-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LLRUvBpSVND7YZbbuPqGBO+npgQeFRGQituHBhzn7f3Tt0hztfHKWUBS0BeKDd4L FZHDHUmjjS9cL1ZW5lSR7g== /in/edgar/work/0000950134-00-009897/0000950134-00-009897.txt : 20001116 0000950134-00-009897.hdr.sgml : 20001116 ACCESSION NUMBER: 0000950134-00-009897 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20000630 FILED AS OF DATE: 20001115 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SOURCE MEDIA INC CENTRAL INDEX KEY: 0000900029 STANDARD INDUSTRIAL CLASSIFICATION: [4822 ] IRS NUMBER: 133700438 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q/A SEC ACT: SEC FILE NUMBER: 000-21894 FILM NUMBER: 770572 BUSINESS ADDRESS: STREET 1: 5400 LBJ FREEWAY STE 680 CITY: DALLAS STATE: TX ZIP: 75240 BUSINESS PHONE: 9727015400 MAIL ADDRESS: STREET 1: 5400 LBJ FREEWAY STE 680 CITY: DALLAS STATE: TX ZIP: 75240 FORMER COMPANY: FORMER CONFORMED NAME: HB COMMUNICATIONS ACQUISITION CORP DATE OF NAME CHANGE: 19950703 10-Q/A 1 d81983ae10-qa.txt AMENDMENT NO. 1 TO FORM 10-Q-QUARTER END 06/30/00 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q AMENDMENT NO. 1 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000 COMMISSION FILE NUMBER 0-21894 SOURCE MEDIA, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 13-3700438 (STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NUMBER) 5400 LBJ FREEWAY, SUITE 680 DALLAS, TEXAS 75240 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (972) 701-5400 (REGISTRANT'S TELEPHONE NUMBER) INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO ------- ------- NUMBER OF SHARES OF COMMON STOCK OUTSTANDING AT AUGUST 7, 2000: 17,151,565 1 2 SOURCE MEDIA, INC. FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2000 The following items of our Quarterly Report on Form-10Q for the fiscal quarter ended June 30, 2000 are hereby amended. Each such item is set forth herein in its entirety, as amended: PART I. FINANCIAL INFORMATION
Page Number ----------- Item 1. Consolidated Financial Statements of Source Media, Inc. Consolidated Balance Sheets of Source Media, Inc. (Unaudited) December 31, 1999 and June 30, 2000 3-4 Consolidated Statements of Operations of Source Media, Inc. (Unaudited) Three and six months ended June 30, 1999 and 2000 5 Consolidated Statements of Cash Flows of Source Media, Inc. (Unaudited) Six months ended June 30, 1999 and 2000 6 Consolidated Statements of Stockholder's Equity (Capital Deficiency) of Source Media, Inc. (Unaudited) June 30, 2000 7 Notes to Consolidated Financial Statements of Source Media, Inc. (Unaudited) 8-17 Financial Statements of SourceSuite LLC Balance Sheet of SourceSuite LLC (Unaudited) June 30, 2000 18 Statement of Operations of SourceSuite LLC (Unaudited) Three months ended June 30, 2000 and Period from Inception (March 3, 2000) to June 30, 2000 19 Statement of Cash Flows of SourceSuite LLC (Unaudited) Period from Inception (March 3, 2000) to June 30, 2000 20 Statement of Members' Equity of SourceSuite LLC (Unaudited) June 30, 2000 21 Notes to Financial Statements of SourceSuite LLC (Unaudited) Period from Inception (March 3, 2000) to June 30, 2000 22-24 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 25-30 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 31
2 3 SOURCE MEDIA, INC. CONSOLIDATED BALANCE SHEETS ASSETS (IN THOUSANDS) (UNAUDITED)
DECEMBER 31, JUNE 30, 1999 2000 ------------ -------- Current Assets: Cash and cash equivalents $ 10,910 $ 13,798 Short-term investments 2,500 -- Restricted investments 5,997 349 Trade accounts receivable, less allowance for doubtful accounts of $605 and $616 in 1999 and 2000 respectively 1,643 1,464 Related party receivables 1,458 1,071 Prepaid expenses and other current assets 1,068 1,021 Investment in securities available for sale -- 25,971 -------- -------- Total current assets 23,576 43,674 Property and equipment: Production equipment 4,511 4,372 Computer equipment 3,612 3,459 Other equipment 1,612 2,617 Furniture and fixtures 656 656 -------- -------- 10,391 11,104 Accumulated depreciation 7,957 9,553 -------- -------- Net property and equipment 2,434 1,551 Intangible assets: Goodwill 3,688 3,688 Contract rights 11,933 11,933 -------- -------- 15,621 15,621 Accumulated amortization 6,119 7,233 -------- -------- Net intangible assets 9,502 8,388 Investment in joint venture 18,669 3,500 Other non-current assets 3,835 3,274 -------- -------- Total assets $ 58,016 $ 60,387 ======== ========
See accompanying Notes to Consolidated Financial Statements. 3 4 SOURCE MEDIA, INC. CONSOLIDATED BALANCE SHEETS LIABILITIES AND STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY) (IN THOUSANDS) (UNAUDITED)
DECEMBER 31, JUNE 30, 1999 2000 ------------ --------- Current Liabilities: Trade accounts payable $ 955 $ 613 Accrued interest 1,991 1,901 Accrued payroll 591 439 Other accrued liabilities 3,706 3,495 Unearned income 1,925 2,032 --------- --------- Total current liabilities 9,168 8,480 Long-term debt 96,250 91,650 Minority interests in consolidated subsidiaries 3,840 3,840 Note receivable and accrued interest from minority stockholder, net of discount of $12 and $0 in 1999 and 2000, respectively (837) (855) --------- --------- 3,003 2,985 Senior redeemable payment-in-kind (PIK) preferred stock, $25 dollar per share liquidation preference, $.001 par value, net of discount Authorized shares - 1,712; Issued and outstanding shares 1,043 and 667 in 1999 and 2000, respectively 18,467 11,055 Non-participating preferred stock, $25 dollar per share liquidation preference, $.001 par value; Authorized and issued - 1 single share -- -- Stockholders' equity (capital deficiency): Common stock, $.001 par value: Authorized shares - 50,000; 16,278 and 17,402 issued and outstanding in 1999 and 2000, respectively 16 17 Less treasury stock, at cost - 268 and 250 shares in 1999 and 2000, respectively (2,647) (2,476) Capital in excess of par value 120,883 132,274 Accumulated other comprehensive income -- (61,467) Accumulated deficit (187,124) (122,131) --------- --------- Total stockholders' equity (capital deficiency) (68,872) (53,783) --------- --------- Total liabilities and stockholders' equity (capital deficiency) $ 58,016 $ 60,387 ========= =========
See accompanying Notes to Consolidated Financial Statements. 4 5 SOURCE MEDIA, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS ENDED ENDED ENDED ENDED JUNE 30, 1999 JUNE 30, 2000 JUNE 30, 1999 JUNE 30, 2000 ------------- ------------- ------------- ------------- Monetary revenues $ 4,406 $ 4,587 $ 9,349 $ 8,563 Nonmonetary revenues 473 666 882 1,326 -------- -------- -------- -------- Total revenues 4,879 5,253 10,231 9,889 Monetary cost of sales 4,044 2,717 6,741 5,057 Nonmonetary cost of sales 473 666 882 1,326 -------- -------- -------- -------- Total cost of sales 4,517 3,383 7,623 6,383 -------- -------- -------- -------- Gross profit 362 1,870 2,608 3,506 Selling, general and administrative expenses 8,551 2,576 14,101 6,419 Amortization of intangible assets 1,237 584 2,473 1,168 Research and development expenses 689 -- 1,519 -- -------- -------- -------- -------- 10,477 3,160 18,093 7,587 -------- -------- -------- -------- Operating loss (10,115) (1,290) (15,485) (4,081) Interest expense 3,204 2,989 6,413 6,083 Interest income (254) (217) (536) (463) Equity interest in losses of joint venture -- 1,126 -- 2,709 Gain on sale of interest in joint venture -- -- -- (74,977) Other expense (income) -- 237 (2) 104 -------- -------- -------- -------- Net income (loss) before extraordinary item (13,065) (5,425) (21,360) 62,463 Extraordinary item gain on extinguishment of debt -- 2,530 -- 2,530 -------- -------- -------- -------- Net income (loss) (13,065) (2,895) (21,360) 64,993 Preferred stock dividends (difference on conversion of preferred stock, net of dividend) 713 (4,702) 1,429 (3,880) -------- -------- -------- -------- Net income (loss) attributable to common stockholders $(13,778) $ 1,807 $(22,789) $ 68,873 ======== ======== ======== ======== Other comprehensive income (loss): Unrealized loss on available for sale securities -- (29,626) 0 (61,467) -------- -------- -------- -------- Comprehensive Income $(13,778) $(27,819) $(22,789) $ 7,406 ======== ======== ======== ======== Basic and diluted net loss per common share: Basic: Net income (loss) before extraordinary item per common share $ (1.03) $ (0.04) $ (1.74) $ 4.08 Extraordinary item -- 0.15 -- 0.16 -------- -------- -------- -------- Net loss attributable to common stockholders $ (1.03) $ 0.11 $ (1.74) $ 4.24 ======== ======== ======== ======== Weighted average basic common shares outstanding: 13,353 16,417 13,093 16,251 ======== ======== ======== ======== Diluted: Net income (loss) before extraordinary item per common share $ (1.03) $ (0.04) $ (1.74) $ 3.86 Extraordinary item -- 0.15 -- 0.15 -------- -------- -------- -------- Net loss attributable to common stockholders $ (1.03) $ 0.11 $ (1.74) $ 4.01 ======== ======== ======== ======== Weighted average basic common shares outstanding: 13,353 16,417 13,093 17,159 ======== ======== ======== ========
See accompanying notes to Consolidated Financial Statements 5 6 SOURCE MEDIA, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
SIX MONTHS SIX MONTHS ENDED ENDED JUNE 30, 1999 JUNE 30, 2000 ------------- ------------- OPERATING ACTIVITIES Net income (loss) $(21,360) $ 64,993 Adjustments to reconcile net income (loss) to net cash used in operating activities: Depreciation 1,361 942 Amortization of intangible assets 2,473 1,114 Deferred Compensation 1,208 829 Non-cash interest expense 174 561 Non-cash interest income (273) (128) Provision for losses on accounts receivable 250 11 Gain on sale of joint venture -- (74,977) Equity investment in losses of joint venture -- 2,709 Extraordinary gain on issuance of common stock in exchange for notes -- (2,530) Changes in operating assets and liabilities: Trade accounts receivable 630 168 Related party receivable -- 387 Prepaid expenses and other current assets 220 12 Deferred expenses 8 35 Trade accounts payable and accrued liabilities 1,505 (796) Accrued interest -- (18) Unearned income 670 107 -------- -------- Net cash used in operating activities (13,134) (6,581) INVESTING ACTIVITIES Capital expenditures (788) (59) Redemption of investments 6,000 5,775 Redemption of short-term investments -- 2,500 Proceeds from sale of joint venture -- 4,392 Investment in SourceSuite LLC -- (4,392) -------- -------- Net cash provided by investing activities 5,212 8,216 FINANCING ACTIVITIES Proceeds from issuance of common stock 4,044 1,009 Warrants exercised -- 244 Other 155 -- -------- -------- Net cash provided by financing activities 4,199 1,253 -------- -------- Net increase (decrease) in cash and cash equivalents (3,723) 2,888 Cash and cash equivalents at beginning of period 11,662 10,910 Cash and cash equivalents at end of period $ 7,939 $ 13,798 ======== ========
See accompanying Notes to Consolidated Financial Statements 6 7 SOURCE MEDIA, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY) (IN THOUSANDS) (UNAUDITED)
TOTAL COMMON STOCK CAPITAL IN STOCKHOLDERS' --------------------- TREASURY EXCESS OF ACCUMULATED COMPREHENSIVE EQUITY (CAPITAL SHARES AMOUNT STOCK PAR VALUE DEFICIT LOSS DEFICIENCY) --------- --------- ---------- ---------- ----------- ------------- --------------- BALANCE AT DECEMBER 31, 1999 16,278 $ 16 $ (2,647) $ 120,883 $(187,124) $ -- $ (68,872) Issuance of common stock upon exercise of stock options 109 -- 171 837 -- -- 1,008 Stock compensation -- -- -- 829 -- -- 829 Net income -- -- -- -- 64,993 -- 64,993 Preferred stock exchange 538 -- -- 3,531 -- -- 3,531 Warrants exercised 83 1 -- 244 -- -- 245 Accumulated other comprehensive loss -- -- -- -- -- (61,467) (61,467) Issuance of common stock for note exchange 394 -- -- 2,070 -- -- 2,070 Preferred stock dividends -- -- -- 3,880 -- -- 3,880 --------- --------- --------- --------- --------- --------- --------- BALANCE AT JUNE 30, 2000 17,402 $ 17 $ (2,476) $ 132,274 $(122,131) $ (61,467) $ (53,783) ========= ========= ========= ========= ========= ========= =========
7 8 SOURCE MEDIA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Unless the context otherwise requires, all references to the "Company" or "Source Media" include Source Media, Inc. and its wholly-owned operating subsidiaries ("Subsidiaries"), including IT Network, Inc. ("IT Network"), Interactive Channel, Inc. ("Interactive Channel"), SMI Holdings, Inc. and its other operating subsidiary, Interactive Channel Technologies Inc., ("ICTI"), as well as its wholly-owned non-operating subsidiary Source Nevada, Inc. and SourceSuite LLC ("SourceSuite"), a 50/50 joint venture with Insight Interactive LLC ("Insight"), a subsidiary of Insight Communications Company, Inc. 1. Basis of Presentation The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, these financial statements include all adjustments, consisting of normal recurring accruals, necessary to present fairly the financial position, results of operations and cash flows of the Company and its consolidated subsidiaries for the periods indicated. Operating results for the three and six months ended June 30, 2000 are not necessarily indicative of the results that may be expected for the year ending December 31, 2000. The balance sheet at December 31, 1999 has been derived from the audited financial statements at that date. For further information, refer to the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 1999. On March 3, 2000 Source Media and Insight sold their respective interests in a joint venture to Liberate Technologies ("Liberate") in exchange for the issuance of 886,000 shares of common stock in Liberate to each of Source Media and Insight and $4.4 million of cash. Prior to the sale of the joint venture, cash equal to the value (as determined by an independent appraisal) of certain retained businesses, consisting of the interactive programming guide and related content business, was contributed by the joint venture to SourceSuite, of which Source Media and Insight each own 50%. SourceSuite used these funds to purchase the retained business from the joint venture, which was comprised of fixed assets with a net book value of approximately $200,000 and certain accrued liabilities, for $1.1 million. 8 9 The following represents the unaudited pro forma results of operations as if the joint venture with Insight and subsequent sale to Liberate had occurred on January 1, 1999.
Three Months Ended Six Months Ended ------------------ -------------------------------- June 30, 1999 June 30, 1999 June 30, 2000 ------------- ------------- ------------- Total revenues $4,879 $10,189 $9,889 Operating loss (7,360) (10,030) (4,081) Net income (loss) attributed to common stockholders (11,752) (18,665) 69,959 Net income (loss) per common share (0.88) (1.43) 4.15
2. Equity Investment in Joint Venture The Company recorded its share of results of operations of its original joint venture with Insight up to March 3, 2000 and records its share of operating results of SourceSuite using the equity method in the Consolidated Statement of Operations. The Company owns a 50% interest in SourceSuite which provides SourceGuide, an interactive programming guide; LocalSource, an interactive television programming service; and is developing other applications for the interactive television industry. SourceSuite is managed by the Company within the terms of the operating agreement and the annual operating plan approved by the management committee. Special actions by SourceSuite require approval of a four member management committee with equal representation, by both Source Media and Insight, on the management committee. The Operating Agreement of SourceSuite restricts any distribution of equity to members for a period of three years. 3. Computation of Net Income (Loss) Per Common Share The Company computes net income (loss) per share in accordance with Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share" (SFAS No. 128) under the provisions of SFAS No. 128. Basic net income (loss) per common share is computed by dividing net income (loss) attributed to common stockholders by the weighted average number of common shares outstanding. In computing dilutive net income (loss) per share, options, warrants, and convertible securities are excluded if their effect would be antidilutive. The reconciliation between the numerator of Basic and Diluted net income (loss) per common share is as follows:
Three Months Ended Six Months Ended ---------------------------------- -------------------------------- June 30, 1999 June 30, 2000 June 30, 1999 June 30, 2000 ------------- ------------- ------------- ------------- Numerator for basic and diluted net income (loss) per share: Net income (loss) before extraordinary items (13,065) (5,425) (21,360) 62,463 Extraordinary items -- 2,530 -- 2,530 Preferred dividends 713 (4,702) 1,429 (3,880) ------------- ------------- ------------- ------------- Income (loss) available to common stockholders $(13,778) $(1,807) $(22,789) $68,873 ============= ============= ============= =============
9 10 The reconciliation between the denominator of Basic and Diluted net income (loss) per common share is as follows:
Three Months Ended Six Months Ended --------------------------------- -------------------------------- June 30, 1999 June 30, 2000 June 30, 1999 June 30, 2000 ------------- ------------- ------------- ------------- Denominator for basic net income (loss) per share - weighted average shares 13,353 16,417 13,093 16,251 Effect of dilutive securities: Employee stock options -- -- -- 161 Warrants -- -- -- 747 Dilutive potential common shares ------ ------ ------- ------ -- -- -- 908 Denominator for diluted net income (loss) per share - adjusted weighted average shares and assumed conversions 13,353 16,417 13,093 17,159 ====== ====== ====== ====== Basic: Net income (loss) per share before extraordinary item $(1.03) $(0.04) $(1.74) $4.08 Extraordinary gain -- 0.15 -- 0.16 ------ ------ ------ ------ Net income (loss) attributable to common stockholders $(1.03) $ 0.11 $(1.74) $4.24 ====== ====== ====== ====== Diluted: Net income (loss) per share before extraordinary item $(1.03) $(0.04) $(1.74) $3.86 Extraordinary gain -- 0.15 -- 0.15 ------ ------ ------ ------ Net income (loss) attributable to common stockholders $(1.03) $ 0.11 $(1.74) $4.01 ====== ====== ====== ======
4. Available for Sale Securities Investment in securities available for sale are recorded at market value as of the reporting date. Temporary declines in market value are charged to shareholders' equity. Other than temporary declines in market value, if any, are charged to earnings. The closing price per share of the Liberate common stock at June 30, 2000 was $29.31 resulting in an aggregate value of $26.0 million. The decline from the previous quarter has been reflected in other comprehensive income. Management does not believe the decline in market value to be other than temporary. 5. New Accounting Pronouncements Financial Accounting Statement 133, Accounting for Derivative Instruments and Hedging Activities was issued in June 1998, and amended by FAS 137 and FAS 138 to be effective for all fiscal quarters of fiscal years beginning after June 15, 2000. The Company has not yet adopted or completed its assessment of the implications of this statement. The Company is also considering the effects of the SEC Staff Accounting Bulletin No. 101, Revenue Recognition which is to be effective no later than the fourth fiscal quarter of fiscal years beginning after December 15, 1999. If the Company were to change its current revenue recognition methodology, it would expect this change in accounting policy to positively impact revenues in 2000, although net income would decrease due to the impact of the cumulative effect of the accounting change from 1999 revenues. Additionally, the Company is evaluating the effects of FASB Interpretation 44, Accounting for Certain Transactions Involving Stock Options. The Company has not yet adopted or completed its assessment of this interpretation on its current practices. 10 11 6. Commitments and Contingencies On August 21, 1998, the first of fourteen class action complaints were filed against the Company and certain of its present and former officers and directors in the United States District Court for the Northern District of Texas asserting violations of sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10-b5 promulgated thereunder. The fourteen complaints were consolidated into the first filed case. Plaintiffs filed an amended complaint on March 3, 1999. The plaintiffs sought damages in an unspecified amount. On May 1, 2000, the Court set a series of deadlines for the disposition of the case with the trial set for April 16, 2001. The Company believes this case is totally without merit and intends to vigorously defend itself and its officers and directors. In addition, the Company is aware of certain claims against the Company that have not developed into litigation, or if they have, are dormant, and in any case are not expected to have a material adverse affect on the Company. Further, the Company is party to ordinary routine litigation, none of which is expected to have a material adverse effect on the Company's results of operations or its financial condition. The Company has employment agreements with three executives which expire in 2001 and 2002. The agreements provide that the Company will pay a base salary amount and grant stock options over a set term to the employees. In the event of a termination without cause, the Company remains obligated to make certain payments as defined in the agreements. 7. Long-Term Debt On October 30, 1997, the Company issued Senior Secured Notes (the "Notes"), in the principal amount of $100 million, which bear interest at the rate of 12% per annum through November 1, 2004. Interest on the Notes is payable semi-annually on May 1 and November 1 of each year commencing on May 1, 1998, to holders of record at the close of business on April 15th or October 15th immediately preceding the interest payment date. The Company placed into an escrow account approximately $22.6 million of the net proceeds from the offering of the Notes, representing funds sufficient, together with interest thereon, to pay the first four interest payments on the Notes. Additionally, the Company placed in escrow $6.0 million in November 1999 from the proceeds received in a transaction with Insight which were used to pay the May 2000 interest payment. The Notes are fully and unconditionally guaranteed, jointly and severally, by all of the Company's Subsidiaries (the "Subsidiary Guarantors"). The guarantees are senior obligations of the Subsidiary Guarantors and are secured by substantially all of the assets of the Subsidiary Guarantors. The guarantees rank pari passu in right of payment with all existing and future senior indebtedness of the Subsidiary Guarantors and rank senior in right of payment to all existing and future subordinated obligations of the Subsidiary Guarantors. The guarantees may be released upon the occurrence of certain events. The guarantee executed by IT Network contains a covenant that restricts payments of dividends on its capital stock to an amount sufficient to cover debt service on the Notes, redemptions or repurchases of the Notes or the Company's Senior PIK 11 12 Preferred Stock (the "Preferred Stock"), dividends on the Preferred Stock and corporate overhead. The assets of Source Media consist solely of investments in its subsidiaries and SourceSuite and invested proceeds from the Notes and the Preferred Stock and related warrants. Financial statements for the Subsidiary Guarantors and Source Media, Inc., on an unconsolidated basis, are not presented because management has determined that they would not be material to investors. In conjunction with the formation of SourceSuite, the Company pledged its membership units in SourceSuite as collateral to secure payments on the Notes. On December 13, 1999, $3.75 million of Notes were tendered to the Company and additional cash received in exchange for an exercise of warrants to purchase shares of common stock. On June 20, 2000 the Company issued 394,285 shares of common stock with a market value of $5.25 per share in exchange for Notes with a carrying value of $4.6 million. This transaction resulted in an extraordinary gain of $2.5 million. The face value of the remaining notes was $91.65 million at June 30, 2000. Except as described below, the Company may not redeem the Notes prior to November 1, 2001. On or after such date, the Company may redeem the Notes, in whole or in part, at any time, at various redemption prices set forth in the indenture governing the terms of the Notes, together with accrued and unpaid interest, if any, to the date of redemption. In addition, at any time and from time to time on or prior to November 1, 2000, the Company may, subject to certain requirements, redeem up to 35% of the aggregate principal amount of the Notes with the cash proceeds of one or more equity offerings at a redemption price equal to 112% of the principal amount to be redeemed, together with accrued and unpaid interest, if any, to the date of redemption, provided, that, at least $65.0 million of the aggregate principal amount of the Notes remain outstanding immediately after each such redemption. The Notes are not subject to any sinking fund requirement. Upon the occurrence of a change in control, the Company will be required to make an offer to repurchase the Notes at a price equal to 101% of the principal amount thereof, together with accrued and unpaid interest, if any, to the date of the repurchase. The indenture contains certain covenants including, but not limited to, limitations on indebtedness, restricted payments, liens, restrictions on distributions from restricted subsidiaries, sales of assets and subsidiary stock, affiliate transactions, issuances of capital stock of restricted subsidiaries and sale/leaseback transactions. As of June 30, 2000, $91.65 million of Notes were outstanding and the dealer quoted value of a Note was $0.32 per dollar face value resulting in an aggregate fair market value of the outstanding Notes of approximately $29.3 million. 8. Senior PIK Preferred Stock On October 30, 1997, the Company issued 800 units (the "Units") for an aggregate purchase price of $20 million, each Unit consisting of 1,000 shares of non-voting Preferred Stock with a liquidation preference of $25.00 per share and 558.75 warrants (the "October 1997 Warrants"). Each October 1997 Warrant entitles the holder to purchase one share of the Company's common stock at a purchase price of $0.01 per share. In the aggregate, the October 1997 Warrants represent the right to purchase 447,000 shares of common stock. The Units were sold in connection with the Company's acquisitions of certain assets. Dividends on the Preferred Stock are payable quarterly on each February 1, May 1, August 1 and November 1, commencing February 1, 1998, at an annual rate of 13 1/2% of the liquidation preference per share. At the Company's option, any dividend payment occurring on or prior to November 1, 2002, may be paid either in cash or by the issuance of additional shares of Preferred Stock with a liquidation preference equal to the amount of such dividends; thereafter, 12 13 dividends will be paid in cash. The certificate of designation governing the Preferred Stock limits the amount of cash dividends that may be paid on the Preferred Stock. At any time and from time to time on or prior to November 1, 2000, the Company may, subject to certain requirements, redeem up to 35% of the aggregate liquidation value of the Preferred Stock with the cash proceeds of one or more equity offerings at a redemption price equal to 113 1/2% of the liquidation preference thereof, plus accumulated dividends, on the date of redemption. After November 1, 2000 and prior to November 1, 2002, the Preferred Stock is not redeemable. On or after November 1, 2002, the Company may redeem the Preferred Stock, in whole or in part, at any time, at various redemption prices, plus accumulated and unpaid dividends, to the date of redemption. Upon the occurrence of a change in control, the Company will be required to make an offer to purchase the outstanding shares of the Preferred Stock at a price equal to 101% of the liquidation preference thereof, plus accumulated and unpaid dividends, to the date of purchase. The Preferred Stock will be subject to mandatory redemption in whole on November 1, 2007, at a price equal to 100% of the then effective liquidation preference thereof, plus, without duplication, all accrued and unpaid dividends to the date of redemption. The certificate of designation contains certain covenants including, but not limited to, limitations on indebtedness, restricted payments, affiliate transactions, issuances of capital stock of restricted subsidiaries and sale/leaseback transactions. The Preferred Stock ranks senior to all classes of common stock and to each other class of capital stock or series of preferred stock with respect to dividend rights and rights on liquidation, winding-up and dissolution of the Company. The Preferred Stock is non-voting except in certain circumstances. The Company may not authorize any new class of preferred stock that ranks senior or pari passu to the Preferred Stock without the approval of the holders of at least a majority of the shares of Preferred Stock then outstanding, voting or consenting, as the case may be, as one class, provided, however, that the Company can issue additional shares of Preferred Stock to satisfy dividend payments on outstanding shares of Preferred Stock; and further provided that the Company can issue shares of preferred stock ranking pari passu with the Preferred Stock if after giving effect thereto, the Consolidated Coverage Ratio, as defined in the certificate of designation, is greater than 1.7 to 1.0. During the second quarter, the Company entered into a number of agreements whereby it exchanged shares of its common stock for shares of Preferred Stock. In each instance the exchange ratio was 1.2 common shares for each share of Preferred Stock. The Company issued 537,744 shares of common stock with a market value of $3.5 million in exchange for Preferred Stock with a carrying value of $8.2 million. Dividends on preferred shares were deducted from the difference between the carrying value of the preferred shares and the market value of the common shares issued to determine the amount ($4.7 million) to be included in arriving at net earnings (loss) available to common shareholders. The estimated fair market value of the October 1997 Warrants, which was estimated to be approximately $5.5 million, was credited to capital in excess of par value and the Preferred Stock was recorded at a corresponding discount. Additionally, $1.2 million of issuance costs were recorded on the Preferred Stock. The discount and issuance costs on the Preferred Stock are being accreted as additional preferred stock dividends using the effective dividend rate method over a ten-year period, resulting in an effective dividend rate of 19.9%. As of June 30, 2000 the estimated fair market value of the preferred stock was approximately $4.68 per share for an aggregate value of the outstanding Preferred Stock of $3.1 million. The shares of Preferred Stock were valued at 1.2 times the closing market price of the common stock at June 30, 2000. This ratio was used to approximate the fair market value based on the fact that approximately 40% of the outstanding Preferred Shares were exchanged at this ratio during the quarter, with little other market activity. 13 14 On February 1 and May 1, 2000, the quarterly dividends due on the Preferred Stock were paid through the issuance of additional Preferred Stock each having a liquidation preference of $0.9 million, with terms identical to those of the Preferred Stock. The estimated fair market value of the stock issued in lieu of a cash payment on February 1 and May 1, 2000 was approximately $0.4 million and $ 0.3 million, respectively, which were recorded as preferred stock dividends. 9. Stock Based Compensation On January 2, 1998, the Company issued stock option grants to its employees which fully vest on January 2, 2004. If certain target stock prices are met, the vesting accelerates. As a portion of the underlying shares for these options had not been authorized by the common stockholders at the date of grant, the portion of unauthorized options were treated as a variable compensation plan through July 28, 1998, when the stockholders authorized the shares. Separately, in the second quarter of 2000, the Company accelerated the vesting and modified the terms of stock options associated with the severance of an employee which resulted in $ 0.6 million of compensation expense on the new measurement date. The Company has recognized stock compensation expense of $0.8 million and $0.7 million in selling, general and administrative expense for the three months ended June 30, 1999 and 2000, respectively. Total expense amounted to $1.2 million and $0.8 million respectively for the six month periods ended June 30, 1999 and 2000. 10. Equity in SourceSuite Joint Venture On November 17, 1999 the Company completed the creation of a joint venture with Insight to conduct the business of its former VirtualModem(TM) and Interactive TV lines of business. The investment in the joint venture was accounted for by the equity method. The Company contributed certain assets of the "VirtualModem(TM)" and "Interactive Channel" products and businesses in exchange for a 50% ownership in the joint venture. Insight contributed $13 million in cash to the joint venture in exchange for a 50% interest. On March 3, 2000, the joint venture conveyed its Interactive TV line of business to SourceSuite and Source Media and Insight each transferred their interests in the joint venture to Liberate in exchange for the issuance of 886,000 shares of Liberate common stock and $4.4 million of cash. This transaction resulted in a gain for the Company of $75.0 million in the first quarter. The gain was calculated based on the closing price of Liberate Common Stock on March 3, 2000 (the closing date) of $98.6875 per share, net of the Company's book basis of $17.4 million. The Company has net operating loss carry forwards in excess of the tax effect of this gain and, consequently, has reported no current or deferred income tax expense. 14 15 Assets contributed to SourceSuite have been valued based on an independent appraisal of fair value and allocated to assets, liabilities and goodwill. The Company records amortization of the assets contributed to the joint venture on its historical basis. Summary financial data of SourceSuite at June 30, 2000 is as follows (in thousands): ASSETS: Current Assets.................... $ 7,824 Property and equipment, net....... 205 Intangible assets, net............ 795 ---------- $ 8,824 ========== LIABILITIES AND MEMBERS' EQUITY: Current liabilities............... $ 1,740 Members' equity................... 7,084 ---------- $ 8,824 ========== NET LOSS: Net loss from period of inception (March 3, 2000) through June 30, 2000. $ (2,883) ==========
11. Segment Reporting In accordance with SFAS 131, the Company has identified two reportable operating segments, IT Network and Interactive TV, for disclosure purposes. These two segments are regularly reviewed by the Company's management for determination of the allocation of resources to these businesses. IT Network sells advertising and related support services to clients who sponsor a promotional message with interactive content supplied primarily by IT Network. The Interactive TV business has developed proprietary software and interactive programming services that can enable digital, two-way television systems equipped with digital (or advanced analog) set-top boxes to deliver two-way, interactive programming with the touch of a set-top remote or the use of a wireless keyboard. The Interactive TV business includes the results of the Interactive Channel and ICTI subsidiaries and the Company's 50% equity interest in the results of SourceSuite (and its predecessor joint venture with Insight) from November 17, 1999. The total revenues, expenses and assets by reportable operating segments are used in the Company's operations and do not include general corporate overhead and assets not allocated to the operating units. These assets and expenses have been separately disclosed for reconciliation purposes. 15 16
Three Months Ended June 30, Six Months Ended June 30, 1999 2000 1999 2000 -------- -------- -------- -------- (In Thousands) (In Thousands) Monetary revenues: IT Network $ 4,406 $ 4,587 $ 9,307 $ 8,563 Interactive TV -- -- 42 -- -------- -------- -------- -------- Total monetary revenues $ 4,406 $ 4,587 $ 9,349 $ 8,563 ======== ======== ======== ======== Nonmonetary revenues: IT Network $ 473 $ 666 $ 882 $ 1,326 Interactive TV -- -- -- -- -------- -------- -------- -------- Total nonmonetary revenues $ 473 $ 666 $ 882 $ 1,326 ======== ======== ======== ======== Net revenues: IT Network $ 4,879 $ 5,253 $ 10,189 $ 9,889 Interactive TV -- -- 42 -- -------- -------- -------- -------- Total net revenues $ 4,879 $ 5,253 $ 10,231 $ 9,889 ======== ======== ======== ======== Operating loss: IT Network $ (2,796) $ (821) $ (3,756) $ (2,067) Interactive TV (2,754) -- (5,454) -- Corporate (4,565) (469) (6,275) (2,014) -------- -------- -------- -------- Total operating loss $(10,115) $ (1,290) $(15,485) $ (4,081) ======== ======== ======== ======== Equity interest in loss of joint venture: Interactive TV $ -- $ (1,126) $ -- $ (2,709) ======== ======== ======== ========
December 31, 1999 June 30, 2000 ----------------- ------------- Identifiable assets: IT Network $15,474 $13,827 Interactive TV 20,675 -- Corporate 21,867 46,560 ------- ------- Total identifiable assets $58,016 $60,387 ======= ======= Investment in joint venture: Interactive TV $18,669 $ 3,500 ======= =======
16 17 12. Subsequent Events In July, the Company exchanged additional shares of common stock for shares of Preferred Stock (See Note 8). The exchange ratio was 1.2 shares of common stock for 1.0 shares of Preferred Stock. As of August 7, 2000, the Company has retired 54% of its outstanding Preferred Stock. The Company offered to extend the exercise period of its redeemable common stock purchase warrants, issued in June 1993 (the "Public Warrants"), to December 22, 2000 from the scheduled June 23, 2000 expiration. The exercise price of the warrants was not changed, however, as a condition of the extension, the Company required each warrantholder to approve a modification to the terms and conditions that govern the circumstances under which the Company may call its warrants for redemption. Under the modification, the Company may exercise its right to redeem the warrants if the closing price of its common stock is $13.00 per share for more than ten consecutive trading days. The extension and modification was accepted by holders of 96.2% of the outstanding warrants. 17 18 SOURCESUITE LLC BALANCE SHEET JUNE 30, 2000 (DOLLARS IN THOUSANDS) (UNAUDITED) ASSETS Current Assets: Cash and cash equivalents $ 7,041 Related Party Receivable 713 Prepaid expenses and other current assets 70 ------- Total current assets 7,824 Property and equipment: Computer and production equipment 231 Accumulated depreciation 26 ------- Net property and equipment 205 Intangible assets: Goodwill 858 Accumulated amortization 63 ------- Net intangible assets 795 ------- Total assets $ 8,824 ======= LIABILITIES AND MEMBERS' EQUITY Current Liabilities: Accounts payable $ 24 Accrued liabilities 645 Payable to Source Media, Inc. 1,071 ------- Total current liabilities 1,740 Members' equity, 1,000,000 units authorized and outstanding 9,967 Accumulated deficit (2,883) ------- Total Members' Equity 7,084 ------- Total liabilities and members' equity $ 8,824 =======
See accompanying Notes to Consolidated Financial Statements. 18 19 SOURCESUITE LLC STATEMENT OF OPERATIONS (DOLLARS IN THOUSANDS) (UNAUDITED)
THREE MONTHS PERIOD OF INCEPTION ENDED (MARCH 3, 2000) TO JUNE 30, 2000 JUNE 30, 2000 ------------- ------------------- Revenues $ -- $ -- Operating expenses: Selling, general and administrative expenses 2,291 2,961 Amortization of intangible assets 63 63 ------- ------- Total operating expenses 2,354 3,024 ------- ------- Operating loss (2,354) (3,024) Interest income 103 141 ------- ------- Net loss $(2,251) $(2,883) ======= =======
See accompanying Notes to Consolidated Financial Statements. 19 20 SOURCESUITE LLC STATEMENT OF CASH FLOWS PERIOD OF INCEPTION (MARCH 3, 2000) TO JUNE 30, 2000 (DOLLARS IN THOUSANDS) (UNAUDITED) OPERATING ACTIVITIES Net Loss $(2,883) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation 14 Amortization of intangible assets 63 Changes in operating assets and liabilities: Related party receivable 368 Prepaid expenses and other current assets (23) Trade accounts payable and accrued liabilities 168 Related party payable 532 ------- Net cash used in operating activities (1,761) INVESTING ACTIVITIES Capital expenditures (30) ------- Net cash used in investing activities (30) ------- Net decrease in cash and cash equivalents (1,791) Cash and cash equivalents at beginning of period 8,832 ------- Cash and cash equivalents at end of period $ 7,041 =======
See accompanying Notes to Consolidated Financial Statements. 20 21 SOURCESUITE LLC STATEMENT OF MEMBERS' EQUITY JUNE 30, 2000 (DOLLARS IN THOUSANDS) (UNAUDITED)
MEMBERSHIP MEMBERS' UNITS EQUITY ---------- -------- Sale of membership units on March 3, 2000 1,000,000 $ 9,967 Net loss -- (2,883) --------- ------- June 30, 2000 1,000,000 $ 7,084 ========= =======
See accompanying Notes to Consolidated Financial Statements. 21 22 SOURCESUITE LLC NOTES TO FINANCIAL STATEMENTS PERIOD FROM INCEPTION (MARCH 3, 2000) THROUGH JUNE 30, 2000 1. DESCRIPTION OF BUSINESS SourceSuite LLC ("SourceSuite" or "Company"), a Delaware limited liability company, was formed on March 3, 2000 as a 50/50 joint venture between Source Media, Inc. ("Source Media") and Insight Interactive, LLC ("Insight"). On November 17, 1999 Source Media conveyed certain assets related to its VirtualModem(TM)" and "Interactive Channel" products and businesses and Insight contributed $13 million in cash to a joint venture in exchange for each owning a 50% interest in that joint venture. On March 3, 2000, Source Media and Insight sold their respective interests in the joint venture to Liberate Technologies ("Liberate") in exchange for the issuance of 886,000 shares of common stock in Liberate to each of Source Media and Insight and $4.4 million of cash. Prior to the sale of the joint venture, cash equal to the value (as determined by an independent appraisal) of certain retained businesses, consisting of SourceGuide, an interactive programming guide; LocalSource, an interactive television programming service; and related content, was contributed by the joint venture to SourceSuite. SourceSuite used these funds to purchase the retained business from the joint venture, which comprised of fixed assets with a net book value of approximately $200,000 and certain accrued liabilities, for $1.1 million. SourceSuite will continue the development of the proprietary software contributed by Source Media and will provide interactive programming services that are enabled on digital, two-way television systems equipped with digital (or advanced analog) set-top boxes to deliver two-way, interactive programming with the touch of a set-top remote or the use of a wireless keyboard. Liberate provides SourceSuite, without charge, specific software development services for the Interactive TV products under a programming services agreement. SourceSuite entered into a preferred content provider agreement with Liberate which allows Liberate to offer pricing incentives to its customers that use SourceSuite's local content services with the VirtualModem(TM) products. 2. ACCOUNTING POLICIES Basis of Presentation Assets contributed to the joint venture by Source Media have been valued at the fair value on the date of contribution based on an independent appraisal and allocated to assets, liabilities and goodwill. 22 23 Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Cash and Cash Equivalents The Company classifies all highly liquid investments with original maturities of three months or less as cash equivalents. These investments are recorded at cost, which approximates market. Computer and Production Equipment Computer and production equipment are recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives (three to five years) of the assets. Intangible Assets Goodwill resulted from the difference between the cash received for the fair value of the assets contributed to the joint venture and their recorded values. Intangible assets are amortized using the straight-line method over an estimated useful life of five years. The carrying value of intangible assets is reviewed for impairment whenever events or changes in circumstances indicated that there may be an impairment. If the review indicates that any of the intangibles will not be recoverable, as determined by an analysis of undiscounted cash flows, the intangible asset will be reduced to its estimated fair value. Comprehensive Income There are no significant comprehensive income items, therefore, comprehensive income is equal to net income and not separately shown on the Statement of Operations. 3. INCOME TAXES SourceSuite has experienced net operating losses from inception. Accordingly, no provision for income taxes has been recorded. A valuation allowance has been established to fully offset the deferred tax asset associated with SourceSuite's net operating loss carry forwards. 4. MEMBERS' EQUITY Distribution of equity to members is restricted by the Company's Operating Agreement for a period of three years. 23 24 5. RELATED PARTY TRANSACTIONS As part of the joint venture agreement between Source Media and Insight, Source Media manages the day to day operations of SourceSuite within the terms of SourceSuite's operating plan. As part of this arrangement, SourceSuite reimburses Source Media for the direct costs of the Interactive TV business and certain overhead costs. These costs have been included in the payable to related parties and are reimbursed to Source Media on a regular basis. Additionally, SourceSuite purchases certain hardware on behalf of Insight. These amounts are billed to Insight and included in related party receivables. 6. COMMITMENTS AND CONTINGENCIES Upon formation, SourceSuite assumed the responsibility for the following litigation: On October 6, 1998, Advanced Interactive, Inc. filed a complaint in U.S. District Court for the Northern District of Illinois, Eastern Division, against ICTI and the following companies: Matsushita Electric Corporation, Matsushita Electric Industrial Co., Ltd., Sharp Electronics Corp., Sharp Corp., Thomson Consumer Electronics, Toshiba Consumer Products, Inc., Toshiba American, Inc., Toshiba Corporation, General Instruments Corp., Scientific Atlanta, Inc., ATI Technologies, Inc., ADS Technologies Inc., Gateway 2000, Inc., STB Systems, Inc., Hauppauge Computer Works, Inc., WebTV Networks, Inc. and WorldGate Communications, Inc. (collectively the "Defendants"). Advanced Interactive, Inc. alleges that ICTI infringed two claims of one of its patents by manufacturing, using and/or selling or offering to sell Sourceware(TM) ChannelLink(TM). The same allegation is made against each Defendant for its particular product or service. The Plaintiff seeks damages, but makes no claims against the patents of ICTI or any other Defendant. ICTI, and each of the Defendants, have filed an Answer and have collectively joined the Motion for Partial Summary Judgment submitted by Matsushita Electric Corporation of America, Sharp Electronics Corp., Sharp Corp. and the Toshiba Defendants. On June 26, 2000, the court entered a judgement that ICTI does not infringe on Advanced Interactive's patent. The Plaintiff has filed a Notice of Appeal of this judgement in the U.S. Court of Appeals of the Federal Circuit dated August 3, 2000. This case was transferred to the joint venture between Source Media and Insight in November 1999 and was assumed by SourceSuite on March 3, 2000. The Company is vigorously defending the appeal. 24 25 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Unless the context otherwise requires, all references to "we", "us" or "our" include Source Media, Inc., its wholly-owned operating subsidiaries ("Subsidiaries"), including IT Network, Inc. ("IT Network"), Interactive Channel, Inc. ("Interactive Channel"), SMI Holdings, Inc., and its other operating subsidiary Interactive Channel Technologies Inc. ("ICTI"), as well as its wholly-owned non-operating subsidiary Source Nevada, Inc. and SourceSuite LLC, a 50/50 joint venture with Insight Interactive LLC ("Insight"), a subsidiary of Insight Communications Company, Inc. FORWARD LOOKING INFORMATION AND RISK FACTORS We or our representatives from time to time may make, or may have made, certain forward-looking statements, whether orally or in writing, including without limitation any such statements made, or to be made, in the Management's Discussion and Analysis of Financial Condition and Results of Operations, press releases and other information contained in our various filings with the Securities and Exchange Commission. We wish to ensure that such statements are accompanied by meaningful cautionary statements, so as to ensure to the fullest extent possible the protections of the "safe harbor" established in the Private Securities Litigation Reform Act of 1995. Accordingly, such statements are qualified in their entirety by reference to, and are accompanied by, the following discussion of certain important factors that could cause actual results to differ materially from those projected in such forward-looking statements. We caution you that this list of factors does not describe all of the risks of an investment in our common stock. We operate in a rapidly changing business environment, and new risk factors continually emerge. We cannot predict every risk factor, nor can we assess the impact of all these risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ from those projected in any forward-looking statements. Accordingly, you should not rely upon forward-looking statements as a prediction of our actual results. Among the factors that could cause actual results to differ materially from our expectations are our high degree of leverage and our ability to service debt, the need for additional financing, that we may not have sufficient collateral to repay our indebtedness in full, the potential for a change of control that would require us to purchase our notes and preferred stock, historical and projected losses, access to channels on cable television systems and uncertainty of subscriber acceptance, the uncertainty of a market for interactive television, the availability of programming, the further technical development needed to improve the economics of deploying interactive television to multiple cable systems, a delay in the roll-out of digital set-top boxes, competition within the industry, rapid technological advances that could render our products obsolete or non-competitive, anti-takeover effects of our shareholder rights plan, stock volatility, the market price of our common stock, our ability to attract and retain key management personnel, government regulation and other factors discussed from time to time in our Annual Report on Form 10-K and other Securities and Exchange Commission filings. 25 26 GENERAL The following discussion should be read in conjunction with our Consolidated Financial Statements and related notes which are included elsewhere in this report. We provide streaming media content and sell interactive advertising that can be accessed over the telephone and the Internet. We also own a 50% interest in SourceSuite LLC, a joint venture we manage, which provides interactive cable television programming services, including a fully interactive program guide, know as SourceGuide(TM), and an information entertainment service, known as LocalSource(TM). We categorize these operations as our IT Network business and our Interactive TV business. We have experienced significant changes in our Interactive TV business since the second quarter of 1999. In November 1999 we contributed this business to a 50/50 joint venture with Insight. Insight contributed $13 million of equity financing to the joint venture and purchased 842,105 shares of our common stock for $12 million ($14.25 per share) and warrants to purchase 4,596,786 additional share of our common stock at $20 per share. On March 3, 2000, we and Insight Interactive sold our interests in the joint venture to Liberate Technologies ("Liberate") in exchange for the issuance to each of us and Insight Interactive of 886,000 shares of Liberate common stock and $4.4 million of cash. Prior to the completion of the sale, the joint venture transferred to SourceSuite its assets and properties not related to the VirtualModem(TM) products and associated businesses. The interests in the new joint venture were distributed to us and Insight Interactive, so that each became a 50% owner of SourceSuite. Liberate thus acquired all patents and intellectual property related to the VirtualModem(TM) products and businesses and granted SourceSuite an exclusive license to use the patents necessary to its business. SourceSuite's business is interactive television programming and services, including SourceGuide(TM) and LocalSource(TM). THREE MONTHS ENDED JUNE 30, 2000 AND 1999 Monetary revenues increased 4% to $4.6 million for the three months ended June 30, 2000 from $4.4 million for the same period in 1999. The increase was primarily driven by $0.5 million of revenues from new products in 2000 including streaming audio sales and internet advertising. These increases were partially offset by $0.1 million of decreased advertising services revenues and $0.2 million of decreased information services revenue from the same period in the prior year, primarily due to some customers' late 1999 decisions to not invest in Y2K equipment upgrades and the resultant termination of our services. Traditional advertising sales remained consistent between the periods. Monetary cost of sales decreased 33% to $2.7 million for the three months ended June 30, 2000 from $4.0 million for the same period in 1999, primarily as a result of 1999 including $1.4 million of payments to customers for unfulfilled sales guarantees, $0.2 million of cost of the Interactive TV operations transitioned to our joint venture partially offset by $0.2 million of increased costs associated with Internet advertising and $0.1 million other operational expense. 26 27 Nonmonetary revenues and nonmonetary cost of sales increased 41% to $0.7 million for the three months ended June 30, 2000. Nonmonetary sales accounted for 13% of revenues for the three months ended June 30, 2000 compared to 10% of revenues for the same period in 1999. Selling, general and administrative expenses decreased 70% to $2.6 million for the three months ended June 30, 2000 from $8.6 million for the same period in 1999. The decrease is primarily due to $1.5 million of cost of the Interactive TV operations transitioned to our joint venture with Insight, a decrease of $2.5 million in professional fees and legal fees which were incurred in 1999 in connection with a proposed joint venture that were expensed after termination of the proposed transaction, a decrease in non-cash variable compensation expense of $0.7 million, and other operational savings of $1.3 million for the three months ended June 30, 2000. Amortization of intangible assets decreased 53% to $0.6 million from $1.2 million for the three months ended June 30, 2000 due to the transfer of patents to our joint venture with Insight in 1999. Research and development activities were transferred to our joint venture with Insight in November 1999, resulting in a decrease of $0.7 million in research and development expense compared to the three months ended June 30, 1999. Equity interest includes our share of the results of operations of SourceSuite for the three months ended June 30, 2000, recorded using the equity method. Interest expense decreased 7% to $3.0 million for the three months ended June 30, 2000 from $3.2 million for the same period in 1999 due to a $3.75 million retirement of notes in December 1999 and a $4.6 million retirement in June, 2000. This expense is associated with a $100 million debt financing completed by the Company in October 1997 and described in detail in the Notes to Consolidated Financial Statements. Interest income decreased 15% to $0.2 million for the three months ended June 30, 2000 from $0.3 million for the same period 1999 due to lower investment cash balances as a result of debt interest payments and normal operating expenditures. Extraordinary gain resulted from the gain recorded on the exchange of $4.6 million of Notes for common stock during the second quarter. Preferred Stock dividends reflect a benefit of $4.7 million realized on the issuance of common stock in exchange for Preferred Stock, based on the excess of the carrying amount of the Preferred Stock over the fair value of the Company's common stock. This benefit is partially offset by $15 thousand of preferred dividend expense for the three months ended June 30, 2000 as compared to $0.7 million of dividend expense in the same period of 1999. The dividends relate to the $20 million Preferred Stock financing completed by the Company in October 1997 and described in detail in the Notes to Consolidated Financial Statements. Dividends are recorded at the fair market value of the shares. Excluding the benefit, the decrease from prior year is related to a decrease in the number of shares of Preferred Stock outstanding for the three months end June 30, 2000 and a decline in the fair market value of the Preferred Stock which resulted in a lower fair value for the quarterly dividend and the reversal of an estimated accrual from the prior quarter. 27 28 SIX MONTHS ENDED JUNE 30, 2000 AND 1999 Monetary revenues decreased 8% to $8.6 million for the six months ended June 30, 2000 from $9.3 million for the same period of 1999. This decrease is primarily due to decreases of $1.0 million in advertising sales, $0.2 million in advertising services, and $0.5 million in information services offset by an increase of $1.0 million in new product revenues including streaming audio sales and internet advertising. Monetary cost of sales decreased 25% to $5.1 million for the six months ended June 30, 2000 from $6.7 million for the same period in 1999 as a result of 1999 costs including a $1.4 million payment for unfulfilled sales guarantees, $0.5 million of Interactive TV costs transferred to SourceSuite and a $0.3 million reduction in page costs related to the decreased advertising sales partially offset by costs incurred on internet sales of $0.4 million in 2000 and other operational cost increases of $0.2 million. Nonmonetary revenues and nonmonetary cost of sales increased 50% to $1.3 million for the six months ended June 30, 2000. Nonmonetary sales accounted for 13% of revenues for the six months ended June 30, 2000 compared to 9% of revenues for the same period in 1999. Selling general and administrative expenses decreased 55% to $6.4 million for the six months ended June 30, 2000 from $14.1 million for the same period in 1999. The decrease is primarily due to the following: (a) $2.7 million of cost of the Interactive TV operations transitioned to our joint venture with Insight; (b) decreased legal and professional fees of $2.8 million which were incurred in 1999 in connection with a proposed joint venture that were expensed after the termination of the proposed transaction; (c) decrease in non-cash variable compensation expense of $1.0 million; and (d) $1.2 million in cost reductions in other administrative expenses. Amortization of intangible assets decreased 53% to $1.2 million from $2.5 million for the six months ended June 30, 2000 due to the transfer of patents to our joint venture with Insight in 1999. Research and development activities were transferred to our joint venture with Insight in November 1999 resulting in a decrease of $1.5 million in research and development expense compared to the six months ended June 30, 1999. Other income includes $75.0 million of gain recorded upon the sale of our interest in the original joint venture with Insight to Liberate in exchange for 886,000 shares of common stock in Liberate and $4.4 million of cash. Equity interest in losses of joint venture includes our share of the results of operations of SourceSuite and its predecessor joint venture for the six months ended June 30, 2000, recorded using the equity method. The original joint venture was formed November 17, 1999. Interest expense decreased 5% to $6.1 million for the six months ended June 30, 2000 from $6.4 million in 1999. This decrease is due to redemptions in the outstanding Note balance due to retirement of $3.75 million of Notes for common stock in December of 1999 and $4.6 28 29 million in June of 2000. The interest is associated with a $100 million debt financing completed by the company in October 1997 and described in detail in the Notes to Consolidated Financial Statements. Interest income decreased 14% to $0.4 million for the six months ended June 30, 2000 from $0.5 million in the prior year due to lower investment and cash balances due to normal operating requirements and debt interest payments. Extraordinary gain resulted from the gain recorded on the exchange of $4.6 million of Notes for common stock. Preferred Stock dividends reflect a benefit of $4.7 million realized on the issuance of common stock in exchange for Preferred Stock, due to the excess of the carrying amount of the Preferred Stock over the fair value of the Company's common stock. This benefit is partially offset by dividend expense of $0.8 million for the six months ended June 30, 2000 as compared to dividend expense of $1.4 million for the six months ended June 30, 1999. The dividend expense relates to the $20 million Preferred Stock financing completed by the Company in October 1997 and described in detail in the Notes to Consolidated Financial Statements. Dividends are recorded at the fair market value of the shares. Excluding the benefit the decrease is related to exchanges of Preferred Stock for common stock, which took place in the second quarter of this year, as well as a decrease in the fair value of the Preferred Stock issued as dividends during the six months ended June 30, 2000. LIQUIDITY AND CAPITAL RESOURCES Since inception, we have experienced substantial operating losses and net losses as a result of our efforts to develop, deploy and support our IT Network business and to develop, conduct trials and commercially launch our Interactive TV business. As of June 30, 2000, we had an accumulated deficit of $124.7 million and had used cumulative net cash in operations of $109.3 million. The difference at June 30, 2000, between the accumulated deficit and cumulative net cash used in operations since inception was attributable primarily to charges related to financing incentives and extinguishment of debt, variable compensation expense, write-downs of analog set-top boxes and intangible assets, depreciation and amortization and other non-cash expenses. We will continue to incur operating losses at least through 2000. Any launch of our television products and services through SourceSuite may require an additional capital contribution which may require us to raise additional capital. On March 3, 2000, we sold our interest in the VirtualModem(TM) business owned by our joint venture with Insight to Liberate for 886,000 shares of Liberate common stock which became tradable after July 31, 2000. In addition to the Liberate common shares, we received from Liberate $4.4 million of working capital adjustments which we contributed to SourceSuite. It is expected that this liquidity will provide the necessary funding for expected future capital requirements. The Liberate shares had an aggregate value of approximately $87.4 million, based on the closing price of Liberate common stock of $98.6875 per share on March 3, 2000. Liberate common stock is traded on the Nasdaq Stock Market under the symbol "LBRT". As of August 7, 2000, the closing price per share of the Liberate common stock was $21.563 resulting in an aggregate value of $19.1 million. Management believes the decline in the Liberate stock price to be temporary as there have been no material adverse changes in Liberate's market position or balance sheet of which management is aware; the market has generally declined for all technology stocks and in particular for cable and related industry stocks; Cisco Systems, Inc. has recently invested an additional $100 million in Liberate; and Liberate continues to receive strong buy recommendations from analysts. 29 30 Since inception, we have financed our operations primarily with $156.6 million raised from various financing activities, including the incurrence of debt and issuance of our common stock and Preferred Stock. In October 1997, we issued $100.0 million of Notes and $20.0 million of Preferred Stock. On December 19, 1999, $3.75 million of Notes were tendered to the Company and additional cash was received in exchange for an exercise of warrants to purchase shares of common stock. On June 20, 2000 an additional $4.6 million of Notes were exchanged for common stock. As of June 30, 2000, $91.65 million of Notes remain outstanding. The interest escrow account created pursuant to the indenture governing the Notes has been used to fund the first four interest payments on the Notes. Interest payments from the interest escrow account were made on May 1, 1998, November 1, 1998, May 1, 1999 and November 1, 1999. Additionally, $6.0 million from proceeds received in a transaction with Insight were placed in escrow and used to pay the May 2000 interest payment. Our primary source of liquidity is our cash, which totaled $13.8 million at June 30, 2000. Additionally, we have an investment of 886,000 shares of Liberate common stock which became tradable after July 31, 2000. Our first interest payment of approximately $5.5 million, not currently held in escrow, is due November 1, 2000. We currently believe our resources will be sufficient to meet our anticipated cash needs for working capital, required interest payment and other capital expenditures related to the further development of our IT Network business and capital requirements for SourceSuite through and beyond the fourth quarter of 2000. Additionally, while we do not currently anticipate any capital calls by the joint venture, we believe our resources are sufficient to meet any capital calls through 2000. Our future capital requirements will depend on many factors, including, but not limited to the following factors, some of which are outside our control: (i) the operating results of our IT Network business, including local advertisers' willingness to purchase Internet based advertising; (ii) the success and timing of the development, introduction and deployment of the Interactive TV products; (iii) the extent of market acceptance of our products; (iv) potential acquisitions or asset purchases; (v) the deployment of digital set-top boxes incorporating technology that we are able to access; (vi) competitive factors; and (vii) changes in the regulatory environment. EFFECT OF INFLATION We believe that the effect of inflation has not been material during the three month periods ended June 30, 1999 and 2000, respectively. NET OPERATING LOSS CARRYFORWARDS At December 31, 1999, we had net operating loss carryforwards of approximately $124.5 million for U.S. Federal income tax purposes, which begin to expire in 2003. The Internal Revenue Code of 1986, as amended, imposes limitations on the use of net operating loss carryforwards if certain stock ownership changes occur. An ownership change occurred in 1995 that caused utilization of $23.1 million of our net operating losses incurred prior to the ownership change to be limited to approximately $9.0 million in a given year. 30 31 Part II - OTHER INFORMATION Item 6 - Exhibits and Reports on Form 8-K (a) Exhibits Exhibit 27 - Financial Data Schedule (b) Reports on Form 8-K during the three months ended June 30, 2000. None 31 32 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934 the Registrant has duly caused this amendment to be signed on its behalf by the undersigned, thereunto duly authorized. SOURCE MEDIA, INC. (Registrant) Date: November 14, 2000 By: /s/ PAUL TIGH ------------------------------------- Paul Tigh Chief Financial Officer and Treasurer (Principal Financial Officer and Duly Authorized Officer) 32 33 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION - ------- ----------- 27 Financial Data Schedule
EX-27 2 d81983aex27.txt FINANCIAL DATA SCHEDULE
5 1,000 6-MOS DEC-31-2000 JAN-01-2000 JUN-30-2000 13,798 349 2,535 616 0 43,674 11,104 9,553 60,387 8,480 91,650 11,055 0 17 (53,800) 60,387 9,889 9,889 6,383 6,383 7,587 0 6,083 62,463 0 62,463 0 2,530 0 68,873 4.24 4.01
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