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As filed with the Securities and Exchange Commission on January 20, 2000
Registration No. 333-________________
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------
FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
--------------------
SOURCE MEDIA, INC.
(Exact name of Registrant as specified in its chapter)
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DELAWARE 4822 13-3700438
(State or other jurisdiction of (Primary Standard Industrial (IRS Employer
incorporation or organization) Classification Code Number) Identification No.)
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5400 LBJ Freeway
Suite 680
Dallas, Texas 75240
(972) 701-5400
(Address, including zip code, and telephone number, including area code
of Registrant's principal executive offices)
STEPHEN W. PALLEY
Chief Executive Officer
Source Media, Inc.
5400 LBJ Freeway
Suite 680
Dallas, Texas 75240
(972) 701-5400
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
--------------------
Copies to:
ROBERT L. WINIKOFF, ESQ.
HARRIS S. JAFFE, ESQ.
Cooperman Levitt Winikoff Lester & Newman, P.C.
800 Third Avenue
New York, New York 10022
(212) 688-7000
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APPROXIMATE DATE OF PROPOSED SALE TO PUBLIC:
As soon as practicable after this Registration Statement becomes effective.
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--------------------
If the securities being registered on this Form are being offered in
connection with the formation of a holding company and there is compliance with
General Instructions G, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
--------------------
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CALCULATION OF REGISTRATION FEE
- --------------------------------------------------------------------------------------------------
Title of Each Class of Amount to be Proposed Maximum Proposed Maximum Amount of
Securities to be Registered Registered Offering Price Aggregate Offering Registration
Per Fee
Share
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Common Stock, par value 5,000,000 $20.00 $59,500,000 $15,708.00
$0.001 per share (1)
- --------------------------------------------------------------------------------------------------
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(1) Calculated pursuant to Rule 457(f)(1) under the Securities Act of 1933
based on the $100,000,000 aggregate principal amount outstanding of the 12%
Senior Secured Notes to be received by the Registrant in exchange for the
Common Stock offered hereby, assuming 100% acceptance of the exchange
offer. Pursuant to Rule 457(c), the aggregate market value of the 12%
Senior Secured Notes due 2004 was calculated based upon the average bid and
asked price as quoted by market makers of such securities as of January 12,
2000.
------------------------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE
A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE
SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
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The information contained in this prospectus is not complete and may be changed.
We may not sell these securities until the registration statement relating to
this exchange and filed with the Securities and Exchange Commission is
effective. This prospectus is not an offer to sell these securities and it is
not soliciting an offer to buy these securities in any state where the offer or
sale is not permitted.
Subject to Completion - January 20, 2000
Prospectus
SOURCE MEDIA, INC.
Offer to Exchange Common Stock
for and Solicitation of Consents with respect to
12% Senior Secured Notes Due 2004
--------------------------------------
. We are offering to exchange up to 50 shares of our common stock for
each $1,000 in principal amount of the notes that you hold, with the number
of shares being determined by the average closing price of our common stock
as follows:
. if the average closing price is higher than $20.00, the number of
shares to be issued will be the result obtained by dividing $1,000 by the
average closing price,
. if the average closing price is between $12.00 and $20.00, 50 shares
per $1,000 principal amount of notes will be issued, and
. if the average closing price is less than $12.00, 50 shares per
$1,000 principal amount of notes will be issued and we shall have the right
but not the obligation to increase the number of shares to be issued.
. The exchange offer expires at 5:00 p.m., New York City time, on [30 days
after effective date of registration statement] ____________, 2000, unless
we extend it.
. Our common stock is traded on the Nasdaq National Market under the symbol
"SRCM." On January 14, 2000, the last reported sale price of our common
stock was $15.25 per share.
. We are also soliciting the holders of the notes for consents to:
. remove substantially all restrictive covenants, and remove the
definition of certain events of default, in the indenture governing
the notes, and
. remove a restrictive covenant limiting the disposition of assets in
the security agreements relating to the notes.
. The consent solicitation expires at 5:00 p.m., New York City time, on
_____________, 2000 unless we extend it pursuant to the terms described
herein.
. Tenders of notes and consents may be withdrawn at any time before the
consent solicitation expires.
------------------------------------------
For a discussion of certain factors that you should consider before you
participate in this exchange offer and consent solicitation, see "Risk Factors"
commencing on page 13.
------------------------------------------
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
--------------------------------------
The dealer manager for the exchange offer and consent solicitation is:
DONALDSON, LUFKIN & JENRETTE
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INCORPORATION BY REFERENCE
The SEC allows us to incorporate by reference in this prospectus other
information we file with them, which means that we can disclose important
information to you by referring you to those documents. This prospectus
incorporates important business and financial information about us that is not
included in or delivered with this prospectus. The information that we file
later with the SEC will automatically update and supersede the information
included in and incorporated by reference in this prospectus. We incorporate by
reference the documents listed below and any future filings made with the SEC
under Sections 13(a), 13(c), 14 or 15(d) of the Securities Exchange Act of 1934
until the expiration of this exchange offer.
1. Our annual report on Form 10-K for the year ended December 31, 1998, as
amended.
2. Our quarterly report on Form 10-Q for the fiscal quarter ended
September 30, 1999.
3. Our current report on Form 8-K dated November 17, 1999 with respect to
the formation of SourceSuite LLC.
4. Our proxy statement for our annual meeting of stockholders held on
November 17, 1999.
5. The description of our common stock in our registration statement on
Form 8-A filed with the SEC on June 10, 1993, including any amendments
or reports filed for the purpose of updating that description.
We have filed each of these documents with the SEC and they are available
from the SEC's Internet site and/or public reference rooms described under
"Where You Can Find More Information" below. You may also request a copy of
these filings, at no cost, by writing or calling us at the following address or
telephone number, Source Media, Inc., 5400 LBJ Freeway, Suite 680, Dallas, Texas
75240; (972) 701-5400; Attention: F. Paul Tigh, Chief Financial Officer and
Treasurer. You should request documents at least five business days before
expiration of the exchange offer to ensure timely delivery.
You should rely only on the information contained or incorporated by
reference in this prospectus. We have not authorized anyone to provide you with
information that is different from or in addition to what is contained in this
prospectus. Therefore, if anyone does give you information of this sort, you
should not rely on it. If you are in a jurisdiction where it is unlawful to
offer to exchange or sell or to ask for offers to exchange or buy the securities
offered by this prospectus, or if you are a person to whom it is unlawful to
direct those activities, then the offer presented in this prospectus does not
extend to you. The information contained in this prospectus speaks only as of
its date unless the information specifically indicates that another date
applies.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the SEC a registration statement on Form S-4, including
all amendments, exhibits, schedules and supplements thereto, under the
Securities Act and the rules and regulations thereunder, for the registration of
the shares of our common stock offered hereby. Although this prospectus, which
forms a part of the registration statement, contains all material information
included in the registration statement, parts of the registration statement have
been omitted as permitted by the rules and regulations of the SEC. For further
information about us and the common stock offered in this prospectus, you should
refer to the registration statement and its exhibits. You may read and copy any
document we file with the Securities and Exchange Commission at the public
reference facilities maintained by the SEC at Room 1024, 450 Fifth Street, N.W.,
Washington, D.C. 20549, and at the SEC's regional offices at 3475 Lenox Road,
N.E., Suite 1000, Atlanta, Georgia 30326-1232. Copies of such material may be
obtained from the Public Reference Section of the SEC at 450 Fifth Street, NW,
Washington, D.C. 20549, at prescribed rates. You can also review such material
by accessing the SEC's Internet web site at http://www.sec.gov. This site
contains reports, proxy and information statements and other information
regarding issuers that file electronically with the SEC. Such reports, proxy
statements and other information may also be inspected at the offices of the
Nasdaq Stock Market Reports Section, at 1735 K Street, Washington, D.C. 20006.
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PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this prospectus.
Because it is a summary, it does not contain all of the information that you
should consider before you participate in this exchange offer. We encourage you
to read this entire prospectus carefully, including the "risk factors" section.
SOURCE MEDIA, INC.
We sell advertising and related support services to clients who sponsor a
promotional message with interactive content supplied or otherwise managed by
us. We also sell advertising as a sales agent for various publisher partners and
provide interactive content and related support services to our publisher
partners. Our products and services are distributed primarily through our
publisher partners which include over 500 Yellow Page directories with
distribution to over 100 million households and more than 170 daily newspapers
with aggregate circulation of over 15 million. Our products and services are
also promoted and distributed over radio, television and the Internet.
On July 29, 1999, we entered into a contribution agreement with Insight
Interactive, LLC, a wholly-owned subsidiary of Insight Communications Company,
Inc., to form a joint venture in the form of a new Delaware limited liability
company to conduct all of our lines of business relating to our VirtualModem and
Interactive Channel products and businesses. The contribution agreement provided
that Insight Interactive would contribute $13 million to the joint venture, and
we would contribute our VirtualModem and Interactive Channel products and
services. On the same date, we entered into a common stock and warrants purchase
agreement with Insight Interactive pursuant to which Insight Interactive agreed
to acquire 842,105 shares of our common stock at a purchase price of $14.25 per
share or an aggregate purchase price of $12 million, and five-year warrants to
acquire up to an additional 4,596,786 shares of our common stock at an exercise
price of $20.00 per share. The closing of the transactions contemplated by the
contribution agreement and the purchase agreement took place on November 17,
1999. On that date, we and Insight Interactive each became owners of fifty
percent of the joint venture known as SourceSuite LLC. See "Affiliate
Transactions" for additional information.
We designed and, prior to entering into the joint venture, were engaged in
the development of the Virtual Modem and Interactive Channel products and
services. SourceSuite, under our management, continues to develop proprietary
software and interactive programming services that can enable digital, two-way
television systems equipped with digital set-top boxes to deliver two-way,
interactive programming with the touch of a set-top remote or the use of a
wireless keyboard. SourceSuite focuses its offerings on cable operators who have
upgraded their infrastructure to two-way digital systems and can therefore offer
the following "LocalSource" suite of products and services:
. content -subscribers may be offered a variety of local and national
information on demand, including local and national news, weather and
sports, stock quotes, local school information, on-line shopping,
interactive Yellow Pages, movie guides, travel information, games and
a variety of other features;
. e-mail;
. Internet access;
. Interactive Program Guide -SourceSuite's Interactive Program Guide can
provide viewers with a navigational tool for all of the cable
television operators' digital offerings; and
. other products, including electronic commerce, video-on-demand and
other interactive services.
Recent Developments
On January 12, 2000, we, SourceSuite and Insight Interactive entered into a
merger agreement and plan of reorganization with Liberate Technologies. Subject
to the terms of the agreement, we and Insight Interactive will exchange our
ownership interests in SourceSuite for an aggregate of 886,000 shares of common
stock of Liberate, and,
3
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as a working capital adjustment, an amount of cash equal to SourceSuite's cash
and cash equivalents at the time of the merger less any taxes payable by
SourceSuite on the sale of its interactive programming guide and related content
business, which comprise the Interactive Channel, to the new joint venture
referred to below. We will receive 443,000 shares of common stock of Liberate,
if the transaction with Liberate satisfies an exemption from Securities Act
registration that permits us to freely transfer the Liberate shares subject to
the volume limitations of Rule 144. These shares are valued at approximately
$103.1 million based on the closing price of Liberate common stock on the Nasdaq
National Market on January 10, 2000. If the transaction with Liberate does not
satisfy the exemption, we will receive 378,536 shares of Liberate common stock,
valued at approximately $88.1 million based on the January 10, 2000 closing
price on the Nasdaq National Market plus $15 million in cash. In either event,
we will also receive as a working capital adjustment, an amount of cash equal to
one-half of the working capital adjustment referred to above. All references to
Liberate shares in this prospectus do not reflect the recently announced
two-for-one stock split of the common shares of Liberate.
Prior to consummation of the merger, SourceSuite will form a new subsidiary
company, SourceSuite Acquisition LLC, and contribute to the subsidiary cash in
an amount equal to the appraised value of SourceSuite's interactive programming
guide and related content business. SourceSuite will distribute the ownership
interests in the new company to us and Insight Interactive. The new company will
be a joint venture between Insight Interactive and us. The new company will
purchase the interactive programming guide and related content business from
SourceSuite at the appraised value. We will act as manager of the new company
and carry out the interactive programming guide and related content business.
Insight Interactive and we will contribute to the new company cash in amount
equal to the working capital adjustment.
Following the merger, Liberate will provide to the new company, without
charge, specified software development services for the Interactive Channel
products, as set forth in a programming services agreement. The new company will
enter into a preferred content provider agreement with Liberate. This agreement
will offer pricing incentives to Liberate customers that use SourceSuite
Acquisition's local content services with the VirtualModem products.
Liberate is a leading provider of a comprehensive software platform for
delivering Internet-enhanced content and applications to information appliances,
such as television set-top boxes, game consoles, smart phones and personal
digital assistants. Its software allows network operators, such as
telecommunications companies, cable and satellite television operators and
Internet service providers, or ISPs, and information appliance manufacturers to
provide consumers access to Internet-based applications and services. See
"Developments in our Business-Business of Liberate."
[chart showing business operations of Source Media prior to and following the
formation of SourceSuite LLC,
and after giving effect to the proposed transaction with Liberate]
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SUMMARY OF EXCHANGE OFFER
AND CONSENT SOLICITATION
We are offering to exchange up to 50 shares of our common stock for each
$1,000 in principal amount of our outstanding notes with the number of shares
being determined by the average closing price of our common stock as noted
below. We will accept for exchange all notes validly tendered and not withdrawn
on or prior to expiration of the exchange offer. We are also seeking your
consent to proposed amendments to the indenture under which the notes were
issued and certain related security agreements. To validly tender your notes,
you will be required to give your consent to the proposed amendments. The
proposed amendments would remove substantially all restrictive covenants and
remove definitions of certain events of default in the indenture. The proposed
amendments would also remove a restrictive covenant from the security agreements
relating to our notes.
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Number of shares of common stock to be issued in We will issue up to 50
exchange offer shares of our common stock
for each $1,000 in principal
amount of notes tendered and
accepted for exchange, based
on the average closing price
per share of our common
stock on the Nasdaq National
Market during the ten
trading days ending on the
second trading day prior to
the exchange offer
expiration date.
. if the average closing
price is higher than
$20.00, the number of
shares of common stock to
be issued in respect of
each $1,000 in principal
amount of notes will be
the result obtained by
dividing $1,000 by the
average closing price.
. if the average closing
price is between $12.00
and $20.00, 50 shares of
common stock per $1,000
principal amount of notes
will be issued.
. if the average closing
price is less than $12.00,
50 shares of common stock
per $1,000 principal
amount of notes will be
issued, and we shall have
the right but not the
obligation to increase the
number of shares of common
stock to be issued.
Accrued interest on notes We will pay interest in
tendered and accepted cash on notes accepted for
exchange from November 1,
1999 through the date of our
payment for such notes at
the time of exchange.
Conditions The exchange offer is
subject to the following
conditions, among other
things:
. the holders of at least a
majority in aggregate
principal amount of notes
outstanding -- excluding
notes held by Insight
Communications, see
"Affiliate Transactions"
--having consented to the
proposed amendments to the
indenture.
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5
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. the holders of our common
stock, by majority vote,
having approved the
issuance of common stock
being offered in the
exchange offer prior to
the expiration of the
exchange offer.
. the holders of at least a
majority in aggregate
principal amount of notes
outstanding having
properly tendered, and not
withdrawn, their notes in
the exchange offer; and
. the exchange of our
ownership interests in
SourceSuite for cash and
shares of common stock of
Liberate shall have
occurred.
We can waive any condition
to the exchange offer and
accept all notes tendered.
We reserve the right to
terminate the exchange offer
and not accept any notes
tendered for exchange.
Purpose The principal purpose of the
exchange offer is to improve
and simplify our capital
structure by reducing our
outstanding indebtedness.
Purpose of the solicitation and The principal purpose of
proposed amendments the solicitation and the
proposed amendments is to
eliminate substantially all
restrictive covenants,
remove definitions of
certain events of default
and modify other provisions
in the indenture and the
related security agreements
so that any non-tendered
notes do not restrict our
future financial and
operating flexibility. The
proposed amendments will not
become operative upon
execution of the
supplemented indenture but
will become operative only
upon consummation of the
exchange offer.
Requisite consents for solicitation Consents from the holders of
a majority in aggregate
principal amount of notes
outstanding-excluding notes
held by Insight
Communications-are necessary
to approve the amendments to
the notes indenture and the
related security agreements.
As $10,225,000 in principal
amount of the notes is held
by Insight Communications,
consents from the holders-
other than Insight
Communications- of more than
$44,875,000 principal amount
of notes are necessary to
approve the amendments to
the indenture.
No separate consent payment No separate payment will be
made for the consents.
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6
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Consent expiration date The consent expiration date is , 2000, at 5:00
p.m.,
New York City time, if on such date we have the
requisite consents to the proposed amendments, or such
later date as we shall have first received the requisite
consents. It is expected that we and the trustee will
execute the supplemental indenture promptly after the
consent expiration date.
Exchange offer expiration date The exchange offer expiration date is 5:00 p.m., New
York City time, on , 2000, unless we extend the
exchange offer. We intend to extend the exchange offer,
if necessary, so that the exchange offer expiration date
occurs no earlier than five business days following the
consent expiration date.
Withdrawal rights You may withdraw your notes and revoke your consent
at any time prior to 5:00 p.m., New York City time, on
the consent expiration date. A valid withdrawal of
tendered notes prior to such time shall be deemed a
revocation of the consent. Tenders of notes may not be
withdrawn and consents may not be revoked following
5:00 p.m., New York City time, on the consent
expiration date except under certain limited
circumstances. Notes tendered after 5:00 p.m., New
York City time, on the consent expiration date may not
be withdrawn and consents may not be revoked with
respect to such notes.
Procedures for tendering If you are a
holder of notes and wish to
accept the exchange offer,
you must either:
. complete, sign and date the accompanying consent
and letter of transmittal, or a facsimile thereof; or
. complete, sign and date
the accompanying consent,
and arrange for The
Depository Trust Company to
transmit required
information to the exchange
agent in connection with a
book-entry transfer.
You must mail or otherwise
deliver such documentation
together with the notes to
the exchange agent at the
address set forth in this
prospectus under "Procedures
for Participating in the
Exchange Offer and Consent
Solicitation - The Exchange
Agent; Assistance."
Federal Income tax consequences The exchange should qualify as a recapitalization under
the Internal Revenue Code. If that is the case, your
receipt of common stock will not be taxable for U.S.
federal income tax purposes. For a discussion of the
federal income tax consequences of the exchange of
notes, see "Certain Federal Income Tax Consequences."
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Use of proceeds We will not receive any cash
proceeds from the issuance
of shares of common stock in
the exchange offer.
No appraisal You do not have any
appraisal rights in
connection with the exchange
offer.
Transfer taxes No transfer taxes will
be payable upon the issuance
of shares of common stock to
registered holders in
exchange for notes.
Market price and trading As of January 14, 2000 , the
common stock which is traded
on the Nasdaq National
Market closed at $15.25 per
share.
As of January 12, 2000, the
notes which are traded in
the over-the-counter market,
last traded at $595.00 for a
$1,000 note.
Dealer manager Donaldson, Lufkin & Jenrette
Securities Corporation is
the dealer manager and
solicitation agent for the
exchange offer and consent
solicitation.
Exchange agent U.S. Trust Company of Texas, N.A. is the exchange
agent for the exchange offer.
Consequences of failure to exchange To the extent we accept notes for exchange, the
aggregate principal amount of the outstanding notes will
decline. Consequently, any liquidity in the market for
the notes could be adversely affected. Additionally, if
the proposed amendments to the indenture and security
agreements are approved, the notes will no longer have
the benefit of the restrictive covenants set forth in the
indenture.
Proposed Amendments The proposed amendments, in substance, would:
. eliminate from the indenture all provisions set forth
in the sections of the Indenture entitled:
. Section 4.04 Compliance Certificates
. Section 4.05 Taxes
. Section 4.06 Stay, Extension and Usury Laws
. Section 4.07 Limitation on Restricted Payments
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. Section 4.08 Limitation on Restrictions on
Distributions from Restricted Subsidiaries
. Section 4.09 Limitation on Indebtedness
. Section 4.10 Limitation on Sales of Assets and
Subsidiary Stock
. Section 4.11 Limitation on Affiliate Transactions
. Section 4.12 Limitation on Liens
. Section 4.14 Change of Control
. Section 4.15 Limitation on Issuances of Capital
Stock of Restricted Subsidiaries
. Section 4.16 Conduct of Business
. Section 4.17 Limitation on Sale/Leaseback
Transactions, and
. Section 4.18 Limitation on Designation of
Unrestricted Subsidiaries
. amend the provisions of
Section 4.03 of the
indenture entitled SEC
Reports to delete
provisions relating to
the delivery to the
holders of reports filed
with the SEC and require
only that we comply with
Section 314(a) of the
Trust Indenture Act;
. amend the provisions of
Section 4.13 of the
indenture entitled
Corporate Existence so
that this covenant would
only apply to us and not
to our subsidiaries;
. amend the provisions of
Section 5.01 of the
indenture entitled
Limitation on Merger,
Consolidation or Sale of
Assets to delete the
requirement that the
surviving corporation in
a merger or the acquiring
corporation in an asset
sale have a consolidated
net worth after giving
effect to the transaction
equal to or greater than
our net worth before the
transaction;
. amend the provisions of
Section 6.01 of the
indenture entitled Events
of Default to delete
clauses (vi) and (vii)
making it an event of
default if we or any of
our subsidiaries defaults
with respect to certain
indebtedness or become
subject to certain
judgments or orders;
. delete certain defined
terms and renumber
certain provisions in the
indenture as is
appropriate in light of
the deletions and
amendments described
herein; and
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. amend the security
agreements related to the
notes to eliminate
restrictions on
dispositions of assets.
See "Consent Solicitation - Proposed Amendments to
the Notes Indenture."
Separate exchange offer Concurrently with the exchange offer and consent
and consent solicitation solicitation, we are making a separate exchange offer and
consent solicitation to the
holders of our senior
payment- in-kind preferred
stock. We will offer to
exchange up to 50 shares of
common stock for each $1,000
of liquidation preference of
senior preferred stock. The
number of shares to be
offered is subject to
adjustment based on the
average closing price of
shares of our common stock.
The number of shares will be
reduced if the average
closing price exceeds
$20.00. We reserve the right
to increase the number of
shares if the average
closing price is less than
$12.00
The principal purpose of the
preferred stock exchange
offer and consent
solicitation is to simplify
our capital structure by
eliminating a class of
stock, and by increasing our
financial and operating
flexibility by eliminating
restrictive covenants that
are comparable to those
contained in the notes
indenture.
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In connection with our merger into a wholly-owned subsidiary of HB
Communications Acquisition Corp, we changed our name to Source Media, Inc. on
June 23, 1995. Our principal executive office is located at 5400 LBJ Freeway,
Suite 680, Dallas, Texas 75240. Our telephone number is (972) 701-5400.
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Pro Forma Consolidated Selected Financial Data of Source Media, Inc.
The following unaudited pro forma consolidated selected financial data for
Source Media, Inc. for the fiscal year ended December 31, 1998 and for the nine
months ended September 30, 1999 were derived from the unaudited pro forma
consolidated statements of operations and the unaudited pro forma consolidated
balance sheet included elsewhere in this prospectus which include the effects of
the transaction with Insight, the proposed transaction with Liberate and the
proposed offers to exchange common stock for 12% Senior Secured Notes due 2004
and Senior PIK Preferred Stock. The result of the proposed offers to exchange
common stock for 12% Senior Secured Notes due 2004 and Senior PIK Preferred
Stock may result in a partial exchange and, as such, we have given the pro forma
effect of the minimum conversion representing: 55% of the outstanding 12% Senior
Secured Notes due 2004 comprised of 10% held by an affiliate and 45%
representing the minimum amount required to approve the exchange and; 50% for
Senior PIK Preferred Stock. This pro forma consolidated selected financial data
should be read in conjunction with the description of the proposed transaction
with Liberate and the proposed offers to exchange common stock for 12% Senior
Secured Notes due 2004 and Senior PIK Preferred Stock, the pro forma financial
data appearing elsewhere in this prospectus, our consolidated financial
statements for the fiscal year ended December 31, 1998 included in this
prospectus and our annual report on Form 10-K for the fiscal year ended December
31, 1998 and our quarterly report on Form 10-Q for the nine months ended
September 30, 1999 and in our current report on Form 8-K dated November 17,
1999.
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PRO FORMA STATEMENT OF OPERATIONS DATA: 100% Conversion
(In thousands, except per share data) Minimum Conversion Nine Months Ended
(Unaudited) 100% Conversion Year Ended September 30, 1999
Year Ended December December 31, 1998
31, 1998
<S> <C> <C> <C>
Revenues $ 26,000 $ 26,000 $ 15,019
Operating loss (35,493) (35,493) (9,595)
Net loss attributable to common stockholders (36,631) (1) (43,903) (1) (11,668)
Pro forma basic and diluted loss per common share (1.91) (2.70) (0.57)
Weighted average common
shares outstanding 19,158 16,256 20,431
<CAPTION>
PRO FORMA STATEMENT OF OPERATIONS DATA: Minimum Conversion
(In thousands, except per share data) Nine Months Ended
(Unaudited) September 30, 1999
<S> <C>
Revenues $ 15,019
Operating loss (9,595)
Net loss attributable to common stockholders (16,714)
Pro forma basic and diluted loss per common share (0.95)
Weighted average common
shares outstanding 17,529
</TABLE>
(1) Includes $25.9 million charge for the write off of impaired intangible
assets. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and Notes 2 and 5 of the Notes to Consolidated Financial
Statements in our annual report on Form 10-K for the fiscal year ended December
31, 1998.
11
<PAGE>
<TABLE>
<CAPTION>
PRO FORMA BALANCE SHEET DATA:
(In thousands, except per share data)
(Unaudited) 100% Conversion Minimum Conversion
As of September 30, 1999 As of September 30, 1999
<S> <C> <C>
Total assets $137,860 $141,547
Stockholders' equity 92,548 39,955
Book value per share:
Historical (7.29) (7.29)
Pro forma 4.53 2.28
</TABLE>
12
<PAGE>
RISK FACTORS
You should consider carefully, in addition to other information contained
in or incorporated by reference in this prospectus, the following factors in
connection with a decision to tender notes and deliver consents.
Risks of the Exchange Offer and Solicitation
Failure To Exchange Notes Could Adversely Affect Your Investment
Notes not exchanged in the exchange offer will remain outstanding. If the
proposed amendments to the notes indenture become effective, holders of notes
that are not exchanged will no longer be entitled to the benefits of certain
restrictive covenants applicable to us and to our subsidiaries. The deletion of
the restrictive covenants may permit certain actions previously prohibited that
could increase the credit risks with respect to us and to our subsidiaries,
adversely affect the market price and credit rating of any remaining notes, or
otherwise be materially adverse to the interests of the holders of the remaining
notes. See "Consent Solicitation - Proposed Amendments to the Notes Indenture."
The proposed amendments are intended to provide increased operating
flexibility following the exchange offer. The proposed amendments might have a
material adverse effect on the value of the notes resulting from, among other
things, the ability of us and our subsidiaries to:
. incur additional debt,
. make investments and transfer assets, and
. pay dividends or make transfers of funds generated by us from
operations or other assets.
The Reduced Trading Market for Untendered Notes Could Adversely Affect the
Market Price of the Untendered Notes
If notes are tendered and accepted for exchange, the trading market could
become limited for any remaining notes. A debt security with a smaller
outstanding principal amount available for trading may command a lower price
than would a comparable debt security with a greater public float. Accordingly,
the market price of any untendered notes could be adversely affected. In
addition, the reduced public float could cause the market price of the notes to
become more volatile.
Potential public sales of a significant number of shares of our common
stock could reduce the market price of our common stock
We cannot predict the effect, if any, that future sales of shares, or the
availability of shares for future sale, will have on the market price of our
common stock. Sales of substantial amounts of common stock, or the perception
that such sales could occur, may adversely affect prevailing market prices for
our common stock.
As of the date of this prospectus, there are _____ shares of our common
stock outstanding and ____ shares issuable upon exercise of outstanding options
and warrants. Restrictions under the securities laws prevent the immediate sale
in the public market of _____ of such shares. However, nearly all of these
restricted shares are entitled to the benefit of agreements, which obligate us
to register these shares for public trading.
If all notes are tendered in the exchange offer and all shares of our
senior payment-in-kind preferred stock are tendered in response to the separate
exchange offer, approximately 6,120,000 additional shares of our common stock
will be outstanding and freely tradeable.
13
<PAGE>
The price of our securities may fluctuate
The market price of our securities is likely to be highly volatile as the
stock market in general, and the market for technology companies in particular,
has been highly volatile. Stockholders may have difficulty selling our common
stock following periods of volatility because of the market's adverse reaction
to such volatility.
Factors which could cause such volatility may include, among others:
. conditions or trends in the interactive television industry;
. changes in the market valuations of other interactive television
companies;
. actual or anticipated variations in quarterly operating results;
. announcements of technological innovations;
. capital commitments and expenditures;
. departure of key employees; and
. announcements by us or our competitors of strategic alliances,
joint ventures and significant acquisitions.
Many of these factors are beyond our control and may materially adversely
affect the market price of our common stock, regardless of our future operating
results.
The trading prices of many technology companies' stocks have reached
historical highs within the last 12 months and have reflected valuations
substantially above historical levels. During the same period, such companies'
stocks have also been highly volatile and have recorded lows well below such
historical highs. We cannot assure you that our securities will trade at the
same levels of other technology companies or that technology stocks in general
will sustain their current levels.
Risks Relating to the Proposed Transaction with Liberate Technologies
. The transaction divides into two businesses the VirtualModem and
server- side interactive programming guide products and services that
we and SourceSuite operated as one interactive television business.
. Liberate will acquire ownership of all U.S. and international patents
and patent applications now owned by SourceSuite. Any benefits not
presently foreseen from the ownership of the patents and patent
applications will belong to Liberate.
. While the server-side interactive programming guide aspect of
SourceSuite Acquisition's Interactive Channel business will receive a
perpetual royalty free license from Liberate to use the patents, the
license will not preclude Liberate from licensing the patents to third
parties for non-server side interactive programming guide use.
. The VirtualModem and interactive programming guide activities share a
common software source code. The source code needs to be separated so
that Liberate and our new joint venture with Insight Interactive will
exclusively possess separate source code for the software necessary to
conduct their respective businesses and provide their respective
products and services. We will rely on Liberate to effect this
separation and to carry out additional software development services
contemplated by the present arrangements with Liberate. We will not
have the ability to do this ourselves as our employees who have
primarily written the existing software source code are expected to
become employees of Liberate. We will need to retain Liberate or a
third party to upgrade the software in the future.
. The VirtualModem software platform enables cable television system
operators, using TV set top boxes, to afford Internet access and other
services to their customers. Because Liberate will own the
14
<PAGE>
VirtualModem business, our ability to offer our interactive server-
side programming guide and content services such as "Local Source" is
dependent on Liberate's ability to successfully persuade cable
television system operators to use the VirtualModem product.
. Even though our arrangements with Liberate provide special marketing
incentives to cable system operators who use SourceSuite Acquisition's
server-side interactive programming guide and local content services
with Liberate VirtualModem products, we can not assure you that we
will successfully persuade cable operators to use SourceSuite
Acquisition's server-side interactive programming guide and content
services.
. The shares of common stock of Liberate we will receive in exchange for
our ownership interests in SourceSuite will represent a very
substantial part of our assets. The price of Liberate common stock has
been subject to extreme fluctuation since its initial public offering
in July 1999.
. If the exchange of our ownership interests in SourceSuite for shares
of common stock of Liberate is, contrary to our expectations, treated
as a taxable exchange in its entirety, our potential tax liability
would exceed both our usable operating loss carryforwards for any
taxable year, and our available cash reserves. We would likely satisfy
any potential tax liability through the sale of our shares of Liberate
common stock or other assets.
Risks Relating to Forward-looking Statements
Forward-looking statements found in this prospectus may not be accurate
indicators of our future performance
. This prospectus contains certain forward-looking statements and
information relating to our business. We have identified forward-
looking statements in this prospectus using words such as "believes,"
""intends," "expects," "predicts," "may," "will," "should,"
"contemplates," "anticipates" or similar statements. These statements
are based on our belief as well as assumptions we made using
information currently available to us. Because these statements reflect
our current views concerning future events, these statements involve
certain risks, uncertainties and assumptions. Actual future results may
differ significantly from the results discussed in the forward-looking
statements.
USE OF PROCEEDS
We will not receive any cash proceeds from the Exchange Offer.
15
<PAGE>
PRICE RANGE OF COMMON STOCK
Our common stock is traded on the Nasdaq National Market under the symbol
"SRCM". The following table sets forth the high and low sales prices for the
common stock, as reported by the Nasdaq National Market for the periods
indicated below.
<TABLE>
<CAPTION>
1998: High Low
<S> <C> <C>
First Quarter $14.44 $ 8.31
Second Quarter 21.63 13.50
Third Quarter 32.25 6.28
Fourth Quarter 19.00 4.94
</TABLE>
<TABLE>
<CAPTION>
1999: High Low
<S> <C> <C>
First Quarter $23.94 $14.81
Second Quarter 23.44 14.50
Third Quarter 16.88 6.00
Fourth Quarter 19.50 7.56
</TABLE>
<TABLE>
<S> <C> <C>
2000: High Low
First Quarter (through January 14, 2000) $21.00 $15.25
</TABLE>
On January 14, 2000, the last reported sale price of the common stock of
the Nasdaq National Market was $15.25 per share. On January 13, 2000, there were
approximately 155 holders of record of common stock.
16
<PAGE>
CAPITALIZATION TABLE
<TABLE>
<CAPTION>
Source Media, Inc.
Capitalization Table
As of September 30, 1999
(In thousands) Insight Liberate
Pro Forma Pro Forma Pro Forma Pro Forma
Historical Adjustments As adjusted Adjustments As adjusted
---------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Long-term debt:
Senior Secured Notes, 12% interest, due 2004 $100,000 $ - $ 100,000 $ - $ 100,000
Stockholder's equity:
Senior redeemable payment-in-kind (PIK) preferred
stock, $25 liquidation preference, $.001 par value,
net of discount
Authorized shares - 1,712
976 shares issued and outstanding 18,061 - 18,061 - 18,061
Non-participating preferred stock, $.001 par value
Authorized and issued - 1 share - - - - -
Common stock, $.001 par value:
authorized shares - 50,000 and
13,748 shares issued 14 1 15 - 15
Less treasury stock, at cost - 275 shares (2,716) - (2,716) - (2,716)
Capital in excess of par value 84,432 25,104 109,536 - 109,536
Accumulated deficit 178,552) - (178,552) 52,380 (126,172)
--------------------------------------------------------------------------
Total stockholders' equity (96,822) 25,105 (71,717) 52,380 (19,337)
--------------------------------------------------------------------------
Total capitalization $ 21,239 $ 25,105 $ 46,344 $ 52,380 $ 98,724
=========================================================================
<CAPTION>
-----------------------------
Common Stock Common Stock
Exchange Minimum Exchange
Pro Forma Pro Forma Pro Forma Pro Forma
Adjustments As adjusted Adjustments As adjusted
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Long-term debt:
Senior Secured Notes, 12% interest, due 2004 $ (100,000) $ - $ (55,000) $ 45,000
Stockholder's equity:
Senior redeemable payment-in-kind (PIK) preferred
stock, $25 liquidation preference, $.001 par value,
net of discount
Authorized shares - 1,712
976 shares issued and outstanding (18,061) - (9,031) 9,030
Non-participating preferred stock, $.001 par value
Authorized and issued - 1 single share - - - -
Common stock, $.001 par value:
authorized shares - 50,000 and
13,748 shares issued 6 21 4 19
Less treasury stock, at cost - 275 shares - (2,716) - (2,716)
Capital in excess of par value 124,394 233,930 67,197 176,733
Accumulated deficit (10,483) (136,655) (5,877) (132,049)
---------------------------------------------------------------------------
Total stockholders' equity 113,917 94,580 61,324 41,987
---------------------------------------------------------------------------
Total capitalization $ (4,144) $ 94,580 $ (2,707) $ 96,017
===========================================================================
</TABLE>
17
<PAGE>
DEVELOPMENTS IN OUR BUSINESS
We sell advertising and related support services to clients who sponsor a
promotional message with interactive content supplied or otherwise managed by
us. We also sell advertising as a sales agent for various publisher partners and
provide interactive content and related support services to the publisher
partners. Our products and services are distributed primarily through our
publisher partners which include over 500 Yellow Page directories with
distribution to over 100 million households and more than 170 daily newspapers
with aggregate circulation of over 15 million. Our products and services are
also promoted and distributed over radio, television and the Internet.
On July 29, 1999, we entered into a contribution agreement with Insight
Interactive, a wholly-owned subsidiary of Insight Communications, which
contemplated the formation of SourceSuite to conduct all of our lines of
business relating to our VirtualModem and Interactive Channel products and
businesses. The contribution agreement provided that Insight Interactive would
contribute $13 million to the joint venture, and we would contribute our
VirtualModem and Interactive Channel products and services. On the same date, we
entered into a common stock and warrants purchase agreement with Insight
Interactive pursuant to which Insight Interactive agreed to acquire 842,105
shares of our common stock at a purchase price of $14.25 per share or an
aggregate purchase price of $12 million and five-year warrants to acquire up to
an additional 4,596,786 shares of our common stock at an exercise price of
$20.00 per share. The closing of the transactions contemplated by the
contribution agreement and the purchase agreement took place on November 17,
1999. On that date, we and Insight each became owners of fifty percent of the
joint venture known as SourceSuite. See "Affiliate Transactions" for additional
information.
We designed and, prior to entering into the joint venture, were engaged in
the development of the VirtualModem and Interactive Channel products and
services. SourceSuite, under our management, continues to develop proprietary
software and interactive programming services that can enable digital, two-way
television systems equipped with digital set-top boxes to deliver two-way,
interactive programming with the touch of a set-top remote or the use of a
wireless keyboard. SourceSuite focuses its offerings on cable operators who have
upgraded their infrastructure to two-way digital systems and can therefore offer
the following "LocalSource" suite of products and services:
. content -- subscribers may be offered a variety of local and national
information on demand, including local and national news, weather and
sports, stock quotes, local school information, on-line shopping,
interactive Yellow Pages, movie guides, travel information, games and
a variety of other features;
. e-mail;
. Internet access;
. Interactive Program Guide ("IPG") -- SourceSuite's IPG can provide
viewers with a navigational tool for all of the cable television
operators' digital offerings; and
. other products, including electronic commerce, video-on-demand and
other interactive services.
To facilitate the proposed transaction with Liberate referred to in the
following paragraphs, SourceSuite will form SourceSuite Acquisition as a wholly-
owned subsidiary prior to consummation of the proposed transaction. In
connection with the proposed transaction, SourceSuite retained a valuation firm
to value the assets and properties of SourceSuite, other than the assets and
properties used in and/or necessary to the conduct of SourceSuite's VirtualModem
business relating to the VirtualModem products and associated businesses as it
currently is conducted. The assets and properties of SourceSuite other than the
VirtualModem business are herein called the retained business, and constitute
the Interactive Channel. SourceSuite will contribute cash to SourceSuite
Acquisition in an amount equal to the value of the retained business, as
determined by the valuation firm. Following SourceSuite's contribution of cash
to SourceSuite Acquisition, SourceSuite will distribute all of the ownership
interests in SourceSuite Acquisition to us and Insight Interactive so that each
of us will become fifty percent owners of SourceSuite Acquisition, which will be
a
18
<PAGE>
joint venture company. We will act as manager. SourceSuite Acquisition will,
before the proposed transaction is effected, then purchase the retained business
from SourceSuite for the appraised value.
On January 19, 2000, we mailed separate consent solicitation statements to
the holders of the notes and of our senior payment-in-kind preferred stock to
obtain consents required to permit us to effect the exchange of our ownership
interests in SourceSuite for shares of common stock of Liberate referred to
below in the section entitled "Merger Agreement." On January 20, 2000, we filed
with the SEC a registration statement covering our proposed exchange offer to
acquire all of our senior payment-in-kind preferred stock.
Merger Agreement
On January 12, 2000, we, SourceSuite, Insight Interactive and Insight
Communications entered into a merger agreement with Liberate. The merger
agreement contemplates that Liberate Acquisition LLC., a Delaware limited
liability company to be formed as a wholly-owned subsidiary of Liberate, will
merge with and into SourceSuite. Upon the effectiveness of the merger, we will
receive, if the California exemption referred to below is available, (a) as a
working capital adjustment, an amount of cash equal to one-half of SourceSuite's
cash and cash equivalents at the time of the merger less any taxes payable by
SourceSuite on the sale of the Retained Business to SourceSuite Acquisition, we
refer to this as the adjustment amount, and (b) 443,000 shares of Liberate
common stock which have a value of approximately $103.1 million based on the
closing price of Liberate common stock on the Nasdaq National Market on January
10, 2000 of $232.6875 per share. If the California exemption is not available,
we will receive (a) as a working capital adjustment, an amount of cash equal to
one-half of the adjustment amount and (b) 378,536 Liberate shares which have a
value of approximately $88.1 million based on the January 10, 2000 closing price
on the Nasdaq National Market plus $15 million in cash for a total value of
Liberate shares and cash of approximately $103.1 million. Insight Interactive
will receive (a) as a working capital adjustment, an amount of cash equal to
one-half of the adjustment amount and (b) 443,000 Liberate shares which have a
value of approximately $103.1 million based on the January 10, 2000 closing
price on the Nasdaq National Market. The value of the Liberate shares on the
closing date of the proposed transaction may be the same, greater or less than
the value of such shares based on the January 10, 2000 closing price on the
Nasdaq National Market. All references to Liberate shares in this prospectus do
not reflect the recently announced two-for-one stock split of the common shares
of Liberate.
The exact number of Liberate shares to be acquired by us in exchange for
the SourceSuite ownership interests in the merger will be determined based on
whether the Liberate shares can be issued in a transaction exempt from
registration by reason of Section 3(a)(10) of the Securities Act. Such an
exemption is provided for by Section 25121 of the California Corporations Code
in certain limited circumstances. It is not yet determinable whether the
proposed transaction will satisfy the criteria necessary for Liberate to issue
the Liberate shares in reliance upon the California exemption. If the California
exemption is available, the Liberate shares will be freely tradeable subject to
the volume limitations of Rule 144 under the Securities Act and the limitation
set forth in the following paragraph. Under either scenario, Insight Interactive
will receive (a) as a working capital adjustment, an amount of cash equal to
one-half of the adjustment amount and (b) 443,000 Liberate shares in exchange
for its ownership interest in SourceSuite. As of January 12, 2000, 443,000
Liberate shares represent less than 1% of the outstanding Liberate shares on a
fully diluted basis.
Pursuant to the terms of merger agreement, we and Insight Interactive each
agreed, prior to July 28, 2000, not to (a) sell, lend, pledge, contract to sell,
grant an option or otherwise transfer or dispose of, directly or indirectly, or
(b) enter any swap or other arrangement that transfers the economic consequences
of ownership of, eighty percent (80%) of the respective Liberate shares received
by us and Insight Interactive in the merger other than our grant of a security
interest and pledge of the Liberate shares for the benefit of the holders of the
notes. The rights of the indenture trustee on behalf of the holders of the notes
will be limited by the aforementioned limitations until July 28, 2000.
If the California exemption is not obtained by March 10, 2000, the merger
agreement provides that Liberate, we and Insight Interactive will enter into a
registration rights agreement. The registration rights agreement will require
Liberate, upon request made by us and Insight Interactive on or after July 28,
2000 and before eighteen months following
19
<PAGE>
the date of the merger, to register the Liberate shares received by us and
Insight Interactive so that they will be freely tradeable.
At the time of the merger of Liberate Acquisition with and into
SourceSuite, SourceSuite will own the VirtualModem products and businesses, as
well as the patents and other intellectual property rights related thereto.
SourceSuite Acquisition, which will be jointly owned by us and Insight
Interactive prior to and following the merger, will have an exclusive license to
use the patents necessary to its business which will consist of the interactive
programming guide and LocalSource comprising the Interactive Channel. Following
the merger, we and Insight Interactive will contribute to SourceSuite
Acquisition, in equal amounts, cash in an aggregate amount equal to
SourceSuite's cash and cash equivalents at the time of the merger less any taxes
payable by SourceSuite on the sale of the retained business to SourceSuite
Acquisition. The merger agreement provides that SourceSuite and SourceSuite
Acquisition will enter into a programming services agreement, and that Liberate
and SourceSuite Acquisition will enter into a preferred content provider
agreement to govern the relationship between the parties following the merger.
Each of these agreements is discussed below. On the date of the merger, Insight
Communications will enter into an agreement with Liberate pursuant to which
Insight Communications, in consideration of fees payable to Liberate, will
acquire a license to utilize Liberate's software for purposes of hosting and
deploying interactive programming services.
Programming Service Agreement
SourceSuite and, prior to the formation of SourceSuite we, had operated the
VirtualModem and Interactive Channel businesses as one enterprise sharing
technology, know-how, patents and software, including software source code. As a
significant portion of the technology and know-how, including all currently
existing and applied-for patents, is being retained by SourceSuite and as a
number of our employees who have worked in the development of this technology
are expected to be hired as employees of SourceSuite following the merger,
Liberate has agreed with us, for the benefit of SourceSuite Acquisition, to
continue the development of the software included in the SourceSuite IPG
technology, the ownership of which is being transferred to SourceSuite
Acquisition, and the development of related implementing technologies as a "work
for hire" for SourceSuite Acquisition, and to create the Server IPG
Implementation, as defined in the programming services agreement, in accordance
with the terms of a mutually agreed statement of work, specifying the tasks to
be completed. This development work will be carried out at Liberate's expense
and is intended to enable SourceSuite Acquisition to carry out its interactive
program guide business with its own software and related technology and know-
how.
Preferred Content Provider Agreement
The preferred content provider agreement, to be entered into by and between
SourceSuite Acquisition and Liberate, will become effective at the time of the
merger. This agreement sets forth the terms and conditions by which SourceSuite
Acquisition, as the successor to SourceSuite's interactive program guide and
local content business, will serve as the preferred content provider for
Liberate's cable television system operator customers using VirtualModem
products. The content applications are to run on top of the Liberate software
products that are created or based substantially on the VirtualModem technology
initially developed by us and then by SourceSuite.
The preferred content provider agreement provides that Liberate will use
commercially reasonable efforts to introduce SourceSuite Acquisition to
Liberate's cable television operator customers who are interested in deploying
VirtualModem products. The preferred content provider agreement also provides
that Liberate will offer a special marketing incentive credit to its customers
so that if they use SourceSuite Acquisition's interactive programming guide or
local content, in addition to VirtualModem, they would receive a discount from
Liberate's standard set of best pricing terms. The preferred content provider
agreement limits the amount of special marketing incentive credits that Liberate
may extend to its cable television operator customers who do not contract with
SourceSuite Acquisition for the deployment of the SourceSuite Acquisition's
server-side interactive program guide or "Local Source" content services but
select another content provider for similar interactive program guide software
or content services. This restriction will not apply when a cable television
operator cancels or terminates its contact with SourceSuite Acquisition because
of its dissatisfaction with SourceSuite Acquisition or because of SourceSuite
Acquisition's breach of its contract. Liberate will
20
<PAGE>
be entitled to a portion of the carriage fees received by SourceSuite
Acquisition from customers of Liberate pursuant to this arrangement.
[chart showing business operations of Source Media prior to and following the
formation of SourceSuite LLC,
and after giving effect to the proposed transaction with Liberate]
Conditions to Closing
The consummation of the proposed transaction with Liberate is subject to
certain conditions, including the receipt of the requisite consents of the
holders of notes, the execution and delivery by the indenture trustee and us of
a second supplemental indenture, the approval by the holders of our senior
preferred stock, certain of our employees becoming employees of Liberate and the
receipt of any necessary governmental or regulatory approvals, including
expiration or early termination of any applicable waiting period under the Hart-
Scott-Rodino Antitrust Improvements Act. Each of the components of the proposed
transaction is conditioned upon the consummation of all other components of the
proposed transaction. The proposed transaction may be terminated by either party
in the event the closing has not occurred by April 15, 2000.
Reasons for the Liberate Transaction
Liquidity. If the California exemption is available, the proposed
transaction-after our contribution of cash to SourceSuite Acquisition-will
provide us with 443,000 Liberate shares which will be freely tradeable following
July 28, 2000 subject to the volume limitations under Rule 144 of the Securities
Act. If the California exemption is not available, the proposed transaction will
provide us with $15 million in cash and 378,536 Liberate shares, which will not
be freely tradeable. If the California exemption is not obtained by March 10,
2000, the merger agreement provides that Liberate, we and Insight Interactive
will enter into a registration rights agreement on the closing date of the
proposed transaction. The registration rights agreement will require Liberate to
register the Liberate shares received by us and Insight Interactive, following
any request made by us and Insight Interactive on or after July 28, 2000 and
before eighteen months following the date of the merger, so that they will be
freely tradeable.
Pursuant to the terms of the merger agreement, we and Insight Interactive
will each agree, prior to July 28, 2000, not to (a) sell, lease, pledge,
contract to sell, grant an option or otherwise transfer or dispose of, directly
or indirectly, or (b) enter any swap or other arrangement that transfers the
economic consequences of ownership of eighty percent (80%) of the respective
Liberate shares received by each in the proposed transaction other than our
grant of a security interest and pledge of the Liberate shares for the benefit
of the holders of the notes. The rights of the indenture trustee on behalf of
the holders of the notes will be limited by the aforementioned limitations until
July 28, 2000.
The cash generated from the sale of a portion of the Liberate shares in
accordance with Rule 144, should we elect to sell any Liberate shares, or the
$15 million in cash if received from Liberate would be used for general
corporate purposes. We believe such funds would provide us with the cash
necessary to meet our operating requirements for the next twelve months. The
Liberate shares received by us, following the effectiveness of a registration
statement under the Securities Act, will be freely tradeable without regard to
volume limitations and would afford an additional source of liquidity to us
should we elect to dispose of them. For more information, see "Risk Factors -
Risks Relating to the Proposed Transaction with Liberate Technologies."
Development of Technology. The programming services agreement requires
Liberate to continue to develop the Interactive Channel products and businesses.
Among other things, we believe that those services will expedite our ability to
make our applications and local content services usable on all available
platforms. Liberate's developmental efforts will also permit SourceSuite
Acquisition to apply the cash SourceSuite would have expended for developmental
efforts to other aspects of its business.
21
<PAGE>
Distribution. The preferred content provider agreement requires Liberate to
use commercially reasonable efforts to introduce SourceSuite Acquisition to
Liberate's cable television system operator customers who are interested in
deploying VirtualModem products and to offer such customers Liberate's standard
best price set of pricing terms together with a special marketing incentive
credit. In order to take advantage of this arrangement, the cable television
system operator customer would need to contract with SourceSuite Acquisition to
purchase SourceSuite Acquisition's interactive programming guide or local
content. We believe that this arrangement with Liberate, a platform developer,
will generate increased carriage opportunities for SourceSuite Acquisition's
interactive programming guide and LocalSource suite products.
Business of Liberate
The summary description of Liberate set forth below is based on a summary
description set forth in Liberate's registration statement on Form S-1, as
amended, filed with the SEC on July 27, 1999. The description is qualified in
its entirety by reference to the information Liberate files with the SEC. See
"Where You Can Find More Information" for an explanation of how you can obtain
from the SEC additional information regarding Liberate. We urge you to obtain
such additional information, but assume no responsibility for any such
information.
Liberate is a leading provider of a comprehensive software platform for
delivering Internet-enhanced content and applications to information appliances,
such as television set-top boxes, game consoles, smart phones and personal
digital assistants. Its software allows network operators, such as
telecommunications companies, cable and satellite television operators and
Internet service providers, or "ISPs", and information appliance manufacturers
to provide consumers access to Internet-based applications and services.
Network operators are investing billions of dollars to deliver high speed
Internet access to their customers so that they can deliver new and enhanced
voice, video and data services. As a result, the number of U.S. households with
access to high speed networks is expected to grow significantly. At the same
time, network operators seek to deliver these services to an increasing number
of electronic devices being adopted by consumers. These "information
appliances," a new category of low-cost devices used for everyday activities
that are designed to be connected to the Internet, are becoming increasingly
popular with consumers. In particular, network operators have identified the
television as an attractive device for the delivery of these new services
because it has powerful sound and display capabilities and is so broadly owned.
Liberate provides network operators and information appliance manufacturers
with a software platform that manages the delivery of Internet content and
applications to a large number of consumers employing many different information
appliances. Its platform includes server and client software and adheres to
Internet standards. Its server software is designed to allow network operators
to offer these services to millions of subscribers. Using its client software,
information appliance manufacturers can enhance their products, even those with
limited memory and computing resources, by adding Internet capability. Its open
platform also creates a uniform environment for developers to enhance existing
content and create new Internet applications and services.
Liberate licenses its server and client software to network operators and
information appliance manufacturers. Its network operator customers include
America Online, Cable & Wireless, NTL and U S West. Liberate Technologies has
developed strategic alliances with leading technology vendors such as Cisco
Systems, Inktomi, Lucent Technologies, Netscape, Oracle, Sun Microsystems and
TiVo. It also has established commercial relationships with several large
network operators, such as Comcast, Cox Communications, MediaOne and Star TV.
AFFILIATE TRANSACTIONS
Insight Communications is the eighth largest cable television system
operator in the United States. In 1999, Insight Communications began offering
new and enhanced products and services, such as interactive digital video in
certain of its systems.
22
<PAGE>
Insight Communications, because of its rights to designate one or more of
our directors and to designate one member of each committee of our board of
directors, is deemed to be an "affiliate" of ours for purposes of the notes
indenture. Notes owned by Insight Communications are disregarded for purposes of
determining whether the requisite consents have been obtained.
Three of the seven members of our board of directors are designees of
Insight Communications in accordance with the terms of the certificate of
designations of the non-participating preferred stock. The three designees of
Insight Communications who serve on our board of directors, Kim D. Kelly, Sidney
R. Knafel and Michael S. Willner, are also members of the board of directors of
Insight Communications.
Insight Communications, the parent of Insight Interactive, our co-venturer
in SourceSuite, holds $10,225,000 principal amount or 10.225% of the outstanding
Notes. Insight Communications holds 842,105 shares of our common stock, warrants
to acquire up to an additional 4,596,786 shares of our common stock and the sole
share of our non-participating preferred stock. Shares individually owned by the
directors of Insight Communications named above are not included in these
amounts.
Insight Communications holds approximately 19.7% of our common stock on a
fully diluted basis assuming exercise of all outstanding options and warrants,
but before giving effect to the issuance of shares of common stock in the
proposed exchange offers. Insight Communications' right to designate three of
seven directors is premised on Insight Communications' continued ownership of
more than fifteen percent (15%) of our voting stock on a fully diluted basis.
Depending on whether there are seven or ten members of our board of directors,
Insight Communications' director designation rights are the following:
<TABLE>
<CAPTION>
Number of board seats to be Percentage of our voting stock owned by Insight
designated by Insight Communications Communications on a fully diluted basis
- ------------------------------------ ---------------------------------------
Based on 7 based on 10
person board person board
- ------------ ------------
<S> <C> <C>
3 4 15% or greater
2 3 7.5% or more but less than 15%
1 2 5% or more but less than 2.5%
1 1 2.5% or more but less than 5%
0 0 less than 2.5%
</TABLE>
Insight Communications has included SourceSuite's LocalSource suite of
products in its Rockford, Illinois and Columbus, Ohio cable television systems.
Insight Communications has informed us of its intention to use the Interactive
Channel program guide in its cable television systems which offer interactive
digital video products, as such systems are rebuilt with the capability to offer
interactive digital video products. Insight Communications also has informed us
that it expects to complete the rebuild of most of its cable television systems
in the current calendar year. This has assisted the development of SourceSuite's
Interactive Channel products, and has also enhanced the appeal of SourceSuite's
VirtualModem products. If the proposed transaction is consummated, Insight
Communications will enter into an agreement with Liberate pursuant to which
Insight Communications, in consideration of fees payable to Liberate, will
acquire a license to utilize Liberate's software for purposes of hosting and
deploying interactive programming services.
A description of the Contribution Agreement pursuant to which Insight
Interactive and the Company agreed to form SourceSuite, and a description of the
Purchase Agreement pursuant to which Insight Interactive acquired its shares of
Common Stock, warrants and non-participating preferred stock, as well as a
description of the rights and terms of that preferred stock, is contained in our
Definitive Proxy Statement for the annual meeting of stockholders held on
November 17, 1999, which has been incorporated herein by reference. Copies of
such Proxy Statement may be obtained from us or as described under "Where You
Can Find More Information."
23
<PAGE>
REASONS FOR EXCHANGE OFFER AND SOLICITATION
Our operations may not generate sufficient cash to permit us to retire the
notes when they become due in 2004 or to purchase the senior payment-in-kind
preferred stock when it must be redeemed in 2007. The proposed transaction with
Liberate provides us-after our contribution of cash to SourceSuite Acquisition-
with 443,000 shares of common stock of Liberate with a value, based on the
January 10 closing price per share, of approximately $103.1 million, or a
reduced number of shares valued at approximately $88.1 million and $15 million
in cash, determined as provided under "Developments in Our Business - Merger
Agreement."
If the exchange offer results in the tender and retirement of a majority of
the indebtedness represented by the notes, we believe that our capital structure
will be simplified and strengthened with the addition of equity and reduction of
debt.
We also seek the consent of the holders of our notes to proposed amendments
to the notes indenture that will eliminate substantially all the restrictive
covenants and remove the definitions of certain events of default in the notes
indenture and remove a covenant in the security agreements that together limit
our financial and operating flexibility.
We will also make a separate and independent exchange offer and consent
solicitation to the holders of our senior payment-in-kind preferred stock
offering to exchange shares of common stock for the senior preferred stock. This
additional exchange offer, if accepted by the holders of our senior preferred
stock, will further simplify and strengthen our capital structure.
TERMS OF EXCHANGE OFFER
We are seeking to exchange shares of common stock for all notes that are
outstanding. We are offering to issue up to 50 shares of our common stock for
each $1,000 principal amount of notes validly tendered and accepted at or prior
to the exchange offer expiration date. The number of shares to be issued will be
based on the average closing price of our common stock on the Nasdaq National
Market during the ten trading days ending on the second trading day prior to the
exchange offer expiration date. If the average closing price is higher than
$20.00, the number of shares to be issued will be the result obtained by
dividing $1,000 by the average closing price. If the average closing price is
between $12.00 and $20.00, 50 shares per $1,000 principal amount of notes will
be issued. If the average closing price is less than $12.00, 50 shares per 1,000
principal amount of notes will be issued, and we shall have the right but not
the obligation to increase the number of shares to be issued.
Fractional shares will not be issued in the exchange and any fractional
share shall be rounded to the nearest whole share. Accrued interest will also be
paid from November 1, 1999 through the date of our payment for the notes
tendered and accepted for exchange.
In order to participate in the exchange offer, a holder of notes must
consent to the proposed amendments to the notes indenture and tender all of the
notes beneficially owned by the holder. We can extend the exchange offer and
accept all notes tendered for exchange or amend the terms of the exchange offer
and any amendment will apply to the notes tendered pursuant to the exchange
offer. Additionally, we reserve the right at any time to terminate the exchange
offer and not accept for exchange any notes tendered for exchange. Notes
tendered in the exchange offer may be withdrawn by the holder prior to the
exchange offer termination date.
We shall be deemed to have accepted validly tendered notes when, as and if
we have given oral or written notice to the exchange agent. The exchange agent
will act as agent for the tendering holders of notes and for the purposes of
receiving shares of common stock and cash from us.
If any tendered notes are not accepted for exchange because of an invalid
tender, the occurrence of other events set forth in this prospectus or
otherwise, certificates for any unaccepted notes will be returned, without
expense, to the tendering holder as promptly as practicable after the exchange
offer expiration date.
24
<PAGE>
We reserve the right in the future to seek to acquire notes not tendered in
the exchange offer by means of open market purchases, privately negotiated
acquisitions, exchange offers, subsequent tender offers, redemptions or
otherwise, at prices and on terms which may be higher or lower or more or less
favorable than in the exchange offer.
Exchange Offer Expiration Date; Extensions; Waiver; Termination; Amendment
The exchange offer expiration date will be ____________, 2000 at 5:00 p.m.,
New York City time, unless we, in our sole discretion, extend the exchange
offer. In that case, the exchange offer expiration date will be the latest date
and time to which the exchange offer is extended. We intend to extend the
exchange offer, if necessary, so that the exchange offer expiration date occurs
no earlier than five business days after the consent expiration date.
In order to extend the exchange offer, we will notify the exchange agent of
any extension by oral followed by written notice and will make a public
announcement. In either case we will do so prior to 9:00 a.m., New York City
time, on the next business day after the previously scheduled exchange offer
expiration date.
We reserve the right, in our sole discretion:
. to delay accepting any notes,
. to extend the exchange offer expiration date and accept any notes
previously tendered,
. to waive any condition to the exchange offer and accept any notes
tendered for exchange,
. to terminate the exchange offer, whether or not any of the conditions set
forth below under "-Conditions of the Exchange Offer" shall have been
satisfied, and
. to amend the terms of the exchange offer in any manner by giving oral or
written notice of delay, extension, termination or modification to the
exchange agent. Any amendment will apply to all notes tendered.
If the exchange offer is amended in a manner determined by us to constitute
a material change, we will promptly disclose these amendments by means of a
public announcement or a supplement to this prospectus that will be distributed
to the registered holders of the notes.
Conditions of the Exchange Offer
The exchange offer is subject to the following conditions:
. holders of at least a majority in aggregate principal amount of the
outstanding notes must consent to the proposed amendments to the indenture
governing the notes,
. holders of at least a majority in aggregate principal amount of the
outstanding notes must have validly tendered their notes in the exchange
offer,
. we shall have exchanged our ownership interest in SourceSuite for
shares of common stock of Liberate,
. our shareholders shall have approved the issuance of the common stock
being offered in the exchange offer,
. no legal action or proceeding shall have been instituted or threatened
with respect to the exchange offer or the consent solicitation, or which,
in our sole judgment, may materially adversely affect our business,
operations or financial condition,
25
<PAGE>
. there has not occurred:
. any material adverse development in any existing action or
proceeding of any nature,
. any general suspension of trading in, or limitation on prices
for, securities on the New York Stock Exchange or Nasdaq National
Market,
. a declaration of a banking moratorium by United States
authorities or any governmental agency in the United States,
. the commencement of a war, armed hostilities or other
international or national calamity directly or indirectly
involving the United States,
. a material adverse change in general economic, political or
financial conditions, if the effect of any economic, political or
financial conditions on the financial markets of the United
States, in our sole judgment, makes it impracticable to
consummate the exchange offer or the preferred stock exchange
offer,
. there has not occurred any change, or development involving a
prospective change, in or affecting our business or financial
affairs which, in our sole judgment, would materially impair the
contemplated benefits of the exchange offer or the consent
solicitation, or
. no statute, rule or regulation has been proposed or enacted, or
any action has been taken by any governmental authority, which,
in our sole judgment, would or might prohibit, restrict or delay
consummation of the exchange offer as presently proposed or
materially impair the contemplated benefits of the exchange offer
or the consent solicitation, and
. there does not exist, in our sole judgment, any other actual or
threatened legal impediment to the acquisition of the notes or
the issuance of the common stock and payment of cash in the
exchange offer.
At any time, we can waive any condition to the exchange offer and accept
all notes tendered for exchange pursuant to the exchange offer.
26
<PAGE>
CONSENT SOLICITATION
General
In connection with the exchange offer, we are soliciting consents from the
holders of the notes to approve proposed amendments to the notes indenture.
Consents of holders of a majority of the outstanding aggregate principal amount
of the notes, excluding the notes held by Insight Communications as set forth
under "Affiliate Transactions," are required to approve the proposed amendments
to the notes indenture. $10,225,000 principal amount of notes are held by
Insight Communications. Consequently, the proposed amendments must be approved
by the holders of more than $44,875,000 principal amount of the notes, excluding
Insight Communications. The proposed amendments will become effective only if
the conditions of the exchange offer are satisfied or waived, and will become
effective concurrently with the purchase of notes pursuant to the exchange
offer. Our acceptance of notes tendered in the exchange offer is contingent upon
our receipt of requisite consents from holders of the notes. If the proposed
amendments become effective with respect to the notes indenture, they will apply
to all notes issued under the indenture.
We will make no separate payment, other than the exchange consideration in
exchange for the notes, for consents delivered in the consent solicitation.
Proposed Amendments to the Notes Indenture
If the requisite consents are received from holders of the notes, we will
enter into a supplemental indenture to the notes indenture, which will set forth
the proposed amendments. The proposed amendments will become effective or
operative concurrently with the purchase of notes pursuant to the exchange
offer, and will eliminate substantially all
of the restrictive covenants.
The proposed amendments will eliminate the following covenants and
definitions of events of default in the notes indenture:
Section 4.04, entitled Compliance Certificates, which sets forth
undertakings to provide to the trustee under the indenture an annual certificate
as to compliance with the terms of the indenture and notice of the occurrence of
an indenture default.
Section 4.05, entitled Taxes, which sets forth an undertaking to pay taxes
when due.
Section 4.06, entitled Stay, Execution and Usury Laws, which sets forth an
undertaking to refrain from using any stay, extension or usury law that may
affect the performance of the indenture.
Section 4.07, entitled Limitation on Restricted Payments, which sets forth
limitations on our ability and that of our subsidiaries to make dividend
payments, acquire shares of capital stock, repay subordinated indebtedness and
make investments.
Section 4.08, entitled Limitations on Restrictions on Distributions from
Restricted Subsidiaries, which sets forth restrictions on our ability to agree
to limitations in our restricted subsidiaries' payments to us.
Section 4.09, entitled Limitation on Indebtedness, which contains
limitations on our ability and that of our restricted subsidiaries to incur
indebtedness.
Section 4.10, entitled Limitations on Sales of Assets and Subsidiary Stock,
which limits us and our restricted subsidiaries in disposing of assets, other
than sales of inventory and disposition of obsolete equipment, where the value
of the assets disposed exceeds $1 million in the aggregate in any year.
27
<PAGE>
Section 4.11, entitled Limitation on Affiliate Transactions, which
restricts our transactions with affiliates, that is persons who control us or
are under common control with us. If a transaction has a value in excess of $2
million, we are required to obtain an opinion from an independent investment
banking firm that the transaction is fair from a financial point of view.
Section 4.12, entitled Limitation on Liens, which limits our ability and
the ability of our restricted subsidiaries to encumber or mortgage our assets.
Section 4.14, entitled Change of Control, which requires us to offer to
purchase notes at a price of 101% of the principal amount if we experience a
change of control.
Section 4.15, entitled Limitation on Issuances of Capital Stock of
Restricted Subsidiaries, which prevents our restricted subsidiaries from issuing
capital stock to persons other than us or one of our wholly-owned subsidiaries.
Section 4.16, entitled Conduct of Business, which restricts the business
conducted by our subsidiary, IT Network, Inc.
Section 4.17, entitled Limitation on Sale/Leaseback Transactions, which
limits our ability and that of our subsidiaries to engage in sale and leaseback
transactions.
Section 4.18, entitled Limitations on Designations of Unrestricted
Subsidiaries, which limits our ability to cause our subsidiaries, that are
subject to the indenture covenants, to no longer be subject to such covenants.
The proposed amendments would also amend the following provisions contained
in the indenture:
Section 4.03 of the indenture, entitled SEC Reports, would be amended to
require only that we comply with Section 314(a) of the Trust Indenture Act of
1939.
Section 4.13 of the indenture, entitled Corporate Existence, would be
amended to apply only to us and not to our subsidiaries.
Section 5.01 of the indenture, entitled Limitation on Merger, Consolidation
or Sale of Assets, would be amended to delete the requirement that the surviving
corporation in a merger or the acquiring corporation in an asset sale have a
consolidated net worth equal to or greater than our consolidated net worth
immediately after giving effect to the transaction.
Section 6.01 of the indenture, entitled Events of Default, sets forth the
events of default with respect to the notes. The proposed amendments would
eliminate the following as events of default:
(i) indebtedness in excess of $3 million owing by us or any restricted
subsidiary is not paid within any applicable grace period or is
accelerated because of a default and the default shall not have been
cured or the acceleration canceled within ten days; and
(ii) any final judgments aggregating more than $3 million shall be
rendered against us or one of our significant subsidiaries and shall
remain unpaid, undischarged or unstayed for a period of 60 days.
Section 5(e) of the security agreements relating to the notes will be
eliminated to remove limitations on the disposition of assets.
The proposed amendments to the notes indenture will also include other
conforming amendments that comport with the changes outlined above.
28
<PAGE>
A holder of notes must consent to the proposed amendments in order to
tender its notes in the exchange offer. Each holder of notes not tendered or
accepted for exchange pursuant to the exchange offer will be bound by the
proposed amendments if they become effective regardless of whether the holder
consented to the proposed amendments.
The proposed amendments will be set forth in a supplemental indenture
substantially in the form filed as exhibit 4.10 to the registration statement of
which this prospectus forms a part.
Consent Expiration Date; Extensions; Amendments
The consent solicitation will expire on the consent expiration date, which
will be 5:00 p.m., New York City time, on __________, 2000, unless we, in our
sole discretion, extend the exchange offer. In that case, the consent expiration
date will be the latest date and time to which the consent solicitation offer is
extended.
In order to extend the consent expiration date, we will make a public
announcement prior to 9:00 a.m., New York City time, on the next business day
after the previously scheduled consent expiration date.
We reserve the right, in our sole discretion,
. to delay accepting any consents,
. to extend the consent solicitation,
. to terminate the consent solicitation, and
. to amend the terms of the consent solicitation in any manner by giving
oral or written notice of the delay, extension, termination or
modification to the exchange agent.
If the consent solicitation is amended in a manner that we determine constitutes
an adverse change to the holders of the notes, we will promptly disclose the
amendment by means of a public announcement or a supplement to this prospectus
that will be distributed to the registered holders of the notes.
Waivers and Nonacceptance of Consents
We reserve the absolute right to waive any defects or irregularities in the
furnishing of the consents. If any consents are not accepted for any reason, the
notes to which the consent relates will be returned without expense to the
submitting holder as promptly as practicable after the expiration or termination
of the consent solicitation.
29
<PAGE>
PROCEDURES FOR PARTICIPATING IN THE EXCHANGE OFFER,
AND CONSENT SOLICITATION
General
As previously discussed, the exchange offer and the consent solicitation
are independent. You must make a separate decision as to each applicable
transaction. The procedures for participating in each of the transactions are
substantially similar and are described below.
Procedures for Tendering Notes in the Exchange Offer and Tendering Consents in
the Consent Solicitation
The tender of a holder's notes or the tender of consents and its acceptance
by us will constitute a binding agreement between the tendering holder and us
upon the terms and subject to the conditions set forth in this prospectus and in
the applicable letter of transmittal and consent form. Except as described
below, a holder who wishes to tender notes for exchange in the exchange offer
and tender consents in the consent solicitation must transmit any tendered
notes, together with a properly completed and duly executed letter of
transmittal and consent form, including all other documents required by the
letter of transmittal and consent form to the exchange agent at the address set
forth below in this prospectus prior to 5:00 p.m., New York City time, on the
exchange offer expiration date. The method of delivery of notes, letter of
transmittal and consent form and all other required documents is at the election
and risk of the holder. If the delivery is by mail, we recommend that tendering
holders use registered mail, properly insured, with return receipt requested.
Instead of delivery by mail, we recommend that the holder use an overnight or
hand delivery service. In all cases, sufficient time should be allowed to assure
timely delivery.
Any financial institution that is a participant in The Depository Trust
Company's book-entry transfer facility system may make book-entry delivery of
the notes by causing The Depository Trust Company to transfer these notes into
the exchange agent's account in accordance with The Depository Trust Company's
procedures for this transfer. In connection with a book-entry transfer, a letter
of transmittal and consent form need not be transmitted to the exchange agent,
provided that the book-entry transfer procedure is completed prior to 5:00 p.m.,
New York City time, on the exchange offer expiration date.
Each signature on a letter of transmittal and consent form or a notice of
revocation, as the case may be, must be guaranteed except that they do not need
to be guaranteed if the notes surrendered for exchange are tendered:
. by a registered holder of the notes who has not completed either the
box entitled ""Special Issuance Instructions" or the box entitled
"Special Delivery Instructions" in the letter of transmittal and
consent form, or
. by an eligible institution.
In the event that a signature on a letter of transmittal and consent form
or a notice of revocation, as the case may be, is required to be guaranteed,
this guarantee must be by a firm which is a member of a registered national
securities exchange or the National Association of Securities Dealers, Inc., a
commercial bank or trust company having an office or correspondent in the United
States or otherwise be an "eligible guarantor institution" within the meaning of
Rule 17Ad-15 under the Securities Exchange Act of 1934. If the letter of
transmittal and consent form is signed by a person other than the registered
holder of the notes, the tendered notes and consents must be endorsed by the
registered holder, with the signature guaranteed by an eligible institution.
All questions concerning the validity, form, eligibility, including time of
receipt, acceptance, and revocation of consents, will be decided by us in our
sole discretion, which decision shall be final and binding. We reserve the
absolute right to reject any and all notes or consents not properly tendered and
to reject any notes or consents which might, in our judgment or that of our
counsel, be unlawful for us to accept. We also reserve the absolute right to
waive any defects or irregularities or conditions of the exchange offer as to
particular notes either before or after the exchange offer
30
<PAGE>
expiration date, including the right to waive the ineligibility of any holder
who seeks to tender notes in the exchange offer, or consents in the consent
solicitation, whether or not similar defects or irregularities are waived in the
case of other holders. Our interpretation of the terms and conditions of the
exchange offer, and consent solicitation, including the letter of transmittal
and its instructions, shall be final and binding on all parties. Unless waived,
any defects or irregularities in connection with tenders of notes for exchange
or tenders of consents must be cured within a period of time as we shall
determine. We, the exchange agent, or any other person will not have any duty to
give notification of defects or irregularities with respect to tenders of notes
and consents and will not incur any liability for failure to give this
notification. Tenders of the notes and consents will not be deemed to have been
made until any irregularities have been cured or waived.
If any letter of transmittal and consent form, endorsement, power of
attorney or any other document required by the letter of transmittal and consent
form is signed by a trustee, executor, corporation or other person acting in a
fiduciary or representative capacity, this person should indicate when signing,
and, unless waived by us, must submit proper evidence satisfactory to us, in our
sole discretion, of this person's authority to act.
Any beneficial owner of notes whose notes are registered in the name of a
broker, dealer, commercial bank, trust company or other nominee and who wants to
tender notes in the exchange offer or tender consents in the consent
solicitation, should contact the registered holder promptly and instruct the
registered holder to tender on the beneficial owner's behalf. If a beneficial
owner wishes to tender directly, the beneficial owner must, prior to completing
and executing the letter of transmittal and consent form and tendering notes and
consents, make appropriate arrangements to register ownership of the notes in
the beneficial owner's name. Beneficial owners should be aware that the transfer
of registered ownership may take considerable time.
Guaranteed Delivery Procedures
Holders who wish to tender their notes and
. whose notes are not immediately available or
. who cannot deliver their notes or any other documents required by the
letter of transmittal and consent form to the exchange agent prior to
the exchange offer expiration date or complete the procedure for book-
entry transfer on a timely basis,
may tender their notes according to the guaranteed delivery procedures described
in the letter of transmittal and consent form. Pursuant to these procedures:
. the tender must be made by or through an eligible institution and a
notice of guaranteed delivery, as defined in the letter of transmittal
and consent form, must be signed by the holder,
. on or prior to the exchange offer expiration date, the exchange agent
must have received from the holder and the eligible institution a
properly completed and duly executed notice of guaranteed delivery by
facsimile transmission, mail or hand delivery setting forth the name
and address of the holder, the certificate number or numbers of the
tendered notes, and the principal amount of tendered notes, stating
that the tender is being made and guaranteeing that, within three
business days after the date of delivery of the notice of guaranteed
delivery, the tendered notes, a duly executed letter of transmittal
and consent form and any other required documents will be deposited by
the eligible institution with the exchange agent, and
. the properly completed and executed documents required by the letter
of transmittal and the consent form and the tendered notes in proper
form for transfer, or confirmation of a book-entry transfer of these
notes into the exchange agent's account at The Depository Trust
Company, must be received by the exchange agent within three business
days after the exchange offer expiration date.
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<PAGE>
Any holder who wishes to tender notes pursuant to the guaranteed delivery
procedures described above must ensure that the exchange agent receives the
notice of guaranteed delivery and letter of transmittal and consent form
relating to these notes prior to 5:00 p.m., New York City time, on the exchange
offer expiration date.
Acceptance of Notes for Exchange and Acceptance of Consents;
Delivery of Common Stock
Upon satisfaction or waiver of all the conditions to the exchange offer, we
will accept any and all notes that are properly tendered in the exchange offer,
and consents properly tendered in the consent solicitation prior to 5:00 p.m.,
New York City time, on the exchange offer expiration date. The common stock
issued pursuant to the exchange offer will be delivered promptly after
acceptance of the notes. For purposes of the exchange offer, we will be deemed
to have accepted validly tendered notes, when, as, and if we have given oral
followed by written notice to the exchange agent.
Revocation of Consents
We will process all properly completed and executed letters of transmittal
and consent forms we receive, unless we receive from a holder a properly
completed and duly executed notice of revocation at any time prior to the
consent solicitation expiration date. Until the consent expiration date, any
holder may revoke a consent as to any or all notes if we receive notice of
revocation.
The Exchange Agent; Assistance
U.S. Trust Company of Texas N.A. is the exchange agent. Questions and
requests for assistance and requests for additional copies of the prospectus, a
letter of transmittal, requests for notice of guaranteed delivery and other
related documents should be directed to the exchange agent. All tendered notes
and consents, executed letters of transmittal and consent forms and other
related documents should be directed to the exchange agent as follows:
Exchange Agent
<TABLE>
<CAPTION>
By Registered or Certified Mail: By Overnight Courier: By Hand: By Facsimile:
<S> <C> <C> <C>
U.S. Trust Company U.S. Trust Company U.S. Trust Company (212) 420-6504
of Texas, N.A. of Texas, N.A. of Texas, N.A.
770 Broadway, 13/th/ Floor 770 Broadway, 13/th/ Floor 770 Broadway, 13/th/ Floor Confirm by Telephone:
New York, New York New York, New York New York, New York 212-225-2388
10003-9598 10003-9598 10003-9598
</TABLE>
Dealer Manager/Solicitation Agent
We have retained Donaldson, Lufkin & Jenrette Securities Corporation to act
as dealer manager and solicitation agent in connection with the exchange offer
and the consent solicitation. As part of such services, employees of Donaldson
Lufkin & Jenrette may solicit, on our behalf, holders of notes to tender their
notes in the exchange offer and to deliver their consent to the proposed
amendments to the indenture governing the notes.
Subject to the terms of a dealer manager agreement between us and Donaldson
Lufkin & Jenrette, we have agreed to pay Donaldson Lufkin & Jenrette a fee of
$1,500,000 for its services in connection with:
. the exchange offer and consent solicitation
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<PAGE>
. the prior solicitation to holders of notes to consent to the proposed
transaction with Liberate
. the exchange offer and consent solicitation made to the holders of our
senior preferred stock, and
. the prior solicitation to holders of our senior preferred stock to
consent to the proposed transaction with Liberate.
We have also agreed to reimburse Donaldson Lufkin & Jenrette for its reasonable
out-of-pocket expenses in connection with the exchange offer and consent
solicitation, and the prior solicitation. We have also agreed to indemnify
Donaldson Lufkin & Jenrette and its affiliates against certain liabilities under
Federal or state securities laws caused by, relating to or arising out of the
exchange offer and consent solicitation, and the prior solicitation. At any
time, Donaldson Lufkin & Jenrette may trade shares of our common stock for its
own account or for the accounts of customers and, accordingly, may hold a long
or short position in our common stock.
Donaldson Lufkin & Jenrette has not undertaken to verify any information
contained or incorporated by reference in this prospectus and assumes no
liability therefor or in connection with any actions taken or not taken by
Source Media or any other party in connection with the exchange offer and
consent solicitation or any actions taken in connection therewith.
Any holder that has questions concerning the terms of the exchange after
and consent solicitation may contact Donaldson Lufkin & Jenrette at the address
and telephone number set forth on the back cover of this prospectus.
Fees and Expenses
In addition to the fees and expenses payable to Donaldson Lufkin & Jenrette
that are described above, we will pay all other fees and expenses incurred in
connection with the exchange offer and the consent solicitation including each
of the following:
. fees and disbursements of our counsel and independent certified public
accountants,
. SEC registration and Nasdaq National Market System quotation fees, and
. customary fees and out-of-pocket expenses incurred by the exchange
agent for its services in connection with the exchange offer.
. customary fees and out-of-pocket expenses incurred by the trustee
under the notes indenture in connection with the proposed supplemental
indenture.
We will pay all transfer taxes, if any, applicable to the exchange of notes
pursuant to the exchange offer. If, however, a transfer tax is imposed for any
reason other than the exchange of notes pursuant to the exchange offer, then the
amount of the transfer taxes, whether imposed on the registered holder or any
other persons, will be payable by the tendering holder. If satisfactory evidence
of payment of these taxes or exemption is not submitted with the letter of
transmittal and consent form, the amount of these transfer taxes will be billed
directly to the tendering holder.
33
<PAGE>
CERTAIN FEDERAL
INCOME TAX CONSIDERATIONS
The following discussion of certain federal income tax considerations sets
forth the opinion of Cooperman Levitt Winikoff Lester & Newman, P.C., our
counsel, regarding the material United States federal income tax consequences to
holders of notes resulting from the exchange and the consent solicitation. The
discussion assumes that holders hold the notes as capital assets within the
meaning of Section 1221 of the Internal Revenue Code of 1986, as amended.
Further, this discussion assumes that the notes are treated as debt and not
equity for United States federal income tax purposes. This discussion does not
purport to deal with all aspects of United States federal income taxation that
may be relevant to holders who may be subject to special federal income tax
laws, such as dealers in securities, financial institutions, life insurance
companies, individuals who are not citizens or residents of the United States or
corporations, partnerships or other entities that are not organized under the
laws of the United States or any political subdivision, or persons that hold the
notes as part of a hedge, conversion transaction, straddle or other risk
reduction transaction. In addition, the following discussion does not consider
the effect of any applicable foreign, state or local tax laws.
The discussion below is based upon the current provisions of the Internal
Revenue Code, existing and proposed Treasury Regulations promulgated under the
Internal Revenue Code, rulings of the Internal Revenue Service and judicial
decisions now in effect as of the date of this prospectus. Such authorities
maybe repealed, revoked or modified, possibly with retroactive effect, so as to
result in United States federal income tax consequences different from those
described below.
As discussed below, the exchange should constitute a recapitalization under
Section 368(a)(1)(E) of the Internal Revenue Code. However, we will not seek a
ruling from the Internal Revenue Service regarding any of the tax issues
described in this discussion, including the tax treatment of the exchange as a
recapitalization. Moreover, as noted in the discussion, issues relevant to the
federal income tax consequences of some matters are factual in nature, and other
issues involve areas of law that are ambiguous or with respect to which legal
authority is lacking and as to which limited guidance is available. It is
possible, for example, that the Internal Revenue Service may challenge the
treatment of the exchange as a recapitalization and assert that the exchange is
a taxable transaction because the notes do not constitute "securities" or
because of other legal positions. Consequently, there can be no assurance that
the Internal Revenue Service will not challenge one or more of the tax
consequences described below.
This discussion does not purport to deal with all aspects of United States
federal income taxation that, because of specific circumstances applicable to a
holder, might be relevant to a holder's decision to participate in the exchange,
or the consent solicitation or to the ownership and disposition of the common
stock. Holders are urged to consult their tax advisors concerning the United
States federal income tax considerations that may be specific to them as well as
any tax consequences arising under the laws of any other taxing jurisdiction.
Tax Consequences to the Holders Upon the Exchange
Importance of Whether the Notes Constitute "Securities." The federal income
tax consequences to the holders of notes will depend, in part, on whether the
notes constitute "securities" for federal income tax purposes. The term
"security" is not defined in the Internal Revenue Code or in the Treasury
Regulations and has not been clearly defined in court decisions. Although there
are a number of factors that may affect the determination of whether a debt
instrument is a "security," one of the most important factors is the original
term of the instrument, or the length of time between the issuance of the
instrument and its maturity. In general, instruments with an original term of
more than ten years are likely to be treated as "securities," and instruments
with an original term of less than five years are unlikely to be treated as
"securities." Because the term of the notes is between five and ten years, it is
impossible to be certain regarding the treatment of such notes as "securities."
Nevertheless, although the issue is not free from doubt, the notes should
constitute "securities" for federal income tax purposes. BECAUSE THE ISSUE IS
UNCERTAIN, HOLDERS ARE URGED TO CONSULT WITH THEIR TAX ADVISORS AS TO THE PROPER
TREATMENT OF THE NOTES.
34
<PAGE>
Treatment of the Exchange as a
Recapitalization Under Internal Revenue Code Section 368
Assuming that the notes are treated as securities, the exchange of notes
for common stock and cash should be treated as a recapitalization under Section
368(a)(1)(E) of the Internal Revenue Code. If the exchange qualifies as a
recapitalization, a holder that exchanges notes for common stock will not
recognize gain or loss in the exchange. We intend to take to take the position
for tax purposes that the exchange qualifies as a recapitalization.
A holder who participates in the exchange will generally have a tax basis
in the common stock received in the exchange equal to the holder's adjusted tax
basis in the notes exchanged, decreased by the amount of cash received in the
exchange. A holder's holding period for the common stock will include the
holding period for the notes exchanged.
Treatment of the Exchange as a Taxable Exchange
Assuming that the notes constitute "securities" for federal income tax
purposes, the exchange should constitute a recapitalization under Internal
Revenue Code Section 368 resulting in the federal income tax consequences
discussed above under "Treatment of the Exchange and Purchase of Notes as a
Recapitalization Under Internal Revenue Code Section 368." However, we will not
seek a ruling from the Internal Revenue Service regarding the treatment of the
notes as "securities," and it is possible that the Service may challenge this
treatment. If an Internal Revenue Service challenge were successful, the
exchange would be considered a taxable exchange with the likely result that a
holder would recognize gain or loss upon the exchange equal to:
. the fair market value of the common stock received in the exchange,
over
. the holder's adjusted tax basis in the notes exchanged.
Any recognized gain or loss would generally be treated as capital gain or
loss and would be long- term capital gain or loss if the holder held the notes
for more than 12 months. If, however, a holder purchased the notes at a market
discount within the meaning of Internal Revenue Code Section 1278, any gain
recognized will be treated as ordinary income to the extent of the accrued
market discount on the notes. A holder's tax basis in the common stock would
equal its fair market values, and its holding period would begin on the day
following the day of the exchange.
Payment of Accrued Interest on Notes
Regardless of the treatment of the exchange as described above, a holder
will recognize ordinary income attributable to any consideration received as
payment for accrued interest on the notes that was not previously included in
the holder's income. Holders that have already included the accrued interest in
income will not recognize any additional income as a result of the consideration
received as payment for the accrued interest on the notes .
For federal income tax purposes, it is unclear how much, if any, of the
cash payment in the exchange should be allocated to accrued interest. Consistent
with the form of the transaction to be consummated as part of the solicitation,
we intend to take the position for tax and accounting purposes, and for purposes
of backup withholding and information reporting, that an amount of cash equal in
value to the accrued interest on the notes will be issued in the exchange to
holders as payment for accrued interest on the notes.
By participating in the exchange, a holder agrees to allocate the cash and
common stock received for the principal amount of the notes and accrued and
unpaid interest in the same manner in which we will make this allocation.
Tax Consequences to Holders Who Do Not Participate in the Exchange Offer
Concurrently with the exchange offer, we will solicit the consents of the
holders of the notes to remove most of the covenants in the notes indenture. The
federal income tax consequences to holders who do not participate in the
35
<PAGE>
exchange offer will depend upon whether removal or amendment of the covenants
results in a deemed exchange of "modified" notes for the "original" notes.
Treasury Regulations promulgated under Section 1001 of the Internal Revenue Code
provide that such a deemed exchange occurs if a "significant modification," as
described in the Treasury Regulations, in the terms of the debt instrument has
occurred, taking into account all relevant facts and circumstances.
The Treasury Regulations provide that a modification to a debt instrument
that adds, deletes or alters customary accounting or financial covenants is not
a significant modification giving rise to a deemed exchange. Based on these
Regulations, the removal of the covenants from the notes indenture will not
constitute a significant modification of the notes. Accordingly, the removal of
the covenants from the notes indenture will not result in a taxable exchange of
the notes under Internal Revenue Code Section 1001.
Backup Withholding and Information Reporting
Under some circumstances, a holder may be subject to backup withholding at
a 31% rate on payments received in the exchange offer and with respect to the
common stock and cash issued or paid in the exchange offer. This withholding
generally applies only if the holder:
. fails to furnish the holder's social security or other taxpayer
identification number,
. furnishes an incorrect taxpayer identification number,
. is notified by the Internal Revenue Service that the holder has failed
to report payment of interest and dividends properly and the Internal
Revenue Service has notified us that the holder is subject to backup
withholding, or
. fails, under some circumstances, to provide a certified statement,
signed under penalties of perjury, that the taxpayer identification
number provided is the holder's correct number and that the holder is
not subject to backup withholding.
Any amount withheld from a payment to a holder under the backup withholding
rules is allowable as a credit against the holder's federal income tax
liability, provided that the required information is furnished to the Internal
Revenue Service. Some holders, such as corporations and financial institutions,
are not subject to backup withholding. Holders should consult their tax advisors
as to their qualification for exemption from backup withholding and the
procedure for obtaining this exemption.
Because the exchange should be treated as a recapitalization under Internal
Revenue Code Section 368, holders will be required to file information regarding
the exchange in connection with filing their federal income tax returns for the
period in which the exchange occurs.
36
<PAGE>
TAX CONSEQUENCES TO SOURCE MEDIA UPON THE EXCHANGE OF NOTES
Discharge of Indebtedness
The principal amount of our aggregate outstanding indebtedness will be
reduced upon the exchange of the notes. Generally, the cancellation or other
discharge of indebtedness results in ordinary income to a debtor unless the
debtor pays equivalent value for the discharge. The shares of our common stock
to be paid and issued in the exchange offer will be equivalent in value to the
indebtedness discharged if the fair market value of the common stock issued is
at least equal to the principal amount of notes accepted for tender in the
exchange. The number of shares of our common stock to be issued in the exchange
offer is calculated on a basis that may result in a value for such stock, on the
date of the exchange, that is different than the principal amount of the notes
satisfied by such shares of common stock. If the principal amount of the notes
discharged in the exchange offer exceeds the fair market value of the shares of
common stock issued in the exchange offer, such excess will be treated as
taxable income to us.
Reduction in Available Loss Carryforwards
At December 31, 1998, we had net operating loss carryforwards of
approximately $87.4 million for United States federal income tax purpose that
expire in 2003 through 2018, which may be used to reduce future United States
taxable income. The Internal Revenue Code imposes limitations on the use of net
operating loss carryforwards if certain stock ownership changes occur. Because
of prior ownership changes, a portion of our operating loss carryforward is
limited in use to approximately $9.0 million in any one taxable year. If the
exchange offer made hereby and the contemporaneous exchange offer we are making
to acquire our senior payment-in-kind preferred stock are accepted by holders of
our notes and senior preferred stock, the resulting issuances of shares of our
common stock may constitute a further ownership change that would subject the
remaining portion of our operating loss carryforward to an annual limit of
approximately $10.0 million in any one taxable year.
Exchange of SourceSuite Ownership Interest
The exchange of our ownership interests in SourceSuite for shares of common
stock of Liberate and/or cash should be treated as a reorganization under
Section 368(a)(2)(E) of the Internal Revenue Code. If the exchange qualifies as
a reorganization, we will recognize taxable gain equal to the amount of cash, if
any, received in the exchange. However, no portion of the Liberate stock we
receive will be taxable to us until we dispose of it in a taxable transaction.
SourceSuite, Insight Interactive and we expect to receive an opinion from
SourceSuite's tax counsel that the exchange of our membership interests in
SourceSuite for shares of common stock of Liberate and/or cash should qualify as
a reorganization under Section 368(a)(2)(E) of the Internal Revenue Code and be
subject to the tax treatment described above. The opinion will be based on
assumptions and factual representations including representations relating to,
among other things, the formation of SourceSuite and the transfer of the
business to SourceSuite and the intent of the parties as to the conduct of the
business. In light of the relatively short period of time between the formation
of SourceSuite and the exchange of ownership interests therein for shares of
common stock of Liberate, the Service could argue that the transfer of assets to
SourceSuite was part of a prearranged integrated plan to transfer assets to
Liberate, in which case the exchange would be taxable. However, the companies
have provided representations to counsel that, and the opinion will assume that,
the transfer of assets to SourceSuite was not part of such a prearranged
integrated plan. The validity of the opinion and this discussion depends on the
accuracy and continuing validity of the assumptions and factual representations.
Opinions of counsel are not binding upon the Internal Revenue Service or the
courts. We will not seek a ruling from the Internal Revenue Service and it is
possible that the Service may challenge this treatment. If an Internal Revenue
Service challenge were successful, the exchange would be taxable in its entirety
with the likely result that we would recognize taxable gain upon the exchange
equal to the sum of the fair market value of the Liberate common stock and the
amount of cash received in the exchange, over our adjusted tax basis in the
ownership interests exchanged.
37
<PAGE>
DESCRIPTION OF CAPITAL STOCK
General
Our authorized capital stock consists of 50,000,000 shares of common stock,
par value $0.001 per share, and 1,712,001 shares of preferred stock, par value
$0.001 per share. As of January 13, 2000, the outstanding capital stock
consisted of 15,909,654 shares of common stock, 1,043,412 shares of senior
payment-in-kind preferred stock and one share of non-participating preferred
stock.
Common Stock
Each share of common stock has one vote per share on all matters submitted
to a vote of shareholders other than the class of common stock designated as
non-voting common stock. The non-voting common stock is identical in all
respects to the common stock except it does not have the right to vote on any
matters presented to stockholders, unless required by law.
Our certificate of incorporation does not provide for cumulative voting in
the election of directors. Subject to any preferential rights of any outstanding
shares of preferred stock, the holders of our common stock are entitled to
dividends only, if, when and as the dividends are declared by the our Board of
Directors.
We have never paid cash dividends on our common stock. Our Board of
Directors anticipates that for the foreseeable future no cash dividends will be
paid on our common stock and that any earnings will be retained for use in our
business. The Board of Directors determines our common stock dividend policy
based on our results of operations, payment of dividends on preferred stock, if
any is then outstanding, financial condition, capital requirements, and other
circumstances. The notes indenture and the senior payment in-kind preferred
stock currently do not permit dividends to be paid on the common stock.
Holders of common stock have no preemptive or other rights to subscribe for
additional shares of capital stock. Upon our liquidation, dissolution, or
winding up, each share of common stock will share equally in assets legally
available for distribution to shareholders.
The transfer agent and registrar for the common stock is ChaseMellon
Shareholder Services, L.L.C.
Preferred Stock
Subject to shareholder approval which is required to increase the number of
authorized shares available for issuance, preferred stock is available for
issuance from time to time in one or more series at the discretion of our Board
of Directors. For each series of preferred stock it establishes, the Board of
Directors has authority to prescribe the number of shares in that series and the
dividend rate, the voting rights, conversion privileges, redemption, sinking
fund provisions and liquidation rights, if any, and any other rights,
preferences and limitations of the particular series.
The issuance of preferred stock could decrease the amount of earnings and
assets available for distribution to the holders of common stock or adversely
affect the rights and powers, including voting rights, of the holders of common
stock. Additionally, the issuance of preferred stock could have the effect of
delaying, deferring or preventing a change in control.
The rights, preferences and limitations of our senior payment-in-kind
preferred stock and our non-participating preferred stock are set forth in their
respective certificates of designations. For information as to how you can
obtain the certificates of designations, see "Where You Can Find More
Information." Our non-participating preferred stock is held by Insight
Communications. See "Affiliate Transactions"
38
<PAGE>
EXPERTS
The consolidated financial statements of Source Media, Inc. at December 31,
1998 and 1997, and for each of the three years in the period ended December 31,
1998, appearing in this Prospectus and Registration Statement have been audited
by Ernst & Young LLP, independent auditors, as set forth in their report thereon
appearing elsewhere herein, and are included in reliance upon such report given
on the authority of such firm as experts in accounting and auditing.
LEGAL MATTERS
Cooperman Levitt Winikoff Lester & Newman, P.C. will pass upon the validity
of the common stock to be issued in the exchange offer.
39
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Report of Independent Auditors F-2
<S> <C>
Consolidated Balance Sheets as of December 31, 1997 and 1998 F-3
Consolidated Statements of Operations for the Years ended December 31,
1996, 1997 and 1998 F-4
Consolidated Statements of Stockholders' Equity (Capital Deficiency) for
the Years ended December 31, 1996, 1997 and 1998 F-5
Consolidated Statements of Cash Flows for the Years ended December 31,
1996, 1997 and 1998 F-6
Notes to Consolidated Financial Statements F-7
Consolidated Balance Sheets (Unaudited) as of December 31, 1998 and
September 30, 1999 F-23
Consolidated Statements of Operations (Unaudited) for the three and nine
month periods ended September 30, 1998 and 1999 F-25
Consolidated Statements of Cash Flows (Unaudited) for the nine months
ended September 30, 1998 and 1999 F-26
Notes to Consolidated Financial Statements (Unaudited) F-27
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders of Source Media, Inc.
We have audited the accompanying consolidated balance sheets of Source Media,
Inc. (the Company) as of December 31, 1997 and 1998, and the related
consolidated statements of operations, stockholders' equity (capital
deficiency), and cash flows for each of the three years in the period ended
December 31, 1998. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Source Media,
Inc., at December 31, 1997 and 1998, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
Dallas, Texas
February 19, 1999, except for Note 15 for
which the date is January 12, 2000
F-2
<PAGE>
SOURCE MEDIA, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
December 31,
----------------------------
1997 1998
-------------- --------------
<S> <C> <C>
Current assets:
Cash and cash equivalents.......................................................................... $ 8,430,941 $ 11,661,703
Short-term investments............................................................................. 15,615,419 --
Restricted investments............................................................................. 11,709,921 11,715,784
Trade accounts receivable, less allowance for doubtful
accounts of $153,694 and $387,330 in 1997 and 1998, respectively................................. 2,796,241 3,595,788
Deferred expenses.................................................................................. 990,687 446,788
Prepaid expenses and other current assets.......................................................... 843,005 937,492
------------ -------------
Total current assets................................................................................. 40,386,214 28,357,555
Property and equipment:
Production equipment............................................................................... 5,693,939 6,050,284
Computer equipment................................................................................. 2,652,103 3,272,883
Other equipment.................................................................................... 753,883 1,149,886
Furniture and fixtures............................................................................. 523,516 660,167
------------ -------------
9,623,441 11,133,220
Accumulated depreciation............................................................................. 4,193,484 6,733,398
------------ -------------
Net property and equipment........................................................................... 5,429,957 4,399,822
Intangible assets:
Patents............................................................................................ 14,942,465 14,944,242
Goodwill........................................................................................... 22,372,837 6,698,137
Contract rights.................................................................................... 24,487,000 11,933,377
------------ -------------
61,802,302 33,575,756
Accumulated amortization............................................................................. 10,528,869 14,556,638
------------ -------------
Net intangible assets................................................................................ 51,273,433 19,019,118
Restricted investments............................................................................... 11,090,574 --
Other non-current assets............................................................................. 5,321,848 4,812,584
------------ -------------
Total assets......................................................................................... $113,502,026 $ 56,589,079
============ =============
LIABILITIES AND STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY)
Current Liabilities:
Trade accounts payable............................................................................. $ 1,654,404 $ 2,500,962
Accrued interest................................................................................... 2,066,667 2,000,000
Accrued payroll.................................................................................... 150,062 539,889
Other accrued liabilities.......................................................................... 1,202,665 1,619,464
Unearned income.................................................................................... 4,024,164 1,750,202
------------ -------------
Total current liabilities............................................................................ 9,097,962 8,410,517
Long-term debt....................................................................................... 100,000,000 100,000,000
Minority interests in consolidated subsidiaries...................................................... 3,839,552 3,839,552
Note receivable and accrued interest from minority
stockholder, net of discount of $95,437 and $53,723 in
1997 and 1998, respectively........................................................................ (723,645) (780,359)
------------ -------------
3,115,907 3,059,193
Senior redeemable payment-in-kind (PIK) preferred stock, $25
liquidation preference, $.001 par value, net of discount
Authorized shares -- 1,000,000 and 1,712,000 and 800,000
and 913,632 shares issued and outstanding in 1997 and
1998, respectively............................................................................... 13,696,799 16,627,978
Stockholders' equity (capital deficiency):
Common stock, $.001 par value:
Authorized shares -- 50,000,000 and 11,969,039 and
13,021,765 shares issued in 1997 and 1998, respectively.......................................... 11,969 13,022
Less treasury stock, at cost -- 410,963 and 280,425
shares in 1997 and 1998, respectively............................................................ (4,075,127) (2,769,726)
Capital in excess of par value..................................................................... 81,066,822 80,268,950
Accumulated deficit................................................................................ (89,313,113) (148,943,329)
Notes receivable and accrued interest from stockholders............................................ (99,193) (77,526)
------------ -------------
Total stockholders' equity (capital deficiency)...................................................... (12,408,642) (71,508,609)
------------ -------------
Total liabilities and stockholders' equity (capital deficiency)...................................... $113,502,026 $ 56,589,079
============ =============
</TABLE>
See accompanying notes.
F-3
<PAGE>
SOURCE MEDIA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------
1996 1997 1998
------------------- -------------- --------------
<S> <C> <C> <C>
Monetary revenues............................................................. $ 8,574,823 $ 12,387,459 $ 24,351,325
Nonmonetary revenues.......................................................... 9,944,082 6,043,859 1,755,546
------------ ------------ ------------
Total revenues...................................................... 18,518,905 18,431,318 26,106,871
Monetary cost of sales........................................................ 3,485,045 8,611,267 12,673,541
Nonmonetary cost of sales..................................................... 9,944,082 6,043,859 1,755,546
------------ ------------ ------------
Total cost of sales................................................. 13,429,127 14,655,126 14,429,087
------------ ------------ ------------
Gross profit.................................................................. 5,089,778 3,776,192 11,677,784
Selling, general and administrative expenses.................................. 11,747,155 19,599,557 24,771,932
Impairment of intangible assets............................................... -- -- 25,935,715
Amortization of intangible assets............................................. 1,031,337 4,987,099 6,320,375
Research and development expenses............................................. 6,330,745 3,679,786 3,409,508
------------ ------------ ------------
19,109,237 28,266,442 60,437,530
------------ ------------ ------------
Operating loss................................................................ (14,019,459) (24,490,250) (48,759,746)
Interest expense.............................................................. 614,037 5,234,433 12,830,302
Interest income............................................................... (788,629) (736,638) (1,932,577)
Other expense (income)........................................................ (36,173) (53,344) (27,255)
Minority interest in earnings (losses) of
consolidated subsidiaries................................................... 46,475 (8,970) --
------------ ------------ ------------
Net loss before extraordinary item............................................ (13,855,169) (28,925,731) (59,630,216)
Extraordinary loss -- early extinguishment of
debt........................................................................ -- 3,455,551 --
------------ ------------ ------------
Net loss...................................................................... (13,855,169) (32,381,282) (59,630,216)
Preferred stock dividends..................................................... -- 416,129 2,995,869
------------ ------------ ------------
Net loss attributable to common stockholders.................................. $(13,855,169) $(32,797,411) $(62,626,085)
============ ============ ============
Basic and diluted net loss per common share:
Net loss attributable to common stockholders
before extraordinary item................................................ $(1.39) $(2.59) $(5.21)
Extraordinary item.......................................................... -- $(0.30) --
------------ ------------ ------------
Net loss attributable to common stockholders................................ $(1.39) $(2.89) $(5.21)
============ ============ ============
Weighted average common shares outstanding.................................... 9,935,455 11,354,203 12,011,906
============ ============ ============
</TABLE>
See accompanying notes.
F-4
<PAGE>
SOURCE MEDIA, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY)
<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, 1995................ 10,303,556 $10,304 $(3,515,563) $59,955,392 $ (43,076,663)
Issuance of common stock upon exercise of
stock options........................... 23,485 23 -- 141,777 --
Issuance of warrant with First Tranche
Note.................................... -- -- -- 745,830 --
Repayment of notes receivable and accrued
interest from stockholder through
surrender of common stock............... -- -- (242,078) -- --
Other..................................... -- -- -- (27,214) --
Net loss.................................. -- -- -- -- (13,855,169)
---------- ------- ----------- ----------- -------------
BALANCE AT DECEMBER 31, 1996.............. 10,327,041 10,327 (3,757,641) 60,815,785 (56,931,832)
========== ======= =========== =========== =============
Issuance of common stock upon exercise of
stock options........................... 219,275 219 (317,486) 1,352,194 --
Acquisition of remaining minority
interest in ICT......................... 1,389,723 1,390 -- 10,384,280 --
Issuance of warrants for services
provided................................ -- -- -- 279,571 --
Issuance of warrants with Aggregate
Tranche Notes........................... -- -- -- 2,823,091 --
Issuance of warrants associated with
Units................................... -- -- -- 5,529,000 --
Other..................................... 33,000 33 -- 299,030 --
Net loss.................................. -- -- -- -- (32,381,281)
Preferred Stock Dividends................. -- -- -- (416,129) --
---------- ------- ----------- ----------- -------------
BALANCE AT DECEMBER 31, 1997.............. 11,969,039 11,969 (4,075,127) 81,066,822 (89,313,113)
========== ======= =========== =========== =============
Issuance of common stock upon exercise of
stock options........................... 93,779 94 -- 640,944 --
Issuance of stock for legal
settlements............................. -- -- 866,876 (243,526) --
Issuance of stock for employee stock
plan.................................... -- -- 438,525 (253,192) --
Exercise of warrants...................... 958,947 959 -- -- --
Stock Compensation........................ -- -- -- 2,053,771 --
Other..................................... -- -- -- -- --
Net loss.................................. -- -- -- -- (59,630,216)
Preferred Stock Dividends................. -- -- -- (2,995,869) --
---------- ------- ----------- ----------- -------------
BALANCE AT DECEMBER 31, 1998.............. 13,021,765 $13,022 $(2,769,726) $80,268,950 $(148,943,329)
========== ======= =========== =========== =============
</TABLE>
<TABLE>
<CAPTION>
Notes Total
Receivable Stockholders'
from Equity (Capital
Stockholders Deficiency)
------------- ----------------
<S> <C> <C>
BALANCE AT DECEMBER 31, 1995................ $(301,575) $ 13,071,895
Issuance of common stock upon exercise of
stock options........................... -- 141,800
Issuance of warrant with First Tranche
Note.................................... -- 745,830
Repayment of notes receivable and accrued
interest from stockholder through
surrender of common stock............... 242,078 --
Other..................................... (50,694) (77,908)
Net loss.................................. -- (13,855,169)
--------- ------------
BALANCE AT DECEMBER 31, 1996.............. (110,191) 26,448
========= ============
Issuance of common stock upon exercise of
stock options........................... -- 1,034,927
Acquisition of remaining minority
interest in ICT......................... -- 10,385,670
Issuance of warrants for services
provided................................ -- 279,571
Issuance of warrants with Aggregate
Tranche Notes........................... -- 2,823,091
Issuance of warrants associated with
Units................................... -- 5,529,000
Other..................................... 10,998 310,061
Net loss.................................. -- (32,381,281)
Preferred Stock Dividends................. -- (416,129)
--------- ------------
BALANCE AT DECEMBER 31, 1997.............. (99,193) (12,408,642)
========= ============
Issuance of common stock upon exercise of
stock options........................... -- 641,038
Issuance of stock for legal
settlements............................. -- 623,350
Issuance of stock for employee stock
plan.................................... -- 185,333
Exercise of warrants...................... -- 959
Stock Compensation........................ -- 2,053,771
Other..................................... 21,667 21,667
Net loss.................................. -- (59,630,216)
Preferred Stock Dividends................. -- (2,995,869)
--------- ------------
BALANCE AT DECEMBER 31, 1998.............. $ (77,526) $(71,508,609)
========= ============
</TABLE>
F-5
<PAGE>
SOURCE MEDIA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss..................................................... $(13,855,169) $(32,381,282) $(59,630,216)
Adjustments to reconcile net loss to net cash used in
operating activities:
Impairment of intangible assets............................ -- -- 25,935,715
Depreciation............................................... 906,982 2,313,692 2,539,914
Amortization of intangible assets.......................... 1,031,337 4,987,099 6,320,375
Stock Compensation......................................... -- -- 2,053,771
Write-off of analog set-top boxes.......................... -- 1,999,339 --
Non-cash interest expense.................................. 589,990 2,969,179 832,716
Non-cash interest income................................... -- -- (981,955)
Provision for losses on accounts receivable................ 82,269 194,731 1,076,753
Extinguishment of debt..................................... -- 3,455,551 --
Warrants issued for services provided...................... -- 279,571 --
Issuance of common stock in litigation settlement.......... -- 299,063 623,350
Other, net................................................. (12,978) 260,382 (61,714)
Changes in operating assets and liabilities:
Trade accounts receivable.................................. 37,892 (2,034,894) (1,876,300)
Prepaid expenses and other current assets.................. (274,967) 324,196 (94,487)
Deferred expenses.......................................... 159,574 (260,868) 543,899
Trade accounts payable and accrued liabilities............. (518,287) 312,463 1,586,517
Accrued interest........................................... -- 1,893,604 --
Unearned income............................................ (748,713) 47,920 (2,273,962)
------------ ------------ ------------
Net cash used in operating activities........................ (12,602,070) (15,340,254) (23,405,624)
INVESTING ACTIVITIES
Capital expenditures....................................... (2,678,970) (2,674,729) (1,509,779)
Redemption of short-term investments....................... -- -- 27,682,085
Restricted investments..................................... (611,182) (22,189,313) --
Acquisition of equipment and contract rights............... (1,200,000) (1,350,000) --
Purchase of short-term investments......................... -- (15,615,419) --
Interactive Channel Technologies acquisition costs......... (645,984) -- --
Acquisition of Brite....................................... -- (35,550,000) --
Acquisition of VNN......................................... -- (9,000,000) --
Capitalized acquisition costs.............................. -- (262,352) --
Other...................................................... (47,998) -- --
------------ ------------ ------------
Net cash provided by (used in) investing activities.......... (5,184,134) (86,641,813) 26,172,306
FINANCING ACTIVITIES
Net proceeds from issuance of long-term debt............... 4,606,163 94,548,351 --
Net proceeds from issuance of Second Tranche Notes......... -- 13,922,625 --
Payments on debt........................................... -- (21,986,792) --
Net proceeds from issuance of preferred stock and
warrants................................................. -- 18,809,670 --
Proceeds from issuance of common stock upon exercise of
stock options............................................ 141,800 1,034,927 641,997
Other...................................................... (138,039) (218,716) (177,917)
------------ ------------ ------------
Net cash provided by financing activities.................... 4,609,924 106,110,065 464,080
Net increase (decrease) in cash and cash equivalents......... (13,176,280) 4,127,998 3,230,762
Cash and cash equivalents at beginning of period............. 17,479,223 4,302,943 8,430,941
------------ ------------ ------------
Cash and cash equivalents at end of period................... $ 4,302,943 $ 8,430,941 $ 11,661,703
============ ============ ============
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest on long-term debt................................. $ 24,047 $ 285,671 $ 12,066,000
============ ============ ============
</TABLE>
See accompanying notes.
F-6
<PAGE>
SOURCE MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
1. Company Description and History
Source Media, Inc. (the "Company") operates through its subsidiaries SMI
Holdings, Inc. ("Holdings"), IT Network, Inc. ("IT Network"), Interactive
Channel, Inc. ("Interactive Channel"), and Interactive Channel Technologies Inc.
("ICT") in two business segments: IT Network and Interactive TV.
IT Network sells advertising and related support services to clients who
sponsor a promotional message with interactive content supplied or otherwise
managed by IT Network. IT Network's products and services are distributed
primarily through the Company's Publisher Partners which include Yellow Page
directories and daily newspapers. IT Network's products and services are
available in North America, Hawaii and the Caribbean. Products and services are
also promoted and distributed over radio, television and the Internet.
The Company's Interactive TV business consists of the combined efforts of the
Interactive Channel and ICT subsidiaries. The Company has designed and is
developing proprietary software and interactive programming services that can
enable digital, two-way television systems equipped with digital (or advanced
analog) set-top boxes to deliver two-way, interactive programming with the touch
of a set-top remote or the use of a wireless keyboard.
Holdings (formerly known as IT Network) was incorporated on July 19, 1988, as
a Colorado corporation and subsequently, on July 23, 1991, reincorporated in
Texas. On June 23, 1995, Holdings merged (the "Merger") into a wholly-owned
subsidiary of HB Communications Acquisition Corp. ("HBAC"). Pursuant to the
Merger agreement, Holdings' outstanding common stock and preferred stock were
converted into an aggregate 6,696,992 shares of the Company's common stock. In
connection with the Merger, HBAC changed its name to Source Media, Inc.
On February 11, 1999 the Company and Prevue Ventures, Inc. and its parent,
United Video Satellite Group, Inc. (collectively, "Prevue") executed a Letter of
Intent to form a joint venture ("Newco") to exploit the Company's Interactive TV
line of business. The Letter of Intent is subject to the execution of definitive
documentation, including representations and warranties, covenants and
conditions to closing. There can be no assurance that the Company, Prevue and
United Video will be able to agree on the form of such definitive documents or
that, if agreed upon, the transaction will be consummated. See Note 3 --
Commitments and Contingencies.
2. Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of the Company, its
wholly-owned subsidiaries Holdings, IT Network, Interactive Channel; and
Holdings' wholly-owned Canadian subsidiaries, ICT and 997758 Ontario Inc.
("997758"). All material intercompany amounts and transactions have been
eliminated. Certain amounts from prior year financial statements have been
reclassified to conform to the current year's presentation.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
Minority Interests in Consolidated Subsidiaries
Minority interests in consolidated subsidiaries represent the minority
stockholders' proportionate shares of the equity of 997758 and ICT. At December
31, 1997 and 1998, the Company owned 100% of the voting Class X shares of
997758, while an individual owned 100% of the Class Y nonvoting shares of
997758, as more fully discussed in Note 8 -- Stock Options, Warrants, Employee
F-7
<PAGE>
Stock Purchase Plan and Retirement Plan. At December 31, 1996, the Company owned
approximately 51% of ICT's capital stock, representing approximately 74% voting
control. In January 1997, the Company completed an arrangement whereby it
acquired the remaining shares of ICT, as more fully discussed in Note 5 --
Acquisitions.
Cash and Cash Equivalents
The Company classifies all highly liquid investments with original maturities
of three months or less to be cash equivalents. These investments are recorded
at cost, which approximates market.
Monetary Revenue Recognition
IT Network earns monetary revenues by selling advertising and related support
services to clients who sponsor a promotional message with interactive content
supplied primarily by IT Network. The products and services are distributed
primarily through certain Regional Bell Operating Companies or their affiliates
or other Publisher Partners. Monetary revenues and associated costs relating to
print ads appearing in Yellow Pages are recognized at the time of distribution
by the Directory Publishers. For certain contracts, where an obligation exists
to service the advertisement for the contract period, a portion of the revenue
is deferred and amortized on a straight-line basis over the term of the
respective contracts, beginning at the time of the annual distribution of the
applicable local Yellow Pages directory, or at the applicable contract start
date, if later, and continuing to the end of the term of the respective
contracts, which is typically from 3 to 12 months. The Company also earns
monetary revenues from sales of voice information services to certain Publisher
Partners. Monetary revenues relating to non-Yellow Pages products are also
recognized as the services are performed.
Nonmonetary Revenue Recognition
In many of its markets, IT Network has entered into nonmonetary barter
agreements with local television and radio stations. These media sponsors
provide IT Network with advertising time on their stations and update local
news, weather and sports programming in exchange for promotional messages and
print advertisements. Revenues and cost of sales associated with these
nonmonetary barter transactions are included in the Company's consolidated
statements of operations at the estimated fair value of the on-air
advertisements and information content provided to the Company by media
sponsors.
Nonmonetary revenues and cost of sales are recognized on a straight-line basis
over the terms of the respective contracts. The Company was obligated to provide
future services and was entitled to receive future advertising and information
content of $0.3 million and $2.0 million at December 31, 1998 and 1997,
respectively.
Property and Equipment
Property and equipment are recorded at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of the assets. Computer
equipment is depreciated over a three-year period. Production and other
equipment are depreciated over a five-year period. Furniture and fixtures are
depreciated over a seven-year period.
The Company continually evaluates the propriety of the carrying value of
property and equipment to determine whether current events and circumstances
warrant adjustment to the carrying value of the assets. As a result of this
periodic evaluation and in light of the Company's decision to discontinue its
analog set-top box strategy in favor of a digital set-top box strategy, in 1997,
the Company recorded a write-down of the remaining net book value of its analog
set-top boxes in the amount of $2.0 million which was charged to monetary cost
of sales.
Intangible Assets
Intangible assets are amortized using the straight-line method over the
following estimated useful lives: patents -- five years; contract rights --
three to seven years; and goodwill -- five years.
The carrying value of intangible assets is reviewed for impairment whenever
events or changes in circumstances indicate that there may be an impairment. If
the review indicates that any of the intangibles will not be recoverable, as
determined by an analysis of undiscounted cash flows, the intangible asset will
be reduced to its estimated fair value. Subsequent to the Brite acquisition,
(see Note 5 -- Acquisitions) the Company learned that former Brite and IT
Network employees had formed a company to service many of these former Brite
clients. As a result, several former Brite customers canceled or did not renew
their contracts with IT Network. The
F-8
<PAGE>
Company reviewed the valuation of the acquired assets recorded at the time of
the acquisition, and found these assets to be impaired. As a result of the
financial analysis of the expected discounted future cash flows of the remaining
customer base, the Company recorded a $25.9 million ($2.16 per share) non-cash
write-down of the Brite contract rights, non-compete agreement and goodwill in
the second quarter of 1998.
Advertising Costs
The Company expenses the costs of advertising as incurred. Advertising
expenses were $1.3 million, $0.4 million and $0.4 million for the years ended
December 31, 1996, 1997 and 1998, respectively.
Translation of Foreign Currencies
The financial positions and results of operations of ICT and 997758 are
measured using local currency (Canadian dollar) as the functional currency.
Assets and liabilities of these subsidiaries are translated at the exchange rate
in effect at each balance sheet date. Statement of operations accounts are
translated at the average rate of exchange prevailing during the year.
Translation adjustments and foreign currency gains and losses have not been
significant and accordingly, have not been separately presented.
Computation of Net Loss Per Common Share
Net loss per common share is calculated in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share". Dilutive
earnings per share has not been presented because the options and warrants are
anti-dilutive.
Stock Options
The Company accounts for employee and director stock option grants in
accordance with Accounting Principles Board Opinion No. 25, "Accounting For
Stock Issued to Employees" ("APB 25") and related Interpretations. Under APB 25,
no compensation expense is recognized for stock option grants to employees and
directors if the exercise price of the Company's stock option grants is at or
above the fair market value of the underlying stock on the date of grant as more
fully described in Note 8 -- Stock Options, Warrants, Employee Stock Purchase
Plan and Retirement Plan.
On January 2, 1998, the Company granted stock options to its employees. The
options fully vest on January 2, 2004. If certain target stock prices are met,
the vesting accelerates. As a portion of the underlying shares for these options
had not been authorized by the common stockholders at the date of grant, the
portion of unauthorized options were treated as a variable compensation plan
through July 28, 1998, when the stockholders authorized the shares. The Company
has recognized stock compensation expense of $2.1 million in selling, general
and administrative expense for the year ended December 31, 1998.
3. Commitments and Contingencies
In October 1998, the Company settled all litigation in Ontario, Canada, in
connection with Marvin Lerch, the former Chief Executive Officer and a former
shareholder of ICT and certain of his relatives, also former ICT shareholders.
The settlement resolved all litigation by Lerch and his family members against
the Company, certain executive officers and a former director of ICT. Under the
terms of the settlement, the parties agreed to dismiss all actions, and the
Company agreed to transfer a total of 87,500 shares of the Company's common
stock to the plaintiffs. The Company recorded an additional expense of $.5
million in the fourth quarter of 1998 reflecting this settlement.
On May 11, 1998, ICT and Holdings filed an action in U.S. District Court for
the District of Delaware against WorldGate Communications, Inc. ("WorldGate")
alleging that WorldGate has infringed four of the Company's patents. Each party
has filed a Motion to Dismiss certain claims and no date has been set for a
hearing by the district court. The Company intends to aggressively defend its
patents.
In July 1998, the Company initiated an action in the Western District of
Michigan federal court against a former employee of Brite, Michael Shell
("Shell") and three companies (Interactive Media Services, Inc., Interactive
Information Services, LLC, and Talking Directories, Inc. ("TDI")), alleging
copyright infringement and breach of contract. On October 14, 1998, the federal
judge issued a preliminary injunction in favor of the Company enjoining the
competitors from, among other things, selling, licensing, distributing or
reproducing works derived from the Company's information. On December 2, 1998,
the Company filed a Motion for Further Preliminary Injunctive Relief in Michigan
federal court against the same companies involved in the first action. The
action for
F-9
<PAGE>
Further Relief is based on alleged copyright infringement by the
defendant companies of the Company's proprietary satellite software used to
transmit the Company's voice information to its customers' receiving systems. A
trial date has been set for November 8, 1999. The Company is also involved in
certain litigation in federal and state courts in Kansas related to tortious
interference with the Company's contractual relationships with customers and to
violations of non-compete agreements by former employees of IT Network. The
Company intends to aggressively pursue all of these cases.
On January 11, 1999, Brite Voice Systems, Inc. ("Brite") filed a lawsuit
against IT Network and Source in the United States District Court of the
District of Kansas. Brite alleges three claims: (1) breach of a September 1997
Asset Purchase Agreement for which Brite seeks recovery of alleged damages of
approximately $112,000; (2) breach of an October 1997 Lease and Service
Agreement in connection with such Asset Purchase Agreement, for which Brite
seeks recovery of alleged damages of approximately $30,000; and (3) a
declaratory judgment with respect to all indemnity claims for which IT Network
has provided Brite notice pursuant to the Asset Purchase Agreement. The Company
is required to respond by April 26, 1999, and intends to vigorously defend
itself and to assert counterclaims.
On August 21, 1998, the first of fourteen class action cases was filed against
the Company and certain officers and directors in federal court in the Northern
District of Texas. The litigation is pursuant to the provisions of the Private
Securities Litigation Reform Act of 1995. The federal court has appointed three
firms collectively as the lead counsel, and on March 3, 1999 the plaintiffs
filed a Consolidated and Amended Class Action Complaint to which a response is
due by April 19, 1999. The Company believes that all of these cases are without
merit and will vigorously defend itself and its officers and directors.
On October 6, 1998, Advanced Interactive, Inc. filed a complaint in U.S.
District Court for the Northern District of Illinois, Eastern Division, against
ICT and the following other companies: Matsushita Electric Corporation,
Matsushita Electric Industrial Co., Ltd., Sharp Electronics Corp., Sharp Corp.,
Thomson Consumer Electronics, Toshiba Consumer Products, Inc., Toshiba America,
Inc., Toshiba Corporation, General Instruments Corp., Scientific Atlanta, Inc.,
ATI Technologies, Inc., ADS Technologies Inc., Gateway 2000, Inc., STB Systems,
Inc., Hauppauge Computer Works, Inc., WebTV Networks, Inc. and WorldGate
Communications, Inc. (collectively the "Defendants"). Advanced Interactive
alleges that ICT infringed two claims of one of its patents by manufacturing,
using and/or selling or offering to sell "Sourceware(TM) ChannelLink(TM)". The
same allegation is made against each Defendant for its particular product or
service. The Plaintiff seeks damages, but makes no claims against ICT's or any
other Defendant's patents. ICT, and each of the Defendants, have filed an Answer
and seek to collectively join the Motion for Partial Summary Judgment submitted
by Matsushita Electric Corporation of America, Sharp Electronics Corp., Sharp
Corp. and the Toshiba Defendants. The court has not yet considered the
Defendant's collective Motion for Partial Summary Judgment. The Company believes
this case is totally without merit and intends to vigorously defend itself.
In addition, the Company is aware of certain claims against the Company that
have not developed into litigation, or if they have, are dormant, and in any
case are not expected to have a material adverse affect on the Company. Further,
the Company is party to ordinary routine litigation, none of which is expected
to have a material adverse effect on the Company's results of operations or its
financial condition.
On February 11, 1999, the Company signed a Letter of Intent with Prevue to
enter into a joint venture, Newco. Under the terms of the Letter of Intent, if
either the Company or Prevue fails to use its good faith commercially reasonable
efforts as such, the other has agreed to pay as liquidated damages $3.0 million
plus out-of-pocket costs and expenses associated with due diligence and
negotiation. In addition, the Company has agreed to pay such liquidated damages
and costs and expenses if it breaches the exclusivity agreement prior to
execution of definitive documents and, within 240 days after the execution of
the Letter of Intent, enters into a significant transaction with a third party.
If the transaction is not consummated after the execution of definitive
documents as a result of the Company's breach of the exclusivity agreement and
the Company enters into a significant transaction with a third party within one
year after the execution of the Letter of Intent, in addition to a non-exclusive
licenses grant, the Company would be required to pay Prevue as liquidated
damages $10.0 million plus out-of-pocket costs and expenses, provide for two
Prevue representatives on a seven-member Board of Directors of the Company and
issue to Prevue five-year warrants to acquire 3,208,700 shares of the Company's
common stock at an exercise price of $7.125 per share. See Note 15.
F-10
<PAGE>
4. Short-Term and Restricted Investments
The Company held certain short-term investments in 1997, which consisted of
securities that management held to maturity. In 1998, all investments are highly
liquid investments with maturities of three months or less and, therefore, are
classified as cash equivalents.
In connection with the October 1997 offering of Senior Secured Notes, as more
fully described in Note 6 -- Long Term Debt, the Company placed approximately
$22.6 million of the net proceeds from the offering, representing funds
sufficient, together with interest thereon, to pay the first four interest
payments on the Senior Secured Notes, into an Interest Escrow Account (the
Escrow Account) for the benefit of the holders of the Senior Secured Notes. As
of December 31, 1998, the Escrow Account, including accrued interest, totaled
$11.7 million. Until disbursed in accordance with the Escrow and Disbursement
Agreement relating to the Escrow Account, the Escrow Account is designed to
secure a portion of the Company's obligations under the Senior Secured Notes.
Funds will be disbursed from the Escrow Account only to pay interest on the
Notes and, upon certain repurchases or redemptions of the Senior Secured Notes,
to pay principal of and premium, if any, thereon. Management has the intent and
ability to hold the securities in the Escrow Account to maturity. These
investments are carried at amortized cost and are summarized as follows on
December 31, 1998:
<TABLE>
<CAPTION>
Gross
Amortized Unrealized Fair
Cost Gains Value
--------------- -------------- -------------
(In thousands)
<S> <C> <C> <C>
U.S. Government agencies.................................................. $ 5,806 $28 $ 5,834
Corporate obligations..................................................... 5,910 10 5,920
------- --- -------
Restricted investments.................................................... $11,716 $38 $11,754
======= === =======
</TABLE>
Security fair values are based on market prices or dealer quotes. All
securities mature in 1999.
5. Acquisitions
In October 1996, the Company acquired certain voice information assets from
The Reuben H. Donnelly Corporation (Donnelly) for an aggregate purchase price of
$0.8 million. In connection therewith, the Company executed a services agreement
with a three year minimum term under which Donnelly is obligated to pay the
Company a minimum of $3.2 million over the term of the agreement and the Company
is assuming Donnelly's operating responsibilities for its voice information
services business. The Donnelly asset acquisition has been accounted for as the
purchase of equipment and contract rights and the purchase price was allocated
to the assets based on the estimated fair values at the date of acquisition.
In December 1996, the Company acquired certain voice information servicing
assets from GTE Directories Corporation (GTE) for an aggregate purchase price of
$1.8 million. GTE and the Company executed sales agency and services agreements
with a three year minimum term under which the parties have agreed to share
revenues. The Company assumed operating responsibilities for GTE's voice
information services business. The Company has guaranteed GTE a minimum of
approximately $3.7 million as its percentage of shared revenues over the term of
the agreement with minimum annual targets. If the Company pays the minimum
required amount to GTE under the sales agency agreement, then pursuant to the
services agreement, GTE will pay the Company a minimum of approximately $0.7
million for services rendered in the final year of the agreement. Through
December 31, 1998 the Company has shared $1.7 million of revenues under this
agreement. Assuming the 1999 target is met, it is expected that any shortfall of
advertising sales in previous years will be offset by the amount received as the
minimum payment from GTE under the final settlement terms of the service
agreements; however, should the Company not meet the minimum revenue target it
may be liable to GTE for such shortfall. The GTE asset acquisition has also been
accounted for as the purchase of equipment and contract rights and the purchase
price was allocated to the assets based on the estimated fair values at the date
of acquisition.
In January 1997, the Company acquired all of the outstanding shares of ICT
held by minority interest shareholders in exchange for 1,390,000 shares of the
Company's common stock, making ICT a wholly-owned subsidiary of the Company. The
Company also issued options to purchase 177,000 shares of the Company's common
stock at exercise prices ranging from $1.43 to $4.96 per share to certain
employees and directors of ICT in exchange for their outstanding options to
purchase ICT common shares. Cash expenses related to the acquisition were
approximately $0.8 million. The aggregate purchase price for the acquisition of
the ICT minority interest was approximately $11.3 million, and the acquisition
was accounted for by the purchase method of accounting. The purchase price was
allocated to patents, which are being amortized over a five year period.
On October 30, 1997, the Company acquired certain of the electronic publishing
assets of Brite Voice Systems, Inc. (Brite) for a
F-11
<PAGE>
purchase price of approximately $35.6 million. The Brite acquisition has been
accounted for by the purchase method of accounting and the purchase price was
allocated to equipment, contract rights and goodwill based on the estimated fair
values of the assets at the date of acquisition. (See Note 2 -- Significant
Accounting Policies for a description of events subsequent to the date of
acquisition.)
Also on October 30, 1997, the Company acquired certain of the assets of Voice
News Network, Inc. (VNN), a subsidiary of Tribune Media Services, Inc., a unit
of Tribune Company, for a purchase price of $9.0 million. The VNN acquisition
has been accounted for by the purchase method of accounting and the purchase
price was allocated to equipment, contract rights and goodwill based on the
estimated fair values of the assets at the date of acquisition.
The operating results of Brite and VNN are included in the Company's results
from the date of acquisition. The following represents the unaudited pro forma
results of operations as if the acquisitions of ICT, Brite and VNN had occurred
on January 1, 1996, after giving effect to certain adjustments, including
minority interest in earnings (losses) of consolidated subsidiaries, interest
expense, preferred stock dividends and amortization of intangibles resulting
from the allocation of the purchase price.
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------
1996 1997
------------------- -------------------
<S> <C> <C>
(In thousands,
except per share amount)
Total revenues......................................................................... $ 30,356 $ 31,637
Operating loss......................................................................... (20,574) (28,789)
Net loss............................................................................... (32,552) (40,778)
Net loss attributable to common stockholders........................................... $(35,187) $(43,904)
Net loss per common share.............................................................. $ (3.11) $ (3.87)
</TABLE>
Pro forma results presented above are not necessarily indicative of what
actually would have occurred if the acquisitions had been consummated as of
January 1, 1996, and are not intended to be a projection of future results or
trends.
6. Long-Term Debt
On April 3, 1996, the Company issued a senior note (the "First Tranche Note")
in the principal amount of $5.0 million and a warrant (the "First Tranche
Warrant") which entitled the holder thereof to purchase 500,000 shares of the
Company's common stock at a purchase price of $10.21 per share. On September 30,
1996 and March 31, 1997, the Company issued additional senior notes in the
amounts of $0.3 million and $0.4 million, respectively, for the payment of
interest on the First Tranche Note. The First Tranche Note and the additional
senior notes (collectively, the "Aggregate First Tranche Notes") were due on
March 31, 2001 and bore interest at the rate of 13% per annum through March 31,
1998 and 12% thereafter. The estimated fair market value at the date of issuance
of the First Tranche Warrant of $0.7 million was credited to capital in excess
of par value and the First Tranche Note was recorded at a corresponding
discount. The discount on the First Tranche Note was being amortized to interest
expense using the effective interest rate method over the stated term of the
First Tranche Note, resulting in an effective interest rate of 16.2%.
On April 9, 1997, the Company received cash proceeds of $15.0 million upon the
issuance of additional senior notes (the "Second Tranche Notes") in the
principal amount of $15.0 million and warrants (the "Second Tranche Warrants")
which entitled the holders thereof to purchase in the aggregate 2,000,000 shares
of the Company's common stock at a purchase price of $6.00 per share at any time
until their expiration on March 31, 2004. The estimated fair market value of the
Second Tranche Warrants of $1.7 million at the date of issuance was credited to
capital in excess of par value and the Second Tranche Notes were recorded at a
corresponding discount. The discount on the Second Tranche Notes was being
amortized to interest expense using the effective interest rate method over the
stated terms of the Second Tranche Notes resulting in an effective interest rate
of 15.4%. Additionally, in connection with the issuance of the Second Tranche
Notes and the Second Tranche Warrants, the Aggregate First Tranche Notes and the
First Tranche Warrant were amended and restated to terms identical to those of
the Second Tranche Notes and the Second Tranche Warrants, respectively. The
amended Aggregate First Tranche Notes and the Second Tranche Notes were due on
March 31, 2002 and bore interest at the rate of either: (i) 12% per annum
through March 31, 1999 if paid in cash, or (ii) 13% per annum through March 31,
1999 if paid through the issuance of additional notes, and 12% thereafter. On
September 30, 1997 the interest due was paid through the issuance of additional
notes, with terms identical to those of the Second Tranche Notes, in the amount
of approximately $1.3 million and warrants to purchase approximately 165,000
shares of common stock in payment of the interest accrued on the Aggregate First
Tranche Notes and the Second Tranche Notes. The estimated fair market values of
the notes and warrants issued in lieu of a cash interest payment on September
30, 1997 were approximately $1.1 million and $1.1 million, respectively, which
were recorded as interest expense during 1997.
The amendment of the Aggregate First Tranche Notes and First Tranche Warrant
was accounted for as the extinguishment and
F-12
<PAGE>
replacement of the existing senior notes and the cancellation of the existing
warrants and issuance of new warrants due to the significance of the
modification to the terms of the senior notes and warrants. The extinguishment
resulted in a loss of approximately $0.3 million, which was included in other
(income) expense during the second quarter of 1997.
In connection with the issuance of the Senior Secured Notes (the "Senior
Secured Notes", or the "Notes"), the Company used $22.2 million of the proceeds
received to pay off the amended Aggregate First Tranche Notes and the Second
Tranche Notes, including accrued interest thereon, and the notes issued on
September 30, 1997 in lieu of a cash interest payment. The early extinguishment
of these notes resulted in a charge to earnings of approximately $3.5 million
related to unamortized discount on the Second Tranche Notes and unamortized
issuance costs which were recorded as an extraordinary item in 1997. The
proceeds were also used in part to complete the Company's acquisitions of
certain assets more fully described in Note 5 -- Acquisitions.
On October 30, 1997, the Company issued Senior Secured Notes in the principal
amount of $100 million, which bear interest at the rate of 12% per annum through
November 1, 2004. Interest on the Notes is payable semi-annually on May 1 and
November 1 of each year commencing on May 1, 1998, to holders of record at the
close of business on April 15th or October 15th immediately preceding the
interest payment date. The Company placed approximately $22.6 million of the net
proceeds from the offering, representing funds sufficient, together with
interest thereon, to pay the first four interest payments on the Notes, into the
Escrow Account. Interest payments of $12.1 million were made in 1998. As
discussed in Note 4 -- Short-term and Restricted Investments, $11.7 million
remains in escrow at December 31, 1998 to pay the interest due in 1999.
The Notes are fully and unconditionally guaranteed, jointly and severally, by
each of the Company's subsidiaries (the "Subsidiary Guarantors"). The guarantees
are senior obligations of the Subsidiary Guarantors and are secured by
substantially all of the assets of the Subsidiary Guarantors. The guarantees
rank pari passu in right of payment with all existing and future senior
indebtedness of the Subsidiary Guarantors and rank senior in right of payment to
all existing and future subordinated obligations of the Subsidiary Guarantors.
The guarantees may be released upon the occurrence of certain events. The
guarantee executed by IT Network contains a covenant that restricts payments of
dividends on its capital stock to an amount sufficient to cover debt service on
the Notes, redemptions or repurchases of the Notes or the Preferred Stock,
dividends on the Preferred Stock and corporate overhead. The assets of Source
consist solely of investments in its subsidiaries and invested proceeds from the
Notes and the Senior PIK Preferred Stock and related warrants. Financial
statements for the Subsidiary Guarantors and the parent, Source Media, Inc. are
not presented because management has determined that they would not be material
to investors.
Except as described below, the Company may not redeem the Notes prior to
November 1, 2001. On or after such date, the Company may redeem the Notes, in
whole or in part, at any time, at various redemption prices set forth in the
indenture governing the sale of the Notes, together with accrued and unpaid
interest, if any, to the date of redemption. In addition, at any time and from
time to time on or prior to November 1, 2000, the Company may, subject to
certain requirements, redeem up to 35% of the aggregate principal amount of the
Notes with the cash proceeds of one or more equity offerings at a redemption
price equal to 112% of the principal amount to be redeemed, together with
accrued and unpaid interest, if any, to the date of redemption, provided, that,
at least $65.0 million of the aggregate principal amount of the Notes remain
outstanding immediately after each such redemption. The Notes are not subject to
any sinking fund requirement. Upon the occurrence of a change in control, the
Company will be required to make an offer to repurchase the Notes at a price
equal to 101% of the principal amount thereof, together with accrued and unpaid
interest, if any, to the date of the repurchase. The indenture contains certain
covenants including, but not limited to, limitations on indebtedness, restricted
payments, liens, restrictions on distributions from restricted subsidiaries,
sales of assets and subsidiary stock, affiliate transactions, issuances of
capital stock of restricted subsidiaries and sale/leaseback transactions. As of
December 31, 1998, the dealer quoted value of a Note was $0.70 per dollar
resulting in an aggregate fair market value of approximately $70.0 million.
7. Senior PIK Preferred Stock
On October 30, 1997, the Company issued 800 units (the Units) for an aggregate
purchase price of $20 million, each Unit consisting of 1,000 shares of non-
voting Senior Preferred Stock (the "Preferred Stock") with a liquidation
preference of $25.00 per share and 558.75 warrants (the "October 1997 Warrants")
to purchase one share of the Company's common stock at a purchase price of $0.01
per share. In the aggregate, the October 1997 Warrants represent the right to
purchase 447,000 shares of common stock. The Units were sold in connection with
the Company's acquisitions of certain assets more fully described in Note 5 --
Acquisitions.
F-13
<PAGE>
Dividends on the Preferred Stock are payable quarterly on each February 1, May
1, August 1 and November 1, commencing February 1, 1998, at a rate of 13 1/2%
of the liquidation preference per share. At the Company's option, on any
dividend payment date occurring on or prior to November 1, 2002 dividends may be
paid either in cash or by the issuance of additional shares of Preferred Stock
with a liquidation preference equal to the amount of such dividends; thereafter,
dividends will be paid in cash. The certificate of designation governing the
sale of the Units limits the amount of cash dividends that may be paid on the
Preferred Stock. At any time and from time to time on or prior to November 1,
2000, the Company may, subject to certain requirements, redeem up to 35% of the
aggregate liquidation value of the Preferred Stock with the cash proceeds of one
or more equity offerings at a redemption price equal to 113 1/2% of the
liquidation preference thereof, plus accumulated dividends, on the date of
redemption. After November 1, 2000 and prior to November 1, 2002, the Preferred
Stock is not redeemable. On or after November 1, 2002, the Company may redeem
the Preferred Stock, in whole or in part, at any time, at various redemption
prices, plus accumulated and unpaid dividends, to the date of redemption. Upon
the occurrence of a change in control, the Company will be required to make an
offer to purchase the outstanding shares of the Preferred Stock at a price equal
to 101% of the liquidation preference thereof, plus accumulated and unpaid
dividends, to the date of purchase. The Preferred Stock will be subject to
mandatory redemption in whole on November 1, 2007, at a price equal to 100% of
the then effective liquidation preference thereof, plus, without duplication,
all accrued and unpaid dividends to the date of redemption. The certificate of
designation contains certain covenants including, but not limited to,
limitations on indebtedness, restricted payments, affiliate transactions,
issuances of capital stock of restricted subsidiaries and sale/leaseback
transactions.
The Preferred Stock ranks senior to all classes of common stock and to each
other class of capital stock or series of preferred stock with respect to
dividend rights and rights on liquidation, winding-up and dissolution of the
Company. The Preferred Stock is non-voting except in certain circumstances. The
Company may not authorize any new class of preferred stock that ranks senior or
pari passu to the Preferred Stock without the approval of the holders of at
least a majority of the shares of Preferred Stock then outstanding, voting or
consenting, as the case may be, as one class, provided, however, that the
Company can issue additional shares of Preferred Stock to satisfy dividend
payments on outstanding shares of Preferred Stock; and further provided that the
Company can issue shares of preferred stock ranking pari passu with the
Preferred Stock if after giving effect thereto, the Consolidated Coverage Ratio,
as defined in the certificate of designation, is greater than 1.7 to 1.0.
The estimated fair market value of the October 1997 Warrants, which was
estimated to be approximately $5.5 million, was credited to capital in excess of
par value and the Preferred Stock was recorded at a corresponding discount.
Additionally, $1.2 million of issuance costs were recorded on the Preferred
Stock. The discount and issuance costs on the Preferred Stock are being accreted
as additional preferred stock dividends using the effective dividend rate method
over a ten year period, resulting in an effective dividend rate of 19.9%. As of
December 31, 1998, the dealer quoted fair market value of the preferred stock
was $18.00 per share for an aggregate value of $16.4 million.
During 1998, the quarterly dividends due on the Preferred Stock were paid
through the issuance of additional Preferred Stock having a total liquidation
preference of $2.8 million with terms identical to those of the Preferred Stock.
The estimated fair market value of the stock issued in lieu of a cash payment on
the respective dividend dates totaled $2.4 million which was recorded as
preferred stock dividends.
8. Stock Options, Warrants, Employee Stock Purchase Plan and Retirement Plan
Stock Options
In 1995 the Company adopted the 1995 Performance Equity Plan (the Equity
Plan). The Equity Plan provides for the grant of options to purchase shares of
the Company's common stock to employees, officers, directors, and consultants of
the Company and its subsidiaries, including Holdings, IT Network and Interactive
Channel. Options granted pursuant to the Equity Plan have a term of ten years
from the date of grant and generally vest over four or five years. The Equity
Plan, as amended, authorizes the granting of awards (stock options, stock
appreciation rights, restricted stock, deferred stock, stock reload options, and
other stock-based awards, as defined), the exercise of which would allow up to
an aggregate of 1,975,000 shares of the Company's common stock to be acquired.
In 1989, the Company established a qualified incentive employee stock option
plan. Options granted in 1989 and 1990 have a term of ten years from the date of
grant and vested over a three year period. During 1991 and 1993, the Company
established additional qualified incentive employee stock option plans whereby
granted options have a term of ten years from the date of grant and vest over a
five year period. The Company does not intend to grant any additional options
under these plans and, accordingly, all remaining options available for grant
under such plans are assumed to be canceled.
F-14
<PAGE>
The following table is a summary of stock option activity under the employee
stock option plans during the years ended December 31, 1996, 1997, and 1998:
<TABLE>
<CAPTION>
Weighted
Average
Options Available Shares Under Aggregate Options or Exercise Exercise Price
Employee Stock Option Activity for Grant Option Price Price per Share per Share
- ---------------------------------------- ------------------ ------------- ------------- ------------------- --------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1995............ 358,999 348,609 $ 3,271,718 $0.74- $11.50 $ 9.39
Options authorized.................... 400,000 -- -- -- --
Options granted....................... (775,224) 775,224 7,181,190 8.25- 10.50 9.26
Options exercised..................... -- (23,485) (141,796) 0.74- 9.77 6.04
Options canceled -- 1995 Plan......... 16,225 (16,225) (169,731) 8.25- 11.12 10.46
Options canceled -- Other plans....... -- (22,379) (217,980) 3.72- 9.77 9.74
---------- --------- ----------- ------------- ------
Balance at December 31, 1996............ -- 1,061,744 9,923,401 0.74- 11.50 9.35
Options authorized.................... 500,000 -- -- -- --
Options granted....................... (176,000) 176,000 1,280,700 6.41- 13.31 7.28
Options exercised..................... -- (90,803) (758,755) 0.74- 10.40 8.36
Options canceled -- 1995 Plan......... 149,324 (149,324) (1,376,794) 6.41- 11.12 9.22
Options canceled -- Other plans....... -- (21,910) (204,820) 3.72- 9.77 9.35
---------- --------- ----------- ------------- ------
Balance at December 31, 1997............ 473,324 975,707 8,863,732 0.74- 13.31 9.08
Options authorized.................... 575,000 -- -- -- --
Options granted....................... (1,068,201) 1,068,201 9,357,781 6.28- 14.00 8.76
Options exercised..................... -- (51,888) (469,317) 0.74- 11.12 9.04
Options canceled -- 1995 Plan......... 38,653 (38,653) (353,452) 6.41- 11.12 9.14
Options canceled -- Other Plan........ -- (9,898) (96,272) 3.72- 9.77 9.73
---------- --------- ----------- ------------- ------
Balance at December 31, 1998............ 18,776 1,943,469 $17,302,472 $3.72- $14.00 $ 8.90
========== ========= =========== ============= ======
</TABLE>
During 1995, the Company adopted the 1995 Nonqualified Stock Option Plan for
Non-Employee Directors (the "Directors' Plan"). The Directors' Plan provides for
the automatic annual grant to each non-employee director of the Company an
option to purchase 3,000 shares of common stock. Options granted under the
Directors' Plan have an exercise price equal to the fair market value of the
common stock on the date of grant and are exercisable at any time from the date
of grant until the fifth anniversary thereof. The Directors' Plan, as amended on
May 21, 1997, provides for the grant of options to purchase up to 300,000 shares
of common stock. The following table is a summary of stock option activity under
the Directors' Plan during the years ended December 31, 1996, 1997, and 1998:
<TABLE>
<CAPTION>
Weighted
Average
Options Available Shares Under Aggregate Options or Exercise Exercise Price
Directors' Plan Stock Option Act for Grant Option Price Price per Share per Share
- ------------------------------------- ------------------ ------------- ---------- ------------------- --------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1995......... 78,000 12,000 $130,650 $ 10.89 $10.89
Options granted...................... (18,000) 18,000 187,650 10.43 10.43
------- ------ -------- -------------- ------
Balance at December 31, 1996......... 60,000 30,000 318,300 10.43 - 10.89 10.61
Options authorized................... 50,000 -- -- -- --
Options granted...................... (15,000) 15,000 88,650 5.91 5.91
------- ------ -------- -------------- ------
Balance at December 31, 1997......... 95,000 45,000 406,950 5.91 - 10.89 9.04
Options granted...................... (33,000) 33,000 617,670 13.77 - 22.84 18.72
Options exercised.................... -- (6,000) (63,938) 10.43 - 10.89 10.66
------- ------ -------- -------------- ------
Balance at December 31, 1998......... 62,000 72,000 $960,682 $5.91 - $22.84 $13.34
======= ====== ======== ============== ======
</TABLE>
Pursuant to an agreement, each of the 176,958 options for ICT common shares
outstanding at the effective time of the acquisition of the remaining minority
interest of ICT was exchanged for an option (a "Replacement Option") to purchase
shares of common stock. During 1998, 35,891 Replacement Options were exercised
at a weighted average exercise price of $4.11. As of December 31, 1998, the
remaining options represent the right to purchase 35,891 shares of common stock
at a weighted average exercise price of $4.12 per share.
F-15
<PAGE>
Certain additional information for all outstanding options as of December 31,
1998, is being presented based on a range of exercise prices as follows
<TABLE>
<CAPTION>
Exercise
Prices
$3.72 - $4.15 $5.91 - $14.00 $ 22.84
------------- -------------- -------
<S> <C> <C> <C>
Number of outstanding options..................................................... 35,958 1,997,402 18,000
Weighted average exercise price of outstanding
options......................................................................... $ 4.12 $ 8.94 $ 22.84
Weighted average remaining life................................................... 7.4 years 8.4 years 9.6 years
Number of options exercisable..................................................... 35,958 705,055 18,000
Weighted average exercise price of options
exercisable..................................................................... $ 4.12 $ 9.36 $ 22.84
</TABLE>
As required by the Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("FAS 123"), pro forma information
regarding net loss and loss per share has been determined as if the Company had
accounted for employee and director stock options granted subsequent to December
31, 1994 under the fair value method provided for under FAS 123. The fair value
for the stock options granted to directors, officers and key employees of the
Company on or after January 1, 1995 was estimated at the date of the grant using
the Black-Scholes option pricing model with the following weighted-average
assumptions:
<TABLE>
<CAPTION>
1996 1997 1998
--------------- --------------- ---------------
<S> <C> <C> <C>
Risk-free interest rate.................................................. 6.39% 6.21% 5.31%
Expected dividend yield.................................................. 0.00% 0.00% 0.00%
Expected volatility...................................................... 30% 30% 76%
Expected lives........................................................... 4.0 years 4.0 years 2.7 years
</TABLE>
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
The weighted-average fair value of stock options granted during the years
ended December 31, 1996, 1997 and 1998 was $2.34, $2.55 and $4.50, respectively.
For purposes of the pro forma disclosures, the estimated fair value of stock
options granted from January 1, 1995 through December 31, 1998 have been
amortized to expense over the vesting period. The Company's pro forma
information for FAS 123 follows (in thousands, except for loss per common share
information):
<TABLE>
<CAPTION>
1996 1997 1998
-------- -------- --------
<S> <C> <C> <C> <C>
Net loss attributable to common stockholders As reported $13,855 $32,797 $62,626
Pro forma.. $14,411 $33,471 $64,271
Net loss per common share As reported $ 1.39 $ 2.89 $ 5.21
Pro forma.. $ 1.45 $ 2.95 $ 5.35
</TABLE>
Because FAS 123 is applicable only to options and stock-based awards granted
subsequent to December 31, 1994, its pro forma effect will not be fully
reflected until 1999.
F-16
<PAGE>
Warrants
The Company has issued warrants for the purchase of shares of its common stock
from time to time in connection with various financing transactions and for
advisory and consulting services provided to the Company. The majority of the
warrants provide for registration rights. As of December 31, 1998, outstanding
warrants for the purchase of common stock of the Company were:
<TABLE>
<CAPTION>
Shares Issuable Exercise Price
Upon Exercise Per Share Expiration Date
- --------------------- ------------------ --------------------
<S> <C> <C>
1,034,687 $ 6.00 May 2000
200,000 6.41 May 2000
2,326,500(1) 11.00 June 2000
83,085 10.80 February 2001
252,676 10.50 December 2002
1,335,924 6.00 March 2004
25,000(1) 11.00 June 2005
37,748 4.38 June 2007
447,000 0.01 November 2007
---------
5,742,620
=========
</TABLE>
__________
(1) In the event the sales price of the Company's common stock equals or exceeds
$20.00 per share for 20 consecutive trading days, the Company will have the
right to redeem warrants representing 2,351,500 common shares upon 20 days
written notice at a price of $11.00 per share.
997758 Class Y Stock Exchange Rights
On September 24, 1992, the Company's subsidiary, 997758, entered into an
agreement with an individual to issue shares of 997758's nonvoting Class Y
shares in exchange for Class A Subordinate Voting Shares and Class B Multiple
Voting Shares of ICT owned by such individual. The individual has the right at
any time through February 14, 2000, to exchange any or all of the Class Y shares
of 997758 for up to an aggregate of 206,376 shares of the Company's common
stock. Each exercise of the exchange rights shall include at least Cdn $150,000
in value of Class Y shares of 997758 being exchanged for the Company's common
stock.
Shares Reserved for Future Issuance
As of December 31, 1998, common shares reserved for future issuance were as
follows:
<TABLE>
<CAPTION>
Number of
Security Reserved Shares
- -------------------------------------------------------------------------------------------- --------------------
<S> <C>
Warrants.................................................................................... 5,742,620
Stock options............................................................................... 2,132,136
Employee stock purchase plan................................................................ 57,557
997758 Class Y Stock exchange rights........................................................ 206,376
---------
8,138,689
=========
</TABLE>
Employee Stock Purchase Plan and Retirement Plan
During July 1996, the Company's Board of Directors adopted the Employee Stock
Purchase Plan (the "Plan"), which was approved by the Company's stockholders at
the 1997 annual meeting. Under the Plan, eligible employees may purchase shares
of the Company's common stock at a discount through voluntary monthly payroll
deductions with a maximum contribution being 10% of an eligible employee's
salary, beginning in September 1996. Semi-annually, on June 30 and December 31,
participant account balances are used to purchase shares at the lesser of 85
percent of the fair market value of the common stock on either the first or last
day of the subscription period. In connection with the Plan, the Company has set
aside 100,000 shares of common stock held in treasury. On June 30, 1998 and
December 31, 1998, 11,595 shares and 7,055 shares of common stock were purchased
by employees at prices of $7.38 per share and $14.13 per share, respectively.
The Company sponsors a defined contribution plan covering substantially all
employees; the plan is qualified under Section 401(k) of the Internal Revenue
Code. Under the provisions of the plan, eligible participating employees may
elect to contribute up to the maximum amount of tax deferred contribution
allowed by the Internal Revenue Code.
F-17
<PAGE>
Anti-Dilution Provisions
Certain of the warrants to purchase common stock contain anti-dilution
provisions whereby the exercise price and the number of shares exercisable
pursuant to the warrants may be adjusted from time to time upon the occurrence
of certain events. In connection with such provisions, warrants to purchase
1,034,687 shares of common stock at a purchase price of $7.44 per share were
adjusted to provide for the purchase of the same number of shares at a purchase
price of $6.00 per share, and warrants to purchase 28,302 shares of common stock
at a purchase price of $10.60 per share were adjusted to provide for the
purchase of 68,498 shares at a purchase price of $4.38 per share upon the
issuance of common stock in connection with the ICT acquisition discussed in
Note 5 -- Acquisitions and the amendment to the First Tranche Warrant and
issuance of the Second Tranche Warrants discussed in Note 6 -- Long-Term Debt,
respectively.
9. Notes Receivable from Stockholders
On May 20, 1993, the Company loaned $0.8 million to the individual holding
Class Y shares of 997758, which note is secured by the individual's holdings in
997758 and bears interest at a rate per annum of 2%, payable quarterly. The
unpaid principal and interest become due on May 20, 2000. At that time, the
Company recorded a discount to reflect the difference between the actual
interest rate and a reasonable market rate (10%) and increased goodwill
accordingly. The note and accrued interest, net of the unamortized discount of
$0.1 million and $0.1 million as of December 31, 1997 and 1998, respectively,
are reflected as a reduction of minority interests in the accompanying
consolidated balance sheet.
On June 30, 1993, the Company loaned $0.1 million to an officer, director and
stockholder. This loan bears interest at the rate of 10% per annum, with the
principal amount and accrued interest due and payable on May 31, 1999. Payment
of the note is secured by a pledge of 6,719 shares of common stock. Amounts
outstanding, including accrued interest, are included in stockholders' equity
(capital deficiency) in the accompanying consolidated balance sheets.
10. Leases
The Company leases office space and various office equipment under operating
leases. Rent expense was $0.5 million, $0.9 million and $1.1 million for the
years ended December 31, 1996, 1997, and 1998, respectively.
At December 31, 1998, aggregate amounts of future minimum payments under lease
commitments are as follows:
<TABLE>
<CAPTION>
Operating Leases
----------------------
(In thousands)
<S> <C>
1999....................................................................................... $ 819
2000....................................................................................... 698
2001....................................................................................... 282
2002....................................................................................... 4
2003....................................................................................... 6
------
Total future minimum lease payments........................................................ $1,809
======
</TABLE>
11. Income Taxes
For the years ended December 31, 1996, 1997 and 1998, the Company had no
provision or benefit for income taxes because the deferred benefit from the
operating losses was offset by an increase in the valuation allowance of $5.6
million, $4.1 million and $18.3 million, respectively. Significant components of
the Company's deferred tax assets and liabilities are as follows:
F-18
<PAGE>
<TABLE>
<CAPTION>
1997 1998
-------------------- --------------------
<S> <C> <C>
Deferred tax liabilities:
Tax over book depreciation............................................................ $ (548,386) $ (523,243)
Other................................................................................. (11,156) (7,706)
------------ ------------
Total deferred tax liabilities........................................................ (559,542) (530,949)
Deferred tax assets
Net operating loss carryforwards.................................................... 24,136,650 32,431,574
Investment tax credits.............................................................. 801,712 488,025
Unearned income..................................................................... 1,491,716 787,065
Book over tax amortization of intangibles........................................... 414,831 10,420,726
Reserve for fixed asset impairment.................................................. 739,763 739,763
Accrued expenses.................................................................... 61,248 927,397
Other............................................................................... 56,967 143,312
------------ ------------
Total deferred tax assets............................................................. 27,702,887 45,937,862
Valuation allowance for deferred tax assets........................................... (27,143,345) (45,406,913)
------------ ------------
Net of valuation allowance............................................................ 559,542 530,949
------------ ------------
Net deferred tax asset................................................................ $ -- $ --
=================== ===================
</TABLE>
At December 31, 1998, the Company had net operating loss carryforwards of
approximately $87.4 million for United States income tax purposes, that expire
in 2003 through 2018, which may be used to reduce future United States taxable
income. The Tax Reform Act of 1986 imposes limitations on the use of net
operating loss carryforwards if certain stock ownership changes occur. An
ownership change occurred that will cause utilization of a portion of the
Company's net operating losses to be limited to approximately $9.0 million in a
given year.
At December 31, 1998, ICT had net operating loss carryforwards for Canadian
income tax purposes of approximately Cdn $0.3 million, expiring in 1999 through
2003, which may be used to reduce future Canadian taxable income of ICT. ICT
also has available at December 31, 1998 investment tax credits totaling Cdn $0.8
million, expiring in 1999 through 2002. At December 31, 1998, ICT had net
operating loss carryforwards for Ontario Provincial income tax purposes of
approximately Cdn $0.1 million, expiring in 2002 through 2003, which may be used
to reduce future Ontario taxable income of ICT.
Certain transactions between ICT and its subsidiaries in March 1997 resulted
in taxable income of approximately $7.0 million in the United States and Canada
and the utilization of net operating losses in both countries in 1997. Certain
transactions between ICT and its subsidiaries in 1998 resulted in utilization of
approximately Cdn $4.0 million of Canadian net operating loss carryforwards.
12. Concentration of Credit Risk and Major Customers
The Company performs ongoing credit evaluations of its customers and does not
require collateral. Overall concentrations of credit risk with respect to
receivables, except for the customers discussed below, are limited because of
the large number of customers in the Company's customer base, the relatively
small dollar amount of individual customer balances and their dispersion across
many different industries and geographic areas. The Company maintains an
allowance for doubtful accounts which was $0.4 million and $0.2 million as of
December 31, 1998 and 1997, respectively, to reserve for potential credit
losses, which have historically been within management's expectations.
As of December 31, 1998 and 1997, balances due from BellSouth Advertising and
Publishing represented 21% and 22%, respectively, of the Company's accounts
receivable. No other customer represented more than 10% of the Company's
accounts receivable as of December 31, 1998 or 1997.
For the year ended December 31, 1998, a major customer accounted for 12% of
monetary revenues. For the year ended December 31, 1997, a major customer
accounted for 11% of the monetary revenues while another major customer
accounted for 10% of monetary revenues. No other customer accounted for greater
than 10% of monetary revenues for any of the three years ended December 31,
1998.
13. Management Plans
The Company has reported a net loss of approximately $59.6 million for the
year ended December 31, 1998, incurred accumulated losses from inception to
December 31, 1998 aggregating to approximately $148.9 million, and reported
negative cash flows from operations for the year ended December 31, 1998 of
approximately $23.4 million and a capital deficiency of $71.5 million. The
Company's 1999 operating plan contemplates focusing activities to expand
revenues at the Company's IT Network division and successfully launch its
VirtualModem(TM) and Interactive Channel products. Based on its plan, management
expects to be able to meet its current maturing obligations through the end of
1999; however, there can be no assurance that the Company will be
F-19
<PAGE>
successful in its attempt to expand monetary revenues, successfully launch its
VirtualModem(TM) and Interactive Channel products, secure additional financing,
or consummate a strategic alternative. Since the development of the 1999
operating plan, the Company executed a Letter of Intent with Prevue. Management
intends to finalize the Prevue transaction. If management's plans are not
successful, management may not be able to secure additional financing or
consummate a strategic alternative that would provide adequate working capital
to meet the requirements of existing obligations beginning in 2000.
14. Segment Reporting
The Company adopted Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information:" ("SFAS
131") in the year ended December 31, 1998.
In accordance with SFAS 131, the Company has identified two reportable
operating segments, IT Network and Interactive TV, for disclosure purposes.
These two segments are regularly reviewed by the Company's management for
determination of the allocation of resources to these businesses.
IT Network sells advertising and related support services to clients who
sponsor a promotional message with interactive content supplied primarily by IT
Network.
Interactive TV has designed and is developing proprietary software and
interactive programming services that can enable digital, two-way television
systems equipped with digital (or advanced analog) set-top boxes to deliver two-
way, interactive programming with the touch of a set-top remote or the use of a
wireless keyboard.
The total revenues, expenses and assets by reportable operating segments are
used in the Company's operations and do not include general corporate overhead
and assets not allocated to the operating units. These assets and expenses have
been separately disclosed for reconciliation purposes.
The following are operating results and certain other information by business
segment:
<TABLE>
<CAPTION>
Year Ended
December 31,
---------------------------------------
1996 1997 1998
---------------- ---------- ----------
(In thousands)
<S> <C> <C> <C>
Monetary revenues:
IT Network.................................................................. $ 7,543 $ 12,082 $ 24,244
Interactive TV.............................................................. 1,032 305 107
-------- -------- --------
Total monetary revenues....................................................... $ 8,575 $ 12,387 $ 24,351
======== ======== ========
Nonmonetary revenues:
IT Network.................................................................. $ 9,944 $ 6,044 $ 1,756
Interactive TV.............................................................. -- -- --
-------- -------- --------
Total nonmonetary revenues.................................................... $ 9,944 $ 6,044 $ 1,756
======== ======== ========
Net revenues:
IT Network.................................................................. $ 17,487 $ 18,126 $ 26,000
Interactive TV.............................................................. 1,032 305 107
-------- -------- --------
Total net revenues............................................................ $ 18,519 $ 18,431 $ 26,107
======== ======== ========
Operating loss:
IT Network.................................................................. $ (301) $ (163) $(29,475)
Interactive TV.............................................................. (10,311) (19,892) (11,325)
Corporate................................................................... (3,407) (4,435) (7,960)
-------- -------- --------
Total operating loss.......................................................... $(14,019) $(24,490) $(48,760)
======== ======== ========
Identifiable assets:
IT Network.................................................................. $ 6,482 $ 51,374 $ 19,408
Interactive TV.............................................................. 4,166 9,959 8,401
Corporate................................................................... 5,249 52,169 28,780
-------- -------- --------
Total identifiable assets..................................................... $ 15,897 $113,502 $ 56,589
======== ======== ========
Depreciation and amortization:
IT Network.................................................................. $ 361 $ 2,835 $ 5,684
Interactive TV.............................................................. 1,577 6,465 2,925
Corporate................................................................... -- -- 251
-------- -------- --------
Total depreciation and amortization........................................... $ 1,938 $ 9,300 $ 8,860
======== ======== ========
Capital expenditures:
IT Network.................................................................. $ 591 $ 2,838 $ 993
Interactive TV.............................................................. 2,088 1,944 432
Corporate................................................................... -- -- 85
-------- -------- --------
Total capital expenditures.................................................... $ 2,679 $ 4,782 $ 1,510
======== ======== ========
</TABLE>
F-20
<PAGE>
15. Subsequent Events
Proposed Transaction with Prevue
On February 11, 1999, the Company and Prevue executed a Letter of Intent to
enter into a joint venture, Newco. The Letter of Intent is subject to the
execution of definitive documentation, including representations and warranties,
covenants and conditions to closing. Although the transaction was not
consummated, the parties subsequently agreed that no damages would be payable by
either party to the other. See discussion of contingencies related to the Letter
of Intent in Note 3 -- Commitments and Contingencies.
Joint Venture with Insight Interactive, LLC
On November 17, 1999 the Company conveyed certain assets related to the
"Virtual Modem" and "Interactive Channel" products and businesses to SourceSuite
LLC, a Delaware limited liability company (SourceSuite), in exchange for a 50%
ownership interest in SourceSuite. Insight Interactive, LLC contributed $13
million to SourceSuite in exchange for a 50% interest in SourceSuite. Insight
Interactive also acquired 842,105 shares of the Company's common stock,
representing approximately 6% of the Company's issued and outstanding stock, for
a purchase price of $12 million in cash. The Company also issued to Insight
Interactive five-year warrants to acquire up to 4,596,786 shares of the
Company's common stock at an exercise price of $20.00 per share.
Proposed sale of SourceSuite LLC to Liberate Technologies
On January 12, 2000 the Company, Insight Communications Company, Inc. and
SourceSuite entered into a definitive agreement with Liberate Technologies, Inc.
(Liberate) to sell their interests in SourceSuite to Liberate in exchange for
886,000 shares of common stock in Liberate. The agreement with Liberate provides
for the Company to receive 443,000 shares of common stock if the transaction
with Liberate satisfies an exemption from Securities Act registration that
permits the free transfer the Liberate shares subject to volume limitations of
Rule 144. If the transaction does not satisfy this exemption, then the Company
will receive $15 million of cash and 378,536 shares of Liberate common stock.
Prior to the sale of SourceSuite, certain assets of SourceSuite will be
contributed to a new company, SourceSuite Acquisition LLC, of which the Company
and Insight Interactive will each own 50%. The company will also receive in cash
an amount equal to 50% of the cash and cash equivalents of SourceSuite at the
time of closing, reduced by a 50% share of the tax liability incurred by
SourceSuite upon the sale of the retained business, as defined below, to
SourceSuite Acquisition LLC. These funds will then be contributed by the Company
to SourceSuite Acquisition LLC. SourceSuite Acquisition LLC will purchase the
retained business which includes the interactive programming guide and related
content business from SourceSuite. The Company will act as a manager of
SourceSuite Acquisition and carry out the interactive programming guide and
related content business. Additionally, the Company will be required to provide
additional funding to SourceSuite Acquisition LLC in the event of a capital call
by SourceSuite Acquisition LLC.
Following the merger, Liberate will provide to SourceSuite Acquisition LLC
without charge, specific software development services for the Interactive
Channel products under a programming services agreement. SourceSuite Acquisition
LLC will enter into a preferred content provider agreement with Liberate. This
agreement will offer pricing incentives to Liberate customers that use
SourceSuite Acquisition LLC's local content services with the Virtual Modem
products.
The following unaudited pro forma summary consolidated statements of
operations for the three fiscal years ended December 31, 1998 reflect our
historical accounts for those periods, adjusted to give pro forma effect to the
transaction with Insight and the proposed subsequent sale of SourceSuite LLC as
if the transactions had occurred as of January 1, 1996.
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
(In thousands, except for per December 31, December 31, December 31,
share amounts) 1998 1997 1996
<S> <C> <C> <C>
Pro forma net sales $ 26,000 $ 18,126 $ 17,486
Pro forma operating loss (35,493) (7,375) (6,430)
Pro forma net loss
attributable to common (52,457) (20,467) (10,729)
shareholders (1)
Pro forma basic and dilutive
loss per common share $ (4.08) $ (1.57) $ (1.00)
</TABLE>
F-21
<PAGE>
<TABLE>
<S> <C> <C> <C>
Weighted average common shares
outstanding 12,854 12,196 10,777
</TABLE>
(1) 1998 amount includes $25.9 million for the write-off of impaired
intangible assets. See Note 2. 1997 includes $1.7 million of expense related to
the early extinguishment of debt.
F-22
<PAGE>
Part I - Financial Information
Source Media, Inc.
Consolidated Balance Sheets
(In Thousands)
(Unaudited)
<TABLE>
<CAPTION>
December 31, September 30,
1998 1999
------------------- ----------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $11,662 $5,768
Restricted investments 11,716 6,011
Trade accounts receivable, less allowance
for doubtful accounts of $387 and $742
in 1998 and 1999, respectively 3,596 1,491
Deferred expenses 447 501
Prepaid expenses and other current assets 937 996
------------------- ----------------
Total current assets 28,358 14,767
Property and equipment:
Production equipment 6,050 6,776
Computer equipment 3,273 3,467
Other equipment 1,150 1,401
Furniture and fixtures 660 656
------------------- ----------------
11,133 12,300
Accumulated depreciation 6,733 8,765
------------------- ----------------
Net property and equipment 4,400 3,535
Intangible assets:
Patents 14,945 14,945
Goodwill 6,698 6,698
Contract rights 11,933 11,933
------------------- ----------------
33,576 33,576
Accumulated amortization 14,557 18,266
------------------- ----------------
Net intangible assets 19,019 15,310
Other non-current assets 4,812 4,571
------------------- ----------------
Total assets $56,589 $38,183
=================== ================
</TABLE>
F-23
<PAGE>
Source Media, Inc.
Consolidated Balance Sheets (continued)
(In Thousands)
(Unaudited)
<TABLE>
<CAPTION>
December 31, September 30,
1998 1999
------------------ ---------------------
<S> <C> <C>
Liabilities and Stockholders' Equity (Capital Deficiency)
Current liabilities:
Trade accounts payable $ 2,501 $ 826
Accrued interest 2,000 5,000
Accrued payroll 540 1,101
Other accrued liabilities 1,619 4,648
Unearned income 1,750 2,352
------------------ ---------------------
Total current liabilities 8,410 13,927
Long-term debt 100,000 100,000
Minority interests in consolidated subsidiaries 3,840 3,840
Note receivable and accrued interest from minority
stockholder, net of discount of $53 and
$22 in 1998 and 1999, respectively (780) (823)
------------------ ---------------------
3,060 3,017
Senior redeemable payment-in-kind (PIK) preferred stock,
$25 liquidation preference, $.001 par value, net of
discount
Authorized shares - 1,712; Issued and outstanding
shares 914 and 1009 in 1998 and 1999, respectively 16,628 18,061
Stockholders' equity (capital deficiency):
Common stock, $.001 par value:
Authorized shares - 50,000
Issued shares - 13,021 and 13,914 in 1998
and 1999, respectively 13 14
Less treasury stock, at cost - 280 and 275 in 1998
and 1999, respectively (2,770) (2,716)
Capital in excess of par value 80,269 84,238
Accumulated deficit (148,943) (178,358)
Notes receivable and accrued interest
from stockholders (78) 0
------------------ ---------------------
Total stockholders' equity (capital deficiency) (71,509) (96,822)
------------------ ---------------------
Total liabilities and stockholders' equity (capital deficiency) $ 56,589 $ 38,183
================== =====================
See accompanying notes.
</TABLE>
F-24
<PAGE>
Source Media, Inc.
Consolidated Statements of Operations
(In Thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Quarter Quarter Nine Months Nine Months
ended ended ended ended
September 30, September 30, September 30, September 30,
1998 1999 1998 1999
-------------------------------------- ----------------------------------
<S> <C> <C> <C> <C>
Monetary revenues $6,344 $4,275 $17,335 $13,624
Nonmonetary revenues 377 555 1,490 1,437
-------------------------------------- ----------------------------------
Total revenues 6,721 4,830 18,825 15,061
Monetary cost of sales 3,480 3,085 8,784 9,826
Nonmonetary cost of sales 377 555 1,490 1,437
-------------------------------------- ----------------------------------
Total cost of sales 3,857 3,640 10,274 11,263
-------------------------------------- ----------------------------------
Gross profit 2,864 1,190 8,551 3,798
Selling, general and administrative expenses 6,493 4,122 17,827 18,223
Impairment of intangible assets 0 0 25,936 0
Amortization of intangible assets 1,237 1,236 5,084 3,709
Research and development expenses 917 783 2,614 2,302
-------------------------------------- ----------------------------------
8,647 6,141 51,461 24,234
-------------------------------------- ----------------------------------
Operating loss (5,783) (4,951) (42,910) (20,436)
Interest expense 3,191 3,208 9,601 9,621
Interest income (456) (104) (1,598) (640)
Other (income) expense 13 0 (27) (2)
Net loss ($8,531) ($8,055) ($50,886) ($29,415)
====================================== ==================================
Preferred stock dividends 734 4 2,314 1,433
Net loss attributable to common stockholders (9,265) (8,059) (53,200) (30,848)
====================================== ==================================
Basic and diluted net loss per common share ($0.76) ($0.60) ($4.51) ($2.32)
====================================== ==================================
Weighted average common shares outstanding 12,195 13,499 11,792 13,285
====================================== ==================================
</TABLE>
See accompanying notes.
F-25
<PAGE>
Source Media, Inc.
Consolidated Statements of Cash Flows
(In Thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
1998 1999
------------ ---------------
<S> <C> <C>
Operating Activities
Net loss ($50,886) ($29,415)
Adjustments to reconcile net loss to net cash used in
operating activities:
Impairment of intangible assets 25,936 - -
Depreciation 1,884 2,032
Amortization of intangible assets 5,084 3,709
Stock based compensation 1,752 894
Non-cash interest expense 602 619
Non-cash interest income (818) (296)
Provision for losses on accounts receivable 251 250
Other, net (46) (43)
Changes in operating assets and liabilities:
Trade accounts receivable (1,786) 1,854
Prepaid expenses and other assets (43) (436)
Deferred expenses 484 (54)
Trade accounts payable and accrued liabilities 2,534 4,915
Unearned income (788) 602
------------ ---------------
Net cash used in operating activities (15,840) (15,369)
Investing Activities
Capital expenditures (1,225) (1,166)
Redemption of short-term investments 17,932 6,000
------------ ---------------
Net cash provided by investing activities 16,707 4,834
Financing Activities
Proceeds from issuance of common stock upon exercise
of stock options and warrants 722 4,479
Other (160) 162
------------ ---------------
Net cash provided by financing activities 562 4,641
Net increase (decrease) in cash and cash equivalents 1,429 (5,894)
Cash and cash equivalents at beginning of period 8,431 11,662
------------ ---------------
Cash and cash equivalents at end of period $9,860 $5,768
============ ===============
</TABLE>
See accompanying notes.
F-26
<PAGE>
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 subsidiaries, IT
Network, Inc. ("IT Network"), Interactive Channel, Inc. ("Interactive Channel"),
SMI Holdings, Inc. ("Holdings"), and Interactive Channel Technologies Inc.,
marketed under the name of VirtualModemTM ("ICT").
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 and nine months ended September 30, 1999
are not necessarily indicative of the results that may be expected for the year
ended December 31, 1999. The balance sheet at December 31, 1998 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, 1998.
Since its inception, the Company has financed its operations primarily with
$156.6 million raised from various financing activities, including the
incurrence of debt and issuance of the Company's common stock and preferred
stock. In October 1997, the Company issued $100.0 million of Senior Secured
Notes (the "Notes") and $20.0 million of preferred stock. The interest escrow
account created pursuant to the indenture has been and will be used to fund the
first four interest payments on the Notes. Interest payments from the interest
escrow account were made on May 1, 1998, November 1, 1998 and May 1, 1999. The
Company's primary source of liquidity is its cash, cash equivalents and
restricted investments, which totaled $11.8 million at September 30, 1999. This
cash position consisted of $6.0 million held in escrow for the November 1, 1999
interest payment and $5.8 million of cash available for operations. The
Company's first interest payment of $6.0 million not currently held in escrow is
due May 1, 2000.
The Company currently believes its resources will be sufficient to meet the
Company's anticipated cash needs for working capital and other capital
expenditures related to the Company's business and operations through the fourth
quarter of 1999. Upon the closing of a joint venture with a subsidiary of
Insight Communications Company, Inc., the cost of Interactive TV's operations
will be funded by the joint venture. Additionally, the Company will receive
$12.0 million cash from the sale of common stock related to the Insight
transaction which is expected to adequately fund the
F-27
<PAGE>
Company's continuing operations for approximately twelve months and the interest
payment on its debt, due on May 1, 2000. If the Insight transaction is not
approved the Company would be required to seek alternative financing. There can
be no assurance that the Company will be able to obtain such financing.
2. Computation of Net Loss Per Common Share
Net loss per common share is calculated in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share". Dilutive
earnings per share has not been presented because the options and warrants are
anti-dilutive.
3. Translation of Foreign Currencies
The financial positions and results of operations of ICT and related
Canadian subsidiaries are measured using local currency (Canadian dollar) as the
functional currency. Assets and liabilities of these subsidiaries are
translated at the exchange rate in effect at each balance sheet date. Statement
of operations accounts are translated at the average rate of exchange prevailing
during the period. Translation adjustments and foreign currency gains and
losses have not been significant and accordingly, have not been separately
presented.
4. Commitments and Contingencies
Interactive Channel Technologies Inc. and SMI Holdings, Inc. 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 plaintiffs and Source Media, Inc. for, among other things, unfair
competition, interference with contract, and trade secret misappropriation. The
Counterclaim defendants have denied the allegations in the Counterclaim and on
July 27, 1998 filed a motion to dismiss certain of Worldgate's claims. The
motion was denied by Order of the Court dated May 17, 1999.
The Court held a status conference on May 13, 1999. The following
deadlines for the disposition of the case were set by the Court:
Joinder of Parties and Amendment of Pleadings December 1, 1999
Close of Fact Discovery May 12, 2000
Close of Expert Discovery July 14, 2000
Deadline for Dispositive Motions July 21, 2000
Trial November 27, 2000
Pursuant to the Scheduling Order, limited discovery commenced on August 16,
1999. Full-scale discovery commenced on October 1, 1999. Both parties have
propounded discovery requests, responses to which are due on or before December
1, 1999.
F-28
<PAGE>
On July 17, 1998, IT Network, Inc. ("ITN") filed a lawsuit against a former
employee of Brite Voice Systems, Inc. ("Brite"), Michael Shell ("Shell"), the
two companies he founded Interactive Media Services, Inc. ("IMS") and
Interactive Information Services, LLC ("IIS"), and a third company called
Talking Directories, Inc. ("TDI"). The lawsuit was filed in the Western
District of Michigan and alleged two causes of action, one for the copyright
infringement against all of the defendants arising out of the defendants'
alleged use of ITN's 1997 BDR Audio Guide (the "Catalogue") and the thousands of
narrative scripts that correspond to the subject matter categories contained in
the Catalogue (the "Scripts"), and a second for breach of contract against TDI
arising out of TDI's alleged wrongful termination of its information services
contract with ITN. As of September 30, 1999, the litigation was settled with
respect to all defendants.
A total of fourteen class action complaints were filed against Source
Media, Inc. ("SMI") and certain of its 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 and Rule 10b-5 of the
accompanying regulations. The fourteen complaints were consolidated by Judge
Buchmeyer into the first filed case, Hartsell, et al. v. Source Media, Inc., et
al., Civil Action No. 398-CV-1980-R (filed August 21, 1998), on October 9, 1998.
Plaintiffs filed a motion for the appointment of lead plaintiff and lead
plaintiffs' counsel on October 20, 1998. Plaintiff proposed the appointment of
three law firms to serve as "Co-Lead Counsel," Weiss & Yourman, Abbey, Gardy &
Squitieri, and Milberg Weiss Bershad Hynes & Lerach, LLC. On November 12, 1998,
defendants filed a statement of non-opposition to the plaintiffs' motion. The
Court granted plaintiffs' motion on January 5, 1999.
Pursuant to an Order entered by the Court on February 24, 1999, plaintiffs'
time for filing the consolidated amended complaint was extended from February
24, 1999 to March 3, 1999. Plaintiffs filed their amended complaint on March 3,
1999. Defendants filed a motion to dismiss on April 19,1999, plaintiffs filed
an opposition to the motion on May 24, 1999, and defendants filed a reply brief
on June 12, 1999. A hearing on the motion to dismiss was held on July 15, 1999.
By Order dated July 15, 1999, the Court denied defendants' motion.
On July 26, 1999, defendants filed an Application For Immediate Appellate
Review Under 28 U.S.C. (S) 1292(b) concerning two issues central to the Court's
denial of defendants' motion to dismiss. Plaintiffs filed an opposition on or
about August 13, 1999. By Order dated August 24, 1999, the Court denied
defendants' motion.
On August 16, 1999, plaintiffs filed a complaint against Ernst & Young,
LLP, Source Media, Inc.'s outside accountants, alleging violations of the
federal securities laws (the "E&Y Complaint"). The facts and circumstances
underlying the E&Y Complaint are nearly identical to those underlying the
amended complaint. By Order dated August 31,
F-29
<PAGE>
1999, the Court consolidated the E&Y Complaint with the amended complaint. Ernst
& Young moved to dismiss the E&Y Complaint on September 21, 1999, plaintiffs
filed an opposition to the motion on October 28, 1999 and defendants' reply
brief is due on November 19, 1999.
The Court held a status conference on October 8, 1999. In light of the E&Y
Complaint and the resurrection of the mandatory discovery stay as to Ernst &
Young, the Court continued the trial date in the case until October 2, 2000.
Plaintiffs and defendants have submitted alternative scheduling proposals to the
Court regarding deadlines for discovery and dispositive motions. To date, the
Court has not issued a revised scheduling order. Discovery is proceeding.
On October 27, 1999, plaintiffs filed a Summary Notice of Pendency of Class
Action advising class members of the pendency of the litigation. Plaintiffs
filed a proposed Order Approving Class Notices on November 5, 1999. The
proposed Order has not yet been signed by the Court.
On October 6, 1998, Advanced Interactive, Inc. filed a complaint in U.S.
District Court for the Northern District of Illinois, Eastern Division, against
ICT and the following companies: Matsushita Electric Corporation, Matsushita
Electric Industrial Co., Ltd., Sharp Electronics Corp., Sharp Corp., Thomson
Consumer Electronics, Toshiba Consumer Products, Inc., Toshiba America, Inc.,
Toshiba Corporation, General Instruments Corp., Scientific Atlanta, Inc., ATI
Technologies, Inc., ADS Technologies Inc., Gateway 2000, Inc., STB Systems,
Inc., Hauppauge Computer Works, Inc., WebTV Networks, Inc. and WorldGate
Communications, Inc. (collectively the "Advanced Interactive Defendants").
Advanced Interactive alleges that ICT infringed two claims of one of its patents
by manufacturing, using and/or selling or offering to sell "Sourceware(TM)
ChannelLink(TM)". The same allegation is made against each Advanced Interactive
Defendant for its particular product or service. The Plaintiff seeks damages,
but makes no claims against the patents of ICT or any other Advanced Interactive
Defendant. ICT, 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. The court has not
yet considered the Advanced Interactive Defendant's collective Motion for
Partial Summary Judgment. The Company believes this case is totally without
merit and intends to vigorously defend itself.
On August 3, 1999, the Company announced that it had filed an action in the
District Court of Dallas County, Texas against TV Guide, Inc. for breach of a
Non-Disclosure Agreement entered into in September 1998. The petition sought
damages of approximately $60 million representing the decline in share value
caused by improper statements made by TV Guide and an injunction precluding TV
Guide from any further violations of the Non-Disclosure Agreement. The parties
entered into a settlement agreement and release effective August 31, 1999
pursuant to which TV Guide affirmed and agreed to honor the terms of the Non-
Disclosure Agreement.
F-30
<PAGE>
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.
As part of the Company's review of its booking performance against customer
sales guarantees, the Company anticipates a shortfall on several contracts. In
connection with these guarantees, the Company has recorded a $0.2 million
expense in the third quarter for a total expense of $1.6 million for the nine
months ended September 30, 1999.
The Company has employment agreements with two executives. 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. One contract terminates in 2001 and the other in 2002.
In the second quarter, the Company entered into severance agreements with
certain executives that provide for salary continuation for up to six months and
Company payment of health insurance premiums.
5. 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, representing funds sufficient, together with interest thereon, to pay
the first four interest payments on the Notes. At September 30, 1999, $6.0
million remains in escrow to pay the interest due November 1, 1999.
The Notes are fully and unconditionally guaranteed, jointly and severally,
by each of the Company's subsidiaries (the "Subsidiary Guarantors"). The
guarantees are senior obligations of the Subsidiary Guarantors and are secured
by substantially all of the assets of the Subsidiary Guarantors. The guarantees
rank pari passu in right of payment with all existing and future senior
indebtedness of the Subsidiary Guarantors and rank senior in right of payment to
all existing and future subordinated obligations of the Subsidiary Guarantors.
The guarantees may be released upon the occurrence of certain events. The
guarantee executed by IT Network contains a covenant that restricts payments of
dividends on its capital stock to an amount sufficient to cover debt service on
the Notes, redemptions or repurchases of the Notes or the Company's Senior PIK
Preferred Stock (the "Preferred Stock"), dividends on the Preferred Stock and
corporate overhead. The
F-31
<PAGE>
assets of Source Media consist solely of investments in its subsidiaries and
invested proceeds from the Notes and the Preferred Stock and related warrants.
Financial statements for the Subsidiary Guarantors and the parent, Source Media,
Inc., on an unconsolidated basis, are not presented because management has
determined that they would not be material to investors.
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
September 30, 1999, the dealer quoted value of a Note was $0.38 per dollar
resulting in an aggregate fair market value of approximately $38.0 million.
6. 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, on
any dividend payment date occurring on or prior to November 1, 2002, dividends
may be paid either in cash or by the issuance of additional shares of Preferred
Stock with a liquidation preference equal to the amount of such dividends;
thereafter, dividends will be paid in cash. The certificate of designation
governing the terms of the Preferred Stock limits the amount of cash dividends
that may be paid on the Preferred Stock. At any time and from
F-32
<PAGE>
time to time on or prior to November 1, 2000, the Company may, subject to
certain requirements, redeem up to 35% of the aggregate liquidation value of the
Preferred Stock with the cash proceeds of one or more equity offerings at a
redemption price equal to 113 1/2% of the liquidation preference thereof, plus
accumulated dividends, on the date of redemption. After November 1, 2000 and
prior to November 1, 2002, the Preferred Stock is not redeemable. On or after
November 1, 2002, the Company may redeem the Preferred Stock, in whole or in
part, at any time, at various redemption prices, plus accumulated and unpaid
dividends, to the date of redemption. Upon the occurrence of a change in
control, the Company will be required to make an offer to purchase the
outstanding shares of the Preferred Stock at a price equal to 101% of the
liquidation preference thereof, plus accumulated and unpaid dividends, to the
date of purchase. The Preferred Stock will be subject to mandatory redemption in
whole on November 1, 2007, at a price equal to 100% of the then effective
liquidation preference thereof, plus, without duplication, all accrued and
unpaid dividends to the date of redemption. The certificate of designation
contains certain covenants including, but not limited to, limitations on
indebtedness, restricted payments, affiliate transactions, issuances of capital
stock of restricted subsidiaries and sale/leaseback transactions.
The Preferred Stock ranks senior to all classes of common stock and to each
other class of capital stock or series of preferred stock with respect to
dividend rights and rights on liquidation, winding-up and dissolution of the
Company. The Preferred Stock is non-voting except in certain circumstances. The
Company may not authorize any new class of preferred stock that ranks senior or
pari passu to the Preferred Stock without the approval of the holders of at
least a majority of the shares of Preferred Stock then outstanding, voting or
consenting, as the case may be, as one class, provided, however, that the
Company can issue additional shares of Preferred Stock to satisfy dividend
payments on outstanding shares of Preferred Stock; and further provided that the
Company can issue shares of preferred stock ranking pari passu with the
Preferred Stock if after giving effect thereto, the Consolidated Coverage Ratio,
as defined in the certificate of designation, is greater than 1.7 to 1.0.
The estimated fair market value of the October 1997 Warrants, which was
estimated to be approximately $5.5 million, was credited to capital in excess of
par value and the Preferred Stock was recorded at a corresponding discount.
Additionally, $1.2 million of issuance costs were recorded on the Preferred
Stock. The discount and issuance costs on the Preferred Stock are being accreted
as additional preferred stock dividends using the effective dividend rate method
over a ten-year period, resulting in an effective dividend rate of 19.9%. As of
September 30, 1999 the dealer quoted fair market value of the preferred stock
was $5.00 per share for an aggregate value of $5.0 million.
On February 1, May 1 and August 1, 1999 the quarterly dividends due on the
Preferred Stock were paid through the issuance of additional Preferred Stock
having a liquidation preference of $0.8 million for each dividend payment, 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, May 1 and August 1,
1999 was approximately $0.5 million, $0.6 million and $0.1 million,
respectively, which was recorded as preferred
F-33
<PAGE>
stock dividends.
7. Stock Based Compensation
The Company has granted stock options to employees in excess of shares
reserved for issuance under the stock option plan at the date of grant. The
portion of unauthorized options are treated as a variable compensation plan
through the date an amendment to the stock option plan increasing the number of
shares is approved by shareholders. The Company recognizes stock compensation
expense over the vesting period of the related options. Total non-cash stock
based compensation expense for the three month period ended September 30, 1998
was $1.1 million, with income of $0.3 million for the three month period ended
September 30, 1999 due to a decline in the stock price. Total expense amounted
to $1.8 million and $0.9 million, respectively for the nine month periods ended
September 30, 1998 and 1999.
8. Segment Reporting
The Company adopted Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("SFAS
131") in the year ended December 31, 1998.
In accordance with SFAS 131, the Company has identified two reportable
operating segments, IT Network and Interactive TV, for disclosure purposes.
These two segments are regularly reviewed by the Company's management for
determination of the allocation of resources to these businesses.
IT Network sells advertising and related support services to clients who
sponsor a promotional message with interactive content supplied primarily by IT
Network.
Interactive TV has designed and is developing proprietary software and
interactive programming services that can enable digital, two-way television
systems equipped with digital (or advanced analog) set-top boxes to deliver two-
way, interactive programming with the touch of a set-top remote or the use of a
wireless keyboard.
The total revenues, expenses and assets by reportable operating segments
are used in the Company's operations and do not include general corporate
overhead and assets not allocated to the operating units. These assets and
expenses have been separately disclosed for reconciliation purposes.
F-34
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
1998 1999 1998 1999
---- ---- ----- ----
(In Thousands) (In Thousands)
<S> <C> <C> <C> <C>
Monetary revenues:
IT Network $ 6,243 $ 4,275 $ 17,148 $ 13,582
Interactive TV 100 - 187 42
------- ------- -------- --------
Total monetary revenues $ 6,343 $ 4,275 $ 17,335 $ 13,624
======= ======= ======== ========
Nonmonetary revenues:
IT Network $ 377 $ 555 $ 1,490 $ 1,437
Interactive TV - - - -
------- ------- -------- --------
Total nonmonetary revenues $ 377 $ 555 $ 1,490 $ 1,437
======= ======= ======== ========
Net revenues:
IT Network $ 6,620 $ 4,830 $ 18,638 $ 15,019
Interactive TV 100 - 187 42
------- ------- -------- --------
Total net revenues $ 6,720 $ 4,830 $ 18,825 $ 15,061
======= ======= ======== ========
Operating loss:
IT Network $ (614) $(1,617) $(28,779) $ (5,372)
Interactive TV (2,759) (2,598) (8,733) (8,053)
Corporate $(2,407) (930) (5,398) (7,011)
------- ------- -------- --------
Total operating loss $(5,780) $(5,145) $(42,910) $(20,436)
======= ======= ======== ========
December 31, 1998 September 30, 1999
-------------- -------------------
Identifiable assets:
IT Network $19,408 $ 16,784
Interactive TV 8,401 6,868
Corporate 28,780 14,531
------- --------
Total identifiable assets $56,589 $ 38,183
======= ========
</TABLE>
On October 30, 1997, the Company purchased certain of the electronic
publishing assets of Brite for $35.6 million and certain of the assets of VNN, a
unit of Tribune Company, for $9.0 million. Throughout the second quarter of
1998, a significant portion of the customer contracts purchased in the Brite
acquisition were cancelled or not renewed. As a result, the Company reviewed
the value assigned to the contract rights and certain related intangible assets
acquired in the Brite purchase and found them, along with the goodwill
associated with the Brite acquisition, to be impaired, resulting in a write-off
of $25.9 million in the second quarter of 1998.
F-35
<PAGE>
9. Subsequent Events
Proposed Transaction with Prevue
On February 11, 1999, the Company and Prevue executed a Letter of Intent to
enter into a joint venture, Newco. The Letter of Intent is subject to the
execution of definitive documentation, including representations and warranties,
covenants and conditions to closing. Although the transaction was not
consummated, the parties subsequently agreed that no damages would be payable by
either party to the other. See discussion of contingencies related to the Letter
of Intent in Note 3 -- Commitments and Contingencies.
Joint Venture with Insight Interactive, LLC
On November 17, 1999 the Company conveyed certain assets related to the
"Virtual Modem" and "Interactive Channel" products and businesses to SourceSuite
LLC, a Delaware limited liability company (SourceSuite), in exchange for a 50%
ownership interest in SourceSuite. Insight Interactive, LLC contributed $13
million to SourceSuite in exchange for a 50% interest in SourceSuite. Insight
Interactive also acquired 842,105 shares of the Company's common stock,
representing approximately 6% of the Company's issued and outstanding stock, for
a purchase price of $12 million in cash. The Company also issued to Insight
Interactive five-year warrants to acquire up to 4,596,786 shares of the
Company's common stock at an exercise price of $20.00 per share.
Proposed Sale of SourceSuite LLC to Liberate Technologies
On January 12, 2000 the Company, Insight Communications Company, Inc. and
SourceSuite entered into a definitive agreement with Liberate Technologies, Inc.
(Liberate) to sell their interests in SourceSuite to Liberate in exchange for
886,000 shares of common stock in Liberate. The agreement with Liberate provides
for the Company to receive 443,000 shares of common stock if the transaction
with Liberate satisfies an exemption from Securities Act registration that
permits the free transfer the Liberate shares subject to volume limitations of
Rule 144. If the transaction does not satisfy this exemption, then the Company
will receive $15 million of cash and 378,536 shares of Liberate common stock.
Prior to the sale of SourceSuite, certain assets of SourceSuite will be
contributed to a new company, SourceSuite Acquisition LLC, of which the Company
and Insight Interactive will each own 50%. The company will also receive in cash
an amount equal to 50% of the cash and cash equivalents of SourceSuite at the
time of closing, reduced by a 50% share of the tax liability incurred by
SourceSuite upon the sale of the retained business, as defined below, to
SourceSuite Acquisition LLC. These funds will then be contributed by the Company
to SourceSuite Acquisition LLC. SourceSuite Acquisition LLC will purchase the
retained business which includes the interactive programming guide and related
content business from SourceSuite. The Company will act as a manager of
SourceSuite Acquisition and carry out the interactive programming guide and
related content business. Additionally, the Company will be
F-36
<PAGE>
required to provide additional funding to SourceSuite Acquisition LLC in the
event of a capital call by SourceSuite Acquisition LLC.
Following the merger, Liberate will provide to SourceSuite Acquisition LLC
without charge, specific software development services for the Interactive
Channel products under a programming services agreement. SourceSuite Acquisition
LLC will enter into a preferred content provider agreement with Liberate. This
agreement will offer pricing incentives to Liberate customers that use
SourceSuite Acquisition LLC's local content services with the Virtual Modem
products.
F-37
<PAGE>
INDEX TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Pro Forma Financial Data P-2
<S> <C>
Unaudited Pro Forma Consolidated Balance Sheet as of September 30, 1999 P-3
Unaudited Pro Forma Consolidated Statement of Operations for the Nine Months
ended September 30, 1999 P-5
Unaudited Pro Forma Consolidated Statement of Operations for the
Year ended December 31, 1998 P-6
Footnotes to Unaudited Pro Forma Consolidated Balance Sheet and Footnotes
to Unaudited Pro Forma Consolidated Statements of Operations P-7
</TABLE>
P-1
<PAGE>
Pro Forma Financial Data
The following unaudited pro forma consolidated balance sheet as of
September 30, 1999 reflects our historical accounts as of that date adjusted to
give pro forma effect to the Insight transaction and the proposed transaction
with Liberate and the proposed offers to exchange Common Stock for 12% Senior
Secured Notes due 2004 and Senior PIK Preferred Stock as if the transactions had
occurred as of September 30, 1999.
The following unaudited pro forma consolidated statements of operations for
the fiscal year ended December 31, 1998 and the nine months ended September 30,
1999 reflect our historical accounts for those periods, adjusted to give pro
forma effect to the Insight transaction and the proposed transaction with
Liberate and the proposed offers to exchange Common Stock for 12% Senior Secured
Notes due 2004 and Senior PIK Preferred Stock as if the proposed transactions
had occurred as of January 1, 1998.
The result of the proposed offers to exchange common stock for 12% Senior
Secured Notes due 2004 and Senior PIK Preferred Stock may result in a partial
exchange and, as such, we have given the pro forma effect of the minimum
conversion representing: 55% of the outstanding 12% Senior Secured Notes due
2004 comprised of 10% held by an affiliate and 45% representing the minimum
amount required to approve the exchange and; 50% for Senior PIK Preferred Stock.
The pro forma financial data and accompanying notes should be read in
conjunction with the description of the proposed transaction with Liberate and
the proposed offers to exchange Common Stock for 12% Senior Secured Notes due
2004 and Senior PIK Preferred Stock contained in the prospectus dated January
19, 2000 and the Consolidated Financial Statements and related notes for the
fiscal year ended December 31, 1998 included in this prospectus and our Annual
Report on Form 10-K for the fiscal year ended December 31, 1998, and the Form
10-Q for the nine months ended September 30, 1999. We believe that the
assumptions used in the following statements provide a reasonable basis on which
to present the pro forma financial data. The pro forma financial data is
provided for informational purposes only and should not be construed to be
indicative of our financial condition or results of operations had the Insight
transaction and the proposed transaction with Liberate and the proposed offer to
exchange Common Stock for 12% Senior Secured Notes due 2004 and Senior PIK
Preferred Stock been consummated on the dates assumed and are not intended to
project our financial condition on any future date or results of operations for
any future period.
P-2
<PAGE>
Source Media, Inc.
Pro Forma Consolidated Balance Sheet
Unaudited
As of September 30, 1999
(In thousands)
<TABLE>
<CAPTION>
Insight Liberate
Pro Forma Pro Forma Pro Forma
Historical Adjustments As adjusted Adjustments
---------- ----------- ----------- -----------
ASSETS
<S> <C> <C> <C> <C>
Current Assets:
Cash and cash equivalents ............... $ 5,768 $ 5,104(2)(1) $10,872 $ (733)(5)(6)(7)
Restricted investments .................. 6,011 6,000(2) 12,011 --
Trade accounts receivable, less allowance
for doubtful accounts of $647 ........ 1,491 -- 1,491 --
Deferred expenses ....................... 501 -- 501 --
Prepaid expenses and other current assets 996 -- 996 --
------------------------------------------------------------
Total current assets ....................... 14,767 11,104 25,871 (733)
Property and equipment:
Production equipment .................... 6,776 (1,910)(1) 4,866 --
Computer equipment ...................... 3,467 -- 3,467 --
Other equipment ......................... 1,401 -- 1,401 --
Furniture and fixtures .................. 656 -- 656 --
------------------------------------------------------------
12,300 (1,910) 10,390 --
Accumulated depreciation ................... 8,765 (1,314)(1) 7,451 --
------------------------------------------------------------
Net property and equipment ................. 3,535 (596) 2,939 --
Intangible assets:
Patents ................................. 14,945 (14,945)(1) -- --
Goodwill ................................ 6,698 (3,010)(1) 3,688 --
Contract rights ......................... 11,933 -- 11,933 --
------------------------------------------------------------
33,576 (17,955) 15,621 --
Accumulated amortization ................... 18,266 (12,868)(1) 5,398 --
------------------------------------------------------------
Net intangible assets ...................... 15,310 (5,087) 10,223 --
Investment in SourceSuite .................. -- 20,061 1)(3) 20,061 (20,061)(6)
Investment in SourceSuite spin-off ......... -- -- -- 7,050(5)
Investment in Liberate Technologies, Inc. .. -- -- -- 97,460(6)
Other non-current assets ................... 4,571 (377)(1) 4,194 --
------------------------------------------------------------
Total assets ............................... $38,183 $25,105 $63,288 $83,716
============================================================
See accompanying Notes to Pro Forma Consolidated Balance Sheet.
</TABLE>
<TABLE>
<CAPTION>
Common Stock
Common Stock Minimum
Exchange Exchange
Pro Forma Pro Forma Pro Forma Pro Forma Pro Forma
As adjusted Adjustments As adjusted Adjustments As Adjusted
----------- ----------- ----------- ----------- -----------
ASSETS
<S> <C> <C> <C> <C> <C>
Current Assets:
Cash and cash equivalents ............... $ 10,139 $ 7,061 (10)(11)(13) $ 17,200 $ 3,456(16)(17)(19) $ 13,595
Restricted investments .................. 12,011 (12,011)(10) -- (6,606)(16) 5,405
Trade accounts receivable, less allowance
for doubtful accounts of $647 ........ 1,491 -- 1,491 -- 1,491
Deferred expenses ....................... 501 -- 501 -- 501
Prepaid expenses and other current assets 996 -- 996 -- 996
--------------------------------------------------------------------------
Total current assets ....................... 25,138 (4,950) 20,188 (3,150) 21,988
Property and equipment:
Production equipment .................... 4,866 -- 4,866 -- 4,866
Computer equipment ...................... 3,467 -- 3,467 -- 3,467
Other equipment ......................... 1,401 -- 1,401 -- 1,401
Furniture and fixtures .................. 656 -- 656 -- 656
--------------------------------------------------------------------------
10,390 -- 10,390 -- 10,390
Accumulated depreciation ................... 7,451 -- 7,451 -- 7,451
--------------------------------------------------------------------------
Net property and equipment ................. 2,939 -- 2,939 -- 2,939
Intangible assets:
Patents ................................. -- -- -- -- --
Goodwill ................................ 3,688 -- 3,688 -- 3,688
Contract rights ......................... 11,933 -- 11,933 -- 11,933
--------------------------------------------------------------------------
15,621 -- 15,621 -- 15,621
Accumulated amortization ................... 5,398 -- 5,398 -- 5,398
--------------------------------------------------------------------------
Net intangible assets ...................... 10,223 -- 10,223 -- 10,223
Investment in SourceSuite .................. -- -- -- -- --
Investment in SourceSuite spin-off ......... 7,050 7,050 7,050
Investment in Liberate Technologies, Inc. .. 97,460 97,460 97,460
Other non-current assets ................... 4,194 (4,194)(8) -- (2,307)(14) 1,887
--------------------------------------------------------------------------
Total assets ............................... $147,004 $ (9,144) $137,860 $(5,457) $141,547
==========================================================================
See accompanying Notes to Pro Forma Consolidated Balance Sheet.
</TABLE>
P-3
<PAGE>
Source Media, Inc.
Pro Forma Consolidated Balance Sheet
Unaudited (In thousands)
As of September 30, 1999
<TABLE>
<CAPTION>
Insight Liberate
Pro Forma Pro Forma Pro Forma
LIABILITIES Historical Adjustments As adjusted Adjustments
<S> <C> <C> <C> <C>
Current Liabilities:
Trade accounts payable $ 826 $ - $ 826 $ -
Accrued interest 5,000 - 5,000 -
Accrued payroll 1,101 - 1,101 -
Other accrued liabilities 4,648 - 4,648 -
Unearned income 2,352 - 2,352 -
---------------------------------------------------------------
Total current liabilities 13,927 - 13,927 -
Long-term debt 100,000 - 100,000 -
Deferred taxes - - - 33,368 (6)
Minority interests in consolidated subsidiaries 3,840 - 3,840 -
Note receivable and accrued interest from minority
stockholder, net of discount of $32 (823) - (823) -
--------------------------------------------------------------
3,017 - 3,017 -
Senior redeemable payment-in-kind (PIK) preferred
stock, $25 liquidation preference, $.001 par value,
net of discount
Authorized shares - 1,712
976 shares issued and outstanding 18,061 - 18,061 -
Non-participating preferred stock, $.001 par value
Authorized and issued - 1 single share - - (4)(3) - 0
Stockholders' equity (capital deficiency):
Common stock, $.001 par value:
authorized shares - 50,000 and
13,748 shares issued 14 1 (2) 15 -
Less treasury stock, at cost - 275 shares (2,716) - (2,716) -
Capital in excess of par value 84,432 25,799 (2)(3) 110,231 -
Accumulated deficit (178,552) (695) (179,247) 50,348 (5)(6)(7)
--------------------------------------------------------------
Total stockholders' equity (capital deficiency) (96,822) 25,105 (71,717) 50,348
--------------------------------------------------------------
Total liabilities and stockholders'
Equity (capital deficiency) $38,183 $25,105 $63,288 $83,716
==============================================================
Common Stock
Pro Forma Pro Forma Pro Forma
LIABILITIES As adjusted Adjustments As adjusted
Current Liabilities:
Trade accounts payable $ 826 $ - $ 826
Accrued interest 5,000 (5,000) (12) -
Accrued payroll 1,101 - 1,101
Other accrued liabilities 4,648 - 4,648
Unearned income 2,352 - 2,352
------------------------------------------------------------------------------
Total current liabilities 13,927 (5,000) 8,927
Long-term debt 100,000 (100,000) (8) -
Deferred taxes 33,368 33,368
Minority interests in consolidated subsidiaries 3,840 - 3,840
Note receivable and accrued interest from minority
stockholder, net of discount of $32 (823) - (823)
------------------------------------------------------------------------------
3,017 - 3,017
Senior redeemable payment-in-kind (PIK) preferred
stock, $25 liquidation preference, $.001 par value
net of discount
Authorized shares - 1,712
976 shares issued and outstanding 18,061 (18,061) (9) -
Non-participating preferred stock, $.001 par value
Authorized and issued - 1 single share - - -
Stockholders' equity (capital deficiency):
Common stock, $.001 par value:
authorized shares - 50,000 and
13,748 shares issued 15 6 (8)(9) 21
Less treasury stock, at cost - 275 shares (2,716) - (2,716)
Capital in excess of par value 110,231 124,394 (8)(9) 234,625
Accumulated deficit (128,899) (10,483) (8)(9)(11) (139,382)
(12)(13)
------------------------------------------------------------------------------
Total stockholders' equity (capital deficiency) (21,369) 113,917 92,548
------------------------------------------------------------------------------
Total liabilities and stockholders'
equity (capital deficiency) $147,004 $(9,144) $137,860
==============================================================================
Common Stock
Minimum Exchange
Pro Forma Pro Forma
LIABILITIES Adjustments As adjusted
Current Liabilities:
Trade accounts payable $ - $ 826
Accrued interest (2,750) (18) 2,250
Accrued payroll - 1,101
Other accrued liabilities - 4,648
Unearned income - 2,352
--------------------------------------------------------------
Total current liabilities (2,750) 11,177
Long-term debt (55,000) (14) 45,000
Deferred taxes 33,368
Minority interests in consolidated subsidiaries - 3,840
Note receivable and accrued interest from minority
stockholder, net of discount of $32 - (823)
--------------------------------------------------------------
- 3,017
Senior redeemable payment-in-kind (PIK) preferred
stock, $25 liquidation preference, $.001 par val
net of discount
Authorized shares - 1,712
976 shares issued and outstanding (9,031) (15) 9,030
Non-participating preferred stock, $.001 par value
Authorized and issued - 1 single share - -
Stockholders' equity (capital deficiency):
Common stock, $.001 par value:
authorized shares - 50,000 and
13,748 shares issued 4 (14)(15) 19
Less treasury stock, at cost - 275 shares - (2,716)
Capital in excess of par value 67,197 (14)(15) 177,428
Accumulated deficit (5,877) (14)(15)(17) (134,776)
(18)(19)
--------------------------------------------------------------
Total stockholders' equity (capital deficiency) 61,324 39,955
--------------------------------------------------------------
Total liabilities and stockholders'
equity (capital deficiency) $(5,457) $141,547
==============================================================
</TABLE>
See accompanying Notes to Pro Forma Consolidated Balance Sheet
P-4
<PAGE>
Source Media, Inc.
Pro Forma Consolidated Statement of Operations
Nine Months Ended September 30, 1999
Unaudited (In thousands, except
per share data)
<TABLE>
<CAPTION>
Insight Liberate
Pro Forma Pro Forma Pro Forma
Historical Adjustments As adjusted Adjustments
---------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Monetary revenues $ 13,624 $ (42) (1) $ 13,582 $ -
Nonmonetary revenues 1,437 - 1,437 -
-------------------------------- ----------------------------------
Total revenues 15,061 (42) 15,019 -
Monetary cost of sales 9,826 (754) (1) 9,072 -
Nonmonetary cost of sales 1,437 - 1,437 -
-------------------------------- ----------------------------------
Total cost of sales 11,263 (754) 10,509 -
-------------------------------- ----------------------------------
Gross profit 3,798 712 4,510 -
Selling, general and administrative expenses 18,223 (6,110) (1) 12,113 -
Amortization of intangible assets 3,709 (1,717) (1) 1,992 -
Research and development expenses 2,302 (2,302) (1) - -
-------------------------------- ----------------------------------
24,234 (10,129) 14,105 -
-------------------------------- ----------------------------------
Operating loss (20,436) 10,841 (9,595) -
Interest expense 9,621 - 9,621 -
Interest (income) (640) - (640) -
Other (income) expense (2) 1 (1) (1) -
Equity interest in losses of the joint venture - 7,491 (2)(3) 7,491 (4,776) (5)
-------------------------------- ----------------------------------
Net loss (29,415) 3,349 (26,065) 4,776
Preferred stock dividends 1,433 - 1,433 -
-------------------------------- ----------------------------------
Net loss attributable to common stockholders $(30,848) $3,349 $(27,498) $4,776
================================ ==================================
Basic and diluted net loss per common share $ (2.32) $ (1.95)
Weighted average common shares outstanding 13,285 842 (4) 14,127 0
================================ ==================================
<CAPTION>
Common Stock
Exchange
Pro Forma Pro Forma Pro Forma
As adjusted Adjustments As adjusted
----------- ----------- -----------
<S>
Monetary revenues $ 13,582 $ - $ 13,582
Nonmonetary revenues 1,437 - 1,437
---------------------------------------- ----------------------------
Total revenues 15,019 - 15,019
Monetary cost of sales 9,072 - 9,072
Nonmonetary cost of sales 1,437 - 1,437
---------------------------------------- ----------------------------
Total cost of sales 10,509 - 10,509
---------------------------------------- ----------------------------
Gross profit 4,510 - 4,510
Selling, general and administrative expenses 12,113 - 12,113
Amortization of intangible assets 1,992 - 1,992
Research and development expenses - - -
---------------------------------------- ----------------------------
14,105 - 14,105
---------------------------------------- ----------------------------
Operating loss (9,595) - (9,595)
Interest expense 9,621 (9,621) (6) -
Interest (income) (640) - (640)
Other (income) expense (1) - (1)
Equity interest in losses of the joint venture 2,715 - 2,715
---------------------------------------- ----------------------------
Net loss (21,289) 9,621 (11,668)
Preferred stock dividends 1,433 (1,433) (7) -
---------------------------------------- ----------------------------
Net loss attributable to common stockholders $(22,722) $11,054 $(11,668)
======================================== ============================
Basic and diluted net loss per common share $ (1.61) $ (0.57)
Weighted average common shares outstanding 14,127 6,304 (8) 20,431
======================================== ============================
<CAPTION>
----------------------------------------------------------
Common Stock
Minimum Exchange
Pro Forma Pro Forma
Adjustments As adjusted
----------- -----------
<S>
Monetary revenues $ - $ 13,582
Nonmonetary revenues - 1,437
----------------------- -----------------
Total revenues - 15,019
Monetary cost of sales - 9,072
Nonmonetary cost of sales - 1,437
----------------------- -----------------
Total cost of sales - 10,509
----------------------- -----------------
Gross profit - 4,510
Selling, general and administrative expenses - 12,113
Amortization of intangible assets - 1,992
Research and development expenses - -
----------------------- -----------------
- 14,105
----------------------- -----------------
Operating loss - (9,595)
Interest expense (5,292) (9) 4,329
Interest (income) - (640)
Other (income) expense - (1)
Equity interest in losses of the joint venture - 2,715
----------------------- -----------------
Net loss 5,292 (15,997)
Preferred stock dividends (717) (10) 717
----------------------- -----------------
Net loss attributable to common stockholders $6,008 $(16,714)
======================= =================
Basic and diluted net loss per common share $ (0.95)
Weighted average common shares outstanding 3,402 (11) 17,529
======================= =================
----------------------------------------------------------
</TABLE>
See accompanying Notes to Pro Forma Consolidated Income Statement.
P-5
<PAGE>
Source Media, Inc.
Pro Forma Consolidated Statement of Operations
Year Ended December 31, 1998
Unaudited (In thousands, except per share data)
<TABLE>
<CAPTION>
Insight Liberate
Pro Forma Pro Forma Pro Forma
Historical Adjustments As adjusted Adjustments
---------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Monetary revenues $ 24,351 $ (107) (1) $ 24,244 $ -
Nonmonetary revenues 1,756 - 1,756 -
----------------------------------- --------------------------------
Total revenues 26,107 (107) 26,000 -
Monetary cost of sales 12,674 (1,145) (1) 11,529 -
Nonmonetary cost of sales 1,756 - 1,756 -
----------------------------------- --------------------------------
Total cost of sales 14,430 (1,145) 13,285 -
----------------------------------- --------------------------------
Gross profit 11,677 1,038 12,715 -
Selling, general and administrative expenses 50,708 (6,535) (1) 44,173 -
Amortization of intangible assets 6,320 (2,285) (1) 4,035 -
Research and development expenses 3,410 (3,410) (1) - -
----------------------------------- --------------------------------
60,438 (12,230) 48,208 -
----------------------------------- --------------------------------
Operating loss (48,761) 13,268 (35,493) -
Interest expense 12,830 - 12,830 -
Interest (income) (1,931) - (1,931) -
Other (income) expense (27) 14 (1) (13) -
Equity interest in losses of the joint venture - 9,394 (2)(3) 9,394 (6,311) (5)
----------------------------------- --------------------------------
Net loss (59,633) 3,859 (55,772) 6,311
Preferred stock dividends 2,996 - 2,996 -
----------------------------------- --------------------------------
Net loss attributable to common stockholders $(62,629) $3,859 $(58,768) $6,311
=================================== ================================
Basic and diluted loss per common share $ (5.21) $ (4.57)
Weighted average common shares outstanding 12,012 842 (4) 12,854 0
=================================== ================================
<CAPTION>
Common Stock
Exchange
Pro Forma Pro Forma Pro Forma
As adjusted Adjustments As adjusted
----------- ----------- -----------
<S> <C> <C> <C>
Monetary revenues $ 24,244 $ - $ 24,244
Nonmonetary revenues 1,756 - 1,756
---------------------------------------- -----------------------
Total revenues 26,000 - 26,000
Monetary cost of sales 11,529 - 11,529
Nonmonetary cost of sales 1,756 - 1,756
---------------------------------------- -----------------------
Total cost of sales 13,285 - 13,285
---------------------------------------- -----------------------
Gross profit 12,715 - 12,715
Selling, general and administrative expenses 44,173 - 44,173
Amortization of intangible assets 4,035 - 4,035
Research and development expenses - - -
---------------------------------------- -----------------------
48,208 - 48,208
---------------------------------------- -----------------------
Operating loss (35,493) - (35,493)
Interest expense 12,830 (12,830) (6) -
Interest (income) (1,931) - (1,931)
Other (income) expense (13) - (13)
Equity interest in losses of the joint venture 3,083 - 3,083
---------------------------------------- -----------------------
Net loss (49,461) 12,830 (36,631)
Preferred stock dividends 2,996 (2,996) (7) -
---------------------------------------- -----------------------
Net loss attributable to common stockholders $(52,457) $15,826 $(36,631)
======================================== =======================
Basic and diluted net loss per common share $ (4.08) $ (1.91)
Weighted average common shares outstanding 12,854 6,304 (8) 19,158
======================================== =======================
<CAPTION>
--------------------------------------------------------
Common Stock
Minimum Exchange
Pro Forma Pro Forma
Adjustments As adjusted
----------- -----------
<S> <C> <C>
Monetary revenues $ - $ 24,244
Nonmonetary revenues - 1,756
-------------------------- -----------------
Total revenues - 26,000
Monetary cost of sales - 11,529
Nonmonetary cost of sales - 1,756
-------------------------- -----------------
Total cost of sales - 13,285
-------------------------- -----------------
Gross profit - 12,715
Selling, general and administrative expenses - 44,173
Amortization of intangible assets - 4,035
Research and development expenses - -
-------------------------- -----------------
- 48,208
-------------------------- -----------------
Operating loss - (35,493)
Interest expense (7,057) (9) 5,774
Interest (income) - (1,931)
Other (income) expense - (13)
Equity interest in losses of the joint venture - 3,083
-------------------------- -----------------
Net loss 7,057 (42,405)
Preferred stock dividends (1,498) (10) 1,498
-------------------------- -----------------
Net loss attributable to common stockholders $8,555 $(43,903)
========================== =================
Basic and diluted net loss per common share $ (2.70)
Weighted average common shares outstanding 3,402 (11) 16,256
========================== =================
--------------------------------------------------------
</TABLE>
See accompanying Notes to Pro Forma Consolidated Income Statement.
P-6
<PAGE>
Footnotes to Unaudited Pro Forma Consolidated Balance Sheet
(1) To reflect the elimination of assets and liabilities relating to and
resulting from the operations of the Interactive TV business which were
contributed in the transaction with Insight to form SourceSuite LLC on
November 17, 1999.
(2) To reflect the net proceeds from the sale of stock to Insight upon closing
the transaction with Insight of which $6 million was escrowed for the May
1, 2000 interest payment on the 12% Senior Secured Notes.
(3) To reflect the investment in SourceSuite LLC resulting from the transaction
with Insight. The value of the warrants issued to Insight (based upon the
Black-Scholes model) is credited to additional paid in capital.
(4) To reflect the issuance of a new Non-Participating Preferred Stock upon the
closing of the transaction with Insight. The new share of preferred stock
entitles Insight to designate a certain number of members of the Board of
Directors (based on Insight's ownership percentage of Source Media, Inc.
common stock), committee representation and preemptive rights to maintain
its ownership percentage.
(5) To reflect the proposed formation of SourceSuite Acquisition LLC and Source
Media's 50% proposed ownership in SourceSuite Acquisition LLC. The
investment includes a contribution by Source Media, Inc. to SourceSuite
Acquisition LLC of an amount of cash equivalent to 50% of the balance of
SourceSuite cash at the time of closing.
(6) To reflect the proposed sale of Source Media, Inc.'s investment in
SourceSuite LLC for 443,000 shares of Liberate common stock at an estimated
price at closing of $220 per share based on the January 11, 2000 closing
price and the related gain on the sale, net of applicable income taxes. We
are currently evaluating whether further limitations on the availability of
net operating losses ("NOL's") have or will occur as a result of these
transactions. For the purposes of these pro forma financial statements, we
have assumed an annual NOL limitation of $10 million. The agreement with
Liberate provides for our receiving 443,000 shares of common stock if the
transaction with Liberate satisfies an exemption from Securities Act
registration that permits us to freely transfer the Liberate shares subject
to volume limitations of Rule 144. If the transaction does not satisfy this
exemption, we will receive $15 million of cash and 378,536 shares of
Liberate common stock. For purposes of these pro forma financial
statements, we have assumed the transaction will satisfy the exemption. In
the event it would not satisfy the exemption and cash was received,
additional current tax liability may be incurred. Additionally, Source
Media, Inc. will receive from Liberate cash in an amount equal to 50% of
the cash and cash equivalents of SourceSuite LLC at the time of closing,
reduced by a 50% share of the tax liability incurred by SourceSuite LLC
upon the sale of the retained business to SourceSuite Acquisition LLC.
P-7
<PAGE>
(7) To reflect the costs incurred to complete the proposed sale of Source
Media, Inc.'s investment in SourceSuite LLC for 443,000 shares of Liberate
common stock.
(8) To reflect the proposed exchange of all outstanding Source Media, Inc. 12%
Senior Secured Notes in the principal amount of $100 million for 5,000,000
shares of common stock based on an assumed market price of Source Media,
Inc. stock of $20 per share at the time of exchange and the write-off of
the related deferred financing costs.
(9) To reflect the proposed exchange of 1,043,412 shares of Source Media, Inc.
Senior PIK Preferred Stock for 1,304,265 shares of Source Media, Inc.
common stock based on an assumed market price of Source Media, Inc. stock
of $20 per share at the time of exchange.
(10) To reflect the reclassification of cash held in escrow for interest
payments on Source Media, Inc. 12% Senior Secured Notes into unrestricted
cash upon completion of the proposed exchange of all outstanding Source
Media, Inc. 12% Senior Secured Notes.
(11) To reflect the costs incurred to complete the proposed issuance of
6,304,265 additional shares of common stock upon the conversion of
1,043,412 shares of Source Media, Inc. Senior PIK Preferred Stock and $100
million of 12% Senior Secured Notes to common stock.
(12) To reflect the elimination of accrued interest related to proposed exchange
of all outstanding Source Media, Inc. 12% Senior Secured Notes in the
principal amount of $100 million for 5,000,000 shares of common stock.
(13) To reflect the interest payable at time of proposed exchange of all
outstanding Source Media, Inc. 12% Senior Secured Notes in the principal
amount of $100 million for 5,000,000 shares of common stock.
(14) To reflect the proposed exchange of the outstanding Source Media, Inc. 12%
Senior Secured Notes in the principal amount of $100 million at a 55%
participation level for 2,750,000 shares of common stock based on an
assumed market price of Source Media, Inc. stock of $20 per share at the
time of exchange and the write-off of the related portion of deferred
financing costs.
(15) To reflect the proposed exchange of the outstanding shares of Source Media,
Inc. Senior PIK Preferred Stock at a 50% participation level (521,706
shares) for 652,133 shares of Source Media, Inc. common stock based on an
assumed market price of Source Media, Inc. stock of $20 per share at the
time of exchange.
(16) To reflect the reclassification of 55% of the cash held in escrow for
interest payments on Source Media, Inc. 12% Senior Secured Notes into
unrestricted cash upon completion of the proposed exchange of the
outstanding Source Media, Inc. 12% Senior Secured Notes at a 55%
participation level.
P-8
<PAGE>
(17) To reflect the costs incurred to complete the proposed issuance of
3,402,133 additional shares of common stock upon the conversion of 521,706
shares of Source Media, Inc. Senior PIK Preferred Stock and 55% of the $100
million of 12% Senior Secured Notes to common stock.
(18) To reflect the elimination of a pro rata portion of accrued interest
related to the proposed exchange of outstanding Source Media, Inc. 12%
Senior Secured Notes in the principal amount of $100 million at a 55%
participation level.
(19) To reflect the interest payable at time of proposed exchange on outstanding
Source Media, Inc. 12% Senior Secured Notes in the principal amount of $100
million at a 55% participation level.
Footnotes to Unaudited Pro Forma Consolidated Statements of Operations
(1) To reflect the elimination of net sales, cost of sales, SG&A and other
income or expense of the Interactive TV segment.
(2) To reflect our 50% interest in the operating losses of SourceSuite LLC.
(3) To reflect amortization of the investment in SourceSuite LLC related to the
basis difference resulting from the issuance of warrants to purchase our
common stock issued to Insight upon closing the transaction with Insight.
(4) To reflect the issuance of additional shares of common stock upon closing
of the transaction with Insight.
(5) To reflect the removal of 50% of the losses of the business being acquired
by Liberate which includes the operations of Interactive Channel
Technologies Inc., amortization and patent related expense from the
operating losses of SourceSuite LLC.
(6) To reflect the elimination of interest expense related to the proposed
exchange of all outstanding Source Media, Inc. 12% Senior Secured Notes in
the principal amount of $100 million for 5,000,000 shares of common stock.
(7) To reflect the elimination of Senior PIK Preferred Stock dividend expense
due to the proposed exchange of 1,043,412 shares of Source Media, Inc.
Senior PIK Preferred Stock for 1,304,265 shares of Source Media, Inc.
common stock.
P-9
<PAGE>
(8) To reflect the proposed issuance of 6,304,265 additional shares of common
stock upon the conversion of 1,043,412 shares of Source Media, Inc. Senior
PIK Preferred Stock and $100 million of 12% Senior Secured Notes bonds to
common stock.
(9) To reflect the elimination of interest expense related to the proposed
exchange of the outstanding Source Media, Inc. 12% Senior Secured Notes in
the principal amount of $100 million at a 55% participation level for
2,750,000 shares of common stock.
(10) To reflect the elimination of Senior PIK Preferred Stock dividend expense
due to the proposed exchange of the outstanding shares of Source Media,
Inc. Senior PIK Preferred Stock at a 50% participation level (521,706
shares) for 652,133 shares of Source Media, Inc. common stock.
(11) To reflect the proposed issuance of 3,402,133 additional shares of common
stock upon the conversion of 521,706 shares of Source Media, Inc. Senior
PIK Preferred Stock, representing 50% of the total outstanding; and 55% of
the $100 million of 12% Senior Secured Notes to common stock.
P-10
<PAGE>
<TABLE>
<CAPTION>
======================================================= =======================================================
We have not authorized any dealer, salesperson or any other person to give any
information or represent anything not contained or incorporated by reference in
this prospectus. You must not rely on any unauthorized information. This
prospectus does not offer to sell or buy any notes in any jurisdiction where it
is unlawful.
<S> <C>
SOURCE MEDIA, INC.
Offer to Exchange
shares of Common Stock
Table of Contents for any and all outstanding
- ----------------- 12% Senior Secured Notes due 2004
Page
----
Exchange Agent:
Incorporation by Reference..................... 2
Where You Can Find More Information............ 2 U.S. Trust Company of Texas, N.A.
Prospectus Summary............................. 3 770 Broadway - 13th Floor
Risk Factors................................... 13 New York, NY 10003-9598
Use of Proceeds................................ 15 By Telephone: (212)
Price Range of Common Stock.................... 16 By Facsimile: (212) 420-2398
Capitalization Table........................... 17
Developments in our Business................... 18
Affiliate Transactions......................... 22
Reasons for Exchange Offer..................... Dealer Manager and Solicitation Agent:
and Solicitation.............................. 24
Terms of Exchange Offer........................ 24 Donaldson, Lufkin & Jenrette Securities Corporation
Consent Solicitation........................... 27 277 Park Avenue
Procedures For Participating in the............ New York, NY 10172
Exchange Offer and Consent Solicitation....... 30 Attention:
Certain Federal Income Tax Considerations...... 34 Telephone:
Tax Consequences to Source Media............... Facsimile:
Upon the Exchange of Notes.................... 37
Description of Capital Stock................... 38
Experts........................................ 39
Legal Matters.................................. 39
Index to Financial Statements.................. F-1
Index to Pro Forma Financial Statements........ P-1 PROSPECTUS
, 2000
======================================================= =======================================================
</TABLE>
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of New York, State of New
York, on January 19, 2000.
SOURCE MEDIA, INC.
By: /s/ Stephen W. Palley
-----------------------------------------
Stephen W. Palley, President and Chief
Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS that each person whose signature appears
below constitutes and appoints Stephen W. Palley and F. Paul Tigh as such
person's true and lawful attorney-in-fact and agent, acting alone, with full
powers of substitution and revocation, for such person and in such person's
name, place and stead, in any and all capacities, to sign any and all amendments
(including post-effective amendments) to this registration statement and to file
the same with all exhibits thereto, and other documents in connection therewith,
with the Securities and Exchange Commission, granting unto said attorney-in-fact
and agent, acting alone, full power and authority to do and perform each and
every act and thing requisite and necessary to be done, as fully to all intents
and purposes as such person might or could do in person, hereby ratifying and
confirming all that said attorney-in-fact and agent, acting alone, or his
substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
- -------------------- ------------------------------------- -----------------
<S> <C> <C>
/s/ Stephen W. Palley President, Chief Executive Officer January 19, 2000
(principal executive officer) and
Director
/s/ F. Paul Tigh Treasurer and Chief Financial January 19, 2000
Officer
(principal financial and accounting
officer)
/s/ James L. Greenwald Director January 19, 2000
/s/ Michael J. Marocco Director January 19, 2000
/s/ Barry Rubenstein Director January 19, 2000
/s/ Kim D. Kelly Director January 19, 2000
/s/ Sidney R. Knafel Director January 19, 2000
/s/ Michael S. Willner Director January 19, 2000
</TABLE>
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 20. Indemnification of Directors and Officers
Section 145 of the Delaware General Corporation Law ("DGCL") empowers
a corporation to indemnify any person who was or is a party or is threatened to
be made a party to any threatened, pending or completed action, suit or
proceeding, whether civil, criminal, administrative or investigative (other than
an action by or in the right of the corporation) by reason of the fact that he
is or was a director, officer, employee or agent of the corporation or is or was
serving at the request of the corporation as a director, officer, employee or
agent of another corporation or enterprise, against expenses (including
attorneys' fees), judgments, fines and amounts paid in settlement actually and
reasonably incurred by him in connection with such action, suit or proceeding if
he acted in good faith and in a manner he reasonably believed to be in, or not
opposed to, the best interests of the corporation, and, with respect to any
criminal action or proceeding, had no reasonable cause to believe his conduct
was unlawful.
Section 145 also empowers a corporation to indemnify any person who
was or is a party or is threatened to be made a party to any threatened, pending
or completed action or suit by or in the right of the corporation to procure a
judgment in its favor by reason of the fact that such person acted in any of the
capacities set forth above, against expenses (including attorneys' fees)
actually and reasonably incurred by him in connection with the defense or
settlement of such action or suit if he acted under similar standards, except
that no indemnification may be made in respect of any claim, issue or matter as
to which such person shall have been adjudged to be liable to the corporation
unless, and only to the extent that, the Court of Chancery or the court in which
such action was brought shall determine that despite the adjudication of
liability such person is fairly and reasonably entitled to indemnity for such
expenses which the court shall deem proper.
Section 145 further provides that to the extent that a director or
officer of a corporation has been successful in the defense of any action, suit
or proceeding referred to above or in the defense of any claim, issue or matter
therein, he shall be indemnified against expenses (including attorneys' fees)
actually and reasonably incurred by him in connection therewith; that
indemnification provided for by Section 145 shall not be deemed exclusive of any
other rights to which the indemnified party may be entitled; and that the
corporation is empowered to purchase and maintain insurance on behalf of a
director or officer of the corporation against any liability asserted against
him and incurred by him in any such capacity, or arising out of his status as
such, whether or not the corporation would have the power to indemnify him
against such liabilities under Section 145.
<PAGE>
Article Seventh of the Company's Restated Certificate of
Incorporation, as amended, provides as follows:
A director of the Company shall not be personally liable to the
Company or its stockholders for monetary damages for breach of fiduciary duty as
a director, except for liability (i) for any breach of the director's duty of
loyalty to the Company or its stockholders, (ii) for acts or omissions not in
good faith or which involve intentional misconduct or a knowing violation of
law, (iii) under Section 174 of the DGCL (in respect of certain unlawful
dividend payments or stock purchases or redemptions), or (iv) for a transaction
from which the director derived an improper personal benefit. If the DGCL is
amended to authorize the further elimination or limitation of the liability of
directors, then the liability of a director of the Company, in addition to the
limitation on personal liability described above, shall be limited to the
fullest extent permitted by the DGCL, as so amended. Any repeal or modification
of such provision of the Restated Certificate of Incorporation by the
stockholders of the Company shall not adversely affect any right to protection
of a director of the Company with respect to events occurring prior to the time
of such repeal or modification.
Article V of the Company's By-Laws, as amended, provides that each
director or officer of the Company who was or is a party or is threatened to be
made a party to any threatened, pending or completed action, suit or proceeding,
whether civil, criminal, administrative or investigative (other than an action
by or in the right of the Company), by reason of the fact that he or she is or
was or has agreed to become a director, officer, employee or agent of the
Company or is or was serving or has agreed to serve at the request of the
Company as a director, officer, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise, or by reason of any
action alleged to have been taken or omitted in such capacity, shall be
indemnified by the Company against all costs, charges, expenses (including
attorneys' fees), judgments, fines and amounts paid in settlement actually and
reasonably incurred by such person or on such person's behalf in connection
therewith and any appeal therefrom, if such person acted in good faith and in a
manner he or she reasonably believed to be in or not opposed to the best
interests of the Company, and, with respect to any criminal action or
proceeding, had no reasonable cause to believe his or her conduct was unlawful.
The termination of any action, suit or proceeding by judgment, order,
settlement, conviction, or upon a plea of nolo contendere or its equivalent,
shall not, of itself, create a presumption that the person did not meet the
standards of conduct set forth in the By-laws.
Article V of the Company's By-laws also provides that the Company
shall indemnify any director or officer who was or is a party or is threatened
to be made a party to any threatened, pending or completed action or suit by or
in the right of the Company to procure a judgment in its favor by reason of the
fact that he is or was or has agreed to become a director, officer, employee or
agent of the Company, or is or was serving or has agreed to serve at the request
of the Company as a director, officer, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise, or by reason of any
action alleged to have been taken or omitted in such capacity, against costs,
charges and expenses (including attorneys'
2
<PAGE>
fees) actually and reasonably incurred by him or on his behalf in connection
with the defense or settlement of such action or suit and any appeal therefrom,
if he acted in good faith and in a manner he reasonably believed to be in or not
opposed to the best interests of the Company, except that no indemnification
shall be made in respect of any claim, issue or matter as to which such person
shall have been adjudged to be liable to the Company unless and only to the
extent that the Court of Chancery of Delaware or the court in which such action
or suit was brought shall determine upon application that, despite the
adjudication of such liability but in view of all the circumstances of the case,
such person is fairly and reasonably entitled to indemnity for such costs,
charges and expenses which the Court of Chancery or such other court shall deem
proper.
Notwithstanding such provisions to the contrary, to the extent that a
director or officer of the Company has been successful on the merits or
otherwise, including, without limitation, the dismissal of an action without
prejudice, in defense of any action, suit or proceeding or in the defense of any
claim, issue or matter therein, he or she shall be indemnified against all
costs, charges and expenses (including attorneys' fees) actually and reasonably
incurred by him or her or on his or her behalf in connection therewith.
The right to indemnification provided by the By-laws shall not be
deemed exclusive of any other rights to which a person seeking indemnification
may be entitled under any law (common or statutory), agreement, vote of
stockholder or disinterested directors or otherwise, both as to action in his
official capacity and to action in another capacity while holding office and
shall continue as to a person who has ceased to be a director or officer and
shall inure to the benefit of the estate, heirs, executors and administrators of
such person.
Item 21. Exhibits and Financial Statements Schedules.
(a) Exhibits
Exhibit
Number Description of Exhibit
------ ----------------------
3.1 Restated Certificate of Incorporation,
as amended, of the Company*
3.2 Bylaws (filed as Exhibit 3.2 to HBAC's
Registration Statement on Form S-1, as
3
<PAGE>
amended (No. 33-62606), and incorporated
herein by reference)
4.1 Form of Common Stock Certificate (filed as Exhibit
4.1 to the Company's Registration Statement
on Form S-1 (No. 33-97564), and incorporated
herein by reference)
4.2 Certificate of Designation for Senior PIK
Preferred Stock, as amended*
4.3 Certificate of Designations for Non-Participating
Preferred Stock of the Company*
4.4 Form of proposed second Amendment to Certificate
of Designation*
4.5 Form of proposed third Amendment to Certificate of
Designation*
4.6 Indenture dated as of October 30, 1997 between
Source Media, Inc. and U.S. Trust Company of
Texas, N.A. (filed as Exhibit 4.1 to the
Company's Current Report on Form 8-K dated
October 30, 1997, and incorporated herein by
reference)
4.7 First Supplemental Indenture dated as of November
1, 1999 among Source Media, Inc., its
subsidiaries parties thereto and U.S. Trust
Company of Texas, N.A.*
4.8 Warrant Agreement dated as of October 30, 1997
between Source Media, Inc. and ChaseMellon
Shareholder Services (filed as
4
<PAGE>
Exhibit 4.3 to the Company's Current Report on Form 8-K
dated October 30, 1997, and incorporated herein by
reference)
4.9 Form of proposed Second Supplemental Indenture to
be dated as of January 1, 2000 among Source
Media, Inc., its subsidiaries parties
thereto and U.S. Trust Company of Texas,
N.A.*
4.10 Form of proposed Third Supplemental Indenture
among Source Media, Inc., its subsidiaries
parties thereto and U.S. Trust Company of
Texas, N.A.*
5.1 Opinion of Cooperman Levitt Winikoff Lester &
Newman, P.C.*
8.1 Opinion of Cooperman Levitt Winikoff Lester &
Newman, P.C. with respect to certain Federal
income tax aspects*
10.1 Asset Purchase Agreement dated September 23, 1997
between IT Network, Inc. and Brite Voice
Systems, Inc. (filed as Exhibit 2.1 to the
Company's Current Report on Form 8-K dated
October 30, 1997, and incorporated herein by
reference)
10.2 Amendment dated October 7, 1997 between IT
Network, Inc. and Brite Voice Systems, Inc.
to Asset Purchase Agreement dated September
23, 1997 between IT Network, Inc. and Brite
Voice Systems, Inc. (filed as Exhibit 2.2 to
the Company's Current Report on Form 8-K
dated October 30, 1997, as amended, and
incorporated herein by reference)
10.3 Asset Purchase Agreement dated September 30, 1997
between Source Media, Inc. and IT Network,
Inc. and Voice News Network, Inc. (filed as
Exhibit 2.3 to the Company's
5
<PAGE>
Current Report on Form 8-K dated October 30, 1997, and
incorporated herein by reference)
10.4 Preferred Stock Registration Rights Agreement
dated as of October 30, 1997 between Source
Media, Inc. and Natwest Capital Markets
Limited and Prudential Incorporated (filed
as Exhibit 10.2 to the Company's Current
Report on Form 8-K dated October 30, 1997,
and incorporated herein by reference)
10.5 Exchange and Registration Rights Agreement for
Senior Secured Notes dated as of October 30,
1997 between Source Media, Inc. and certain
of its subsidiaries and Natwest Capital
Markets Limited and Prudential Securities
Incorporated (filed as Exhibit 10.1 to the
Company's Current Report on Form 8-K dated
October 30, 1997, and incorporated herein by
reference)
10.6 Form of Guarantee for domestic subsidiaries (filed
as Exhibit 10.29 to the Company's
Registration Statement on Form S-4 (no. 333-
42017), and incorporated herein by
reference)
10.7 Form of Guarantee for foreign subsidiaries (filed
as Exhibit 10.30 to the Company's
Registration Statement on Form S-4 (no. 333-
42017), and incorporated herein by
reference)
10.8 Contribution Agreement by and among Insight
Interactive, LLC, the Company and Newco, LLC
dated July 29, 1999 (filed as Exhibit B to
the Company's Statement on Schedule 14A
filed September 24, 1999 and incorporated
herein by reference)
6
<PAGE>
10.9 Common Stock and Warrants Purchase Agreement
between the Company and Insight Interactive,
LLC dated as of July 29, 1999 (filed as
Exhibit C to the Company's Statement on
Schedule 14A filed September 24, 1999 and
incorporated herein by reference)
10.10 Merger Agreement and Plan of Reorganization
dated as of January 12, 2000 by and among
Liberate Technologies, SourceSuite LLC,
Source Media, Inc., Insight Communications
Company, Inc. and Insight Interactive, LLC
21 Subsidiaries of Registrant
23.1 Consent of Ernst & Young LLP
23.2 Consent of Cooperman Levitt Winikoff Lester &
Newman, P.C. (included in Exhibits 5.1 and
8.1)*
24.1 Power of Attorney
(included on the signature page of this
registration statement)
27.1 Financial Data Schedule**
99.1 Form of Letters of Transmittal*
* To be filed by amendment
** Filed as an exhibit to the Quarterly Report on Form 10-Q for the quarterly
period ended September 30, 1999 of Registrant and incorporated herein by
reference.
(b) Financial Statement Schedules
All schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required
under the related instructions or not applicable, and therefore have been
omitted.
(c) Item 4(b) Information
Reference is made to Exhibit 99.1 to this Registration Statement.
7
<PAGE>
Item 22. Undertakings.
(a) Registrant hereby undertakes as follows:
(1) that prior to any public reoffering of the securities registered
hereunder through use of a prospectus which is a part of this Registration
Statement, by any person or party who is deemed to be an underwriter within
the meaning of Rule 145(c), Registrant undertakes that such reoffering
prospectus will contain the information called for by the applicable
registration form with respect to reofferings by persons who may be deemed
underwriters, in addition to the information called for by the other items
of the applicable form; and
(2) that every prospectus (i) that is filed pursuant to paragraph (1)
immediately preceding, or (ii) that purports to meet the requirements of
Section 10(a)(3) of the Securities Act of 1933, as amended (the "Securities
Act"), and is used in connection with an offering of securities subject to
Rule 415, will be filed as a part of an amendment to the Registration
Statement and will not be used until such amendment is effective, and that,
for purposes of determining any liability under the Securities Act, each
such post-effective amendment shall be deemed to be a new registration
statement relating to the securities offered therein, and the offering of
such securities at that time shall be deemed to be the initial bona fide
offering thereof.
(b) Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the Registrant of expenses
incurred or paid by a director, officer or controlling person of the Registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the questions whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
(c) The Registrant hereby undertakes to supply by means of a post-effective
amendment all information concerning a transaction, and the company being
acquired involved therein, that was not the subject of and included in the
Registration Statement when it became effective.
8
<PAGE>
Exhibit 10.10
EXECUTION COPY
MERGER AGREEMENT AND
PLAN OF REORGANIZATION
BY AND AMONG
LIBERATE TECHNOLOGIES
LIBERATE ACQUISITION CO.
SOURCESUITE LLC
SOURCESUITE ACQUISITION LLC
SOURCE MEDIA, INC.
INSIGHT INTERACTIVE, LLC
AND
INSIGHT COMMUNICATIONS COMPANY, INC.
Dated as of January 12, 2000
<PAGE>
<TABLE>
<CAPTION>
TABLE OF CONTENTS
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Page
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<S> <C>
ARTICLE 1 THE MERGER...................................................................................................... 2
1.1 The Merger....................................................................................................... 2
1.2 Effective Time................................................................................................... 2
1.3 Effect of the Merger on Constituent Companies.................................................................... 3
1.4 Certificate of Formation, Limited Liability Company Agreement and Management Committee of Surviving Corporation.. 3
1.5 Maximum Number of Shares of Parent Common Stock to be Issued; Effect on Target Units............................. 3
1.6 Exchange Procedures.............................................................................................. 4
1.7 No Further Ownership Rights in Target............................................................................ 5
1.8 Exemption from Registration; California Permit................................................................... 5
1.9 Further Action................................................................................................... 5
1.10 Reduction in Cash Consideration................................................................................. 6
ARTICLE 2 REPRESENTATIONS AND WARRANTIES OF TARGET........................................................................ 6
2.1 Organization and Qualification................................................................................... 6
2.2 Authority Relative to this Agreement............................................................................. 7
2.3 Capitalization................................................................................................... 7
2.4 Subsidiaries..................................................................................................... 8
2.5 No Conflicts..................................................................................................... 8
2.6 Books and Records; Organizational Documents...................................................................... 8
2.7 Target Financials................................................................................................ 9
2.8 Absence of Changes............................................................................................... 9
2.9 No Undisclosed Liabilities....................................................................................... 12
2.10 Taxes........................................................................................................... 12
2.11 Legal Proceedings............................................................................................... 15
2.12 Compliance with Laws and Orders................................................................................. 15
2.13 Employee Benefit Plans.......................................................................................... 15
2.14 Title to Property............................................................................................... 16
2.15 Intellectual Property........................................................................................... 17
2.16 Contracts....................................................................................................... 20
2.17 Insurance....................................................................................................... 21
2.18 Affiliate Transactions.......................................................................................... 21
2.19 Employees; Labor Relations...................................................................................... 22
2.20 Environmental Matters........................................................................................... 23
2.21 Other Negotiations; Brokers; Third Party Expenses............................................................... 24
2.22 Foreign Corrupt Practices Act................................................................................... 24
2.23 Approvals....................................................................................................... 25
2.24 Disclosure...................................................................................................... 25
2.25 Permit Application; Information Statement....................................................................... 25
2.26 Investment Advisors............................................................................................. 26
2.27 Due Diligence................................................................................................... 26
</TABLE>
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ARTICLE 3 REPRESENTATIONS AND WARRANTIES OF ACQUIROR...................................................................... 26
3.1 Organization and Qualification................................................................................... 26
3.2 Authority Relative to this Agreement............................................................................. 26
3.3 SEC Documents; Parent Financial Statements....................................................................... 27
3.4 No Conflicts..................................................................................................... 28
3.5 Information to be Supplied by Parent............................................................................. 28
3.6 Ownership of Merger Sub; No Prior Activities..................................................................... 28
3.7 Investment Advisors.............................................................................................. 29
3.8 Third Party Consents............................................................................................. 29
ARTICLE 4 ADDITIONAL AGREEMENTS........................................................................................... 29
4.1 Information Statement; Permit Application........................................................................ 29
4.2 Target Units Holders Approval.................................................................................... 30
4.3 Access to Information............................................................................................ 31
4.4 Confidentiality.................................................................................................. 31
4.5 Expenses......................................................................................................... 31
4.6 Public Disclosure................................................................................................ 32
4.7 Approvals........................................................................................................ 32
4.8 Notification of Certain Matters.................................................................................. 32
4.9 Additional Documents and Further Assurances...................................................................... 32
4.10 NNM Listing..................................................................................................... 33
4.11 Auditors........................................................................................................ 33
4.12 Benefit Arrangements............................................................................................ 33
4.18 Noncompete...................................................................................................... 34
ARTICLE 5 CONDITIONS TO THE MERGER........................................................................................ 34
5.1 Conditions to Obligations of Each Party to Effect the Merger..................................................... 34
5.2 Additional Conditions to Obligations of Target................................................................... 35
5.3 Additional Conditions to the Obligations of Parent and Merger Sub................................................ 36
ARTICLE 6 SURVIVAL OF REPRESENTATIONS, WARRANTIES, COVENANTS AND AGREEMENTS............................................... 38
6.1 Survival of Representations, Warranties, Covenants and Agreements................................................ 38
6.2 Indemnification by Target and the Holder Indemnitors............................................................. 38
6.3 Market Stand-Off................................................................................................. 39
6.4 Limitation of Liability.......................................................................................... 39
ARTICLE 7 CONDUCT PRIOR TO THE EFFECTIVE TIME............................................................................. 40
7.1 Conduct of Business.............................................................................................. 40
7.2 No Solicitation.................................................................................................. 40
ARTICLE 8 TERMINATION, AMENDMENT AND WAIVER............................................................................... 41
8.1 Termination...................................................................................................... 41
8.2 Effect of Termination............................................................................................ 42
8.3 Amendment........................................................................................................ 42
8.4 Extension; Waiver................................................................................................ 43
</TABLE>
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ARTICLE 9 MISCELLANEOUS PROVISIONS........................................................................................ 43
9.1 Notices.......................................................................................................... 43
9.2 Entire Agreement................................................................................................. 45
9.3 Further Assurances; Post-Closing Cooperation..................................................................... 45
9.4 Waiver........................................................................................................... 45
9.5 Third Party Beneficiaries........................................................................................ 46
9.6 No Assignment; Binding Effect.................................................................................... 46
9.7 Headings......................................................................................................... 46
9.8 Invalid Provisions............................................................................................... 46
9.9 Governing Law.................................................................................................... 46
9.10 Construction.................................................................................................... 46
9.11 Counterparts.................................................................................................... 46
9.12 Specific Performance............................................................................................ 46
9.13 No Solicitation of Employees.................................................................................... 47
9.14 Exculpation..................................................................................................... 47
ARTICLE 10 DEFINITIONS.................................................................................................... 47
10.1 Definitions..................................................................................................... 47
</TABLE>
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EXHIBITS & SCHEDULES
- --------------------
Exhibit A - Forms of Ancillary Agreements
A.1--Programming Services Agreement
A.2--VirtualModem License Agreement
A.3--Preferred Content Provider Agreement
A.4--Registration Rights Agreement [to come]
Exhibit B - Form of Delaware Certificate of Merger [to come]
Exhibit C - Form of Stockholders Certificate [to come]
Exhibit D - Form of Parent Officer's Certificates [to come]
Exhibit E - Matters to be Covered by Legal Opinion of Gunderson Dettmer Stough
Villeneuve Franklin & Hachigian, LLP [to come]
Exhibit F - Form of Target Management Committee's Certificates [to come]
Exhibit G - Matters to be Covered by Legal Opinion of Cooperman Levitt Winkoff
Lester & Newman, P.C. [to come]
Exhibit H - Form Parent Officer's Tax Certificate
Exhibit 4.2 - Support Agreement
</TABLE>
iv
<PAGE>
MERGER AGREEMENT AND
PLAN OF REORGANIZATION
This MERGER AGREEMENT AND PLAN OF REORGANIZATION (the "Agreement") is
---------
made and entered into as of January 12, 2000, by and among LIBERATE
TECHNOLOGIES, a Delaware corporation (the "Parent"), SOURCESUITE LLC, a Delaware
------
limited liability company (the "Target"), SOURCE MEDIA, INC., a Delaware
------
corporation ("Source Media"), INSIGHT COMMUNICATIONS COMPANY, INC., a Delaware
------------
corporation ("Insight Communications") and INSIGHT INTERACTIVE, LLC, a Delaware
----------------------
limited liability company and wholly owned subsidiary of Insight Communications
("Insight Interactive"). This Agreement shall be entered into by LIBERATE
-------------------
ACQUISITION CO., a Delaware limited liability company and a wholly owned
subsidiary of Parent (the "Merger Sub"), and by SOURCESUITE ACQUISITION LLC, a
----------
Delaware limited liability company (the "Other Assets Company"), on or before
--------------------
the Closing. Capitalized terms used and not otherwise defined herein have the
meanings set forth in Article 10.
----------
RECITALS
A. Source Media and Insight Interactive are the holders (individually
a "Holder," collectively the "Holders") of all of the capital ownership
interests in Target ("Target Units"); the affairs of Target and the conduct of
------------
its business is as set forth in the Limited Liability Company Agreement between
Source Media and Insight Interactive dated as of November 17, 1999 ("Target LLC
----------
Agreement"); and a management committee has the final authority with respect to
- ---------
the management of the business and affairs of Target ("Target Management
-----------------
Committee").
- ---------
B. Target and Other Assets Company will enter into agreement(s)
whereby the assets of Target prior to the effectiveness of such agreement(s)
will be separated such that the business, all assets and properties used in
and/or necessary to the conduct of the business, and certain liabilities
associated with the business, each relating to the VirtualModem Products will
remain within Target and all other businesses, assets, properties and
liabilities will be purchased by Other Assets Company at a price equal to their
fair market value as determined by KPMG Peat Marwick in its valuation (the "KPMG
Value").
C. The Board of Directors of Parent and the Management Committees of
each of Merger Sub and Target believe it is in the best interests of Parent,
Merger Sub and Target and their respective stockholders and members that Parent
acquire Target through the merger of Merger Sub with and into Target (the
"Merger") and, in furtherance thereof, have approved the Merger.
- -------
D. The Board of Directors of Parent and the Management Committees of
each of Merger Sub and Target have approved the Merger and this Agreement and
the transactions contemplated hereby.
<PAGE>
E. Pursuant to the Merger, among other things, and subject to the
terms and conditions of the Agreement, all of the Target Units which are
outstanding immediately prior to the Effective Time of the Merger shall be
converted into the right to receive shares of Common Stock of Parent ("Parent
------
Common Stock").
- ------------
F. On the Closing Date, Target and Other Assets Company shall enter
into the Programming Services Agreement; Other Assets Company and Parent shall
enter into the Preferred Content Provider Agreement; Target and Insight
Communications shall enter into the VirtualModem License Agreement; and Parent
and the Holders shall enter into the Registration Rights Agreement, all in the
forms attached hereto as Exhibit A.1 through A.4.
-----------------------
G. Target and Parent desire to make certain representations,
warranties, covenants and agreements in connection with the Merger.
H. For United States federal income tax purposes, it is intended that
the Merger qualify as a "reorganization" within the meaning of Section 368 of
the Internal Revenue Code.
NOW, THEREFORE, in consideration of the covenants, promises,
representations and warranties set forth herein, and for other good and valuable
consideration (the receipt and sufficiency of which are hereby acknowledged by
the parties), and intending to be legally bound hereby, the parties agree as
follows:
ARTICLE 1
THE MERGER
1.1 The Merger. At the Effective Time and subject to and upon the terms and
----------
conditions of this Agreement and the applicable provisions of the DLLCA, and, to
the extent applicable, the California Code, Merger Sub shall be merged with and
into Target, the separate existence of Merger Sub shall cease, and Target shall
continue as the surviving company and as a wholly owned subsidiary of Parent
(the "Surviving Company").
-----------------
1.2 Effective Time. Unless this Agreement is earlier terminated pursuant to
--------------
Section 8.1, the closing and consummation of the Merger (the "Closing") will
- ----------- -------
take place as promptly as practicable, but in no event later than two (2)
Business Days, following satisfaction or waiver of the conditions set forth in
Article 5, at the offices of Gunderson Dettmer Stough Villeneuve Franklin &
- ---------
Hachigian, LLP, unless another place or time is agreed to by Parent and Target.
The date upon which the Closing actually occurs is herein referred to as the
"Closing Date." On the Closing Date, the parties hereto shall cause the Merger
- -------------
to be consummated by filing a certificate of merger in form reasonably
acceptable to the parties, in form and substance to be agreed upon by Parent and
Holders and to be set forth as Exhibit B (the "Delaware Certificate of Merger"),
--------- ------------------------------
in accordance with the relevant provisions of applicable law (the time of
acceptance by the Secretary of State of the State of Delaware of such filing, or
such later time agreed to by the parties and set forth in the Delaware
Certificate of Merger, being referred to herein as the "Effective Time"). The
--------------
Delaware Certificate of Merger shall provide that the Surviving Company shall
change its name, and Parent and the Surviving Company shall take all
2
<PAGE>
actions reasonably requested by the Related Parties to allow the Other Assets
Company to use the name "SourceSuite."
1.3 Effect of the Merger on Constituent Companies. At the Effective Time, the
---------------------------------------------
effect of the Merger shall be as provided in the applicable provisions of the
DLLCA. Without limiting the generality of the foregoing, and subject thereto,
at the Effective Time, all the property, rights, privileges, powers and
franchises of Merger Sub and Target shall vest in the Surviving Company, and all
debts, liabilities, obligations, restrictions, disabilities and duties of Merger
Sub and Target shall become the debts, liabilities, obligations, restrictions,
disabilities and duties of the Surviving Company.
1.4 Certificate of Formation, Limited Liability Company Agreement and
-----------------------------------------------------------------
Management Committee of Surviving Company.
- -----------------------------------------
(a) At the Effective Time, the Certificate of Formation of Target, as in effect
immediately prior to the Effective Time shall be the Certificate of
Formation of the Surviving Company from and after the Effective Time until
thereafter amended as provided by applicable law and such Certificate of
Formation.
(b) At the Effective Time, the Limited Liability Company Agreement of Merger
Sub, as in effect immediately prior to the Effective Time, shall be the
Limited Liability Company Agreement of the Surviving Company until
thereafter amended as provided by applicable law.
(c) At the Effective Time, the Target Management Committee shall no longer have
any rights, power or authority to manage the business or affairs of Target
or the Surviving Company and Parent shall designate the manager(s) of the
Surviving Company.
1.5 Maximum Number of Shares of Parent Common Stock to be Issued; Effect on
-----------------------------------------------------------------------
Target Units. The maximum number of shares of Parent Common Stock to be issued
- ------------
in exchange for the acquisition by Parent of all Target Units which are
outstanding immediately prior to the Effective Time shall not exceed the Maximum
Share Number. On the terms and subject to the conditions of this Agreement, as
of the Effective Time, by virtue of the Merger and without any action on the
part of Parent, Merger Sub or Target or any holder of any Target Units, the
following shall occur:
(a) Transfer of Target Units. At the Effective Time, each Target Unit that is
------------------------
outstanding immediately prior to the Effective Time will be transferred to
Parent in exchange for the issuance by Parent of that number of shares of
Parent Common Stock equal to the Exchange Ratio, rounded down to the
nearest whole share of Parent Common Stock, subject to adjustment in
accordance with Section 1.8, plus as a working capital adjustment an amount
-----------
of cash equal to the quotient of (X) the excess of (A) the amount of
Target's cash and cash equivalents at the Effective Time over (B) any taxes
payable by Target on the sale of assets to the Other Assets Company which
shall be estimated as of the Closing Date (in calculating taxes payable for
this purpose, any losses incurred by Target prior to the Effective Time
shall offset any gain that would otherwise be recognized on such sale),
divided by (Y) the aggregate number of Target Units that are outstanding
immediately prior to the Effective Time. At the Effective
3
<PAGE>
Time, the taxes payable in clause (B) above shall be estimated, based on
the sales price of the assets sold to the Other Assets Company. Adjustments
to the taxes payable, if any, shall be made following the preparation of
Target's federal income tax return for the period ending on the Closing
Date; if the estimated taxes payable as determined on the Closing Date are
higher than the taxes reported on such return, Parent shall make a cash
payment to each Holder equal to one half of such difference, and if the
estimated taxes payable are lower than the taxes reported on such return
each Holder shall make a cash payment to Parent equal to one half of such
difference.
(b) Adjustments to Exchange Ratio. The Exchange Ratio shall be equitably
------------------------------
adjusted to reflect fully the effect of any stock split, reverse split,
stock combination, stock dividend (including any dividend or distribution
of securities convertible into Parent Common Stock), reorganization,
reclassification, recapitalization or other like change with respect to
Parent Common Stock occurring after the date hereof and prior to the
Effective Time.
(c) Fractional Shares. No fraction of a share of Parent Common Stock will be
-----------------
issued in the Merger, but in lieu thereof, each holder of a Target Unit who
would otherwise be entitled to a fraction of a share of Parent Common Stock
(after aggregating all fractional shares of Parent Common Stock to be
received by such holder) shall be entitled to receive from Parent an amount
of cash (rounded to the nearest whole cent) equal to the product of (a)
such fraction, multiplied by (b) the average of the closing prices of
Parent's Common Stock for the ten (10) trading days ended on the second
trading day immediately preceding the Closing Date.
1.6 Exchange Procedures.
-------------------
(a) Parent Common Stock. As soon as practicable after the Effective Time, but
-------------------
in no event later than two (2) Business Days after the Effective Time,
Parent shall transfer to each Holder a certificate for the aggregate number
of shares of Parent Common Stock issuable in exchange for outstanding
Target Units owned by such Holder pursuant to Section 1.5 and cash in an
-----------
amount sufficient to permit the payment of all cash payable in lieu of
fractional shares pursuant to Section 1.5(c).
--------------
(b) Exchange Procedures. As soon as practicable after the Effective Time, but
-------------------
in no event later than two (2) Business Days after the Effective Time, each
Holder shall transfer the Target Units owned by it to the Parent. Until so
transferred, each outstanding Target Unit prior to the Effective Time will
be deemed from and after the Effective Time, for all corporate purposes, to
evidence the ownership of the number of full shares of Parent Common Stock
into which such Target Units shall be so transferable and the right to
receive cash in lieu of fractional shares as provided herein.
(c) Distributions With Respect to Transferred Target Units. No dividends or
------------------------------------------------------
other distributions with respect to Parent Common Stock declared or made
after the Effective Time and with a record date after the Effective Time
will be paid to any Holder of any untransferred Target Units with respect
to the shares of Parent Common Stock represented thereby until the holder
of record of such Target Units shall transfer such Target Units as provided
in this Section 1.6 or as otherwise accepted by Parent. Subject to
-----------
applicable law,
4
<PAGE>
following surrender of any such Target Units, there shall be paid to the
record holder of the certificates representing whole shares of Parent
Common Stock issued in exchange therefor, without interest, at the time of
such transfer, the amount of dividends or other distributions with a record
date after the Effective Time theretofore payable (but for the provisions
of this Section 1.5(c)) with respect to such whole shares of Parent Common
--------------
Stock.
1.7 No Further Ownership Rights in Target. All shares of Parent Common Stock
-------------------------------------
issued upon the transfer of Target Units in accordance with the terms hereof
(including any cash in lieu of fractional shares) shall be deemed to have been
issued in full satisfaction of all rights pertaining to such Target Units, and
there shall be no further registration of transfers on the records of Target of
Target Units which were outstanding immediately prior to the Effective Time.
1.8 Exemption from Registration; California Permit. The shares of Parent
----------------------------------------------
Common Stock to be issued pursuant to Section 1.6 in connection with the Merger
-----------
will be issued in a transaction exempt from registration under the Securities
Act, by reason of Section 3(a)(10) thereof, or pursuant to Section 4.1, by
-----------
reason of Section 4(2) of the Securities Act and SEC rules and regulations
promulgated thereunder. Subject to the provisions of Section 4.1, the shares
-----------
of Parent Common Stock to be issued pursuant to Section 1.6 in connection with
-----------
the Merger will be qualified under the California Code, pursuant to Section
25121 thereof, after a fairness hearing has been held pursuant to the authority
granted by Section 25142 of such law. Parent shall use all requisite
commercially reasonable efforts, with the cooperation of Target, (i) to file, as
promptly as practicable following the execution and delivery of this Agreement
and in any event on or before January 21, 2000, an application for issuance of a
permit pursuant to Section 25121 of the California Code to issue such securities
(the "California Permit") and (ii) to obtain the California Permit as promptly
-----------------
as practicable and in any event no later than March 10, 2000. If the parties
are unable to obtain the California Permit for whatever reason by March 10,
2000, as required by Section 5.1(c), Source Media shall be entitled to receive
for each Target Unit then held by Source Media an amount of cash equal to $15
million divided by the number of Target Units then held by Source Media (plus
any cash for each such Target Unit payable pursuant to Section 1.5(a) hereof),
and the number of shares of Parent Common Stock to which Source Media shall be
entitled to receive pursuant to Section 1.5 shall be reduced by the number of
shares by which the Maximum Share Number is reduced, provided, however, that if
the cash payable pursuant to this Section 1.8 is reduced in accordance with
Section 1.10, the number of shares of Parent Common Stock to which Source Media
- ------------
shall be entitled to receive shall be increased by the increase in the Maximum
Share Number determined in accordance with Section 1.10.
------------
1.9 Further Action. If, at any time after the Effective Time, any such further
--------------
action is necessary or desirable to carry out the purposes of this Agreement or
to vest the Surviving Company with full right, title and possession to all
assets, property, rights, privileges, powers and franchises of Target, Parent is
fully authorized to take, and will take, all such lawful and necessary action.
1.10 Reduction in Cash Consideration. Anything to the contrary herein
-------------------------------
notwithstanding, the aggregate amount of cash payable pursuant to Section 1.5(a)
--------------
and Section 1.8 shall be reduced such that the sum of (A) the cash payable
-----------
pursuant to Section 1.5(a),
--------------
5
<PAGE>
(B) the cash payable pursuant to Section 1.8, (C) the KPMG Value (as defined in
------------
the Recitals of this Agreement) and (D) the value of the royalty-free license
granted to Other Assets Company pursuant to the Programming Services Agreement
by Parent or Target as determined by KPMG Peat Marwick, will not exceed 19.9% of
the total aggregate consideration payable to the Holders calculated based on the
fair market value of the Parent Common Stock at the Effective Time. Any such
reduction shall first be made from the amount of cash payable pursuant to
Section 1.8. If the amount of cash payable is reduced in accordance with this
- -----------
Section 1.10, the Maximum Share Number shall be increased by a number of shares
- ------------
equal to such reduction divided by $232.6875 per share; provided, however, that
in no event shall the Maximum Share Number be increased above 886,000.
ARTICLE 2
REPRESENTATIONS AND WARRANTIES OF TARGET
Target, Target Subsidiary, the Holders and Insight Communications,
jointly and severally, hereby represent and warrant to Parent, subject to such
exceptions and qualifications as specifically disclosed with respect to the
specific numbered and lettered sections and subsections of this Article 2 in the
---------
Target disclosure schedule and schedule of exceptions of Target (the "Target
------
Disclosure Schedule") delivered herewith and which shall become a part hereof,
- -------------------
dated as of the date hereof, and numbered with corresponding numbered and
lettered sections and subsections, as follows:
2.1 Organization and Qualification. Target is a limited liability company and
------------------------------
Target Subsidiary is a corporation; each such entity is duly organized, validly
existing and in good standing under the laws of the state or province of its
formation or incorporation, and each of Target and Target Subsidiary has all
requisite power and authority to conduct its business as now conducted and as
currently proposed to be conducted and to own, use, license and lease its Assets
and Properties. Each of Target and Target Subsidiary is duly qualified to do
business and is in good standing as a limited liability company or a foreign
corporation in each jurisdiction in which the ownership, use, licensing or
leasing of its Assets and Properties, or the conduct or nature of its business,
makes such qualification, licensing or admission necessary, except for such
failures to be so duly qualified, licensed or admitted and in good standing that
could not reasonably be expected to have a Material Adverse Effect on Target.
Section 2.1 of the Target Disclosure Schedule sets forth each jurisdiction where
- ---------------------------------------------
each of Target and Target Subsidiary is so qualified to do business and
separately lists each other jurisdiction in which each of Target and Target
Subsidiary owns, uses, licenses or leases any material Assets and Properties,
conducts business, or has employees or engages independent contractors.
2.2 Authority Relative to this Agreement. Subject only to the requisite
------------------------------------
approval of the Merger, this Agreement and the other agreements attached as
Exhibits A.1 to A.4 hereto (the "Ancillary Agreements") by the holders of Target
--------------------
Units, each of Target, Other Assets Company, Source Media, Insight
Communications and Insight Interactive (individually, a "Related Party;"
collectively, the "Related Parties") (i) has all requisite power and authority
to execute and deliver this Agreement and each Ancillary Agreement to which it
is a party, to perform its obligations hereunder and thereunder and to
consummate the transactions contemplated hereby and thereby. The execution and
delivery by each Related Party of this Agreement and the Ancillary Agreements to
which it is a party and the consummation by each
6
<PAGE>
Related Party of the transactions contemplated hereby and thereby, and the
performance by each Related Party of its obligations hereunder and thereunder,
have been duly and validly authorized by all necessary action by each Related
Party; and no other action on the part of such governing bodies is required to
authorize the execution, delivery and performance by each Related Party of this
Agreement and the Ancillary Agreements to which it is a party and the
consummation by each Related Party of the transactions contemplated hereby and
thereby. The consummation by Source Media of the transactions contemplated
hereby shall at Closing have received all requisite approvals of the Source
Media Bondholders. This Agreement and the Ancillary Agreements to which such
Related Party is a party have been duly and validly executed and delivered by
such Related Party and, assuming the due authorization and valid execution and
delivery hereof by Parent and each other party to such agreement, each
constitutes a legal, valid and binding obligation of such Related Party
enforceable against such Related Party in accordance with its respective terms,
except as the enforceability thereof may be limited by bankruptcy, insolvency,
fraudulent conveyance, reorganization, moratorium or other similar Laws relating
to the enforcement of creditors' rights generally and by general principles of
equity.
2.3 Capitalization. The authorized capital ownership interests of Target
--------------
consists only of 1,000,000 Target Units, all of which are outstanding. All of
the outstanding Target Units are validly issued, fully paid and nonassessable
and have been issued in compliance with all applicable federal, state and
foreign securities Laws. Section 2.3 of the Target Disclosure Schedule lists
---------------------------------------------
the name of each holder of Target Units. Except as set forth in Section 2.3 of
--------------
the Target Disclosure Schedule, Target has not authorized or issued any other
- ------------------------------
units or other measures of capital ownership of Target. Except as set forth in
Section 2.3 of the Target Disclosure Schedule, there are no agreements,
- ---------------------------------------------
arrangements or understandings to which Target is a party (written or oral) to
issue any other units or other measures of capital ownership of Target, there
are no options or other rights to require such units or other measures of
capital ownership and there are no preemptive rights or agreements, arrangements
or understandings to issue preemptive rights with respect to the issuance or
sale of any units or other measures of capital ownership of Target created by
statute, the Certificate of Formation or the Target LLC Agreement, or any
agreement or other arrangement to which Target is a party or to which it is
bound and there are no agreements, arrangements or understandings to which
Target is a party (written or oral) pursuant to which Target has the right to
elect to satisfy any Liability by issuing any units or other measures of capital
ownership of Target. Other than the Target LLC Agreement, Target is not a party
or subject to any agreement or understanding, and, to Target's knowledge, there
is no agreement, arrangement or understanding between or among any Persons which
affects, restricts or relates to voting, giving of written consents,
distributions, allocation of profits and losses, or transferability of units or
other measures of capital ownership of Target, including any voting trust
agreement or proxy.
2.4 Subsidiaries. SourceSuite Canada Inc., a Canadian federal corporation
------------
("Target Subsidiary") is a wholly owned subsidiary of Target. Except for Target
- -------------------
Subsidiary, Target has (and prior to the Closing will have) no Subsidiaries and
does not (and prior to the Closing will not) otherwise hold any equity,
membership, partnership, joint venture or other ownership interest in any
Person.
7
<PAGE>
2.5 No Conflicts. The execution and delivery by Target of this Agreement does
------------
not, and the performance by Target of its obligations under this Agreement and
the consummation of the transactions contemplated hereby do not and will not:
(a) conflict with or result in a violation or breach of any of the terms,
conditions or provisions of the Certificate of Formation of Target or the
Target LLC Agreement or the Certificate of Incorporation or Bylaws of
Target Subsidiary or the charter documents of the Related Parties (other
than Target);
(b) subject to obtaining the consents, approvals and actions, making the
filings and giving the notices disclosed in Section 2.5 of the Target
-------------------------
Disclosure Schedule, if any, conflict with or result in a violation or
-------------------
breach of any Law or Order applicable to Target or Target Subsidiary, any
of their respective Assets and Properties or any Related Party (other than
Target); or
(c) except as would not have a Material Adverse Effect on Target or as
disclosed in Section 2.5 of the Disclosure Schedule (i) conflict with or
--------------------------------------
result in a violation or breach of, (ii) constitute a default (or an event
that, with or without notice or lapse of time or both, would constitute a
default) under, (iii) require Target, Target Subsidiary or any Related
Party (other than Target) to obtain any consent, approval or action of,
make any filing with or give any notice to any Person (other than the
filing of the Delaware Certificate of Merger together with the required
officers' certificates, any filing required under the HSR Act and
regulations promulgated thereunder, and such consents' approvals, orders,
authorizations, registrations, declarations and filings as may be required
under state or federal securities laws) as a result or under the terms of,
(iv) result in or give to any Person any right of termination,
cancellation, acceleration or modification in or with respect to, (v)
result in or give to any Person any additional rights or entitlement to
increased, additional, accelerated or guaranteed payments or performance
under, (vi) result in the creation or imposition of (or the obligation to
create or impose) any material Lien upon Target or Target Subsidiary or any
of their respective material Assets and Properties under or (vii) result in
the loss of a material benefit under, any material Contract or License to
which Target or Target Subsidiary is a party or by which any of Target's or
Target Subsidiary's material Assets and Properties are bound.
2.6 Books and Records; Organizational Documents. The minute books and capital
-------------------------------------------
interests record books and other similar records of Target and Target Subsidiary
have been provided or made available to Parent or its counsel prior to the
execution of this Agreement as set forth in Section 2.6 of the Disclosure
-----------------------------
Schedule, are complete and correct in all material respects and have been
- --------
maintained in accordance with customary business practices. Such minute books
contain a true and complete record of all actions taken at all meetings and by
all written consents in lieu of meetings of the members of Target and Target
Management Committee and of the directors, stockholders and committees of the
Board of Directors of Target Subsidiary from the date of Target's and Target
Subsidiary's respective formation or incorporation through the date hereof.
Target has prior to the execution of this Agreement delivered to Parent true and
complete copies of its Certificate of Formation and limited liability company
agreement and of Target Subsidiary's Certificate and Articles of Incorporation
and Bylaws, as amended through the date hereof. Target is not in violation of
any provisions of its
8
<PAGE>
Certificate of Formation or Target LLC Agreement, as so amended, nor is Target
Subsidiary in violation of any provisions of its Articles of Incorporation or
Bylaws.
2.7 Target Financials. Section 2.7 of the Target Disclosure Schedule sets
----------------- ---------------------------------------------
forth Target Financials. Target Financials delivered to Parent are correct and
complete in all material respects and have been prepared in accordance with GAAP
applied on a basis consistent throughout the periods (except, with respect to
any Target Financials that are unaudited, for the absence of notes thereto and
the effect of the absence of notes thereto and the effect of the absence of
year-end audit adjustments) indicated and consistent with each other (except as
indicated in the notes thereto, as delivered to Parent prior to the date
hereof). Target Financials present fairly the financial condition and operating
results of Target as of the dates and during the periods indicated therein. The
accounts and notes receivable of Target reflected on Target Financials, and all
accounts and notes receivable arising subsequent to November 30, 1999, (a) arose
from bona fide sales transactions, and are payable on ordinary trade terms net
of applicable reserves, (b) are legal, valid and binding obligations of the
respective debtors enforceable in accordance with their respective terms, (c)
are not subject to any known valid set-off or counterclaim net of applicable
reserves and (d) do not represent obligations for goods sold on consignment, on
approval or on a sale-or-return basis or subject to any other repurchase or
return arrangement (except that software licensed by Target is subject to
acceptance by Target). All inventory of Target reflected on the balance sheet
included in the Target Financials consisted, and all such inventory acquired
since November 30, 1999 consists of a quality and quantity usable and salable in
the ordinary course of business net of applicable reserves. None of the items
included in the inventory of Target have been pledged as collateral, is held by
Target on consignment from others; all of the items included in the inventory of
Target conform in all material respects to all standards applicable to such
inventory or its use or sale imposed by Governmental or Regulatory Authorities.
All intercompany indebtedness of Target and Target Subsidiary to any Holder or
other Related Party shall be cancelled or settled on or before the Closing,
provided that Lucky shall pay up to $50,000 of prepaid expenses for goods and
services to be received by Target or Target Subsidiary after the Closing.
2.8 Absence of Changes. Since the Financial Statement Date, there has not been
------------------
any material adverse change in the Business or Condition of Target or any
occurrence or event which, individually or in the aggregate, is expected to have
Material Adverse Effect on Target. In addition, without limiting the generality
of the foregoing, except as expressly contemplated by this Agreement or as set
forth in Section 2.8 of the Target Disclosure Schedule, since the Financial
---------------------------------------------
Statement Date:
(a) neither Target nor Target Subsidiary has entered into any Contract or other
material commitment or transaction and no other Related Party has entered
into a contract relating to the VirtualModem Business;
(b) Target has not entered into any Contract in connection with any transaction
involving a Business Combination;
(c) there has not been any material amendment or other material modification
(or agreement to do so), or material violation of the terms of, any of the
Contracts set forth or described in Section 2.16 of the Target Disclosure
-------------------------------------
Schedule;
--------
9
<PAGE>
(d) neither Target not Target Subsidiary has entered into any transaction with
any member, manager, officer, director, Affiliate or Associate of Target,
other than pursuant to any Contract disclosed to Parent pursuant to (and so
identified in) Section 2.8(d) of the Target Disclosure Schedule.
------------------------------------------------
(e) there has not been any transfer (by way of a License or otherwise) to any
Person (including any Related Party other than Target) of rights to any
material Target Intellectual Property, other than licenses in the ordinary
course of business consistent with past practice;
(f) there has not been any amendment to Target's Certificate of Formation or
Target LLC Agreement or to Target Subsidiary's Articles of Incorporation or
Bylaws;
(g) Target has not declared, set aside or paid any dividends on or made any
other distributions (whether in cash, stock or property) in respect of any
Target Units, or effected or approved any split, combination or
reclassification of any Target Units, or issued or authorized the issuance
of any other securities, in lieu of or in substitution for Target, or
repurchased, redeemed or otherwise acquired, directly or indirectly, any
Target Units;
(h) Target has not issued, granted, delivered, sold or authorized or proposed
to issue, grant, deliver or sell, or purchased or proposed to purchase, any
units or other measures of capital ownership of Target; and there has been
no modification or amendment of the rights of any holder of any units or
other measures of capital ownership of Target;
(i) no Action or Proceeding has been commenced or, to the knowledge of any
Related Party, threatened by or against Target or Target Subsidiary.
(j) neither Target nor Target Subsidiary has made any change in accounting
policies, principles, methods, practices or procedures (including for bad
debts, contingent liabilities or otherwise, respecting capitalization or
expense of research and development expenditures, depreciation or
amortization rates or timing of recognition of income and expense);
(k) Target and Target Subsidiary have taken all commercially reasonable action
required to procure, maintain, renew, extend or enforce any material Target
Intellectual Property;
(l) there has been no physical damage, destruction or other casualty loss
(whether or not covered by insurance) affecting any of the real or personal
property or equipment of Target or Target Subsidiary or in an amount
exceeding fifty thousand dollars ($50,000) individually or one hundred
fifty thousand dollars ($150,000) in the aggregate; and
(m) neither Target nor Target Subsidiary has made or agreed to make any
disposition or sale of, waiver of rights to, license or lease of, or
incurrence of any material Lien on, or a material portion of any Assets and
Properties of Target;
10
<PAGE>
(n) neither Target nor Target Subsidiary has made or agreed to make any
acquisition of any business, company or corporation, whether through the
purchase of stock, a purchase, lease or License of assets, a merger,
consolidation, tender offer or any other form of business combination;
(o) neither Target nor Target Subsidiary has made or agreed to make any
purchase of any Assets and Properties of any Person (including any Related
Party other than Target) other than (1) acquisitions of inventory, or
licenses of products, in the ordinary course of business of Target
consistent with past practice and (2) other acquisitions in an amount not
exceeding fifty thousand dollars ($50,000) in the case of any individual
item or one hundred fifty thousand dollars ($150,000) in the aggregate;
(p) neither Target nor Target Subsidiary has made or agreed to make any capital
expenditures or commitments for additions to property, plant or equipment
constituting capital assets in an amount exceeding fifty thousand dollars
($50,000) individually or one hundred fifty thousand dollars ($150,000) in
the aggregate;
(q) neither Target nor Target Subsidiary has made or agreed to make any write-
off or write-down, any determination to write-off or write-down, or
revalue, any of its Assets and Properties in excess of applicable reserves,
or change in any reserves or liabilities associated therewith, in an amount
exceeding fifty thousand dollars ($50,000) individually or one hundred
fifty thousand dollars ($150,000) in the aggregate;
(r) neither Target nor Target Subsidiary has made or agreed to make payment,
discharge or satisfaction, in an amount in excess of fifty thousand dollars
($50,000) in any one case or one hundred fifty thousand ($150,000) in the
aggregate, of any claim, Liability or obligation (whether absolute,
accrued, asserted or unasserted, contingent or otherwise), other than the
payment, discharge or satisfaction in the ordinary course of business of
Liabilities reflected or reserved against in the Target Financials and
other than Liabilities incurred in the ordinary course of business since
the Financial Statement Date;
(s) neither Target nor Target Subsidiary has failed to pay or otherwise satisfy
any Liabilities presently due and payable except such Liabilities which are
being contested in good faith by appropriate means or proceedings and which
are immaterial in amount;
(t) neither Target nor Target Subsidiary has incurred any Indebtedness or
guaranteed any Indebtedness in any amount exceeding fifty thousand
($50,000) individually or one hundred fifty thousand ($150,000) in the
aggregate or issued or sold any debt securities of Target or guaranteed any
debt securities of others;
(u) neither Target nor Target Subsidiary has granted any severance or
termination pay to any director, officer, employee or consultant, except
payments made pursuant to written Contracts outstanding on the date hereof,
copies of which have been delivered to Parent and the principal terms of
which are disclosed in Section 2.8(u) of the Target Disclosure Schedule;
-------------------------------------------------
11
<PAGE>
(v) except pursuant to a Contract or otherwise disclosed to Parent pursuant to
Section 2.8(d) of the Target Disclosure Schedule, neither Target nor Target
------------------------------------------------
Subsidiary has granted or approved any increase of greater than five
percent (5%) in salary, rate of commissions, rate of consulting fees or any
other compensation of any current officer, director, employee, independent
contractor or consultant;
(w) Target and Target Subsidiary have taken all commercially reasonable action
required to procure, maintain, renew, extend or enforce any Target
Intellectual Property, including submission of required documents or fees
during the prosecution of patent, trademark or other applications for
Registered Intellectual Property rights;
(x) neither Target nor Target Subsidiary has entered into or approved any
contract, arrangement or understanding or acquiesced in respect of any
arrangement or understanding, to do, engage in or cause or having the
effect of any of the foregoing.
2.9 No Undisclosed Liabilities. Except as reflected or reserved against in
--------------------------
Target Financials (including the notes thereto), Target does not have, and as of
the Closing will not have, any material Liabilities, other than Liabilities
incurred in the ordinary course of business consistent with past practice since
the Financial Statement Date that are not material.
2.10 Taxes.
-----
(a) All Tax Returns required to be filed prior to the Effective Time by or with
respect to Target or Target Subsidiary or, to the extent such relationship
results in a tax lien on or against the assets of Target or Target
Subsidiary or successor tax liability with respect to Target or Target
Subsidiary, any affiliated, consolidated, combined, unitary or similar
group of which Target is or was a member (a "Relevant Group") with any
--------------
Taxing Authority with respect to any Taxable period ending on or before the
Effective Time, have been or will be completed and filed when due
(including any extensions of such due date). All such Tax Returns are true,
accurate and complete as filed. Target has previously provided or made
available to Parent true and correct copies of all Tax Returns. No claim
has ever been made by a Taxing Authority of any jurisdiction in which
Target does not file Tax Returns that it is or may be subject to taxation
by that jurisdiction. Neither Target nor Target Subsidiary has been
granted any extension or waiver of the limitation period applicable to any
Tax Returns that is still in effect.
(b) The November 30, 1999 balance sheet included in the Target Financials (the
"Target Balance Sheet") (i) fully accrues all Target's actual and
--------------------
contingent liabilities for Taxes with respect to all periods through
November 30, 1999 and Target has not and will not incur any Tax liability
in excess of the amount reflected on such Target Balance Sheet with respect
to such periods (excluding any amount thereof that reflects timing
differences between the recognition of income for purposes of GAAP and for
Tax purposes), and (ii) properly accrues in accordance with GAAP all
material liabilities for Taxes payable after November 30, 1999 with respect
to all transactions and events occurring on or prior to such date. All
information set forth in the notes to the Target Financials relating to Tax
matters is true, complete and accurate in all material respects. Except as
contemplated by this Agreement, no material Tax liability since November
30, 1999 has been or will be incurred by Target other than
12
<PAGE>
in the ordinary course of business, and adequate provision has been made by
Target for all Taxes since that date in accordance with GAAP on at least a
quarterly basis.
(c) All Taxes due and payable by Target or Target Subsidiary, whether or not
shown on any Tax Return or claimed to be due by any Taxing Authority, have
been paid or accrued on the balance sheet included in the Target
Financials, except for unpaid accruable Taxes incurred by Target in the
ordinary course of its business since November 30, 1999. Target has
withheld and paid to the applicable Taxing Authority all amounts required
to be withheld and paid except where failure to so withhold or pay would
not be material.
(d) There is no material claim, audit, action, suit, proceeding, or (to the
knowledge of Target, Target Subsidiary, Source Media and/or Insight
Interactive) investigation now pending or (to the knowledge of Target,
Target Subsidiary, Source Media and/or Insight Communications) threatened
against or with respect to Target or Target Subsidiary in respect of any
Tax or assessment. No notice of deficiency or similar document of any
Taxing Authority asserting the Target and/or Target Subsidiary has unpaid
Tax liability has been received by Target or Target Subsidiary, and there
are no liabilities for Taxes (including liabilities for interest, additions
to Tax and penalties thereon and related expenses) with respect to the
issues that have been raised (and are currently pending) by any Taxing
Authority that could, if determined adversely to Target, materially and
adversely affect the liability of Target for Taxes. There are no liens for
Taxes (other than for current Taxes not yet due and payable) upon the
assets of Target or Target Subsidiary. Target has never been a member of
an affiliated group of corporations, within the meaning of Section 1504 of
the Code. Target and Target Subsidiary are in full compliance with all the
terms and conditions of any Tax exemptions or other Tax-sharing agreement
or order of a foreign government and the consummation of the Merger will
not have any adverse effect on the continued validity and effectiveness of
any such Tax exemption or other Tax-sharing agreement or order.
(e) Neither Target nor any person on behalf of Target has entered into or will
enter into any agreement or consent pursuant to the collapsible corporation
provisions of Section 341(f) of the Code (or any corresponding provision of
state, local or foreign income tax law) or agreed to have Section 341(f)(2)
of the Code (or any corresponding provision of state, local or foreign
income tax law) apply to any disposition of any asset owned by Target.
(f) None of the assets of Target or Target Subsidiary is property that Target
is required to treat as being owned by any other person pursuant to the so-
called "safe harbor lease" provisions of former Section 168(f)(8) of the
Code. None of the assets of Target directly or indirectly secures any debt
the interest on which is tax-exempt under Section 103(a) of the Code. None
of the assets of Target is "tax-exempt use property" within the meaning of
Section 168(h) of the Code. Target has not made and will not make a deemed
dividend election under Treas. Reg. (S)1.1502-32(f)(2) or a consent
dividend election under Section 565 of the Code. Target has never been a
party (either as a distributing corporation or as a corporation that has
been distributed) to any transaction intended to qualify under Section 355
of the Code or any corresponding provision of state law. Neither Target
nor Target Subsidiary has participated in (and will not participate in) an
international boycott within the meaning of Section 999 of the Code.
Except for Canada, Target does not have and has not had a permanent
establishment in any foreign country, as defined in any applicable tax
treaty or convention
13
<PAGE>
between the United States of America and any such foreign country. Target
has never elected to be treated as an S-corporation under Section 1362 of
the Code or any corresponding provision of federal or state law. Target is
not party to any joint venture, partnership, or other arrangement or
contract which could be treated as a partnership for federal income tax
purposes. Target is not currently, and never has been, subject to the
reporting requirements of Section 6038A of the Code. There is no agreement,
contract or arrangement to which Target is a party that could, individually
or collectively, result in the payment of any amount that would not be
deductible by reason of Sections 280G (as determined without regard to
Section 280G(b)(4) and (5)), 162(a) (by reason of being unreasonable in
amount), 162 (b) through (p) or 404 of the Code. Target is not a party to
or bound by any Tax indemnity, Tax sharing or Tax allocation agreement
(whether written or unwritten or arising under operation of federal law as
a result of being a member of a group filing consolidated Tax returns,
under operation of certain state laws as a result of being a member of a
unitary group, or under comparable laws of other states or foreign
jurisdictions) which includes a party other than Target nor does Target owe
any amount under any such Agreement. Target is not, and has not been, a
United States real property holding corporation (as defined in Section
897(c)(2) of the Code) during the applicable period specified in Section
897(c)(1)(A)(ii) of the Code. Other than by reason of the Merger, Target
has not been and will not be required to include any material adjustment in
Taxable income for any Tax period (or portion thereof) pursuant to Section
481 or 263A of the Code or any comparable provision under state or foreign
Tax laws as a result of transactions, events or accounting methods employed
prior to the Merger.
(g) Except as contemplated by this Agreement, no material election with respect
to Taxes has been or will be made without the prior written consent of
Parent, which consent will not be unreasonably withheld or delayed.
(h) For purposes of this Agreement, the following terms have the following
meanings: "Tax" (and, with correlative meaning, "Taxes" and "Taxable")
means any and all taxes including, without limitation, (i) any net income,
alternative or add-on minimum tax, gross income, gross receipts, sales,
use, ad valorem, transfer, franchise, profits, value added, net worth,
license, withholding, payroll, employment, excise, severance, stamp,
occupation, premium, property, environmental or windfall profit tax,
custom, duty or other tax governmental fee or other like assessment or
charge of any kind whatsoever, together with any interest or any penalty,
addition to tax or additional amount imposed by any Taxing Authority
responsible for the imposition of any such tax (domestic or foreign), (ii)
any liability for the payment of any amounts of the type described in (i)
as a result of being a member of an affiliated, consolidated, combined or
unitary group for any Taxable period or as the result of being a transferee
or successor thereof and (iii) any liability for the payment of any amounts
of the type described in (i) or (ii) as a result of any express or implied
obligation to indemnify any other person.
(i) Target has validly elected or will elect, prior to the Closing Date,
pursuant to Treas. Reg. (S) 301.7701-3(c)(1), to be classified as a
corporation for United States federal income tax purposes effective as of
the date of its formation.
14
<PAGE>
2.11 Legal Proceedings. Except as set forth in Section 2.11 of the Target
----------------- --------------------------
Disclosure Schedule:
- -------------------
(i) there are no Actions or Proceedings pending or, to the knowledge of any
Related Party, threatened against Target or Target Subsidiary or in which
Target or Target Subsidiary is a party, any of which relate to or affect
Target or Target Subsidiary or their respective Assets and Properties; to
the extent that Section 2.11 of the Target Disclosure Schedule identifies
----------------------------------------------
any such Actions or Proceedings, Target has fully disclosed in writing to
Parent all material facts and legal analyses necessary to enable Parent to
make an independent evaluation of the merits of each Action or Proceeding;
(ii) neither Target nor Target Subsidiary has received notice, nor does Target,
Target Subsidiary, Source Media and/or Insight Communications otherwise
have knowledge of any Orders outstanding against Target or Target
Subsidiary; and
(iii) there are no facts or circumstances known to any Related Party that is
reasonably expected to give rise to any Action or Proceeding against, relating
to or affecting Target or Target Subsidiary.
2.12 Compliance with Laws and Orders. Neither Target nor Target Subsidiary has
-------------------------------
violated in any material respect, and is not currently in default in any
material respect under, any Law or Order applicable to Target or Target
Subsidiary or any of their respective Assets and Properties.
2.13 Employee Benefit Plans.
----------------------
(a) Neither Target nor Target Subsidiary maintains, sponsors, is a party to, or
contributes to or is obligated to contribute to, and Target's or Target
Subsidiary's employees or former employees and their dependents or
survivors do not receive benefits under, any of the following (whether or
not set forth in a written document):
(i) Any employee benefit plan, as defined in section 3(3) of ERISA;
(ii) Any bonus, deferred compensation, incentive, restricted stock, stock
purchase, stock option, stock appreciation right, phantom stock,
supplemental pension, executive compensation, cafeteria benefit, dependent
care, director or employee loan, fringe benefit, sabbatical, severance,
termination pay or similar plan, program, policy, agreement or arrangement
(other than any such item provided solely pursuant to the terms of a
written or oral contract with any individual employee that is disclosed in
Section 2.13 of the Target Disclosure Schedule); or
----------------------------------------------
(iii) Any plan, program, agreement, policy, commitment or other arrangement
relating to the provision of any benefit described in section 3(1) of ERISA to
former employees, managers or directors or to their survivors, other than
procedures intended to comply with COBRA.
15
<PAGE>
(b) Neither Target nor any ERISA Affiliate has terminated, suspended,
discontinued contributions to or withdrawn from any employee pension
benefit plan, as defined in section 3(2) of ERISA, including (without
limitation) any multiemployer plan, as defined in section 3(37) of ERISA.
(c) Except as disclosed in Section 2.13 of the Target Disclosure Schedule, the
----------------------------------------------
consummation of the transactions contemplated by this Agreement (excluding
any employment agreement with Parent entered into by any employee or
director of Target in connection with this Agreement) will not result in
(i) any amount becoming payable to any employee, director or independent
contractor of Target or Target Subsidiary, (ii) the acceleration of payment
or vesting of any benefit, option or right to which any employee, director
or independent contractor of Target or Target Subsidiary may be entitled,
(iii) the forgiveness of any indebtedness of any employee, director or
independent contractor of Target or Target Subsidiary or (iv) any cost
becoming due or accruing to Target or Target Subsidiary or Parent with
respect to any employee, director or independent contractor of Target or
Target Subsidiary.
(d) There are no pending, or, to the best knowledge of Target, Target
Subsidiary, Source Media and/or Insight Communications, threatened, Actions
or Proceedings involving any of the plans identified in Section 2.13(a), or
---------------
Target and Target Subsidiary, with any of the IRS, the Department of Labor,
the PBGC, or any other person whomsoever. Target and Target Subsidiary
know of no reasonable basis for any such claim, lawsuit, dispute, action or
controversy.
(e) The Related Parties shall indemnify Target and its Affiliates for any
liability of any employee of VirtualModem Employer who does not become an
employee of Target or its Affiliates on or after the Closing.
2.14 Title to Property. Except for title to Target Intellectual Property,
-----------------
which is covered by Section 2.15 below, Target and Target Subsidiary have good
------------
and valid title to all of their respective material properties, interests in
properties and assets, real and personal, reflected in Target Financials or
acquired after the Financial Statement Date (except properties, interests in
properties and assets sold or otherwise disposed of since the Financial
Statement Date in the ordinary course of business), free and clear of all
material mortgages, liens, pledges, charges or encumbrances of any kind or
character, except (i) liens for current taxes not yet due and payable, (ii) such
imperfections of title, liens and easements as do not and will not materially
detract from or interfere with the use of the properties subject thereto or
affected thereby, or otherwise materially impair business operations involving
such properties and (iii) liens securing debt which is reflected on Target
Financials. The plants, property and equipment of Target and Target Subsidiary
that are used in the operations of its businesses are in good operating
condition and repair, subject to normal wear and tear. All properties used in
the operations of Target and Target Subsidiary are reflected in Target
Financials to the extent generally accepted accounting principles required the
same to be reflected as of the dates of such Target Financials. With respect to
properties and assets leased by Target and Target Subsidiary, Target or Target
Subsidiary, as applicable holds valid leasehold interests in such properties and
assets in accordance with the terms of the agreements governing such leases. The
Assets and Properties of Target and Target Subsidiary that will remain with
Target and Target Subsidiary following the Closing Date are listed in Section
-------
2.14A of the Target Disclosure Schedule and constitute all the
- ---------------------------------------
16
<PAGE>
assets and properties used in and/or necessary to the conduct of the
VirtualModem Business as presently conducted and as proposed to be conducted by
any Related Party. The Assets and Properties that will be purchased by Other
Assets Company are listed in Section 2.14B of the Target Disclosure Schedule,
-----------------------------------------------
and none of such assets or properties are necessary to the conduct of the
VirtualModem Business as presently conducted or as proposed to be conducted by
any Related Party. For purposes of this Section 2.14, the VirtualModem Business
proposed to be conducted by any Related Party shall constitute the VirtualModem
Business proposed to be conducted by Target pursuant to any existing contractual
commitment of Target and pursuant to the rollout schedule for the deployment of
the VirtualModem Business for Insight Communications in the form previously
furnished to Parent.
2.15 Intellectual Property.
---------------------
(a) Section 2.15A of the Target Disclosure Schedule lists all Registered
-----------------------------------------------
Intellectual Property of Target and Target Subsidiary used in and/or
necessary to the conduct of the VirtualModem Business, and lists any
proceeding or actions which to the knowledge of any Related Party are
pending as of the date hereof before any court, tribunal (including the PTO
or equivalent authority anywhere in the world) related to any of the
Registered Intellectual Property of Target and Target Subsidiary used in
and/or necessary to the conduct of the VirtualModem Business. Section
-------
2.15B of the Target Disclosure Schedule lists all Registered Intellectual
---------------------------------------
Property that will be purchased by Other Assets Company and lists any
proceeding or actions which to the knowledge of any Related Party are
pending as of the date hereof before any court, tribunal (including the PTO
or equivalent authority anywhere in the world) related to any of the
Registered Intellectual Property of Other Assets Company. None of
Registered Intellectual Property of Other Assets Company are used in and/or
necessary to the conduct of the VirtualModem Business.
(b) Each item of Intellectual Property of Target and/or Target Subsidiary,
either is owned exclusively by Target or Target Subsidiary, as the case may
be, free and clear of any Liens, or is licensed to Target or Target
Subsidiary under a valid License granting sufficient rights to permit
Target to conduct the VirtualModem Business. Target and Target Subsidiary
own or have the valid right to use all trademarks, service marks and trade
names used by Target and Target Subsidiary in connection with the operation
or conduct of the VirtualModem Business, including the sale of any products
or technology or the provision of any services by Target. Target and Target
Subsidiary own exclusively, and have good title to, all copyrighted works
that are VirtualModem Products or other works of authorship that Target
and/or Target Subsidiary otherwise purport to own; provided, however, that
such works may incorporate copyrighted works or works of authorship,
trademarks or trade names of third parties which are licensed to Target or
Target Subsidiary or are in the public domain.
(c) Except as otherwise provided in Section 2.15A of the Target Disclosure
--------------------------------------
Schedule, to the extent that any Intellectual Property of Target or Target
--------
Subsidiary that is used in or necessary to the VirtualModem Business has
been developed or created by any Person other than Target, Target and/or
Target Subsidiary has a written agreement with such Person with respect
thereto and Target and/or Subsidiary has either (i) obtained ownership of,
and is the exclusive owner of, all such Intellectual Property by operation
of law or by valid assignment of any such rights or (ii) obtained a License
under or to such Intellectual Property. In
17
<PAGE>
each case in which Target or Target Subsidiary has acquired ownership of
any such Intellectual Property rights from any Person, such party has
obtained a valid and enforceable assignment sufficient to irrevocably
transfer all rights in such Intellectual Property (including the right to
seek past and future damages with respect to such Intellectual Property) to
Target and/or Target Subsidiary, as the case may be, and, to the maximum
extent provided for by, and in accordance with, applicable Laws, Target
and/or Target Subsidiary has recorded each such assignment of Registered
Intellectual Property with the relevant Governmental or Regulatory
Authority, including the PTO, the U.S. Copyright Office, or their
respective equivalents in any relevant foreign jurisdiction, as the case
may be.
(d) Neither Target nor Target Subsidiary has transferred ownership of any
Intellectual Property of Target or Target Subsidiary used in or necessary
to the VirtualModem Business, to any other Person. Except pursuant to
agreements described in Section 2.15A of the Target Disclosure Schedule,
-----------------------------------------------
neither Target nor Target Subsidiary has granted any License of or other
right to use or authorized the retention of any rights to use any
Intellectual Property used in or necessary to the VirtualModem Business
that is or was Intellectual Property of Target or Target Subsidiary to any
Person. Section 2.15A of the Target Disclosure Schedule lists all
-----------------------------------------------
Contracts by which Target or Target Subsidiary have been granted any
License of or other right to use any Intellectual Property of any other
Person used in or necessary to the VirtualModem Business.
(e) The Intellectual Property of Target and Target Subsidiary listed on Section
-------
2.15A of the Target Disclosure Schedule constitutes all the Intellectual
---------------------------------------
Property used in and/or necessary to the conduct of the VirtualModem
Business and all Intellectual Property required for the VirtualModem
Products under development by Target as of the date hereof. None of the
Intellectual Property that will be purchased by Other Assets Company listed
on Section 2.15B of the Target Disclosure Schedule or the Intellectual
-----------------------------------------------
Property of any Holder constitutes Intellectual Property used in and/or
necessary to the conduct of the VirtualModem Business or Intellectual
Property required for the VirtualModem Products under development by Target
as of the date hereof.
(f) On or before the Effective Time, the operation of the VirtualModem
Business, including Target's design, development, use, import, manufacture
and sale of the products, technology or services (including products,
technology or services currently under development) in the VirtualModem
Business, as they exist on the date hereof and at the Effective Time: (i)
does not infringe the patent, copyright or trademark rights of any Person;
(ii) does not misappropriate the trade secrets rights of any Person; (iii)
does not violate in any material respect the rights of any Person
(including rights to privacy or publicity other than patent rights or
trademark rights described above); or (iv) does not constitute unfair
competition or an unfair trade practice under any Law. Neither Target nor
Target Subsidiary has received notice from any Person claiming that such
operation or any act, product, technology or service (including products,
technology or services currently under development) of Target infringes or
misappropriates the Intellectual Property of any Person or constitutes
unfair competition or trade practices under any Law. Except as set forth
in Section 2.11 of the Target Disclosure Schedule, there is no Order
----------------------------------------------
outstanding and no Action or Proceeding pending, finding or alleging, and
none of Target, Target Subsidiary, Source Media or Insight Communications
has any reason to believe, that any (i) product, technology, service or
publication of Target, (ii) material published
18
<PAGE>
or distributed by Target or Target Subsidiary, or (iii) conduct or
statements of Target or Target Subsidiary, constitute material, false
advertising or otherwise violates any Law.
(g) Each item of Registered Intellectual Property of Target and Target
Subsidiary used in or necessary to the conduct of the VirtualModem Business
and/or the development, license, use, marketing and distribution of the
VirtualModem Products is valid and subsisting, and all necessary
registration, maintenance, renewal fees, annuity fees and taxes in
connection with such Registered Intellectual Property have been paid and
all necessary documents and certificates in connection with such Registered
Intellectual Property have been filed with the relevant patent, copyright,
trademark or other authorities in the United States or foreign
jurisdictions in which such Registered Intellectual Property is registered,
as the case may be, for the purposes of maintaining such Registered
Intellectual Property. Section 2.15A of the Target Disclosure Schedule
-----------------------------------------------
lists all actions that must be taken by the Surviving Company within one
hundred eighty (180) days from the date hereof, including the payment of
any registration, maintenance, renewal fees, annuity fees and taxes or the
filing of any documents, applications or certificates for the purposes of
maintaining , perfecting or preserving or renewing any Registered
Intellectual Property of Target and Target Subsidiary used in or necessary
to the conduct of the VirtualModem Business and/or the development,
license, use, marketing and distribution of the VirtualModem Products.
(h) There are no Contracts or Licenses between Target and any other Person with
respect to Intellectual Property of Target or Target Subsidiary under which
there is any dispute known to any Related Party regarding the scope of such
Contract or License, or performance under such Contract or License,
including any dispute with respect to any payments to be made or received
by Target or Target Subsidiary thereunder.
(i) Except as set forth on Section 2.15(i) of the Target Disclosure Schedule,
-------------------------------------------------
to the knowledge of the Related Parties, no Person is infringing or
misappropriating any Intellectual Property of Target or Target Subsidiary.
(j) Target has taken all requisite commercially reasonable steps to maintain
and preserve the confidentiality of the confidential information and trade
secrets of Target and Target Subsidiary or any similar information provided
by any other Person to Target subject to a duty of confidentiality.
Without limiting the generality of the foregoing, each Related Party has,
and enforces, a policy requiring each employee, consultant and independent
contractor to execute proprietary information, confidentiality and
invention assignment agreements. All current and former employees,
consultants and independent contractors of each Related Party have executed
such agreements. Copies of all such agreements have been provided to
Parent or made available to Parent for review.
(k) Target has taken all commercially reasonable actions necessary and
appropriate to assure that there shall be no material adverse change to its
business or electronic systems or material interruptions in the delivery of
Target's products and services by reason of computer software errors or
miscalculations associated with the advent of the year 2000, including that
all of its products (including products currently under development) will,
without interruption or manual intervention, continue to consistently,
predictably and accurately record, store, process, calculate and present
calendar dates falling on and after (and if applicable,
19
<PAGE>
spans of time including) January 1, 2000, and will consistently,
predictably and accurately calculate any information dependent on or
relating to such dates in substantially the same manner, and with the same
functionality, data integrity and performance, as such products record,
store, process, calculate and present calendar dates on or before December
31, 1999, or calculate any information dependent on or relating to such
dates.
2.16 Contracts.
---------
(a) Section 2.16A of the Target Disclosure Schedule contains a true and
-----------------------------------------------
complete list of each of Target's and Target Subsidiary's Contracts that
are material to Target's business, operations or financial condition (true
and complete copies or, if none, reasonably complete and accurate written
descriptions of which, together with all amendments and supplements thereto
and all waivers of any terms thereof, have been made available to Parent
prior to the execution of this Agreement) and that are used in or necessary
to VirtualModem Business. Such Contracts shall include any license of any
patent, copyright, trade secret or other proprietary right to or from
Target or Target Subsidiary, and Contract for or affecting the development,
manufacture or distribution of Target's products and services and any
Contract relating to a joint venture, strategic alliance or similar
arrangement. Section 2.16C of the Target Disclosure Schedule contains a
-----------------------------------------------
true and complete list of each Contract to which a Related Party (other
than Target) is a party that is used in or necessary to the VirtualModem
Business. The Holders (A) if reasonably requested by Target, shall use
their commercially reasonable best efforts to assign each such Contract to
Target or, (B), if the Holders are unable to assign any such Contract to
Target after using such commercially reasonable best efforts, shall use
their commercially reasonable best efforts to provide Target with the
benefit of such Contract. Section 2.16B of the Target Disclosure Schedule
-----------------------------------------------
contains a true and complete list of each of Target's and Target
Subsidiary's Contracts that are not used in or necessary to the
VirtualModem Business, which will be assigned to Other Assets Company on or
before the Closing. Section 2.16D of the Target Disclosure Schedule
-----------------------------------------------
contains a true and complete list of each Contract to which Source Media or
any of its subsidiaries is a party that are not used in or necessary to the
Virtual Modem Business. Section 2.16 of the Target Disclosure Schedule
----------------------------------------------
contains a true and complete list of each Contract of Target and Target
Subsidiary not terminable by Target or Target Subsidiary upon 30 days (or
less) notice by Target or Target Subsidiary without penalty or obligation
to make payments based on such termination.
(b) Except as otherwise disclosed in Section 2.16 of the Target Disclosure
-------------------------------------
Schedule, each Contract required to be disclosed in Section 2.16 of the
-------- -------------------
Target Disclosure Schedule is in full force and effect and constitutes a
--------------------------
legal, valid and binding agreement of Target or Target Subsidiary,
enforceable against Target or Target Subsidiary in accordance with its
terms (subject to the effect of bankruptcy and other laws affecting the
rights of creditors generally and limitations on the enforcement of
contracts under principles of equity), and, to the knowledge of Target,
Target Subsidiary, Source Media and/or Insight Communications, each other
party thereto (subject to the effect of bankruptcy and other laws affecting
the rights of creditors generally and limitations on the enforcement of
contracts under principles of equity), and, to the knowledge of Target,
Target Subsidiary, Source Media and/or Insight Communications, no other
party to such Contract is, nor has received notice that it is, in material
violation or breach of or default under any such Contract (or with notice
or lapse of time or both, would be in material violation or breach of or
default under any such Contract).
20
<PAGE>
(c) Neither Target nor Target Subsidiary is a party to or bound by any Contract
that (i) is material to Target's business and automatically terminates or
allows termination by the other party thereto upon consummation of the
transactions contemplated by this Agreement or (ii) contains any covenant
or other provision which limits Target's or Target Subsidiary's ability to
compete with any Person in any line of business or in any area or
territory.
2.17 Insurance. Target and Target Subsidiary have policies of insurance and
---------
bonds of the type and in amounts customarily carried by companies conducting
businesses or owning assets similar to those of Target and Target Subsidiary.
There is no material claim pending under any of such policies or bonds as to
which coverage has been questioned, denied or disputed by the underwriters of
such policies or bonds. All premiums due and payable under all such policies
and bonds have been paid and Target and Target Subsidiary are otherwise in
compliance with the terms of such policies and bonds. Neither Target nor Target
Subsidiary have knowledge of any threatened termination of, or material premium
increase with respect to, any of such policies.
2.18 Affiliate Transactions. Except as disclosed in Section 2.8(f) or 2.18(a)
---------------------- -------------------------
of the Target Disclosure Schedule, and except invention assignment or
- ---------------------------------
confidentiality agreements in favor of Target or Target Subsidiary, (i) there
are no Contracts or Liabilities between Target or Target Subsidiary, on the one
hand, and (A) any current or former officer, director, stockholder, or to the
knowledge of Target, Target Subsidiary, Source Media and Insight Communications,
any Affiliate or Associate of Target (including any other Related Party) or (B)
any Person who, to the knowledge of any Related Party, is an Associate of any
such officer, director, stockholder or Affiliate, on the other hand, (ii)
neither Target nor Target Subsidiary provides or causes to be provided any
assets, services or facilities to any such current or former officer, director,
stockholder, Affiliate or Associate, (iii) except pursuant to the Target LLC
Agreement, none of any Related Party or any current or former officer, director,
stockholder, Affiliate or Associate of any Related Party provides or causes to
be provided any assets, services or facilities to Target or Target Subsidiary
and (iv) neither Target nor Target Subsidiary beneficially owns, directly or
indirectly, any Investment Assets of any such current or former officer,
director, stockholder, Affiliate or Associate.
2.19 Employees; Labor Relations.
--------------------------
(a) Neither Target nor Target Subsidiary employs any Persons or has any
employees. Except as set forth on Section 2.19(a) of the Target Disclosure
----------------------------------------
Schedule, all employees of the VirtualModem Business are employed by
--------
Interactive Channel Technologies Inc. (the "VirtualModem Employer").
(b) The VirtualModem Employer is not party to any collective bargaining
agreement and there is no unfair labor practice or labor arbitration
proceedings pending with respect to Target or Target Subsidiary, or, to the
knowledge of any Related Party, threatened, and there are no facts or
circumstances known to Target, Target Subsidiary, Source Media and/or
Insight Communications that could reasonably be expected to give rise to
such complaint or claim. To the knowledge of Target, Target Subsidiary,
Source Media and/or Insight Communications, there are no organizational
efforts presently underway or threatened involving any employees of the
VirtualModem Employer or any of the employees performing work for
21
<PAGE>
Target or Target Subsidiary but provided by an outside employment agency,
if any. There has been no work stoppage, strike or other concerted action
by employees of the VirtualModem Employer.
(c) Except as set forth on Section 2.19(c) of the Target Disclosure Schedule,
all employees of the VirtualModem Employer providing services to Target and
Target Subsidiary are employed at will. Section 2.19(c) of the Target
-----------------------------
Disclosure Schedule sets forth, individually and by category, the name of
-------------------
each officer, employee and consultant, together with such person's position
or function. The annual base salary or wage and any incentive, severance
or bonus arrangements with respect to each person set forth in Section 2.19
------------
of the Target Disclosure Schedule has been provided to Parent. To the
---------------------------------
knowledge of any Related Party, no employee of the VirtualModem Employer
providing services to or on behalf of Target or Target Subsidiary has made
any threat, or otherwise revealed an intent, to terminate such employee's
relationship with the VirtualModem Employer, for any reason, including
because of the consummation of the transactions contemplated by this
Agreement. Neither Target nor Target Subsidiary is a party to any
agreement for the provision of labor from any outside agency. To the
knowledge of any Related Party, there have been no claims by employees of
such outside agencies, if any, with regard to employees assigned to work
for Target or Target Subsidiary, and no claims by any governmental agency
with regard to such employees except as set forth in Section 2.19(c) of the
----------------------
Target Disclosure Schedule.
--------------------------
(d) There have been no federal or state claims based on sex, sexual or other
harassment, age, disability, race or other discrimination or common law
claims, including claims of wrongful termination, by any employees
providing services to or on behalf of Target or Target Subsidiary or by any
of the employees performing work for the VirtualModem Employer but provided
by an outside employment agency, and there are no facts or circumstances
known to any Related Party that could reasonably be expected to give rise
to such complaint or claim. Target, Target Subsidiary and the VirtualModem
Employer have complied in all material respects with all laws related to
the employment of employees and, except as set forth in Section 2.19(d) of
------------------
the Target Disclosure Schedule, none of Target, Target Subsidiary or the
------------------------------
VirtualModem Employer has received any notice of any claim that it has not
complied in any material respect with any Laws relating to the employment
of employees, including any provisions thereof relating to wages, hours,
collective bargaining, the payment of Social Security and similar taxes,
equal employment opportunity, employment discrimination, the WARN Act,
employee safety, or that it is liable for any arrearages of wages or any
taxes or penalties for failure to comply with any of the foregoing.
(e) None of Target, Target Subsidiary or the VirtualModem Employer has written
policies and/or employee handbooks or manuals except as described in
Section 2.19(e) of the Target Disclosure Schedule.
-------------------------------------------------
(f) To the knowledge of any Related Party, no officer, employee or consultant
of or providing service to or on behalf of Target or Target Subsidiary is
obligated under any Contract or other agreement or subject to any Order or
Law that would interfere with Target's or Target Subsidiary's business as
currently conducted. To the knowledge of any Related Party, none of the
execution, delivery or performance by any Related Party of this Agreement
or any Ancillary Agreement to which it is a party, nor the carrying on of
Target's or
22
<PAGE>
Target Subsidiary's business as presently conducted nor any activity of
such officers, employees or consultants in connection with the carrying on
of Target's or Target Subsidiary's business as presently conducted, will
conflict with or result in a breach of the terms, conditions or provisions
of, constitute a default under, or trigger a condition precedent to any
rights under, any Contract or other agreement under which any of such
officers, employees or consultants is now bound.
(g) Target, Target Subsidiary and the VirtualModem Employer have complied in
all material respects with the verification requirements and the record-
keeping requirements of the Immigration Reform and Control Act of 1986
("IRCA"); to the best knowledge of Target, Target Subsidiary, Source Media
and Insight Communications, the information and documents on which Target
and Target Subsidiary relied to comply with IRCA are true and correct; and
there have not been any discrimination complaints filed against Target,
Target Subsidiary or the VirtualModem Employer pursuant to IRCA, and to the
best knowledge of Target, Target Subsidiary, Source Media and Insight
Communications, there is no basis for the filing of such a complaint.
2.20 Environmental Matters.
---------------------
(a) Target and Target Subsidiary possess all Environmental Permits required for
the operation of their business. Target will obtain, prior to the Closing,
all Environmental Permits that must be obtained as of or immediately after
the Closing in order for Merger Sub, the Surviving Company and/or Target to
conduct the business of Target as it was conducted prior to the Closing.
(b) Target and Target Subsidiary are in compliance in all material respects
with (i) all terms, conditions and provisions of its Environmental Permits;
and (ii) all Environmental Laws.
(c) None of Target or Target Subsidiary or, to the knowledge of any Related
Party, any predecessor of Target or Target Subsidiary nor any entity
previously owned by Target or Target Subsidiary has any obligation or
liability with respect to any Hazardous Material, including any Release or
threatened or suspected Release of any Hazardous Material, and there have
been no events, facts or circumstances since the date of formation of
Target or incorporation of Target Subsidiary, which could reasonably be
expected to form the basis of any such obligation or liability. Neither
Target or Target Subsidiary nor, to the knowledge of any Related Party, any
predecessor of Target nor any entity previously owned by Target has
received any notice of alleged, actual or potential responsibility for, or
any inquiry regarding, (i) any Release or threatened or suspected Release
of any Hazardous Material, or (ii) any violation of Environmental Law.
(d) No Releases of Hazardous Material(s) have occurred at, from, in, to, on, or
under any Site while Target has occupied the Site and, to Target's
knowledge, no Hazardous Material is present in, on, about or migrating to
or from any Site. There have been no environmental investigations, studies,
audits, tests, reviews or other analyses conducted by or for Target or
Target Subsidiary or, to the knowledge of Target, Target Subsidiary, Source
Media and/or Insight Communications, by or for any Other Person with
respect to any Site while Target or Target Subsidiary has occupied the
Site, which have not been delivered to Parent prior to
23
<PAGE>
execution of this Agreement. The Site has not been listed or proposed to be
listed as an Environmental Clean-up Site.
2.21 Other Negotiations; Brokers; Third Party Expenses. No Related Party nor,
-------------------------------------------------
to the knowledge of any Related Party, any of their Affiliates (nor any
investment banker, financial advisor, attorney, accountant or other Person
retained by or acting for or on behalf of Target or at Target's direction) (a)
has entered into any Contract that conflicts with any of the transactions
contemplated by this Agreement or the Ancillary Agreements or (b) has entered
into any Contract or had any discussions with any Person regarding any
transaction involving Target which could reasonably be expected to result in any
Related Party in or any general partner, limited partner, manager, officer,
director, employee, agent or Affiliate of any of them being subject to any claim
for liability to said Person as a result of entering into this Agreement or
consummating the transactions contemplated hereby. There is no Contract with
respect to Third Party Expenses expected to be incurred by Target in connection
with the negotiation and effectuation of the terms and conditions of this
Agreement, the Ancillary Agreements and the transactions contemplated hereby and
thereby, including any fee or commission payable to any broker, investment
broker, finder or financial advisor in connection with this Agreement and the
transactions contemplated hereby.
2.22 Foreign Corrupt Practices Act. Neither Target, Target Subsidiary, nor to
-----------------------------
the knowledge of any Related Party, any agent, employee or other Person acting
on behalf of Target or Target Subsidiary has, directly or indirectly, used any
corporate funds for unlawful contributions, gifts, entertainment or other
unlawful expenses relating to political activity, made any unlawful payment to
foreign or domestic government officials or employees or to foreign or domestic
political parties or campaigns from corporate funds, violated any provision of
the Foreign Corrupt Practices Act of 1977, as amended, or made any bribe,
rebate, payoff, influence payment, kickback or other similar unlawful payment.
2.23 Approvals.
---------
(a) Section 2.23(a) of the Target Disclosure Schedule contains a list of all
-------------------------------------------------
material Approvals of Governmental or Regulatory Authorities relating to
the business conducted by Target (including the VirtualModem Business)
which are required to be given to or obtained by Target prior to the
Closing from any and all Governmental or Regulatory Authorities in
connection with the consummation of the transactions contemplated by this
Agreement.
(b) Section 2.23(b) of the Target Disclosure Schedule contains a list of all
-------------------------------------------------
material Approvals which are required to be given to or obtained by Target
prior to Closing from any and all third parties other than Governmental or
Regulatory Authorities in connection with the consummation of the
transactions contemplated by this Agreement and the Ancillary Agreements.
(c) Target has obtained all material Approvals from Governmental or Regulatory
Authorities necessary to conduct the business conducted by Target
(including the VirtualModem Business) in the manner as it is currently
being conducted and there has been no written notice received by Target of
any material violation or material non-compliance with any such Approvals.
All material Approvals from Governmental or Regulatory Authorities
24
<PAGE>
necessary to conduct the business conducted by Target as it is currently
being conducted are set forth in Section 2.23(c) of the Target Disclosure
----------------------------------------
Schedule.
--------
(d) The affirmative vote or consent of the holders of the Target Units
outstanding as of the applicable record date is the only vote of the
holders of any of Target capital ownership interests necessary to approve
this Agreement and the Merger and the transactions contemplated hereby.
2.24 Disclosure. No representation or warranty contained in Article 2 of this
---------- ---------
Agreement, and no statement contained in the Target Disclosure Schedule or in
any certificate, list or other writing furnished to Parent pursuant to any
provision of this Agreement (including Target Financials and the notes thereto)
contains any untrue statement of a material fact or omits to state a material
fact necessary to make the representations and warranties of Target and Target
Subsidiary in Article 2 (as modified by the Target Disclosure Schedule), in the
---------
light of the circumstances under which they were made, not misleading.
2.25 Permit Application; Information Statement. The information supplied in
-----------------------------------------
writing to Parent, or its counsel or auditors, by Target and Holders for
inclusion in the application for issuance of a California Permit pursuant to
which the shares of Parent Common Stock to be issued in the Merger under the
California Code (the "Permit Application") shall not, at the time the fairness
------------------
hearing is held pursuant to Section 25142 of the California Code and the time
the qualification of such securities is effective under Section 25122 of the
California Code contain any untrue statement of a material fact or omit to state
any material fact required to be stated therein or necessary in order to make
the statements therein, in light of the circumstances under which they were
made, not misleading. The information supplied by Target and Holders for
inclusion in any information statement to be sent to the holders of Target Units
in connection with such holders' consideration of the Merger (the "Target Units
------------
Holders Action") (such information statement as amended or supplemented is
- --------------
referred to herein as the "Information Statement") shall not, on the date the
---------------------
Information Statement is first mailed to holders of Target Units, at the time of
the Target Units Holders Action and at the Effective Time, contain any statement
which, at such time, is false or misleading with respect to any material fact,
or omit to state any material fact necessary in order to make the statements
made therein, in light of the circumstances under which they are made, not false
or misleading; or omit to state any material fact necessary to correct any
statement in any earlier communication with respect to the Target Units Holders
Action which has become false or misleading. Notwithstanding the foregoing,
Target makes no representation, warranty or covenant with respect to any
information supplied by Parent or Merger Sub that is contained in the Permit
Application or the Information Statement.
2.26 Investment Advisors. Except as set forth in Section 2.26 of the Target
------------------- --------------------------
Disclosure Schedule, no broker, investment banker, financial advisor or other
- -------------------
Person is entitled to any broker's, finder's, financial advisor's or similar fee
or commission in connection with this Agreement and the transactions
contemplated hereby based on arrangements made by or on behalf of Target.
25
<PAGE>
2.27 Due Diligence. The Company has delivered or made available true and
-------------
complete copies of each material document (to the extent such documents exist),
or true and complete summaries thereof, requested by Parent in writing prior to
the date of this Agreement.
ARTICLE 3
REPRESENTATIONS AND WARRANTIES OF PARENT AND MERGER SUB
Parent and Merger Sub jointly and severally hereby represent and
warrant to Related Parties, subject to such exceptions as specifically disclosed
with respect to specific sections of this Article 3 in the Parent disclosure
---------
schedule (the "Parent Disclosure Schedule") delivered herewith and which shall
--------------------------
become a part hereof, dated as of the date hereof, and numbered with
corresponding numbered and lettered sections and subsections, as follows
3.1 Organization and Qualification. Parent is a corporation and Merger Sub is
------------------------------
a limited liability company, each duly organized, validly existing and in good
standing under the Laws of the State of Delaware. Each of Parent and Merger Sub
has all requisite corporate power and authority to conduct its business as now
conducted and as currently proposed to be conducted and to own, use and lease
its Assets and Properties. Each of Parent and Merger Sub is duly qualified,
licensed or admitted to do business and is in good standing in each jurisdiction
in which the ownership, use, licensing or leasing of its Assets and Properties,
or the conduct or nature of its business, makes such qualification, licensing or
admission necessary, except for such failures to be so duly qualified, licensed
or admitted and in good standing that could not reasonably be expected to have a
Material Adverse Effect on Parent.
3.2 Authority Relative to this Agreement. Each of Parent and Merger Sub has
------------------------------------
full corporate power and authority to execute and deliver this Agreement and the
Ancillary Agreements, to perform its respective obligations hereunder and to
consummate the transactions contemplated hereby and thereby. The execution and
delivery by Parent and Merger Sub of this Agreement and the Ancillary Agreements
to which Parent or Merger Sub is a party and the consummation by Parent and
Merger Sub of the transactions contemplated hereby and thereby have been duly
and validly authorized by all necessary corporate action of Parent and Merger
Sub, and no other corporate action on the part of either Parent or Merger Sub is
required to authorize the execution, delivery and performance of this Agreement
and the Ancillary Agreements to which Parent or Merger Sub is a party and the
consummation by Parent and Merger Sub of the transactions contemplated hereby
and thereby. This Agreement and the Ancillary Agreements to which Parent or
Merger Sub is a party has been duly and validly executed and delivered by Parent
and, assuming the due authorization and the valid execution and delivery hereof
by Target, constitutes a legal, valid and binding obligation of Parent and
Merger Sub enforceable against Parent and Merger Sub in accordance with its
respective terms, except as the enforceability thereof may be limited by
bankruptcy, insolvency, fraudulent conveyance, reorganization, moratorium or
other similar Laws relating to the enforcement of creditors' rights generally
and by general principles of equity. The Parent Common Stock issued to the
Holders pursuant to Section 1.5 hereof, when issued to the Holders subject to
the terms and conditions of this Agreement, shall be duly and validly
authorized, validly issued and fully paid and nonassessable.
26
<PAGE>
3.3 SEC Documents; Parent Financial Statements. Parent has furnished or made
------------------------------------------
available to Target true and complete copies of all SEC Documents filed by it
with the SEC since July 28, 1999, all in the form so filed. Parent has timely
filed all SEC Documents required to be filed by it since such date. As of the
respective filing dates, such SEC Documents filed by Parent and all SEC
Documents filed after the date hereof but before the Closing complied or will
comply in all material respects with the requirements of the Securities Act and
the Exchange Act and the rules and regulations of the SEC thereunder, as the
case may be, and none of the SEC Documents contained or will contain any untrue
statement of a material fact or omitted to state a material fact required to be
stated therein or necessary to make the statements made therein, in light of the
circumstances in which they were made, not misleading, except to the extent such
SEC Documents have been corrected, updated or superseded by a document
subsequently filed with the SEC. The financial statements of Parent, including
the notes thereto, included in the SEC Documents (the "Parent Financial
----------------
Statements") comply as to form in all material respects with the published rules
- ----------
and regulations of the SEC with respect thereto, have been prepared in
accordance with GAAP consistently applied (except as may be indicated in the
notes thereto, or in the case of unaudited statements, as permitted by Form 10-Q
under the Exchange Act) and present fairly the consolidated financial position
of Parent at the dates thereof and the consolidated results of its operations
and cash flows for the period then ended (subject, in the case of unaudited
financial statements, to normal year-end adjustments). There has been no change
in Parent's accounting policies except as described in the notes to the Parent
Financial Statements. Except as reflected or reserved against in the Parent
Financial Statements, Parent has no material Liabilities, except for Liabilities
and obligations (i) incurred in the ordinary course of business consistent with
past practice since the date of the most recent Parent Financial Statements or
(ii) that would not be required to be reflected or reserved against in the
balance sheet of Parent prepared in accordance with GAAP.
3.4 No Conflicts. The execution and delivery by Parent and Merger Sub of this
------------
Agreement does not, and the performance by Parent of its obligations under this
Agreement and the consummation of the transactions contemplated hereby do not
and will not:
(a) conflict with or result in a violation or breach of any of the terms,
conditions or provisions of the Certificate of Incorporation or Bylaws of
Parent or the Certificate of Formation of Merger Sub;
(b) conflict with or result in a violation or breach of any Law or Order
applicable to Parent or Merger Sub or their respective Assets or
Properties;
(c) except as would not have a Material Adverse Effect on Parent, (i) conflict
with or result in a violation or breach of, (ii) constitute a default (or
an event that, with or without notice or lapse of time or both, would
constitute a default) under, (iii) require Parent to obtain any consent,
approval or action of, make any filing with or give any notice to any
Person as a result of the terms of, (iv) result in or give to any Person
any right of termination, cancellation, acceleration or modification in or
with respect to, (v) result in or give to any person any additional rights
or entitlement to increased, additional, accelerated or guaranteed payments
or performance under, (vi) result in the creation or imposition of (or the
obligation to create or impose) any material Lien upon Parent or any of
their respective material Assets or Properties, or (vii) result in the loss
of a material benefit under, any of the terms, conditions or provisions of
27
<PAGE>
any Contract or License to which Parent is a party or by which any of their
material Assets and Properties are bound.
3.5 Information to be Supplied by Parent. The information supplied by Parent
------------------------------------
and Merger Sub for inclusion in the Permit Application shall not, at the time
the fairness hearing is held pursuant to Section 25142 of the California Code
and the time the qualification of such securities is effective under Section
25122 of the California Code, contain any untrue statement of a material fact or
omit to state any material fact necessary in order to make the statements
therein, in light of the circumstances under which they were mad, not
misleading. The information supplied by Parent for inclusion in the Information
Statement shall not, on the date the Information Statement is first mailed to
holders of Target Units, at the time of the Target Units Holders Action and at
the Effective Time, contain any statement which, at such time, is false or
misleading with respect to any material fact, or omit to state any material fact
necessary in order to make the statements made therein, in light of the
circumstances under which they are made, not false or misleading; or omit to
state any material fact necessary to correct any statement in any earlier
communication with respect to the Target Units Holders Action which has become
false or misleading. Notwithstanding the foregoing, Parent and Merger Sub make
no representation, warranty or covenant with respect to any information supplied
by Target that is contained any of the foregoing documents.
3.6 Ownership of Merger Sub; No Prior Activities. As of the date hereof and
--------------------------------------------
the Effective Time, except for obligations or Liabilities incurred in connection
with its incorporation or organization and the transactions contemplated by this
Agreement and except for this Agreement and any other agreements or arrangements
contemplated by this Agreement, Merger Sub has not and will not have incurred,
directly or indirectly, through any subsidiary or affiliate, any obligations or
liabilities or engaged in any business activities of any type or kind whatsoever
or entered into any agreements or arrangements with any Person other than in
connection with the Merger.
3.7 Investment Advisors. Except as set forth in Section 3.7 of the Disclosure
------------------- -----------------------------
Schedule, no broker, investment banker, financial advisor or other Person is
- --------
entitled to any broker's, finder's, financial advisor's or similar fee or
commission in connection with this Agreement and the transactions contemplated
hereby based on arrangements made by or on behalf of Parent.
3.8 Third Party Consents. Neither Parent nor Merger Sub is required to obtain
--------------------
from any third party any consent, waiver or approval for the consummation of the
Merger (other than consents which will be obtained at or prior to the Closing
and consents, the absence of which could not reasonably be expected to have a
Material Adverse Effect on Parent or to prevent the consummation of the
transactions contemplated by this Agreement).
28
<PAGE>
ARTICLE 4
ADDITIONAL AGREEMENTS
4.1 Information Statement; Permit Application.
-----------------------------------------
(a) As soon as practicable after the execution of this Agreement, Target shall
prepare, with the cooperation of Parent, the Information Statement for the
holders of Target Units to approve this Agreement and the transactions
contemplated hereby. The Information Statement shall constitute a
disclosure document for the offer and issuance of the shares of Parent
Common Stock to be received by the holders of Target Units in the Merger.
Parent and Target shall each use reasonable commercial efforts to cause the
Information Statement to comply with applicable federal and state
securities laws requirements. Each of Parent and Target agrees to provide
promptly to the other such information concerning its business and
financial statements and affairs as, in the reasonable judgment of the
providing party or its counsel, may be required or appropriate for
inclusion in the Information Statement, or in any amendments or supplements
thereto, and to cause its counsel and auditors to cooperate with the
other's counsel and auditors in the preparation of the Information
Statement. Target will promptly advise Parent, and Parent will promptly
advise Target, in writing if at any time prior to the Effective Time either
Target or Parent shall obtain knowledge of any facts that might make it
necessary or appropriate to amend or supplement the Information Statement
in order to make the statements contained or incorporated by reference
therein not misleading or to comply with applicable law. The Information
Statement shall contain the recommendation of the Target Management
Committee that the holders of the Target Units approve the Merger and this
Agreement and the conclusion of the Target Management Committee Board that
the terms and conditions of the Merger are advisable and fair and
reasonable to the holders of the Target Units. Anything to the contrary
contained herein notwithstanding, Target shall not include in the
Information Statement any information with respect to Parent or its
affiliates or associates, the form and content of which information shall
not have been approved by Parent prior to such inclusion.
(b) As soon as practicable after the execution of this Agreement, and subject
to Section 4.1(a), Parent shall prepare, with the cooperation of Target,
the Permit Application. Parent and Target shall each use commercially
reasonable efforts to cause the Permit Application to comply with the
requirements of applicable federal and state laws. Each of Parent and
Target agrees to provide promptly to the other such information concerning
its business and financial statements and affairs as, in the reasonable
judgment of the providing party or its counsel, may be required or
appropriate for inclusion in the Permit Application, or in any amendments
or supplements thereto, and to cause its counsel and auditors to cooperate
with the other's counsel and auditors in the preparation of the Permit
Application. Target will promptly advise Parent, and Parent will promptly
advise Target, in writing if at any time prior to the Effective Time either
Target or Parent shall obtain knowledge of any facts that might make it
necessary or appropriate to amend or supplement the Permit Application in
order to make the statements contained or incorporated by reference therein
not misleading or to comply with applicable law. Anything to the contrary
contained herein notwithstanding, Parent shall not include in the Permit
Application any information with respect to Target or its affiliates or
associates, the form and content of which information shall not have been
approved by Target prior to such inclusion.
29
<PAGE>
(c) In the event that the California Permit cannot be obtained by March 10,
2000, Parent shall effect the issuance of the shares of Parent Common Stock
to be issued pursuant to Section 1.6 in a private placement pursuant to
-----------
Section 4(2) of the Securities Act. The parties hereto acknowledge and
agree that in such event: (i) in accordance with Section 1.8, Parent will
------------
at Closing deliver to Source Media Fifteen Million Dollars ($15,000,000) in
cash and the Maximum Share Number shall be adjusted accordingly; (ii) as a
condition to effecting such issuance as a private placement pursuant to
Section 4(2) of the Securities Act, Parent shall be entitled to obtain from
each Holder of Target Units a Certificate in form and substance to be
agreed upon by Parent and Holders and to be set forth as Exhibit C (or such
----------
other form as shall be reasonably satisfactory to Parent) and that Parent
will be relying upon the representations made by each Holder of Target
Units in the applicable Certificate in connection with the issuance of
Parent Common Stock to such Holder; (iii) at the Closing, Parent and the
Holders shall execute and deliver the Registration Rights Agreement in form
and substance to be agreed upon by Parent and Holders, providing that the
Holders shall be granted a demand registration right on a Form S-3
registration statement under the Securities Act exercisable by the Holders
at any time on and after July 28, 2000 and before eighteen (18) months
following the Closing Date, and to be set forth as Exhibit A-4; (iv) the
-----------
shares of Parent Common Stock so issued pursuant to Section 1.6 will not
-----------
upon issuance be registered under the Securities Act and will constitute
"restricted securities" within the meaning of the Securities Act; and (v)
the certificates representing shares of Parent Common Stock shall bear
appropriate legends to identify such privately placed shares as being
restricted under the Securities Act, to comply with applicable state
securities laws and, if applicable, to notice the restrictions on transfer
of such shares.
4.2 Target Units Holders Approval. As soon as practicable following the
-----------------------------
execution and delivery of this Agreement, Target shall give written notice of
this Agreement to all holders of Target Units and shall use commercially
reasonable efforts to take all other action necessary in accordance with
Delaware Law (and, if applicable, the California Code) and its Certificate of
Formation and Target LLC Agreement to secure the written consent of holders of
Target Units. Subject to Section 4.1, Target shall take all lawful action
necessary or advisable to secure the vote or consent of holders of Target Units
required to effect the Merger. The materials submitted to the holders of Target
Units in respect of the Merger shall have been subject to prior review and
comment by Parent and shall include information regarding Target, the terms of
the Merger and this Agreement, the unanimous recommendation of the Target
Management Committee in favor of the Merger, this Agreement and the transactions
contemplated hereby and such other documents (including the Stockholder
Certificate) in order to satisfy the applicable requirements of the Securities
Act in connection with the issuance and sale of Parent Common Stock in the
Merger. Each Holder agrees to enter into a Support Agreement in the form
attached hereto as Exhibit 4.2 immediately upon request by Parent.
-----------
4.3 Access to Information. Between the date of this Agreement and the earlier
---------------------
of the Effective Time or the termination of this Agreement, upon reasonable
notice Target shall (i) provide Parent, Merger Sub and their respective
officers, managers, employees, accountants and counsel full access during normal
business hours to all buildings, offices, and other facilities and to all its
Books and Records of Target and Target Subsidiary, whether located on its
premises or at another location; (ii) permit Parent and Merger Sub to make such
inspections as they may reasonably require; (iii) cause its officers to furnish
Parent and Merger
30
<PAGE>
Sub such financial, operating, technical and product data and other information
with respect to its business and Assets and Properties of Target and Target
Subsidiary as Parent and Merger Sub from time to time may reasonably request,
including financial statements and schedules; (iv) allow Parent and Merger Sub
the opportunity to interview such employees and other personnel and Affiliates
Target and Target Subsidiary with Target's prior written consent, which consent
shall not be unreasonably withheld or delayed; and (v) assist and cooperate with
Parent and Merger Sub in the development of integration plans for implementation
by Parent and the Surviving Company following the Effective Time; provided,
however, that no investigation pursuant to this Section 4.3 shall affect or be
-----------
deemed to modify any representation or warranty made by such party herein.
4.4 Confidentiality. The parties acknowledge that Parent and Target have
---------------
previously executed a Confidentiality Agreement dated October 7, 1999 (the
"Confidentiality Agreement"), which Confidentiality Agreement shall continue in
- --------------------------
full force and effect in accordance with its terms. Without limiting the
foregoing, all information furnished to Parent and its officers, employees,
accountants and counsel by Target, and all information furnished to Target by
Parent and its respective officers, employees, accountants and counsel, shall be
covered by the Confidentiality Agreement. Each of Parent and Target shall be
fully liable and responsible under the Confidentiality Agreement for any breach
of the terms and conditions thereof by their respective subsidiaries, officers,
employees, accountants and counsel.
4.5 Expenses. Whether or not the Merger is consummated, all fees and expenses
--------
incurred in connection with the Merger including all legal, accounting,
financial advisory, consulting and all other fees and expenses of third parties
("Third Party Expenses") incurred by a party in connection with the negotiation
--------------------
and effectuation of the terms and conditions of this Agreement and the
transactions contemplated hereby, shall be the obligation of the respective
party incurring such Third Party Expenses, provided, however, that Parent shall
be responsible for all filing fees associated with SEC and other regulatory
issues, as applicable, provided that filing fees will be covered for only one
filing party other than Parent in connection with a HSR filing, if any.
4.6 Public Disclosure. Unless otherwise required by Law (including federal and
-----------------
state securities laws) or, as to Parent, by the rules and regulations of the
NASD, prior to the Effective Time, no public disclosure (whether or not in
response to any inquiry) of the existence of any subject matter of, or the terms
and conditions of, this Agreement shall be made by any party hereto unless
approved by Parent and Target prior to release; provided, however, that such
approval shall not be unreasonably withheld or delayed; and provided further,
that if any such public disclosure is required by law or, as to Parent, by the
rules and regulations of the NASD, the disclosing party will give the other
party reasonable advance notice of such disclosure and, if such disclosure is
pursuant to a court order or subpoena or similar process, the disclosing party
will cooperate with the other party's efforts to seek injunctive or other relief
preventing or limiting such disclosure.
4.7 Approvals. Parent and Target shall use all commercially reasonable efforts
---------
required to obtain all Approvals from Governmental or Regulatory Authorities or
under any of the Contracts or other agreements as may be required in connection
with the Merger (all of which Approvals are set forth in either the Target
Disclosure Schedule or the Parent
31
<PAGE>
Disclosure Schedule) so as to preserve all rights of and benefits to Target
thereunder and Parent and Target shall provide each other with such assistance
and information as is reasonably required to obtain such Approvals.
4.8 Notification of Certain Matters. Target shall give prompt notice to
-------------------------------
Parent, and Parent shall give prompt notice to Target, of (i) the occurrence or
non-occurrence of any event that is likely to cause any representation or
warranty of Target or Parent, respectively, contained in this Agreement to be
untrue or inaccurate in any material respect at or prior to the Closing Date and
(ii) any failure of Target or Parent, as the case may be, to comply with or
satisfy any covenant, condition or agreement to be complied with or satisfied by
it hereunder; provided, however, that the delivery of any notice pursuant to
this Section 4.8 shall not limit or otherwise affect any remedies available to
-----------
the party receiving such notice.
4.9 Additional Documents and Further Assurances. Each party hereto, at the
-------------------------------------------
request of the other party hereto, shall use all requisite commercially
reasonable efforts to execute and deliver such other instruments prior to
Closing and do and perform such other acts and things (including all action
reasonably necessary to seek and obtain any and all consents and approvals of
any Government or Regulatory Authority or Person required in connection with the
Merger; provided, however, that neither party shall not be obligated to consent
to any material divestitures or operational limitations or activities in
connection therewith and no party shall be obligated to make a payment of money
as a condition to obtaining any such condition or approval) as may be necessary
or desirable for effecting completely the consummation of this Agreement and the
transactions contemplated hereby.
4.10 NNM Listing. Parent shall cause to be authorized for listing on the NNM,
-----------
effective as of the Effective Time, all shares of Parent Common Stock to be
issued, upon official notice of issuance.
4.11 Auditors. Each party will use commercially reasonable efforts to cause
--------
its respective management and independent auditors to facilitate on a timely
basis (i) the preparation of financial statements (including pro forma financial
statements if required) to comply with applicable SEC regulations, (ii) the
review of any audit or review work papers including the examination of selected
audited financial statements and data, and (iii) the delivery of such
representations from each party's independent accountants as may be reasonably
requested by the other party or its accountants.
4.12 Benefit Arrangements. Parent and Target agree that, following the
--------------------
Effective Time, Parent will provide (or will cause Target to provide) benefits
to Target's employees as of the Effective Time that are at least as favorable,
taken as a whole, as the benefits currently provided to employees of Parent
performing functions similar to those to be performed by such Target employees
after the Effective Time.
4.13 Neither Parent nor Target shall, nor shall they permit their Subsidiaries
to, take any action or fail to take any action before or after the Effective
Time which action or failure to act would prevent, or would be reasonably likely
to prevent, the Merger from qualifying as a reorganization within the meaning of
Section 368 of the Internal Revenue Code.
32
<PAGE>
4.14 Merger Sub was formed solely to facilitate the Merger.
4.15 Parent agrees to report the Merger, and agrees to cause Target to report
the Merger, as a reorganization within the meaning of Section 368 of the
Internal Revenue Code and to take no position inconsistent therewith and further
agrees that it will, and that it will cause Target to, report to sale of assets
by Target to the Other Assets Company as a sale of assets at the purchase price
paid for such assets by the Other Assets Company.
4.16 Merger Sub has elected, or will elect, pursuant to Treasury Regulation
Section 301.7701-3(c)(1), to be classified as a corporation for United States
federal income tax purposes effective as of the date of its formation.
4.17 All Tax Returns with respect to taxable periods ending on or before the
Effective Time required to be filed by or with respect to Target or Target
Subsidiary with any Taxing Authority after the Effective Time will be completed
and filed when due (including extensions). All such Tax Returns will be true
and complete when filed. Not later than 30 days prior to the due date
(including extensions) of each such Tax Return, Parent shall deliver a copy of
such Tax Return to the Holders. The Holders shall have an opportunity to review
and comment upon each such Tax Return and Parent will make any changes to such
Tax Return as reasonably requested by the Holders.
4.18 Noncompete.
----------
(a) In order to maximize the value of the assets acquired by Parent under this
Agreement, none of Other Assets Company, Source Media and its Affiliates
will enter into or continue the business of making, having made, using and
directly selling Generic Middleware (as defined in the Programming Services
Agreement).
(b) If all or substantially all of the assets of Other Assets Company are
acquired by, or Other Assets Company is merged into, a third party, such
third party may sell and market Generic Middleware if:
(i) the third party is selling and marketing independently developed Generic
Middleware prior to and at the time of the acquisition or merger; and
(ii) Other Assets Company provides Parent with written notice sixty (60) days
prior to such acquisition or merger to the extent practicable.
(c) This Section 4.18 shall terminate when Section 2.1(c) of the Preferred
Content Provider Agreement is no longer in effect.
ARTICLE 5
CONDITIONS TO THE MERGER
5.1 Conditions to Obligations of Each Party to Effect the Merger. The
------------------------------------------------------------
respective obligations of each party to this Agreement to effect the Merger
shall be subject to the satisfaction at or prior to the Closing of the following
conditions:
33
<PAGE>
(a) Governmental and Regulatory Approvals. Approvals from any Governmental or
-------------------------------------
Regulatory Authority (if any) necessary for consummation of the
transactions contemplated by this Agreement shall have been timely
obtained, unless the failure to obtain such Approval could not be
reasonably expected to have a Material Adverse Effect on Parent, Target or
the Holders, and any waiting period applicable to the consummation of the
Merger under the HSR Act shall have expired or been terminated.
(b) No Injunctions or Regulatory Restraints; Illegality. No temporary
---------------------------------------------------
restraining order, preliminary or permanent injunction or other Order
issued by any court of competent jurisdiction or Governmental or Regulatory
Authority or other legal or regulatory restraint or prohibition preventing
the consummation of the Merger shall be in effect; nor shall there be any
action taken, or any Law or Order enacted, entered, enforced or deemed
applicable to the Merger or the other transactions contemplated by the
terms of this Agreement that would prohibit the consummation of the Merger
or which would permit consummation of the Merger only if certain material
divestitures were made or if Parent were to agree to material limitations
on its business activities or operations.
(c) Target Units Holder Action. The Merger shall have been approved by the
--------------------------
requisite votes of the holders of Target Units of Target in accordance with
the DLLCA and, if applicable, the California Code.
(d) Legal Proceedings. No Governmental or Regulatory Authority shall have
-----------------
notified either party to this Agreement that such Governmental or
Regulatory Authority intends to commence proceedings to restrain or
prohibit the transactions contemplated hereby or force rescission, unless
such Governmental or Regulatory Authority shall have withdrawn such notice
and abandoned any such proceedings prior to the time which otherwise would
have been the Closing Date.
(e) Fairness Hearing and California Permit; Private Placement Alternative. The
---------------------------------------------------------------------
fairness hearing shall have been held by the Commissioner of Corporations
of the State of California and the California Permit shall have been issued
by the State of California. In the alternative, if for whatever reason the
California Permit shall not have been issued by March 10, 2000, or if a
determination shall have been made by such Commission not to issue the
California Permit, Parent shall have executed and delivered to Holders the
Registration Rights Agreement (and such Registration Rights Agreement shall
be in full force and effect upon delivery).
5.2 Additional Conditions to Obligations of Target. The obligations of Target
----------------------------------------------
to consummate the Merger and the other transactions contemplated by this
Agreement shall be subject to the satisfaction at or prior to the Closing of
each of the following conditions, any of which may be waived, in writing,
exclusively by Target:
(a) Representations and Warranties. Each of the representations and warranties
------------------------------
made by Parent and Merger Sub in this Agreement (as qualified by the Parent
Disclosure Schedule, as such may be updated at the Closing Date and prior
to the Effective Time, as provided below) shall be true and correct when
made and (other than representations and warranties which by their express
terms are made solely as of a specified earlier date) shall
34
<PAGE>
be true and correct on and as of the Closing Date so as to not have any
Material Adverse Effect on Parent as though such representation or warranty
was made on and as of the Closing Date, and any representation or warranty
made as of a specified date earlier than the Closing Date shall be true and
correct on and as of such earlier date, provided, however, that Parent
shall have the opportunity to update its Disclosure Schedule as of the
Closing Date as necessary for their representations and warranties (other
than representations and warranties which by their express terms were made
solely as of a specified earlier date) to be true and correct in all
material respects as of the Closing Date.
(b) Performance. Parent and Merger Sub shall have performed and complied in
-----------
all material respects with each agreement, covenant and obligation required
by this Agreement to be so performed or complied with by Parent or Merger
Sub at or before the Closing.
(c) Officers' Certificates. Parent shall have delivered to Target (i) a
----------------------
certificate, dated the Closing Date and executed by the President and Chief
Executive Officer of Parent and (ii) a certificate, dated the Closing Date
and executed by the Secretary of Parent, both in form and substance to be
agreed upon by Parent and Holders and to be set forth as Exhibit D hereto.
---------
Parent shall have delivered to special tax counsel for Target a
certificate, dated as of the Closing Date and executed by an authorized
officer of Parent, in substantially the form set forth in Exhibit H hereto.
---------
(d) No Material Adverse Change. There shall have occurred no material adverse
--------------------------
change in the Business or Condition of Target or Parent since the date
hereof; provided that for purposes of this Section 5.2(d) and Sections 2.8
-------------- ------------
and 5.2(a), changes which are attributable to or result from (i) the public
----------
announcement or pendency of the transactions contemplated hereby on
customers of each party, (ii) changes in general economic conditions or
changes affecting the industry generally in which such party operates,
(iii) changes resulting from the acts or omissions of a party to this
Agreement (other than the party asserting that such changes constitutes a
material adverse change in its Business or Condition); provided, that a
reduction in the market price of a party's capital stock shall not, in and
of itself, constitute a material adverse change in the Business or
Condition of such party; (it being understood that in any controversy
concerning the applicability of this clause (d) the party claiming the
benefit of this clause (d) shall have the burden of proof with respect to
the elements of such clause).
(e) Legal Opinion. Target shall have received a legal opinion from Gunderson
-------------
Dettmer Stough Villeneuve Franklin & Hachigian, LLP, counsel to Parent, in
form and substance to be agreed upon by Parent and Holders and to be set
forth on Exhibit E hereto.
---------
(f) NNM Listing. Parent shall have caused to be authorized for listing on the
-----------
NNM, effective as of the Effective Time, all shares of Parent Common Stock
to be issued, upon official notice of issuance.
(g) Ancillary Agreements. Parent and Merger Sub shall have executed and
--------------------
delivered each Ancillary Agreement to which it is a party.
35
<PAGE>
5.3 Additional Conditions to the Obligations of Parent and Merger Sub. The
-----------------------------------------------------------------
obligations of Parent and Merger Sub to consummate the Merger and the other
transactions contemplated by this Agreement shall be subject to the satisfaction
at or prior to the Closing of each of the following conditions, any of which may
be waived, in writing, exclusively by Parent:
(a) Representations and Warranties. Each of the representations and warranties
------------------------------
made by Target in this Agreement (as qualified by the Target Disclosure
Schedule, as such may be updated at the Closing Date and prior to the
Effective Time, as provided below) shall be true and correct when made and
(other than representations and warranties which by their express terms are
made solely as of a specified earlier date) shall be true and correct on
and as of the Closing Date so as to not have any Material Adverse Effect on
Target and Target Sub, taken as a whole, as though such representation or
warranty was made on and as of the Closing Date, and any representation or
warranty made as of a specified date earlier than the Closing Date shall be
true and correct on and as of such earlier date, provided, however, that
Target shall have the opportunity to update its Disclosure Schedule as of
the Closing Date as necessary for its representations and warranties (other
than representations and warranties which by their express terms were made
solely as of a specified earlier date) to be true and correct in all
respects as of the Closing Date.
(b) Performance. Target shall have performed and complied in all material
-----------
respects with each agreement, covenant and obligation required by this
Agreement to be so performed or complied with by Target on or before the
Closing Date. Target shall have obtained all necessary approvals of the
Source Media Bondholders and preferred shareholders to the transactions
contemplated by this Agreement and the Ancillary Agreements.
(c) Certificates. Target shall have delivered to Parent (i) a certificate,
------------
dated the Closing Date and executed by the Target Management Committee and
(ii) a certificate, dated the Closing Date and executed by the manager of
Target, both substantially in the forms set forth in Exhibit F hereto.
---------
(d) No Material Adverse Change. There shall have occurred no material adverse
--------------------------
change in the Business or Condition of Parent since the date hereof;
provided that for purposes of this Section 5.3(d) and Section 5.3(a),
-------------- --------------
changes which are attributable to or result from (i) the public
announcement or pendency of the transactions contemplated hereby on
customers of each party, (ii) changes in general economic conditions or
changes affecting the industry generally in which such party operates,
(iii) changes resulting from the acts or omissions of a party to this
Agreement (other than the party asserting that such changes constitutes a
material adverse change in its Business or Condition); provided, that a
reduction in the market price of a party's capital stock shall not, in and
of itself, constitute a material adverse change in the Business or
Condition of such party; (it being understood that in any controversy
concerning the applicability of this clause (d) the party claiming the
benefit of this clause (d) shall have the burden of proof with respect to
the elements of such clause).
(e) Third Party Consents. Parent shall have been furnished with evidence
--------------------
satisfactory to it that Target has obtained the consents, approvals and
waivers listed in Section 2.5 of the Target Disclosure Schedule (except for
---------------------------------------------
such consents, approvals and waivers
36
<PAGE>
the failure of which to receive could not reasonably be expected to have a
Material Adverse Effect on the Surviving Company).
(f) Legal Opinion. Parent shall have received a legal opinion from Cooperman
-------------
Levitt Winikoff Lester & Newman, P.C., legal counsel to Target, in form and
substance to be agreed upon by Parent and Holders and to be set forth on
Exhibit G hereto.
---------
(g) Ancillary Agreements. Each Related Party shall have executed and delivered
--------------------
each Ancillary Agreement to which it is a party.
(h) Employees. At least eighty percent (80%) of the employees of the
---------
VirtualModem Employer, which employees are identified on Schedule 2.19(c),
----------------
(A) shall continue to be employed by the VirtualModem Employer immediately
prior to the Closing, (B) shall have accepted employment with Parent by
executing and delivering to Parent its standard form offer letter and (C)
shall not have given any notice or other indication that they are not
willing to be employed by Parent or a Subsidiary of Parent (as Parent shall
designate), following the Merger.
ARTICLE 6
SURVIVAL OF REPRESENTATIONS, WARRANTIES, COVENANTS
AND AGREEMENTS
6.1 Survival of Representations, Warranties, Covenants and Agreements.
-----------------------------------------------------------------
Notwithstanding any right of Parent, Merger Sub or Target (whether or not
exercised) to investigate the affairs of Parent, Merger Sub or Target or a
waiver by Parent or Target of any condition to Closing set forth in Article 5,
---------
each party shall have the right to rely fully upon the representations,
warranties, covenants and agreements of the other party contained in this
Agreement or in any instrument delivered pursuant to this Agreement. The
representations and warranties of Target relating to the ownership of Target
Intellectual Property shall survive the Merger for a period of two (2) years.
All other representations and warranties of Target and all of the
representations and warranties of Parent shall survive the Merger for a period
of one (1) year. None of the other covenants and agreements of Target and
Parent, which by their terms are to be performed on or prior to the Closing
Date, shall survive after the Merger.
6.2 Indemnification by the Holder Indemnitors. Each of Source Media, Insight
-----------------------------------------
Interactive and Insight Communications (the "Holder Indemnitors") shall
------------------
indemnify Parent, Merger Sub and the Surviving Company and any employee,
director, officer or agent (the "Indemnified Parties") of each of them against,
-------------------
hold each of them harmless from, and reimburse each of them for any claim,
costs, loss, liability or expense (including reasonable attorneys' fees and
expenses) or other damage (including, without limitation, expectation, actual,
punitive and consequential damages) (collectively, "Damages") arising, directly
-------
or indirectly, from or in connection with: (a) any inaccuracy in or breach of
any of the representations or warranties of Target, Target Subsidiary or the
Holders in this Agreement, (b) any failure by Target, Target Subsidiary or the
Holders to perform or comply with any covenant or obligation in this Agreement,
(c) any Third Party Claim relating to an inaccuracy or failure referred to in
clause (a) or (b) above, (d) except as provided in Section 2.11 of the Target
--------------------------
Disclosure Schedule with respect to the Worldgate Litigation, any liability
- -------------------
incurred by Parent or any of its Affiliates
37
<PAGE>
relating to the Litigation and (e) any assets, including contract rights,
transferred from Target to Other Assets Company prior to the Closing and any
liabilities of Target assumed by the Other Assets Company prior to the Closing.
In addition, to the extent that any representation or warranty of Target, Target
Subsidiary, or the Holders is qualified, limited or subject to a materiality or
other standard or threshold, such as "to the knowledge of", "the best of the
knowledge of" or by the condition that such representation, warranty, covenant
or agreement would not, or is not or are not expected to "have a Material
Adverse Effect" or by any other similar qualification or limitation (whether
such qualification or limitation, standard or threshold is set forth therein or
under applicable law pertaining to another document to which reference is made
herein), then for all purposes of this Section 6.2 and the indemnification
-----------
obligation imposed hereunder, such disclosure, representation or warranty shall
be deemed to have been made without such limitation, qualification, material
adverse effect standard or other similar standard or threshold, with it being
the intent of the parties that the Indemnified Parties be fully indemnified
hereunder for any Damages incurred by such party without regard to the
qualification, limitation, standard or threshold set forth in the disclosure,
representation or warranty. No claim for Damages shall be made until the
cumulative amount of the Damages exceeds One Hundred Thousand Dollars
($100,000), at which point claim may be made for the entire amount of the
incurred Damages.
6.3 Market Stand-Off. Each Holder hereby agrees that it will not during the
----------------
period commencing on the Effective Time and ending on July 31, 2000, (i) lend,
offer, pledge, sell, contract to sell, sell any option or contract to purchase,
purchase any option or contract to sell, grant any option, right or warrant to
purchase, or otherwise transfer or dispose of, directly or indirectly, eighty
percent (80%) of the shares of Parent Common Stock acquired by Holder pursuant
to the Merger or (ii) enter into any swap or other arrangement that transfers to
another, in whole or in part, any of the economic consequences of ownership of
eighty percent (80%) of the shares of Parent Common Stock acquired by Source
Media or Insight Interactive pursuant to the Merger, whether any such
transaction described in clause (i) or (ii) above is to be settled by delivery
of Parent Common Stock or such other securities, in cash or otherwise, provided
that Source Media may grant a security interest and pledge in respect of such
Parent Common Stock for the benefit of the Source Media Bondholders, provided
further that such pledge(s) shall be subject to the restrictions of this Section
6.3.
6.4 Limitation of Liability. The aggregate liability of each of Source Media,
-----------------------
Insight Interactive and Insight Communications in respect of their obligations
under this Agreement and the Ancillary Agreements shall be limited to an amount
equal to the sum of (i) the amount of proceeds (net of sales commissions,
---
discounts and brokerage fees) from any sale of Parent Common Stock by such party
(or its Affiliates) issued pursuant to Section 1.5 hereof that occurs prior to
the close of business on the date such liability is determined (the
"Determination Date"), without regard to any use or application of such
proceeds, and (ii) in the case of Parent Common Stock held by such party or its
Affiliates issued pursuant to Section 1.5 hereof and held at the close of
business on the Determination Date, the lesser of (A) the fair market value of
such stock, based on the closing sale price of such stock on the Determination
Date, or (B) the net proceeds from the sale of such stock during the thirty (30)
days following the Determination Date when such stock is both publicly traded
and traded on the Nasdaq National Market or on established trading exchange,
minus the amount of any liability of such party (or its Affiliate) for any such
- -----
obligations that have already been paid by such party (or its Affiliate).
38
<PAGE>
Except for obligations arising under the Programming Services Agreement, any
such obligations shall terminate on the second anniversary of the Closing Date.
Except as provided in the following sentence, any such obligations arising under
the Programming Services Agreement shall terminate in accordance with the
Programming Services Agreement. Notwithstanding any other provision hereof,
this Section 6.4 shall not apply to the obligations of Source Media arising
under the Programming Services Agreement.
ARTICLE 7
CONDUCT PRIOR TO THE EFFECTIVE TIME
7.1 Conduct of Business.
-------------------
(a) During the period from the date of this Agreement and continuing until the
earlier of the termination of this Agreement and the Effective Time, Target
and Parent each agree (unless such party receives prior consent in writing
from the other party, which consent shall not be unreasonably withheld) to
carry on its business in the ordinary and usual course and consistent with
its past practices, to pay its Liabilities and Taxes consistent with its
past practices (and in any event when due), to pay or perform other
obligations when due consistent with its past practices (other than
Liabilities, Taxes and other obligations, if any, contested in good faith
through appropriate proceedings), and, to the extent consistent with such
business, to use commercially reasonable efforts to preserve intact its
present business organization, keep available the services of its present
officers and key employees and preserve its relationships with customers,
suppliers, distributors, licensors, licensees, independent contractors and
other Persons having business dealings with it, all with the express
purpose and intent of preserving unimpaired its goodwill and ongoing
businesses at the Effective Time.
(b) Without limiting Section 7.1(a), and except as otherwise specifically
provided in this Agreement, Target shall not, without the prior written
consent of Parent, which consent shall not be unreasonably withheld, take,
or agree in writing or otherwise to take, any of the actions described in
Section 2.8 of this Agreement, or any other action that would make any of
-----------
its representations or warranties contained in this Agreement untrue or
incorrect in any material respect or prevent Target from performing or
cause Target not to perform its agreements and covenants hereunder.
7.2 No Solicitation.
---------------
(a) Until the earlier of the Effective Time and the date of termination of this
Agreement pursuant to the provisions of Section 8.1 hereof, Target will not
-----------
take (and since December 1, 1999, inclusive, neither Target nor Target
Subsidiary has taken), nor will Target permit (and since December 1, 1999
inclusive has not permitted) any of its members, managers, agents,
employees, affiliates, attorneys, accountants, financial advisers or other
representatives (collectively, "Representatives") to (directly or
---------------
indirectly): (i) solicit, encourage, initiate, entertain, review or
participate in any negotiations or discussions with respect to an offer or
proposal, oral, written, or otherwise, formal or informal to acquire all or
any part of the VirtualModem Business or the VirtualModem Products, whether
by purchase of assets, exclusive license, joint venture formation, purchase
of stock, business combination or otherwise, (ii) disclose any information
not customarily disclosed to any Person concerning Target as such
39
<PAGE>
information relates to the VirtualModem Business and which Target believes
would be used for the purposes of formulating any such offer or proposal,
(iii) assist, cooperate with, facilitate or encourage any Person to make
any offer or proposal to acquire all or any substantial portion of the
VirtualModem Business or the VirtualModem Products (directly or
indirectly), (iv) agree to, enter into a contract regarding, approve,
recommend or endorse any transaction involving the acquisition of all or
any part of Target (a "Acquisition Proposal"), or (v) authorize or permit
--------------------
any of Target's Representatives to take any such action. Target shall
notify Parent as promptly as practical if any proposal or offer (formal or
informal, oral, written or otherwise), or any inquiry or contact with any
Person with respect thereto, regarding a Acquisition Proposal is made, such
notice to include the identity of the Person proposing such Acquisition
Proposal and the terms thereof, and shall keep Parent apprised, on a
current basis of the status of any such Acquisition Proposal and of any
modifications to the terms thereof. Target immediately shall cease and
cause to be terminated all existing discussions or negotiations with any
parties other than Parent conducted heretofore with respect to any
Acquisition Proposal.
(b) Except as set forth below in this subsection (b), neither the Target
Management Committee nor any committee thereof shall: (i) fail to include,
withdraw or modify, or propose to withdraw or modify, in a manner adverse
to Parent, the approval or recommendation by such management committee or
any such committee of this Agreement or the Merger, (ii) approve or
recommend or propose to approve or recommend, any Acquisition Proposal, or
(iii) enter into any agreement with respect to any Acquisition Proposal.
ARTICLE 8
TERMINATION, AMENDMENT AND WAIVER
8.1 Termination. Except as provided in Section 8.2 below, this Agreement may
----------- -----------
be terminated and the Merger abandoned at any time prior to the Effective Time:
(a) by mutual written consent of Target and Parent;
(b) by Parent or Target if:
(i) the Effective Time has not occurred before 5 p.m. (Pacific Time) on April
15, 2000 (provided however, that the right to terminate this Agreement
under this Section 8.1(b)(i) shall not be available to any party whose
-----------------
willful failure to fulfill any obligation hereunder has been the cause of
or resulted in, the failure of the Effective Time to occur on or before
such date);
(ii) there shall be any statute, rule, regulation or order enacted,
promulgated or issued or deemed applicable to the Merger by any
Governmental or Regulatory Authority that would make consummation of the
Merger illegal or there shall be a final nonappealable order of a federal
or state court in effect preventing consummation of the Merger;
(iii) there shall be any action taken, or any Law or Order enacted,
promulgated or issued or deemed applicable to the Merger, by any Governmental or
Regulatory Authority, which would (A) prohibit Parent's or the Merger Sub's
ownership or operation of all or any portion of the business of Target or (B)
compel Parent or Merger Sub to
40
<PAGE>
dispose of or hold separate all or a portion of the Assets and Properties of
Target as a result of the Merger; or
(iv) the Merger is not approved and adopted by the affirmative vote of the
Holders as required by the DLLCA, the California Code (if applicable), and
Target's LLC Agreement.
(c) by Target if:
(i) prior to the Effective Time, Parent Board shall have withdrawn, modified
or changed in a manner adverse to Target its approval or recommendation of this
Agreement or the Merger; or
(ii) (Target is not in breach in any material respect of any of its
representations, warranties, covenants or agreements in this Agreement) if
there has been a material breach of any representation, warranty, covenant
or agreement contained in this Agreement on the part of Parent or Merger
Sub and (A) Parent is not using its reasonable efforts to cure such breach,
or has not cured such breach within thirty (30) days, after notice of such
breach to Parent (provided, however, that no cure period shall be required
for a breach which by its nature cannot be cured) and (B) as a result of
such breach and assuming such breach is not cured, the conditions set forth
in Section 5.1 or Section 5.2, as the case may be, would not at Closing be
----------- -----------
satisfied.
(d) by Parent if:
(i) prior to the Effective Time, Target Board shall have withdrawn, modified
or changed in a manner adverse to Parent its approval or recommendation of this
Agreement or the Merger; or
(ii) Parent is not in breach in any material respect of any of its
representations, warranties, covenants or agreements in this Agreement) if there
has been a material breach of any representation, warranty, covenant or
agreement contained in this Agreement on the Target and (A) Target is not using
its reasonable efforts to cure such breach, or has not cured such breach within
thirty (30) days, after notice of such breach to Target (provided, however, that
no cure period shall be required for a breach which by its nature cannot be
cured) and (B) as a result of such breach and assuming such breach is not cured,
the conditions set forth in Section 5.1 or Section 5.3, as the case may be,
----------- -----------
would not at Closing be satisfied.
8.2 Effect of Termination. In the event of a valid termination of this
---------------------
Agreement as provided in Section 8.1, this Agreement shall forthwith become void
-----------
and there shall be no liability or obligation on the part of Parent or Target,
or their respective officers, directors or stockholders or Affiliates or
Associates; provided, however, that each party shall remain liable for any
breaches of this Agreement prior to its termination; and provided further that,
the provisions of Sections 4.4, 4.5, 4.6, 8.2, 9.6, 9.9, 9.10 and 9.11 of this
----------------------------------------------------
Agreement shall remain in full force and effect and survive any termination of
this Agreement.
41
<PAGE>
8.3 Amendment. Except as is otherwise required by applicable law, this
---------
Agreement may be amended by the parties hereto at any time by execution of an
instrument in writing signed on behalf of each of the parties hereto.
8.4 Extension; Waiver. At any time prior to the Effective Time, Parent and
-----------------
Target may, to the extent legally allowed, (i) extend the time for the
performance of any of the obligations of the other party hereto, (ii) waive any
inaccuracies in the representations and warranties made to such party contained
herein or in any document delivered pursuant hereto, and (iii) waive compliance
with any of the agreements, covenants or conditions for the benefit of such
party contained herein. Any agreement on the part of a party hereto to any such
extension or waiver shall be valid only if set forth in an instrument in writing
signed on behalf of such party.
ARTICLE 9
MISCELLANEOUS PROVISIONS
9.1 Notices. All notices, requests and other communications hereunder must be
-------
in writing and will be deemed to have been duly given only if delivered
personally against written receipt or by facsimile transmission against
facsimile confirmation or mailed by prepaid first class certified mail, return
receipt requested, or mailed by overnight courier prepaid, to the parties at the
following addresses or facsimile numbers:
If to Parent or Merger Sub to:
Liberate Technologies
2 Circle Star Way
San Carlos, CA 94070
(650) 701-4000 Phone
(650) 701-4951 Facsimile
Attention: General Counsel
with a copy to:
Gunderson Dettmer Stough Villeneuve Franklin & Hachigian, LLP
155 Constitution Drive
Menlo Park, California 94025
(650) 321-2400 Phone
(650) 321-2800 Facsimile
Attention: Brooks Stough
If to Target to:
SourceSuite LLC
c/o Source Media, Inc.
5400 LBJ Freeway, Suite 680
Dallas, Texas 75240
Attention: Stephen W. Palley, Chief Executive Officer
42
<PAGE>
with a copy to:
Cooperman Levitt Winikoff Lester & Newman, P.C.
800 Third Avenue
New York, NY 10022
(212) 688-7000 Phone
(212) 755-2839 Facsimile
Attention: Robert L. Winikoff, Esq.
If to SourceSuite Acquisition LLC:
c/o Source Media, Inc.
5400 LBJ Freeway, Suite 680
Dallas, Texas 75240
(972) 701-5400 Phone
(972) 701-5566 Facsimile
Attention: Stephen W. Palley, Chief Executive Officer
with a copy to:
Cooperman Levitt Winikoff Lester & Newman, P.C.
800 Third Avenue
New York, NY 10022
(212) 688-7000 Phone
(212) 755-2839 Facsimile
Attention: Robert L. Winikoff, Esq.
If to Source Media:
Source Media, Inc.
5400 LBJ Freeway, Suite 680
Dallas, Texas 75240
(972) 701-5400 Phone
(972) 701-5566 Facsimile
Attention: Stephen W. Palley, Chief Executive Officer
with a copy to:
Cooperman Levitt Winikoff Lester & Newman, P.C.
800 Third Avenue
New York, NY 10022
(212) 688-7000 Phone
(212) 755-2839 Facsimile
Attention: Robert L. Winikoff, Esq.
43
<PAGE>
If to Insight Interactive, LLC or Insight Communications Company,
Inc.:
Insight Communications Company, Inc.
126 East 56th Street
New York, New York 10022
(212) 371-2266 Phone
(212) 371-1549 Facsimile
Attention: General Counsel
All such notices, requests and other communications will (i) if delivered
personally to the address as provided in this Section 9.1, be deemed given upon
-----------
delivery, (ii) if delivered by facsimile transmission to the facsimile number as
provided for in this Section 9.1, be deemed given upon facsimile confirmation,
-----------
(iii) if delivered by mail in the manner described above to the address as
provided for in this Section 9.1, be deemed given on the earlier of the third
-----------
Business Day following mailing or upon receipt and (iv) if delivered by
overnight courier to the address as provided in this Section 9.1, be deemed
-----------
given on the earlier of the first Business Day following the date sent by such
overnight courier or upon receipt (in each case regardless of whether such
notice, request or other communication is received by any other Person to whom a
copy of such notice is to be delivered pursuant to this Section 9.1). Any party
-----------
from time to time may change its address, facsimile number or other information
for the purpose of notices to that party by giving notice specifying such change
to the other party hereto.
9.2 Entire Agreement. This Agreement and the Exhibits and Schedules hereto,
----------------
including Target Disclosure Schedule and the Parent Disclosure Schedule, and all
agreements required to be executed and delivered pursuant hereto, constitute the
entire agreement and understanding among the parties with respect to the subject
matter hereof and supersede all prior agreements and understandings, both
written and oral, among the parties with respect to the subject matter hereof,
except for the Confidentiality Agreement, which shall continue in full force and
effect and shall survive any termination of this Agreement or the Closing in
accordance with its terms.
9.3 Further Assurances; Post-Closing Cooperation. At any time or from time to
--------------------------------------------
time after the Closing, the parties shall execute and deliver to the other party
such other documents and instruments, provide such materials and information and
take such other actions as the other party may reasonably request to consummate
the transactions contemplated by this Agreement and otherwise to cause the other
party to fulfill its obligations under this Agreement and the transactions
contemplated hereby. Each party agrees to use diligent efforts to cause the
conditions to its obligations to consummate the Merger to be satisfied.
9.4 Waiver. Any term or condition of this Agreement may be waived at any time
------
by the party that is entitled to the benefit thereof, but no such waiver shall
be effective unless set forth in a written instrument duly executed by or on
behalf of the party waiving such term or condition. No waiver by any party of
any term or condition of this Agreement, in any one or more instances, shall be
deemed to be or construed as a waiver of the same or any other term or condition
of this Agreement on any future occasion. All remedies, either under this
Agreement or by Law or otherwise afforded, will be cumulative and not
alternative.
44
<PAGE>
9.5 Third Party Beneficiaries. The terms and provisions of this Agreement are
-------------------------
intended solely for the benefit of each party hereto and their respective
successors or permitted assigns, and it is not the intention of the parties to
confer third-party beneficiary rights, and this Agreement does not confer any
such rights, upon any other Person.
9.6 No Assignment; Binding Effect. Neither this Agreement nor any right,
-----------------------------
interest or obligation hereunder may be assigned (by operation of law or
otherwise) by any party without the prior written consent of the other party and
any attempt to do so will be void. Subject to the preceding sentence, this
Agreement is binding upon, inures to the benefit of and is enforceable by the
parties hereto and their respective successors and assigns and any third party
that shall acquire all or substantially all of the assets hereto or at least
fifty percent (50%) of the outstanding equity of a party hereto.
9.7 Headings. The headings and table of contents used in this Agreement have
--------
been inserted for convenience of reference only and do not define or limit the
provisions hereof.
9.8 Invalid Provisions. If any provision of this Agreement is held to be
------------------
illegal, invalid or unenforceable under any present or future Law, and if the
rights or obligations of any party hereto under this Agreement will not be
materially and adversely affected thereby, (a) such provision will be fully
severable, (b) this Agreement will be construed and enforced as if such illegal,
invalid or unenforceable provision had never comprised a part hereof, (c) the
remaining provisions of this Agreement will remain in full force and effect and
will not be affected by the illegal, invalid or unenforceable provision or by
its severance herefrom and (d) in lieu of such illegal, invalid or unenforceable
provision, there will be added automatically as a part of this Agreement a
legal, valid and enforceable provision as similar in terms to such illegal,
invalid or unenforceable provision as may be possible.
9.9 Governing Law. This Agreement shall be governed by and construed in
-------------
accordance with the domestic laws of the State of Delaware, without giving
effect to any choice of law or conflict of law provision or rule (whether of the
State of California or any other jurisdiction) that would cause the application
of the laws of any jurisdiction other than the State of Delaware.
9.10 Construction. Ambiguities in this Agreement, if any, shall not be
------------
construed strictly or in favor of or against any party hereto but rather shall
be given a fair and reasonable construction.
9.11 Counterparts. This Agreement may be executed in any number of
------------
counterparts, each of which will be deemed an original, but all of which
together will constitute one and the same instrument.
9.12 Specific Performance. The parties hereto agree that irreparable damage
--------------------
would occur in the event that any of the provisions of this Agreement were not
performed in accordance with their specific terms or were otherwise breached.
Except where this Agreement specifically provides for arbitration, it is agreed
that the parties shall be entitled to an injunction or injunctions to prevent
breaches of this Agreement and to enforce specifically the terms and
45
<PAGE>
provisions hereof in any court of the United States or any state having
jurisdiction, this being in addition to any other remedy to which they are
entitled at law or in equity.
9.13 No Solicitation of Employees. Following the Closing, neither Source Media
----------------------------
nor Insight Communications shall directly or indirectly solicit any employee of
the Surviving Company, Parent or Merger Sub to leave or terminate their
employment with that party.
9.14 Exculpation. Notwithstanding the foregoing or any other provision of this
-----------
Agreement or any other document related to the Merger that refers to the
treatment of the Merger as a reorganization, including without limitation the
application and information statement relating to California Permit, Source
Media and Insight Interactive each (i) acknowledge and agree that none of
Parent, Merger Sub or Target has made pursuant to this Agreement or otherwise in
connection with the Merger any representation regarding, or shall Parent, Merger
Sub nor Target be held liable with respect to, the tax consequences of the
receipt of the Merger consideration, and (ii) represent that they have consulted
with their respective tax advisors regarding the tax consequences of the Merger
and understand that any tax disclosure provided in connection with the
California Permit has been prepared by such tax advisors.
9.15 Adjustments. Anything to the contrary herein notwithstanding, Target
-----------
shall have the right, at Target's option, anytime prior to Effective Time to
contribute to the Other Assets Company any or all of the cash and cash
equivalents held by Target (other than the proceeds from the sale of assets to
Other Assets LLC).
ARTICLE 10
DEFINITIONS
10.1 Definitions.
-----------
(a) As used in this Agreement, the following defined terms shall have the
meanings indicated below:
"Acquisition Proposal" has the meaning ascribed to it in Section 7.3.
-----------
"Actions or Proceedings" means any action, suit, complaint, petition,
investigation, proceeding, arbitration, litigation or Governmental or Regulatory
Authority investigation, audit or other proceeding, whether civil or criminal,
in law or in equity, or before any arbitrator or Governmental Regulatory
Authority.
"Affiliate" means, as applied to any Person, (a) any other Person
directly or indirectly controlling, controlled by or under common control with,
that Person, or (b) any other Person that owns or controls (i) twenty percent
(20%) or more of any class of voting ownership interests of that Person or any
of its Affiliates or (ii) twenty percent (20%) or more of any class of voting
ownership interests (including any ownership interests issuable upon the
exercise of any option or convertible security) of that Person or any of its
Affiliates. For the purposes of this definition, "control" (including with
correlative meanings, the terms "controlling", "controlled by", and "under
common control with") as applied to any Person, means the possession, directly
46
<PAGE>
or indirectly, of the power to direct or cause the direction of the management
and policies of that Person, whether through ownership of voting ownership
interests or by contract or otherwise.
"Agreement" means this Merger Agreement and Plan of Reorganization,
including (unless the context otherwise requires) the Exhibits and Schedules
hereto and the certificates and instruments delivered in connection herewith, or
incorporated by reference, as the same may be amended or supplemented from time
to time in accordance with the terms hereof.
"Agreement Date" means the date first written above.
"Ancillary Agreements" has the meaning ascribed to it in Section 2.2.
-----------
"Approval" means any approval, authorization, consent, permit,
qualification or registration, or any waiver of any of the foregoing, required
to be obtained from or made with, or any notice, statement or other
communication required to be filed with or delivered to, any Governmental or
Regulatory Authority or any other Person.
"Assets and Properties" of any Person means all assets and properties
of every kind, nature, character and description (whether real, personal or
mixed, whether tangible or intangible, whether absolute, accrued, contingent,
fixed or otherwise and wherever situated), including the goodwill related
thereto, operated, owned, licensed or leased by such Person, including cash,
cash equivalents, Investment Assets, accounts and notes receivable, chattel
paper, documents, instruments, general intangibles, real estate, equipment,
inventory, goods and Intellectual Property.
"Associate" means, with respect to any Person, any corporation or
other business organization of which such Person is an officer or partner or is
the beneficial owner, directly or indirectly, of twenty percent (20%) or more of
any class of voting ownership interests, any trust or estate in which such
Person has a substantial beneficial interest or as to which such Person serves
as a trustee or in a similar capacity and any relative or spouse of such Person,
or any relative of such spouse, who has the same home as such Person.
"Books and Records" means all files, documents, instruments, papers,
books and records relating to the Business or Condition of such party, including
financial statements, internal reports, Tax Returns and related work papers and
letters from accountants, budgets, pricing guidelines, ledgers, journals, deeds,
title policies, minute books, stock certificates and books, stock transfer
ledgers, Contracts, Licenses, customer lists, computer files and programs
(including data processing files and records), retrieval programs, operating
data and plans and environmental studies and plans.
"Business Combination" means, with respect to any Person, (i) any
merger, consolidation or other business combination to which such Person is a
party, (ii) any sale, dividend, split or other disposition or any capital stock
or other equity interests of such Person, (iii) any tender offer (including a
self tender), exchange offer, recapitalization, restructuring, liquidation,
dissolution or similar or extraordinary transaction, (iv) any sale, dividend or
other disposition of all or a material portion of the Assets and Properties of
such Person, or (v) the
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entering into of any agreement or understanding, the granting of any rights or
options, or the acquiescence of such Person, with respect to any of the
foregoing.
"Business Day" means a day other than Saturday, Sunday or any day on
which banks located in the State of California are authorized or obligated to
close.
"Business or Condition" means, with respect to Parent, the business,
condition (financial or otherwise), results of operations or Assets and
Properties of Parent and each of its Subsidiaries, taking Parent together with
such Subsidiaries as a whole, and, with respect to Target, the business
(including the VirtualModem Business), condition (financial or otherwise),
results of operations or Assets and Properties of Target and Target Subsidiary,
taking Target together with Target Subsidiary as a whole.
"California Code" means the California Corporations Code and all
amendments and additions thereto.
"California Permit" has the meaning ascribed to it in Section 1.8.
------------
"Closing" means the closing of the transactions contemplated by
Section 1.2.
- -----------
"Closing Date" has the meaning ascribed to it in Section 1.2.
-----------
"COBRA" means the Consolidated Omnibus Budget Reconciliation Act of
1986, as amended.
"Confidentiality Agreement" has the meaning ascribed to it in Section
-------
4.4.
- ---
"Contract" means any material contract, including:
(a) any distributor, sales, advertising, agency or manufacturer's representative
contract;
(b) any continuing contract for the purchase of materials, supplies, equipment
or services involving in the case of any such contact more than two hundred
thousand dollars ($200,000) over the life of the contract;
(c) any trust indenture, mortgage, promissory note, loan agreement or other
contract for the borrowing of money, any currency exchange, commodities or
other hedging arrangement or any leasing transaction of the type required
to be capitalized in accordance with generally accepted accounting
principles;
(d) any contract for unexpended capital expenditures in excess of two hundred
thousand dollars ($200,000) in the aggregate;
(e) any contract limiting the freedom of such party to engage in any line of
business or to compete with any other Person as that term is defined in the
Exchange Act, as defined herein, or any confidentiality, secrecy or non-
disclosure contract;
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(f) any contract pursuant to which such party is a lessor of any machinery,
equipment, motor vehicles, office furniture, fixtures or other personal
property;
(g) any contract with any person with whom such party does not deal at arm's
length; or
(h) any agreement of guarantee, support, indemnification, assumption or
endorsement of, or any similar commitment with respect to, the obligations,
liabilities (whether accrued, absolute, contingent or otherwise) or
indebtedness of any other Person.
"DLLCA" means the Limited Liability Company Act of the State of
Delaware.
"Delaware Certificate of Merger" has the meaning set forth in Section
-------
1.2.
- ---
"Effective Time" has the meaning ascribed to it in Section 1.2.
-----------
"Environment" means air, surface water, ground water, or land,
including land surface or subsurface, and any receptors such as persons,
wildlife, fish, biota or other natural resources.
"Environmental Clean-up Site" means any location which is listed or
proposed for listing on the National Priorities List, the Comprehensive
Environmental Response, Compensation and Liability Information System, or on any
similar state list of sites relating to investigation or cleanup, or which is
the subject of any pending or threatened action, suit, proceeding, or
investigation related to or arising from any location at which there has been a
Release or threatened or suspected Release of a Hazardous Material.
"Environmental Law" means any federal, state, local or foreign
environmental, health and safety or other Law relating to of Hazardous
Materials, including the Comprehensive, Environmental Response Compensation and
Liability Act, the Clean Air Act, the Federal Water Pollution Control Act, the
Solid Waste Disposal Act, the Federal Insecticide, Fungicide and Rodenticide
Act, and the California Safe Drinking Water and Toxic Enforcement Act.
"Environmental Permit" means any permit, license, approval, consent or
authorization required under or in connection with any Environmental Law and
includes without limitation any and all orders, consent orders or binding
agreements issued or entered into by a Governmental or Regulatory Authority.
"ERISA" means the Employee Retirement Income Security Act of 1974, as
amended, and the rules and regulations promulgated thereunder.
"ERISA Affiliate" means each person (as defined in section 3(9) of
ERISA) that, together with Target, would be treated as a single employer under
section 4001(b) of ERISA or that would be deemed to be a member of the same
"controlled group" within the meaning of section 414(b) or (c) of the Internal
Revenue Code.
"Exchange Act" means the Securities Exchange Act of 1934, as amended,
and the rules and regulations of the SEC thereunder.
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"Exchange Ratio" means the quotient obtained by dividing (x) the
Maximum Share Number (without regard to any adjustment thereof) by (y) the
aggregate number of Target Units that are outstanding immediately prior to the
Effective Time.
"Expiration Date" shall mean the date 180 days after the Effective
Date.
"Financial Statement Date" means November 30, 1999.
"GAAP" means generally accepted accounting principles in the United
States, as in effect from time to time.
"Governmental or Regulatory Authority" means any court, tribunal,
arbitrator, authority, agency, bureau, board, commission, department, official
or other instrumentality of the United States, any foreign country or any
domestic or foreign state, county, city or other political subdivision, and
shall include any stock exchange, quotation service and the National Association
of Securities Dealers.
"Hazardous Material" means (a) any chemical, material, substance or
waste including, containing or constituting petroleum or petroleum products,
solvents (including chlorinated solvents), nuclear or radioactive materials,
asbestos in any form that is or could become friable, radon, lead-based paint,
urea formaldehyde foam insulation or polychlorinated biphenyls, (b) any
chemicals, materials, substances or wastes which are now defined as or included
in the definition of "hazardous substances," "hazardous wastes," "hazardous
materials," "extremely hazardous wastes," "restricted hazardous wastes," "toxic
substances," "toxic pollutants" or words of similar import under any
Environmental Law; or (c) any other chemical, material, substance or waste which
is regulated by any Governmental or Regulatory Authority or which could
constitute a nuisance.
"HSR Act" means the Hart-Scott-Rodino Antitrust Improvements Act of
1976, as amended, and the regulations promulgated thereunder.
"Indebtedness" of any Person means all obligations of such Person (a)
for borrowed money, (b) evidenced by notes, bonds, debentures or similar
instruments, (c) for the deferred purchase price of goods or services (other
than trade payables or accruals incurred in the ordinary course of business),
(d) under capital leases and (e) in the nature of guarantees of the obligations
described in clauses (a) through (d) above of any other Person.
"Information Statement" has the meaning ascribed to it in Section
-------
2.25.
"Intellectual Property" means all trademarks and trademark rights,
trade names and trade name rights, service marks and service mark rights,
service names and service name rights, patents and patent rights, utility models
and utility model rights, copyrights, moral rights, mask work rights, brand
names, trade dress, product designs, product packaging, business and product
names, logos, slogans, rights of publicity, trade secrets, inventions (whether
patentable or not), invention disclosures, improvements, processes, formulae,
industrial models, processes, designs, specifications, technology,
methodologies, computer software (including all source code and object code),
firmware, development tools, flow charts, annotations, all Web addresses, sites
and domain names, all data bases and data collections and all rights therein,
any other
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confidential and proprietary right or information, whether or not subject to
statutory registration, and all related technical information, manufacturing,
engineering and technical drawings, know-how and all pending applications for
and registrations of patents, utility models, trademarks, service marks and
copyrights, and the right to sue for past infringement, if any, in connection
with any of the foregoing, and all documents, disks, records, files and other
media on which any of the foregoing is stored.
"Internal Revenue Code" means the Internal Revenue Code of 1986, as
amended, and the rules and regulations promulgated thereunder.
"Investment Assets" means all debentures, notes and other evidences of
Indebtedness, stocks, securities (including rights to purchase and securities
convertible into or exchangeable for other securities), interests in joint
ventures and general and limited partnerships, mortgage loans and other
investment or portfolio assets owned of record or beneficially by Target or
Target Subsidiary.
"IRS" means the United States Internal Revenue Service or any
successor entity.
"Law" or "Laws" means any law, statute, order, decree, consent decree,
judgment, rule, regulation, ordinance or other pronouncement having the effect
of law whether in the United States, any foreign country, or any domestic or
foreign state, county, city or other political subdivision or of any
Governmental or Regulatory Authority.
"Liabilities" means all Indebtedness, obligations and other
liabilities of a Person, whether absolute, accrued, contingent (or based upon
any contingency), known or unknown, fixed or otherwise, or whether due or to
become due.
"License" means any Contract that grants a Person the right to use or
otherwise enjoy the benefits of any Intellectual Property (including any
covenants not to sue with respect to any Intellectual Property).
"Liens" means any mortgage, pledge, assessment, security interest,
lease, lien, easement, license, covenant, condition, restriction, adverse claim,
levy, charge, option, equity, adverse claim or restriction or other encumbrance
of any kind, or any conditional sale Contract, title retention Contract or other
Contract to give any of the foregoing, except for any restrictions on transfer
generally arising under any applicable federal or state securities law.
"Loss(es)" means any and all damages, payments, fines, fees, Taxes,
penalties, deficiencies, losses (including lost profits or diminution in value),
expenses, reasonable expenses of investigation, court costs, reasonable fees and
expenses of attorneys, accountants and other experts or other expenses of
litigation or other proceedings or of any claim, default or assessment (such
fees and expenses to include all fees and expenses, including fees and expenses
of attorneys).
"Material Adverse Effect" when used with reference to any entity or
group of related entities, means any event, change or effect that is (or will
with the passage of time be) materially adverse to the condition (financial or
otherwise), properties, assets, liabilities, business, operations or results of
operations of such entity and its subsidiaries, taken as a whole.
51
<PAGE>
"Maximum Share Number" means 886,000 shares of Parent Common Stock,
provided, however, that if the parties are unable to obtain the California
Permit for whatever reason, the Maximum Share Number shall be reduced to 821,536
shares of Parent Common Stock.
"Merger" has the meaning ascribed to it in the recitals to this
Agreement.
"NASD" means the National Association of Securities Dealers, Inc.
"NNM" means the distinct tier of The Nasdaq Stock Market referred to
as the Nasdaq National Market.
"Order" means any writ, judgment, decree, injunction or similar order
of any Governmental or Regulatory Authority (in each such case whether
preliminary or final).
"Parent Affiliate" has the meaning ascribed to it in Section 5.11.
------------
"Parent Common Stock" has the meaning ascribed to it in the recitals
of this Agreement.
"Parent Financial Statements" has the meaning ascribed to it in
Section 3.3.
- -----------
"PBGC" means the Pension Benefit Guaranty Corporation established
under ERISA.
"Permit" means any license, permit, franchise or authorization.
"Person" means any natural person, corporation, general partnership,
limited partnership, limited liability Target or partnership, proprietorship,
other business organization, trust, union, association or Governmental or
Regulatory Authority.
"Preferred Content Provider Agreement" means the Contract to be
entered into on the Closing Date by and between Other Assets Company and Parent,
substantially in the form of Exhibit A-3 attached hereto, whereby Other Assets
-----------
Company shall be a preferred content provider of Parent.
"Programming Services Agreement" means the Contract between Other
Assets Company and Target, substantially in the form of Exhibit A-1 attached
-----------
hereto, whereby Target will continue development of the Server IPG application
(as defined therein).
"PTO" means the United States Patent and Trademark Office.
"Registered Intellectual Property" shall mean all United States,
international and foreign: (i) patents, patent applications (including
provisional applications); (ii) registered trademarks and servicemarks,
applications to register trademarks and servicemarks, intent-to-use
applications, other registrations or applications to trademarks or servicemarks,
or trademarks or servicemarks in which common law rights are owned or otherwise
controlled; (iii) registered copyrights and applications for copyright
registration; (iv) any mask work registrations and
52
<PAGE>
applications to register mask works; and (v) any other Intellectual Property
that is the subject of an application, certificate, filing, registration or
other document issued by, filed with, or recorded by, any state, government or
other public legal authority.
"Related Party" has the meaning subscribed to it in Section 2.2.
-----------
"Registration Rights Agreement" means the Contract among Parent and
the holders of Target Units, substantially in the form of Exhibit A-4 attached
-----------
hereto, whereby Parent grants such holders one demand registration right which
can be exercised by such holders only during a certain period and only in
certain events.
"Release" means any spilling, leaking, pumping, pouring, emitting,
emptying, discharging, injecting, escaping, leaching, dumping or disposing of a
Hazardous Material into the Environment.
"SEC" means the Securities and Exchange Commission or any successor
entity.
"SEC Documents" means, with respect to any Person, each report,
schedule, form, statement or other document filed with the SEC by such Person
pursuant to Section 13(a) and 15(d) of the Exchange Act and all final and
effective registration statements and prospectuses filed by such Person with the
SEC pursuant to the Securities Act.
"Securities Act" means the Securities Act of 1933, as amended, and the
rules and regulations promulgated thereunder.
"Site" means any of the real properties currently or previously owned,
leased, occupied, used or operated by Target or Target Subsidiary, any
predecessors of Target or Target Subsidiary, or any entities previously owned by
Target or Target Subsidiary, including all soil, subsoil, surface waters and
groundwater.
"Source Media Bondholders" means the holders of Source Media's 12%
Senior Secured Notes due 2004.
"Subsidiary" means, in addition to Target Subsidiary, any Person in
which Target or Parent, as the context requires, directly or indirectly through
Subsidiaries or otherwise, beneficially owns at least 50% of either the equity
interest in, or the voting control of, such Person, whether or not existing on
the date hereof.
"Surviving Company" has the meaning ascribed to it in Section 1.1.
-----------
"Target" has the meaning ascribed to it in the forepart of this
Agreement.
"Target Affiliates" has the meaning ascribed to it in Section 5.10.
------------
"Target Financials" means the unaudited consolidated balance sheets of
Target and Target Subsidiary as of November 30, 1999 and the related audited
consolidated statements of operations, stockholders' equity and cash flows for
the fiscal year then ended, including the notes thereto.
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<PAGE>
"Target 401(k) Plan" means Target's 401(k) Plan.
"Target Intellectual Property" shall mean any Intellectual Property
that is (i) owned by; (ii) licensed to; or (iii) was developed or created by or
for Target or Target Subsidiary, that is used in or necessary for the conduct of
the present or anticipated business of Target or Target Subsidiary.
"Target LLC Agreement" has the meaning ascribed to it in the recitals
of this Agreement.
"Target Management Committee" has the meaning ascribed to it in the
recitals of this Agreement.
"Target Registered Intellectual Property" means all Registered
Intellectual Property owned by, or filed in the name of, Target or Target
Subsidiary.
"Target Subsidiary" means Source Media Canada, Inc.
"Target Units" has the meaning ascribed to it in the recitals.
"Tax" or "Taxes" has the meaning ascribed to it in Section 2.10(h).
"Tax Returns" means any return, statement, report, declaration,
information return, schedule, certificate, statement or other document
(including any related or supporting information) filed or required to be filed
a Taxing Authority.
"Taxing Authority" means any governmental agency, board, bureau, body,
department or authority of any United States federal, state or local
jurisdiction or any foreign jurisdiction, having jurisdiction with respect to
any Tax.
"Third Party Expenses" has the meaning ascribed to it in Section 5.5.
-----------
"VirtualModem Business" means Target's business relating to the
VirtualModem Products and associated businesses as it currently is conducted or
proposed to be conducted
"VirtualModem Products" means the server-based software platform that
is designed to enable cable and satellite signal transmitted television viewers,
among others, to enjoy interactive connectivity using a VirtualModem enabled
digital set top box, allowing viewers to browse the Internet, send and receive
email, facilitate e-commerce and access a wide variety of interactive television
applications.
"VirtualModem License Agreement" means the License between Target and
Insight Communications, substantially in the form of Exhibit A-2 attached
-----------
hereto, whereby Insight Communications will obtain a license to Target's
Intellectual Property for certain purposes.
(i) Unless the context of this Agreement otherwise requires, (i) words of any
gender include each other gender, (ii) words using the singular or plural number
54
<PAGE>
also include the plural or singular number, respectively, (iii) the terms
"hereof," "herein," "hereby" and derivative or similar words refer to this
entire Agreement as a whole and not to any particular Article, Section or other
subdivision, (iv) the terms "Article" or "Section" or other subdivision refer to
the specified Article, Section or other subdivision of the body of this
Agreement, (v) the phrases "ordinary course of business" and "ordinary course of
business consistent with past practice" refer to the business and practice of
Target, (vi) the words "include," "includes" and "including" shall be deemed to
be followed by the phrase "without limitation," and (vii) when a reference is
made in this Agreement to Exhibits, such reference shall be to an Exhibit to
this Agreement unless otherwise indicated. All accounting terms used herein and
not expressly defined herein shall have the meanings given to them under GAAP.
The term "party" or "parties" when used herein refer to Parent, on the one hand,
and Target, on the other.
(j) When used herein, the phrase "to the knowledge of" any Person, "to the best
knowledge of" any Person, "known to" any Person or any similar phrase, means (i)
with respect to any Person who is an individual, the actual knowledge of such
Person, and (ii) with respect to any other Person, the actual knowledge of the
directors and officers of such Person and other individuals that have a similar
position or have similar powers and duties as the officers and directors of such
Person.
[SIGNATURE PAGE FOLLOWS]
55
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IN WITNESS WHEREOF, the parties hereto have caused this Agreement to
be signed by their duly authorized representatives, all as of the date first
written above.
LIBERATE TECHNOLOGIES SOURCESUITE LLC
By: By:
--------------------------- ---------------------------
Name: Name:
--------------------------- ---------------------------
Title: Title:
--------------------------- ---------------------------
SOURCE MEDIA, INC INSIGHT INTERACTIVE, LLC
By: By:
--------------------------- ---------------------------
Name: Name:
--------------------------- ---------------------------
Title: Title:
--------------------------- ---------------------------
INSIGHT COMMUNICATIONS COMPANY, INC.
By: By:
--------------------------- ---------------------------
Name: Name:
--------------------------- ---------------------------
Title: Title:
--------------------------- ---------------------------
To be entered into before Closing by:
- ------------------------------------
LIBERATE ACQUISITION CO. SOURCESUITE ACQUISITION LLC
By: By:
--------------------------- ---------------------------
Name: Name:
--------------------------- ---------------------------
Title: Title:
--------------------------- ---------------------------
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EXHIBIT 21
SUBSIDIARIES OF REGISTRANT
SMI Holdings, Inc. Texas
IT Network, Inc. Delaware
Interactive Channel, Inc. Delaware
Interactive Channel Technologies Inc. Ontario, Canada
997758 Ontario Inc. Ontario, Canada
Cable Share International Inc. Barbados
Cableshare B.V. Netherlands
Cableshare (U.S.) Limited Illinois
1229501 Ontario Inc. Ontario, Canada
<PAGE>
Exhibit 23.1
Consent of Independent Auditors
We consent to the reference to our firm under the caption "Experts" and to the
use of our report dated February 19, 1999 (except Note 15, as to which the date
is January 12, 2000) in the Registration Statement (Form S-4) and related
Prospectus of Source Media, Inc. for the offer to exchange common stock for
Source Media, Inc. 12% Senior Secured Notes due 2004.
Dallas, Texas /s/ Ernst & Young LLP
January 18, 2000
