15,621 15,621
Accumulated amortization 6,119 7,233
-------- --------
Net intangible assets 9,502 8,388
Investment in joint venture 18,669 3,500
Other non-current assets 3,835 3,274
-------- --------
Total assets $ 58,016 $ 60,387
======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
3
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SOURCE MEDIA, INC.
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY)
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1999 2000
------------ ---------
Current Liabilities:
<S> <C> <C>
Trade accounts payable $ 955 $ 613
Accrued interest 1,991 1,901
Accrued payroll 591 439
Other accrued liabilities 3,706 3,495
Unearned income 1,925 2,032
--------- ---------
Total current liabilities 9,168 8,480
Long-term debt 96,250 91,650
Minority interests in consolidated subsidiaries 3,840 3,840
Note receivable and accrued interest from minority stockholder,
net of discount of $12 and $0 in 1999 and 2000, respectively (837) (855)
--------- ---------
3,003 2,985
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 667 in 1999 and 2000, respectively 18,467 11,055
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 17,402
issued and outstanding in 1999 and 2000, respectively 16 17
Less treasury stock, at cost - 268 and 250 shares in
1999 and 2000, respectively (2,647) (2,476)
Capital in excess of par value 120,883 132,274
Accumulated other comprehensive income -- (61,467)
Accumulated deficit (187,124) (122,131)
--------- ---------
Total stockholders' equity (capital deficiency) (68,872) (53,783)
--------- ---------
Total liabilities and stockholders' equity (capital deficiency) $ 58,016 $ 60,387
========= =========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
4
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SOURCE MEDIA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
JUNE 30, 1999 JUNE 30, 2000 JUNE 30, 1999 JUNE 30, 2000
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Monetary revenues $ 4,406 $ 4,587 $ 9,349 $ 8,563
Nonmonetary revenues 473 666 882 1,326
-------- -------- -------- --------
Total revenues 4,879 5,253 10,231 9,889
Monetary cost of sales 4,044 2,717 6,741 5,057
Nonmonetary cost of sales 473 666 882 1,326
-------- -------- -------- --------
Total cost of sales 4,517 3,383 7,623 6,383
-------- -------- -------- --------
Gross profit 362 1,870 2,608 3,506
Selling, general and administrative expenses 8,551 2,576 14,101 6,419
Amortization of intangible assets 1,237 584 2,473 1,168
Research and development expenses 689 -- 1,519 --
-------- -------- -------- --------
10,477 3,160 18,093 7,587
-------- -------- -------- --------
Operating loss (10,115) (1,290) (15,485) (4,081)
Interest expense 3,204 2,989 6,413 6,083
Interest income (254) (217) (536) (463)
Equity interest in losses of joint venture -- 1,126 -- 2,709
Gain on sale of interest in joint venture -- -- -- (74,977)
Other expense (income) -- 237 (2) 104
-------- -------- -------- --------
Net income (loss) before extraordinary item (13,065) (5,425) (21,360) 62,463
Extraordinary item gain on extinguishment of debt -- 2,530 -- 2,530
-------- -------- -------- --------
Net income (loss) (13,065) (2,895) (21,360) 64,993
Preferred stock dividends (difference on conversion
of preferred stock, net of dividend) 713 (4,702) 1,429 (3,880)
-------- -------- -------- --------
Net income (loss) attributable to common stockholders $(13,778) $ 1,807 $(22,789) $ 68,873
======== ======== ======== ========
Other comprehensive income (loss):
Unrealized loss on available for sale securities -- (29,626) 0 (61,467)
-------- -------- -------- --------
Comprehensive Income $(13,778) $(27,819) $(22,789) $ 7,406
======== ======== ======== ========
Basic and diluted net loss per common share:
Basic:
Net income (loss) before extraordinary item per
common share $ (1.03) $ (0.04) $ (1.74) $ 4.08
Extraordinary item -- 0.15 -- 0.16
-------- -------- -------- --------
Net loss attributable to common stockholders $ (1.03) $ 0.11 $ (1.74) $ 4.24
======== ======== ======== ========
Weighted average basic common shares outstanding: 13,353 16,417 13,093 16,251
======== ======== ======== ========
Diluted:
Net income (loss) before extraordinary item per
common share $ (1.03) $ (0.04) $ (1.74) $ 3.86
Extraordinary item -- 0.15 -- 0.15
-------- -------- -------- --------
Net loss attributable to common stockholders $ (1.03) $ 0.11 $ (1.74) $ 4.01
======== ======== ======== ========
Weighted average basic common shares outstanding: 13,353 16,417 13,093 17,159
======== ======== ======== ========
</TABLE>
See accompanying notes to Consolidated Financial Statements
5
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SOURCE MEDIA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, 1999 JUNE 30, 2000
------------- -------------
OPERATING ACTIVITIES
<S> <C> <C>
Net income (loss) $(21,360) $ 64,993
Adjustments to reconcile net income (loss) to net cash used in
operating activities:
Depreciation 1,361 942
Amortization of intangible assets 2,473 1,114
Deferred Compensation 1,208 829
Non-cash interest expense 174 561
Non-cash interest income (273) (128)
Provision for losses on accounts receivable 250 11
Gain on sale of joint venture -- (74,977)
Equity investment in losses of joint venture -- 2,709
Extraordinary gain on issuance of common stock in
exchange for notes -- (2,530)
Changes in operating assets and liabilities:
Trade accounts receivable 630 168
Related party receivable -- 387
Prepaid expenses and other current assets 220 12
Deferred expenses 8 35
Trade accounts payable and accrued liabilities 1,505 (796)
Accrued interest -- (18)
Unearned income 670 107
-------- --------
Net cash used in operating activities (13,134) (6,581)
INVESTING ACTIVITIES
Capital expenditures (788) (59)
Redemption of investments 6,000 5,775
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 investing activities 5,212 8,216
FINANCING ACTIVITIES
Proceeds from issuance of common stock 4,044 1,009
Warrants exercised -- 244
Other 155 --
-------- --------
Net cash provided by financing activities 4,199 1,253
-------- --------
Net increase (decrease) in cash and cash equivalents (3,723) 2,888
Cash and cash equivalents at beginning of period 11,662 10,910
Cash and cash equivalents at end of period $ 7,939 $ 13,798
======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements
6
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SOURCE MEDIA, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY)
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
TOTAL
COMMON STOCK CAPITAL IN STOCKHOLDERS'
--------------------- TREASURY EXCESS OF ACCUMULATED COMPREHENSIVE EQUITY (CAPITAL
SHARES AMOUNT STOCK PAR VALUE DEFICIT LOSS DEFICIENCY)
--------- --------- ---------- ---------- ----------- ------------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1999 16,278 $ 16 $ (2,647) $ 120,883 $(187,124) $ -- $ (68,872)
Issuance of common stock upon
exercise of stock options 109 -- 171 837 -- -- 1,008
Stock compensation -- -- -- 829 -- -- 829
Net income -- -- -- -- 64,993 -- 64,993
Preferred stock exchange 538 -- -- 3,531 -- -- 3,531
Warrants exercised 83 1 -- 244 -- -- 245
Accumulated other comprehensive
loss -- -- -- -- -- (61,467) (61,467)
Issuance of common stock for
note exchange 394 -- -- 2,070 -- -- 2,070
Preferred stock dividends -- -- -- 3,880 -- -- 3,880
--------- --------- --------- --------- --------- --------- ---------
BALANCE AT JUNE 30, 2000 17,402 $ 17 $ (2,476) $ 132,274 $(122,131) $ (61,467) $ (53,783)
========= ========= ========= ========= ========= ========= =========
</TABLE>
7
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SOURCE MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Unless the context otherwise requires, all references to the "Company"
or "Source Media" include Source Media, Inc. and its wholly-owned operating
subsidiaries ("Subsidiaries"), including IT Network, Inc. ("IT Network"),
Interactive Channel, Inc. ("Interactive Channel"), SMI Holdings, Inc. and its
other operating subsidiary, Interactive Channel Technologies Inc., ("ICTI"), as
well as its wholly-owned non-operating subsidiary Source Nevada, Inc. 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 and six months ended June 30, 2000 are not
necessarily indicative of the results that may be expected for the year ending
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 each of Source
Media and Insight and $4.4 million of cash. 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 was comprised of
fixed assets with a net book value of approximately $200,000 and certain accrued
liabilities, for $1.1 million.
8
<PAGE> 9
The following represents the unaudited pro forma results of operations
as if the joint venture with Insight and subsequent sale to Liberate had
occurred on January 1, 1999.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------ --------------------------------
June 30, 1999 June 30, 1999 June 30, 2000
------------- ------------- -------------
<S> <C> <C> <C>
Total revenues $4,879 $10,189 $9,889
Operating loss (7,360) (10,030) (4,081)
Net income (loss) attributed to
common stockholders (11,752) (18,665) 69,959
Net income (loss) per common share (0.88) (1.43) 4.15
</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 using the equity method in the Consolidated
Statement of Operations. The Company owns a 50% interest in SourceSuite which
provides SourceGuide, an interactive programming guide; LocalSource, an
interactive television programming service; and is developing other
applications for the interactive television industry. 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 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 Income (Loss) Per Common Share
The Company computes net income (loss) per share in accordance with
Statement of Financial Accounting Standards ("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) attributed to
common stockholders by the weighted average number of common shares outstanding.
In computing dilutive net income (loss) per share, 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>
Three Months Ended Six Months Ended
---------------------------------- --------------------------------
June 30, 1999 June 30, 2000 June 30, 1999 June 30, 2000
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Numerator for basic and diluted
net income (loss) per share:
Net income (loss) before
extraordinary items (13,065) (5,425) (21,360) 62,463
Extraordinary items -- 2,530 -- 2,530
Preferred dividends 713 (4,702) 1,429 (3,880)
------------- ------------- ------------- -------------
Income (loss) available to common
stockholders $(13,778) $(1,807) $(22,789) $68,873
============= ============= ============= =============
</TABLE>
9
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The reconciliation between the denominator of Basic and Diluted net income
(loss) per common share is as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
--------------------------------- --------------------------------
June 30, 1999 June 30, 2000 June 30, 1999 June 30, 2000
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Denominator for basic net income
(loss) per share - weighted average
shares 13,353 16,417 13,093 16,251
Effect of dilutive securities:
Employee stock options -- -- -- 161
Warrants -- -- -- 747
Dilutive potential common shares ------ ------ ------- ------
-- -- -- 908
Denominator for diluted net
income (loss) per share -
adjusted weighted average shares
and assumed conversions 13,353 16,417 13,093 17,159
====== ====== ====== ======
Basic:
Net income (loss) per share before
extraordinary item $(1.03) $(0.04) $(1.74) $4.08
Extraordinary gain -- 0.15 -- 0.16
------ ------ ------ ------
Net income (loss) attributable
to common stockholders $(1.03) $ 0.11 $(1.74) $4.24
====== ====== ====== ======
Diluted:
Net income (loss) per share before
extraordinary item $(1.03) $(0.04) $(1.74) $3.86
Extraordinary gain -- 0.15 -- 0.15
------ ------ ------ ------
Net income (loss) attributable
to common stockholders $(1.03) $ 0.11 $(1.74) $4.01
====== ====== ====== ======
</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. Other than temporary declines in market value, if any,
are charged to earnings. The closing price per share of the Liberate common
stock at June 30, 2000 was $29.31 resulting in an aggregate value of $26.0
million. The decline from the previous quarter has been reflected in other
comprehensive income. Management does not believe the decline in market value to
be other than temporary.
5. New Accounting Pronouncements
Financial Accounting Statement 133, Accounting for Derivative
Instruments and Hedging Activities was issued in June 1998, and amended by FAS
137 and FAS 138 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 which is to be effective no later than the fourth fiscal quarter of
fiscal years beginning after December 15, 1999. If the Company were to change
its current revenue recognition methodology, it would expect this change in
accounting policy to positively impact revenues in 2000, although net income
would decrease due to the impact of the cumulative effect of the accounting
change from 1999 revenues. 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 its current practices.
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<PAGE> 11
6. Commitments and Contingencies
On August 21, 1998, the first of fourteen class action complaints were
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 May 1,
2000, the Court set a series of deadlines for the disposition of the case with
the trial set for April 16, 2001. The Company believes this case is totally
without merit and intends to vigorously defend itself and its officers and
directors.
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 three executives which
expire in 2001 and 2002. The agreements provide that the Company will pay a base
salary amount and grant stock options 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 a
transaction with Insight which were used to pay the May 2000 interest payment.
The Notes are fully and unconditionally guaranteed, jointly and
severally, by all 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
11
<PAGE> 12
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.
On June 20, 2000 the Company issued 394,285 shares of common stock with
a market value of $5.25 per share in exchange for Notes with a carrying value of
$4.6 million. This transaction resulted in an extraordinary gain of $2.5
million. The face value of the remaining notes was $91.65 million at June 30,
2000.
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
June 30, 2000, $91.65 million of Notes were outstanding and the dealer quoted
value of a Note was $0.32 per dollar face value resulting in an aggregate fair
market value of the outstanding Notes of approximately $29.3 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 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,
12
<PAGE> 13
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.
During the second quarter, the Company entered into a number of
agreements whereby it exchanged shares of its common stock for shares of
Preferred Stock. In each instance the exchange ratio was 1.2 common shares for
each share of Preferred Stock. The Company issued 537,744 shares of common stock
with a market value of $3.5 million in exchange for Preferred Stock with a
carrying value of $8.2 million. Dividends on preferred shares were deducted from
the difference between the carrying value of the preferred shares and the market
value of the common shares issued to determine the amount ($4.7 million) to be
included in arriving at net earnings (loss) available to common shareholders.
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
June 30, 2000 the estimated fair market value of the preferred stock was
approximately $4.68 per share for an aggregate value of the outstanding
Preferred Stock of $3.1 million. The shares of Preferred Stock were valued at
1.2 times the closing market price of the common stock at June 30, 2000. This
ratio was used to approximate the fair market value based on the fact that
approximately 40% of the outstanding Preferred Shares were exchanged at this
ratio during the quarter, with little other market activity.
13
<PAGE> 14
On February 1 and May 1, 2000, the quarterly dividends due on the
Preferred Stock were paid through the issuance of additional Preferred Stock
each 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 and May 1, 2000 was approximately
$0.4 million and $ 0.3 million, respectively, which were recorded as preferred
stock dividends.
9. Stock Based Compensation
On January 2, 1998, the Company issued stock option grants to its
employees which 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. Separately, in the second quarter of 2000, the Company accelerated the
vesting and modified the terms of stock options associated with the severance of
an employee which resulted in $ 0.6 million of compensation expense on the new
measurement date. The Company has recognized stock compensation expense of $0.8
million and $0.7 million in selling, general and administrative expense for the
three months ended June 30, 1999 and 2000, respectively. Total expense amounted
to $1.2 million and $0.8 million respectively for the six month periods ended
June 30, 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.
This transaction resulted in a gain for the Company 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 the Company's book basis of $17.4 million. The Company has net operating
loss carry forwards in excess of the tax effect of this gain and, consequently,
has reported no current or deferred income tax expense.
14
<PAGE> 15
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.
Summary financial data of SourceSuite at June 30, 2000 is as follows (in
thousands):
<TABLE>
<S> <C>
ASSETS:
Current Assets.................... $ 7,824
Property and equipment, net....... 205
Intangible assets, net............ 795
----------
$ 8,824
==========
LIABILITIES AND MEMBERS' EQUITY:
Current liabilities............... $ 1,740
Members' equity................... 7,084
----------
$ 8,824
==========
NET LOSS:
Net loss from period of inception (March 3, 2000)
through June 30, 2000. $ (2,883)
==========
</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 has 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.
15
<PAGE> 16
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
1999 2000 1999 2000
-------- -------- -------- --------
(In Thousands) (In Thousands)
<S> <C> <C> <C> <C>
Monetary revenues:
IT Network $ 4,406 $ 4,587 $ 9,307 $ 8,563
Interactive TV -- -- 42 --
-------- -------- -------- --------
Total monetary revenues $ 4,406 $ 4,587 $ 9,349 $ 8,563
======== ======== ======== ========
Nonmonetary revenues:
IT Network $ 473 $ 666 $ 882 $ 1,326
Interactive TV -- -- -- --
-------- -------- -------- --------
Total nonmonetary revenues $ 473 $ 666 $ 882 $ 1,326
======== ======== ======== ========
Net revenues:
IT Network $ 4,879 $ 5,253 $ 10,189 $ 9,889
Interactive TV -- -- 42 --
-------- -------- -------- --------
Total net revenues $ 4,879 $ 5,253 $ 10,231 $ 9,889
======== ======== ======== ========
Operating loss:
IT Network $ (2,796) $ (821) $ (3,756) $ (2,067)
Interactive TV (2,754) -- (5,454) --
Corporate (4,565) (469) (6,275) (2,014)
-------- -------- -------- --------
Total operating loss $(10,115) $ (1,290) $(15,485) $ (4,081)
======== ======== ======== ========
Equity interest in loss of joint venture:
Interactive TV $ -- $ (1,126) $ -- $ (2,709)
======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
December 31, 1999 June 30, 2000
----------------- -------------
<S> <C> <C>
Identifiable assets:
IT Network $15,474 $13,827
Interactive TV 20,675 --
Corporate 21,867 46,560
------- -------
Total identifiable assets $58,016 $60,387
======= =======
Investment in joint venture:
Interactive TV $18,669 $ 3,500
======= =======
</TABLE>
16
<PAGE> 17
12. Subsequent Events
In July, the Company exchanged additional shares of common stock for
shares of Preferred Stock (See Note 8). The exchange ratio was 1.2 shares of
common stock for 1.0 shares of Preferred Stock. As of August 7, 2000, the
Company has retired 54% of its outstanding Preferred Stock.
The Company offered to extend the exercise period of its redeemable
common stock purchase warrants, issued in June 1993 (the "Public Warrants"), to
December 22, 2000 from the scheduled June 23, 2000 expiration. The exercise
price of the warrants was not changed, however, as a condition of the extension,
the Company required each warrantholder to approve a modification to the terms
and conditions that govern the circumstances under which the Company may call
its warrants for redemption. Under the modification, the Company may exercise
its right to redeem the warrants if the closing price of its common stock is
$13.00 per share for more than ten consecutive trading days. The extension and
modification was accepted by holders of 96.2% of the outstanding warrants.
17
<PAGE> 18
SOURCESUITE LLC
BALANCE SHEET
JUNE 30, 2000
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<S> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 7,041
Related Party Receivable 713
Prepaid expenses and other current assets 70
-------
Total current assets 7,824
Property and equipment:
Computer and production equipment 231
Accumulated depreciation 26
-------
Net property and equipment 205
Intangible assets:
Goodwill 858
Accumulated amortization 63
-------
Net intangible assets 795
-------
Total assets $ 8,824
=======
LIABILITIES AND MEMBERS' EQUITY
Current Liabilities:
Accounts payable $ 24
Accrued liabilities 645
Payable to Source Media, Inc. 1,071
-------
Total current liabilities 1,740
Members' equity, 1,000,000 units authorized and
outstanding 9,967
Accumulated deficit (2,883)
-------
Total Members' Equity 7,084
-------
Total liabilities and members' equity $ 8,824
=======
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
18
<PAGE> 19
SOURCESUITE LLC
STATEMENT OF OPERATIONS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS PERIOD OF INCEPTION
ENDED (MARCH 3, 2000) TO
JUNE 30, 2000 JUNE 30, 2000
------------- -------------------
<S> <C> <C>
Revenues $ -- $ --
Operating expenses:
Selling, general and administrative expenses 2,291 2,961
Amortization of intangible assets 63 63
------- -------
Total operating expenses 2,354 3,024
------- -------
Operating loss (2,354) (3,024)
Interest income 103 141
------- -------
Net loss $(2,251) $(2,883)
======= =======
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
19
<PAGE> 20
SOURCESUITE LLC
STATEMENT OF CASH FLOWS
PERIOD OF INCEPTION (MARCH 3, 2000) TO JUNE 30, 2000
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<S> <C>
OPERATING ACTIVITIES
Net Loss $(2,883)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation 14
Amortization of intangible assets 63
Changes in operating assets and liabilities:
Related party receivable 368
Prepaid expenses and other current assets (23)
Trade accounts payable and accrued liabilities 168
Related party payable 532
-------
Net cash used in operating activities (1,761)
INVESTING ACTIVITIES
Capital expenditures (30)
-------
Net cash used in investing activities (30)
-------
Net decrease in cash and cash equivalents (1,791)
Cash and cash equivalents at beginning of period 8,832
-------
Cash and cash equivalents at end of period $ 7,041
=======
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
20
<PAGE> 21
SOURCESUITE LLC
STATEMENT OF MEMBERS' EQUITY
JUNE 30, 2000
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
MEMBERSHIP MEMBERS'
UNITS EQUITY
---------- --------
<S> <C> <C> <C>
Sale of membership units on March 3, 2000 1,000,000 $ 9,967
Net loss -- (2,883)
--------- -------
June 30, 2000 1,000,000 $ 7,084
========= =======
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
21
<PAGE> 22
SOURCESUITE LLC
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM INCEPTION (MARCH 3, 2000) THROUGH JUNE 30, 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 each of Source
Media and Insight and $4.4 million of cash. 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 SourceGuide, an interactive
programming guide; LocalSource, an interactive television programming service;
and related content, was contributed by the joint venture to SourceSuite.
SourceSuite used these funds to purchase the retained business from the joint
venture, which comprised of fixed assets with a net book value of approximately
$200,000 and certain accrued liabilities, for $1.1 million.
SourceSuite will continue the development of the proprietary software
contributed by Source Media and will provide interactive programming services
that are enabled on 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.
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 an independent
appraisal and allocated to assets, liabilities and goodwill.
22
<PAGE> 23
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 indicated 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 carry forwards.
4. MEMBERS' EQUITY
Distribution of equity to members is restricted by the Company's
Operating Agreement for a period of three years.
23
<PAGE> 24
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 June 26, 2000, the court
entered a judgement that ICTI does not infringe on Advanced Interactive's
patent. The Plaintiff has filed a Notice of Appeal of this judgement in the U.S.
Court of Appeals of the Federal Circuit dated August 3, 2000. 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. The Company is vigorously
defending the appeal.
24
<PAGE> 25
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
("Subsidiaries"), including IT Network, Inc. ("IT Network"), Interactive
Channel, Inc. ("Interactive Channel"), SMI Holdings, Inc., and its other
operating subsidiary Interactive Channel Technologies Inc. ("ICTI"), as well as
its wholly-owned non-operating subsidiary Source Nevada, Inc. 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.
25
<PAGE> 26
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 second 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
Interactive sold our interests in the joint venture to Liberate Technologies
("Liberate") in exchange for the issuance to each of us and Insight Interactive
of 886,000 shares 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 Interactive, 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 JUNE 30, 2000 AND 1999
Monetary revenues increased 4% to $4.6 million for the three months
ended June 30, 2000 from $4.4 million for the same period in 1999. The increase
was primarily driven by $0.5 million of revenues from new products in 2000
including streaming audio sales and internet advertising. These increases were
partially offset by $0.1 million of decreased advertising services revenues and
$0.2 million of decreased information services revenue from the same period in
the prior year, primarily due to some customers' late 1999 decisions to not
invest in Y2K equipment upgrades and the resultant termination of our services.
Traditional advertising sales remained consistent between the periods.
Monetary cost of sales decreased 33% to $2.7 million for the three
months ended June 30, 2000 from $4.0 million for the same period in 1999,
primarily as a result of 1999 including $1.4 million of payments to customers
for unfulfilled sales guarantees, $0.2 million of cost of the Interactive TV
operations transitioned to our joint venture partially offset by $0.2 million of
increased costs associated with Internet advertising and $0.1 million other
operational expense.
26
<PAGE> 27
Nonmonetary revenues and nonmonetary cost of sales increased 41% to
$0.7 million for the three months ended June 30, 2000. Nonmonetary sales
accounted for 13% of revenues for the three months ended June 30, 2000 compared
to 10% of revenues for the same period in 1999.
Selling, general and administrative expenses decreased 70% to $2.6
million for the three months ended June 30, 2000 from $8.6 million for the same
period in 1999. The decrease is primarily due to $1.5 million of cost of the
Interactive TV operations transitioned to our joint venture with Insight, a
decrease of $2.5 million in professional fees and legal fees which were incurred
in 1999 in connection with a proposed joint venture that were expensed after
termination of the proposed transaction, a decrease in non-cash variable
compensation expense of $0.7 million, and other operational savings of $1.3
million for the three months ended June 30, 2000.
Amortization of intangible assets decreased 53% to $0.6 million from
$1.2 million for the three months ended June 30, 2000 due to the transfer of
patents to our joint venture with Insight in 1999.
Research and development activities were transferred to our joint
venture with Insight in November 1999, resulting in a decrease of $0.7 million
in research and development expense compared to the three months ended June 30,
1999.
Equity interest includes our share of the results of operations of
SourceSuite for the three months ended June 30, 2000, recorded using the equity
method.
Interest expense decreased 7% to $3.0 million for the three months
ended June 30, 2000 from $3.2 million for the same period in 1999 due to a $3.75
million retirement of notes in December 1999 and a $4.6 million retirement in
June, 2000. 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 decreased 15% to $0.2 million for the three months
ended June 30, 2000 from $0.3 million for the same period 1999 due to lower
investment cash balances as a result of debt interest payments and normal
operating expenditures.
Extraordinary gain resulted from the gain recorded on the exchange of
$4.6 million of Notes for common stock during the second quarter.
Preferred Stock dividends reflect a benefit of $4.7 million realized on
the issuance of common stock in exchange for Preferred Stock, based on the
excess of the carrying amount of the Preferred Stock over the fair value of the
Company's common stock. This benefit is partially offset by $15 thousand of
preferred dividend expense for the three months ended June 30, 2000 as compared
to $0.7 million of dividend expense in the same period of 1999. The dividends
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.
Excluding the benefit, the decrease from prior year is related to a decrease in
the number of shares of Preferred Stock outstanding for the three months end
June 30, 2000 and a decline in the fair market value of the Preferred Stock
which resulted in a lower fair value for the quarterly dividend and the reversal
of an estimated accrual from the prior quarter.
27
<PAGE> 28
SIX MONTHS ENDED JUNE 30, 2000 AND 1999
Monetary revenues decreased 8% to $8.6 million for the six months ended
June 30, 2000 from $9.3 million for the same period of 1999. This decrease is
primarily due to decreases of $1.0 million in advertising sales, $0.2 million in
advertising services, and $0.5 million in information services offset by an
increase of $1.0 million in new product revenues including streaming audio sales
and internet advertising.
Monetary cost of sales decreased 25% to $5.1 million for the six months
ended June 30, 2000 from $6.7 million for the same period in 1999 as a result of
1999 costs including a $1.4 million payment for unfulfilled sales guarantees,
$0.5 million of Interactive TV costs transferred to SourceSuite and a $0.3
million reduction in page costs related to the decreased advertising sales
partially offset by costs incurred on internet sales of $0.4 million in 2000 and
other operational cost increases of $0.2 million.
Nonmonetary revenues and nonmonetary cost of sales increased 50% to
$1.3 million for the six months ended June 30, 2000. Nonmonetary sales accounted
for 13% of revenues for the six months ended June 30, 2000 compared to 9% of
revenues for the same period in 1999.
Selling general and administrative expenses decreased 55% to $6.4
million for the six months ended June 30, 2000 from $14.1 million for the same
period in 1999. The decrease is primarily due to the following: (a) $2.7 million
of cost of the Interactive TV operations transitioned to our joint venture with
Insight; (b) decreased legal and professional fees of $2.8 million which were
incurred in 1999 in connection with a proposed joint venture that were expensed
after the termination of the proposed transaction; (c) decrease in non-cash
variable compensation expense of $1.0 million; and (d) $1.2 million in cost
reductions in other administrative expenses.
Amortization of intangible assets decreased 53% to $1.2 million from
$2.5 million for the six months ended June 30, 2000 due to the transfer of
patents to our joint venture with Insight in 1999.
Research and development activities were transferred to our joint
venture with Insight in November 1999 resulting in a decrease of $1.5 million in
research and development expense compared to the six months ended June 30, 1999.
Other income includes $75.0 million of gain recorded upon the sale of
our interest in the original joint venture with Insight to Liberate in exchange
for 886,000 shares of common stock in Liberate and $4.4 million of cash.
Equity interest in losses of joint venture includes our share of the
results of operations of SourceSuite and its predecessor joint venture for the
six months ended June 30, 2000, recorded using the equity method. The original
joint venture was formed November 17, 1999.
Interest expense decreased 5% to $6.1 million for the six months ended
June 30, 2000 from $6.4 million in 1999. This decrease is due to redemptions in
the outstanding Note balance due to retirement of $3.75 million of Notes for
common stock in December of 1999 and $4.6
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million in June of 2000. The interest 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 decreased 14% to $0.4 million for the six months ended
June 30, 2000 from $0.5 million in the prior year due to lower investment and
cash balances due to normal operating requirements and debt interest payments.
Extraordinary gain resulted from the gain recorded on the exchange of
$4.6 million of Notes for common stock.
Preferred Stock dividends reflect a benefit of $4.7 million realized on
the issuance of common stock in exchange for Preferred Stock, due to the excess
of the carrying amount of the Preferred Stock over the fair value of the
Company's common stock. This benefit is partially offset by dividend expense of
$0.8 million for the six months ended June 30, 2000 as compared to dividend
expense of $1.4 million for the six months ended June 30, 1999. The dividend
expense relates 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. Excluding the benefit the decrease is related to exchanges of Preferred
Stock for common stock, which took place in the second quarter of this year, as
well as a decrease in the fair value of the Preferred Stock issued as dividends
during the six months ended June 30, 2000.
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 June 30, 2000, we had an accumulated deficit of
$124.7 million and had used cumulative net cash in operations of $109.3 million.
The difference at June 30, 2000, between the accumulated deficit and cumulative
net cash used in operations since inception was attributable primarily to
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.
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 which became tradable after July 31, 2000. In addition to
the Liberate common shares, we received from Liberate $4.4 million of working
capital adjustments which we contributed to SourceSuite. 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 August 7, 2000, the closing price per
share of the Liberate common stock was $21.563 resulting in an aggregate value
of $19.1 million. Management believes the decline in the Liberate stock price to
be temporary as there have been no material adverse changes in Liberate's market
position or balance sheet of which management is aware; the market has generally
declined for all technology stocks and in particular for cable and related
industry stocks; Cisco Systems, Inc. has recently invested an additional $100
million in Liberate; and Liberate continues to receive strong buy
recommendations from analysts.
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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. On December
19, 1999, $3.75 million of Notes were tendered to the Company and additional
cash was received in exchange for an exercise of warrants to purchase shares of
common stock. On June 20, 2000 an additional $4.6 million of Notes were
exchanged for common stock. As of June 30, 2000, $91.65 million of Notes remain
outstanding. 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. Additionally, $6.0
million from proceeds received in a transaction with Insight were placed in
escrow and used to pay the May 2000 interest payment. Our primary source of
liquidity is our cash, which totaled $13.8 million at June 30, 2000.
Additionally, we have an investment of 886,000 shares of Liberate common stock
which became tradable after July 31, 2000. Our first interest payment of
approximately $5.5 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 payment 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.
EFFECT OF INFLATION
We believe that the effect of inflation has not been material during
the three month periods ended June 30, 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.
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Part II - OTHER INFORMATION
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 June 30, 2000.
None
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934 the
Registrant has duly caused this amendment to be signed on its behalf by the
undersigned, thereunto duly authorized.
SOURCE MEDIA, INC.
(Registrant)
Date: November 14, 2000 By: /s/ PAUL TIGH
-------------------------------------
Paul Tigh
Chief Financial Officer and Treasurer
(Principal Financial Officer and
Duly Authorized Officer)
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EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
27 Financial Data Schedule
</TABLE>
