-----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, K4l48P4GbzVjDY/ZcIU52liM7syPQLkfiibchfdQjwzpvxcLdPuVqERxPyaMV/5r KaFbaEo+EF0FLojcxxsTYQ== 0000950134-01-508582.txt : 20020410 0000950134-01-508582.hdr.sgml : 20020410 ACCESSION NUMBER: 0000950134-01-508582 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20010930 FILED AS OF DATE: 20011114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SOURCE MEDIA INC CENTRAL INDEX KEY: 0000900029 STANDARD INDUSTRIAL CLASSIFICATION: TELEGRAPH & OTHER MESSAGE COMMUNICATIONS [4822] IRS NUMBER: 133700438 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-21894 FILM NUMBER: 1788745 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 1 d92237e10-q.txt FORM 10-Q FOR QUARTER ENDED SEPTEMBER 30, 2001 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001 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) 5601 EXECUTIVE DR., SUITE 200 IRVING, TEXAS 75038 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (972) 753-8200 (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 NOVEMBER 2, 2001: 17,887,942 1 SOURCE MEDIA, INC. FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2001
PART I. FINANCIAL INFORMATION Page Number ----------- Item 1. Consolidated Financial Statements of Source Media, Inc. Consolidated Balance Sheets (unaudited) December 31, 2000 and September 30, 2001 4-5 Consolidated Statements of Operations (unaudited) Three and nine months ended September 30, 2000 and 2001 6 Consolidated Statement of Stockholders' Equity (Capital Deficiency) (unaudited) Nine months ended September 30, 2001 7 Consolidated Statements of Cash Flows (unaudited) Nine months ended September 30, 2000 and 2001 8 Notes to Consolidated Financial Statements (unaudited) 9-26 Financial Statements of SourceSuite LLC Balance Sheets (unaudited) December 31, 2000 and September 30, 2001 27 Statements of Operations (unaudited) Three months ended September 30, 2000 and 2001 and period from Inception (March 3, 2000) to September 30, 2000 and nine months ended September 30, 2001 28 Statement of Members' Equity (unaudited) Nine months ended September 30, 2001 29 Statements of Cash Flows (unaudited) Period from inception (March 3, 2000) to September 30, 2000 and nine months ended September 30, 2001 30 Notes to Financial Statements (unaudited) 31-34 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 35-42 Item 3. Quantitative and Qualitative Disclosures About Market Risk 42-43
2 PART II. OTHER INFORMATION Item 1. Legal Proceedings 44 Item 2. Changes in Securities and Use of Proceeds 44 Item 3. Defaults Upon Senior Securities 44 Item 4. Submission of Matters to a Vote of Security Holders N/A Item 5. Other Information 44-45 Item 6. Exhibits and Reports on Form 8-K 46
3 SOURCE MEDIA, INC. CONSOLIDATED BALANCE SHEETS ASSETS (in thousands) (unaudited)
DECEMBER 31, SEPTEMBER 30, 2000 2001 ------------ ------------- Current Assets: Cash and cash equivalents ......................... $ 7,774 $ 1,590 Restricted cash ................................... -- 3,138 Trade accounts receivable, less allowance for doubtful accounts of $716 and $340 in 2000 and 2001, respectively .......................... 1,402 708 Related party receivables ......................... 390 1,119 Prepaid expenses and other current assets ......... 1,759 584 Investment in securities available for sale ....... 12,072 6,447 ------- ------- Total current assets ......................... 23,397 13,586 Property and equipment: Production equipment .............................. 3,232 3,284 Computer equipment ................................ 3,702 3,756 Other equipment ................................... 2,431 2,444 Furniture and fixtures ............................ 606 606 ------- ------- 9,971 10,090 Accumulated depreciation .............................. 8,694 9,229 ------- ------- Net property and equipment ............................ 1,277 861 Intangible assets: Contract rights ................................... 1,578 1,578 Accumulated amortization .............................. -- 321 ------- ------- Net intangible assets ................................. 1,578 1,257 Investment in joint venture ........................... 2,008 389 Other non-current assets .............................. 2,796 2,233 ------- ------- Total assets ................................. $31,056 $18,326 ======= =======
See accompanying Notes to Consolidated Financial Statements 4 SOURCE MEDIA, INC. CONSOLIDATED BALANCE SHEETS LIABILITIES AND STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY) (in thousands, except per share data) (unaudited)
DECEMBER 31, SEPTEMBER 30, 2000 2001 ------------ ------------ Current Liabilities: Trade accounts payable ............................ $ 1,315 $ 1,921 Accrued interest .................................. 1,771 10,792 Accrued payroll ................................... 150 542 Other accrued liabilities ......................... 1,870 641 Unearned income ................................... 4,267 1,114 Long-term debt in default ......................... -- 88,542 --------- --------- Total current liabilities .................... 9,373 103,552 Long-term debt ........................................ 88,542 -- Minority interest in consolidated subsidiaries ........ 3,840 -- Note receivable and accrued interest from minority stockholder ......................................... (865) -- --------- --------- 2,975 -- Senior redeemable payment-in-kind (PIK) preferred stock, $25 per share liquidation preference, $.001 par value, net of discount Authorized shares - 1,712; 547 and 584 issued and outstanding in 2000 and 2001, respectively ......... 8,571 9,090 Non-participating preferred stock, $25 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; 17,869 and 18,075 issued in 2000 and 2001, respectively ............. 18 18 Less treasury stock, at cost - 187 shares in 2000 and 2001 ......................................... (1,861) (1,861) Capital in excess of par value ...................... 136,576 139,954 Accumulated other comprehensive loss - unrealized loss on securities available for sale -- (2,372) Accumulated deficit ................................. (213,138) (230,055) --------- --------- Total capital deficiency .............................. (78,405) (94,316) --------- --------- Total liabilities and capital deficiency .............. $ 31,056 $ 18,326 ========= =========
See accompanying Notes to Consolidated Financial Statements 5 SOURCE MEDIA, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30, 2000 2001 2000 2001 -------- -------- -------- -------- (in thousands, except per share data) (in thousands, except per share data) Monetary revenues ................................... $ 4,588 $ 2,507 $ 13,695 $ 9,269 Nonmonetary revenues ................................ 178 15 617 126 -------- -------- -------- -------- Total revenues ...................................... 4,766 2,522 14,312 9,395 Monetary cost of sales .............................. 2,637 1,403 8,443 5,411 Nonmonetary cost of sales ........................... 178 15 617 126 -------- -------- -------- -------- Total cost of sales ................................. 2,815 1,418 9,060 5,537 -------- -------- -------- -------- Gross profit ........................................ 1,951 1,104 5,252 3,858 Selling, general and administrative expenses ........ 2,677 1,604 8,955 5,945 Restructuring expense ............................... -- 750 -- 2,267 Amortization of intangible assets ................... 584 107 1,752 321 -------- -------- -------- -------- 3,261 2,461 10,707 8,533 -------- -------- -------- -------- Operating loss ...................................... (1,310) (1,357) (5,455) (4,675) Interest expense .................................... (2,843) (3,895) (8,926) (9,580) Interest income ..................................... 169 20 632 147 Equity in losses of joint venture .................. (734) (488) (3,443) (1,823) Other income (expense), net ......................... (110) (114) (214) (986) Gain on sale of interest in joint venture ........... -- -- 74,977 -- -------- -------- -------- -------- Income (loss) before extraordinary item and cumulative effect of change in accounting principle . (4,828) (5,834) 57,571 (16,917) Extraordinary gain - early extinguishment of debt ... 1,709 -- 4,239 -- Cumulative effect of change in accounting principle . -- -- (1,159) -- -------- -------- -------- -------- Net income (loss) ................................... (3,119) (5,834) 60,651 (16,917) Preferred stock (dividends) difference on conversion of preferred stock, net of dividend ................. 1,763 (186) 5,643 (519) -------- -------- -------- -------- Net income (loss) attributable to common stockholders $ (1,356) $ (6,020) $ 66,294 $(17,436) ======== ======== ======== ======== Other comprehensive income (loss): unrealized gain (loss) on securities available for sale ............................................ (332) (2) (61,799) (2,372) -------- -------- -------- -------- Comprehensive income (loss) ......................... $ (1,688) $ (6,022) $ 4,495 $(19,808) ======== ======== ======== ======== Basic and diluted net loss per common share: Basic: Income (loss) before extraordinary item and cumulative effect of change in accounting principle . $ (0.18) $ (0.34) $ 3.80 $ (0.98) Extraordinary gain - early extinguishment of debt ... 0.10 -- 0.25 -- Cumulative effect of change in accounting principle . -- -- (0.07) -- -------- -------- -------- -------- Income (loss) attributable to common stockholders ... $ (0.08) $ (0.34) $ 3.98 $ (0.98) ======== ======== ======== ======== Weighted average basic common shares outstanding .... 17,451 17,775 16,648 17,782 ======== ======== ======== ======== Dilutive: Income (loss) before extraordinary item and cumulative effect of change in accounting principle . $ (0.18) $ (0.34) $ 3.64 $ (0.98) Extraordinary gain - early extinguishment of debt ... (0.10) -- 0.25 -- Cumulative effect of change in accounting principle . -- -- (0.07) -- -------- -------- -------- -------- Net income (loss) attributable to common stockholders $ (0.08) $ (0.34) $ 3.82 $ (0.98) ======== ======== ======== ======== Weighted average diluted common shares outstanding .. 17,451 17,775 17,353 17,782 ======== ======== ======== ========
See accompanying Notes to Consolidated Financial Statements 6 SOURCE MEDIA, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY) (in thousands) (unaudited)
ACCUMULATED TOTAL CAPITAL OTHER STOCKHOLDERS' COMMON STOCK TREASURY IN EXCESS OF COMPREHENSIVE ACCUMULATED EQUITY (CAPITAL SHARES AMOUNT STOCK PAR VALUE LOSS DEFICIT DEFICIENCY) --------- --------- --------- --------- ------------- ----------- --------------- BALANCE AT DECEMBER 31, 2000 17,869 $ 18 $ (1,861) $ 136,576 $ -- $(213,138) $ (78,405) Stock compensation -- -- -- 58 -- -- 58 Net loss -- -- -- -- -- (16,917) (16,917) Unrealized loss on securities available for sale -- -- -- -- (2,372) -- (2,372) Preferred stock dividends -- -- -- (519) -- -- (519) Exchange of common stock for minority interest shares 206 -- 3,839 -- -- 3,839 --------- --------- --------- --------- --------- --------- --------- BALANCE AT SEPTEMBER 30, 2001 18,075 $ 18 $ (1,861) $ 139,954 $ (2,372) $(230,055) $ (94,316) ========= ========= ========= ========= ========= ========= =========
See accompanying Notes to Consolidated Financial Statements 7 SOURCE MEDIA, INC. CONSOLIDATED STATEMENTS OF CASH FLOW (in thousands) (unaudited)
NINE MONTHS ENDED SEPTEMBER 30, 2000 2001 --------- ----------- OPERATING ACTIVITIES Net income (loss) .................................................. $ 60,652 $(16,917) Adjustments to reconcile net income (loss) to net cash used in operating activities: Depreciation ................................................... 1,337 535 Amortization of intangible assets .............................. 1,753 321 Amortization of debt issuance cost ............................. 857 563 Stock compensation ............................................. 1,077 58 Non-cash interest income ....................................... (118) -- Realized loss on sale of investments............................ -- 114 Reserve for loss on note receivable from minority stockholder .. -- 872 Provision for losses on accounts receivable .................... (47) 308 Extraordinary gain on sale of interest in joint venture ........ (74,977) -- Extraordinary gain on exchange of notes for common stock ....... (4,239) -- Equity interest in losses of joint venture ..................... 3,443 1,819 Changes in operating assets and liabilities: Trade accounts receivable ...................................... 116 386 Related party receivable ....................................... 985 (729) Prepaid expenses and other current assets ...................... 710 1,168 Trade accounts payable and accrued liabilities ................. (1,359) (230) Accrued interest ............................................... 2,566 9,020 Unearned income ................................................ 75 (3,153) -------- -------- Net cash used in operating activities .............................. (7,169) (5,864) INVESTING ACTIVITIES Capital expenditures ............................................. (99) (120) Redemption of investments ........................................ 5,775 3,138 Redemption of short-term investments............................. 2,500 -- Proceeds from sale of interest in joint venture .................. 4,392 -- Investment in SourceSuite LLC .................................... (4,392) (200) -------- -------- Net cash provided by investing activities .......................... 8,176 2,818 FINANCING ACTIVITIES Transfer of cash to restricted brokerage account ................. -- (3,138) Proceeds from issuance of common stock ........................... 1,008 -- Other ............................................................ 246 -- -------- -------- Net cash provided by (used in) financing activities ................ 1,254 (3,138) -------- -------- Net increase (decrease) in cash and cash equivalents ............... 2,261 (6,184) Cash and cash equivalents at beginning of period ................... 10,910 7,774 -------- -------- Cash and cash equivalents at end of period ......................... $ 13,171 $ 1,590 ======== ========
See accompanying Notes to Consolidated Financial Statements 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 Interactive Channel Technologies Inc., ("ICTI"), as well as its wholly owned non-operating subsidiary, Source Investments, Inc., and SourceSuite LLC ("SourceSuite"), a 50/50 joint venture with Insight Interactive LLC, a subsidiary of Insight Communications Company, Inc. ("Insight"). 1. BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States 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 nine months ended September 30, 2001 are not necessarily indicative of the results that may be expected for the year ending December 31, 2001. The balance sheet at December 31, 2000 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, 2000. Source Media aggregates, produces and delivers rich media content across a range of communication platforms including the Internet, digital television, telephone-based voice portal systems, wireless and wireline telephone networks and automobile telematic systems. The Company also operates SourceSuite which provides interactive television programming applications and services, including its SourceGuide(TM) interactive program guide and its LocalSource(TM) interactive programming service. The Company categorizes these operations as its IT Network business and its Interactive TV business, respectively. On March 3, 2000, Source Media and Insight sold their respective interests in a prior joint venture to Liberate Technologies ("Liberate") in exchange for the issuance of 886,000 shares of common stock of Liberate and $4.4 million of cash to each of Source Media and Insight. Prior to the sale of that joint venture, cash equal to the value (as determined by an independent appraisal) of certain retained businesses, consisting of the interactive programming guide and related content business, was contributed by the joint venture to SourceSuite. SourceSuite used these funds to purchase the retained businesses from the prior joint venture, which were comprised of fixed assets with a net book value of approximately $200,000 and certain accrued liabilities, for $1.1 million. 9 Effective January 1, 2000, the Company changed its method of accounting for revenue recognition in accordance with Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB 101"). The cumulative effect of this change on prior years resulted in a charge of $1.2 million in 2000. Financial Condition The Company has reported both an operating loss and a net loss each year since its inception, including an operating loss of $4.7 million and a net loss attributable to common stockholders of $17.4 million for the nine months ended September 30, 2001. Additionally, the Company did not make the interest payment on its 12% Senior Secured Notes ("Notes") of approximately $5.3 million due on May 1, 2001. As of May 31, 2001, the indenture trustee of the Notes declared that the Company was in default on the Notes and that the entire unpaid principal amount of the Notes and all accrued interest were due and payable immediately. In addition, the Company is obligated to pay interest on overdue principal and on overdue installments of interest at the rate of 2% per annum in excess of the 12% interest rate on the Notes. Following default on the Notes, the Company does not intend to use the proceeds from any sales of its Liberate shares without the consent of the holders of its Notes. In August 2001, the unofficial committee of the holders of the Notes and the Company agreed in principle that the Company would sell all of its 886,000 Liberate shares over the next few months. The Company is finalizing arrangements to place its Liberate shares, and the net proceeds of any sales thereof, except for $2 million, into a controlled account pledged in favor of the indenture trustee and established in the name of Source Media, Inc., subject to the lien of the indenture trustee. The Company will not have the ability to withdraw the Liberate shares, or any proceeds of sales thereof, from the controlled account. All shares and proceeds in the controlled account will be distributed automatically to the Note holders on December 31, 2001 unless the Note holders agree otherwise or judicial action is taken to suspend such distribution. The Company expects to withhold $2 million from the controlled account to fund operations through December 31, 2001 and for additional contributions to SourceSuite. During the third quarter, the Company sold 238,700 shares of the Liberate common stock yielding net proceeds of $3.1 million. The proceeds were placed into a segregated brokerage account, from which the Company has agreed not to make any withdrawals, until arrangements regarding the controlled account have been finalized. Excluding the proceeds in the segregated brokerage account and the remaining Liberate shares, the Company's primary source of liquidity as of September 30, 2001 was $1.6 million of cash. The Company and Insight have determined to commit additional aggregate contributions to SourceSuite of $1.6 million ($0.8 million each), to be advanced in increments through the balance of 2001. During the third quarter, $0.4 million ($0.2 million each) of the commitment amount was contributed to SourceSuite by the Company and Insight. In an effort to reduce costs, the Company began restructuring efforts in the fourth quarter of 2000, which include discontinuing FOB (front-of-book) advertising services, exiting low margin products and reducing the number of employees. The Company has continued to analyze its performance resulting in additional restructuring and cost cutting efforts. The workforce at the Company and its IT Network subsidiary was reduced from 147 employees at December 31, 2000 to 96 at September 30, 2001. Selling, general and administrative expense was reduced to $1.6 10 million for the quarter ended September 30, 2001 from $2.7 million for the same quarter in the prior year. The market for the Company's IT Network audio content is in its early stages and the success of IT Network is dependent upon its ability to build revenues in a timely manner. The Company has observed a significant downturn in IT Network's sales activity and cannot predict the duration of this downturn. The Company has engaged Evercore Partners L.P. as its financial advisor to help it evaluate strategic alternatives, including the potential for a merger, sale of assets, or restructuring of its balance sheet. The Company is cooperating with the holders of the Notes who have formed an unofficial committee as it works through this process. There can be no assurance that the Company's efforts will be successful. The foregoing factors raise substantial doubt about the Company's ability to continue as a going concern. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that might result from the outcome of this uncertainty. Accordingly, the asset and liability carrying amounts do not represent realizable values in the event of liquidation. 2. 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." In computing diluted net income (loss) per share, all options, warrants, and convertible securities are excluded if their effects would be antidilutive. The reconciliation between the denominator of Basic and Diluted net income (loss) per common share is as follows:
NINE MONTHS ENDED SEPTEMBER 30, 2000 ----------------- Denominator for basic net income (loss) per share - weighted average shares ..................................................... 16,648 Effect of dilutive securities: Employee stock options ............................................. 141 Warrants ........................................................... 564 ------ Dilutive potential common shares ..................................... 705 ------ Denominator for diluted net income (loss) per share - ................ -- weighted average shares ............................................ 17,353 ======
3. SECURITIES AVAILABLE FOR SALE Investment in securities available for sale, which consists of the Company's investment in Liberate's common stock, is recorded at fair value. Unrealized gains and losses on the investment are included in other comprehensive loss. Declines in fair value deemed other than temporary are charged to earnings. During the third quarter of 2001, the Company sold 238,700 shares of its Liberate common stock for aggregate net proceeds of $3.1 million and recorded a 11 realized loss of $114 thousand. The proceeds have been placed into a segregated brokerage account, from which the Company has agreed not to make any withdrawals, until arrangements regarding the controlled account have been finalized. See "Financial Condition" section of Note 1 for further discussion. At September 30, 2001, the closing price per share of the Liberate common stock had declined to $9.96 from $13.625 at December 31, 2000, resulting in an aggregate market value of the Company's Liberate shares of $6.4 million, as adjusted for interim sales. The decline in the market value of the Company's Liberate shares during 2001 has been reflected in other comprehensive loss. Management does not believe that the decline in the market value of its Liberate shares, as compared to December 31, 2000, is other than temporary. 4. NEW ACCOUNTING PRONOUNCEMENTS Financial Accounting Statement ("FAS") 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 adopted this statement January 1, 2001. There has been no impact on the Company from the implementation of this statement in 2001. FAS 141, Business Combinations, and FAS 142, Goodwill and Other Intangible Assets were issued in July 2000 to be effective for all fiscal years beginning after December 15, 2001. FAS 141 eliminates the pooling-of-interests method of accounting for business combinations except for qualifying business combinations that were initiated prior to July 1, 2001. Under FAS 142, goodwill and indefinite lived intangibles are no longer amortized but are reviewed annually for impairment. Other intangible assets will continue to be amortized over their useful lives. The Company does not expect these new statements to have a material impact on financial results. 5. COMMITMENTS AND CONTINGENCIES Securities Class Action Litigation On August 21, 1998, the first of fourteen class action complaints were filed against the Company and certain of its 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 Court consolidated the complaints into one action entitled Hartsell et al. v. Source Media, Inc., et al., Civil Action No. 3-98-CV-1980-M. The Source Media defendants moved to dismiss the complaint on April 19, 1999. That motion was denied by the Court on July 16, 1999. On August 16, 1999, plaintiffs filed a related complaint against Ernst & Young LLP. The action against Ernst & Young was consolidated with the Source Media action on August 31, 1999. On November 19, 1999, Ernst & Young moved to dismiss plaintiffs' complaint and the Court granted that motion with leave to amend. Plaintiffs filed their First Amended Complaint against Ernst & Young on April 20, 2000. Ernst & Young moved to dismiss plaintiffs' First Amended Complaint, and on January 11, 2001 the Court issued an Order denying Ernst & Young's motion. In the January 11, 2001 Order, the Court required the parties to complete discovery related to the claims against Ernst & Young within 120 days. On March 26, 2001, the Court granted Ernst & Young's unopposed motion to extend that deadline by 60 days. By Order 12 dated July 13, 2001, the Court granted plaintiffs' unopposed motion for an extension of the discovery deadline pertaining to claims against Ernst & Young through October 31, 2001. The Court also vacated all existing pre-trial and trial dates in the case with new dates to be set by future order of the Court. On July 20, 2001, defendants' excess insurance carrier, Reliance Insurance Company, requested that the Court enter a 60 day stay of the case in light of Reliance's deteriorated financial situation and an Order of Rehabilitation entered by the Pennsylvania Department of Insurance. Plaintiffs opposed Reliance's request by letter date July 24, 2001. There is currently no deadline for the completion of discovery related to claims against the Source Media defendants and no trial date has been set. Discovery related to the Ernst & Young claims is ongoing. The Company believes it is adequately insured against losses from this litigation and that this case is totally without merit. The Company has continued to have settlement discussions with the plaintiffs and intends to defend itself, and its officers and directors, vigorously. Other Commitments and Contingencies From time to time, the Company may consider asserting claims to protect its contractual, intellectual property and other rights and may become aware of claims threatened against it that may develop into litigation. The Company has not asserted any claims and is not aware of any threatened claim that, if determined adversely to it, would have a material and adverse effect on its business or financial condition. Further, from time to time, the Company is a party to routine litigation arising out of the ordinary course of business, none of which is expected to have a material and adverse effect on its business or financial condition. The Company has employment agreements with six executives that expire in 2002. The agreements generally provide that the Company will pay a base salary amount and grant stock options to the employees, which vest over a fixed period, typically four years. In the event of a termination without cause, the Company remains obligated to make certain payments as defined in the agreements. The Company has amended and restated the employment agreement of Phil Howort effectively making him the President and CEO of the Company's IT Network subsidiary. In June 2001, the Company's Board of Directors approved a management incentive plan whereby key executives receive cash payments for remaining with the Company for a specified period of time. Specifically, each employee that remains with the Company is entitled to receive an amount equal to two months base salary, paid out in equal monthly installments on the last day of each month beginning in June and ending November 2001. 6. 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. 13 The Notes are fully and unconditionally guaranteed, jointly and severally, by each of the Company's subsidiaries (the "Subsidiary Guarantors"), other than Source Investments, Inc. Source Investments, Inc. has pledged the Liberate shares as collateral to secure payment on the Notes. As of September 30, 2001, $88.5 million in face value of Notes were outstanding. At December 31, 2000, the aggregate fair market value of the outstanding Notes was approximately $17.7 million. The current market value is not readily attainable, however, it is believed to be substantially less than the value at December 31, 2000. The Company failed to make the approximately $5.3 million interest payment on the Notes due May 1, 2001. As a result of the Company's continued default on the Notes, on May 31, 2001, the indenture trustee of the Notes declared the entire unpaid principal amount of the Notes and all accrued interest due and payable immediately. Accordingly, the Company has classified the Notes as a current liability. See "Financial Condition" section of Note 1 for further discussion. In addition, the Company is obligated to pay interest on overdue principal and on overdue installments of interest at the rate of 2% per annum in excess of the 12% interest rate on the Notes. 7. SENIOR PIK PREFERRED STOCK On October 30, 1997, the Company issued 800 units (the "Units") of the Preferred Stock (the "Preferred Stock") and warrants for an aggregate purchase price of $20 million. Each Unit consisted 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. Dividends on the Preferred Stock are payable quarterly on each February 1, May 1, August 1 and November 1, commencing February 1, 1998, at an annual rate of 13 1/2% of the liquidation preference per share. At the Company's option, any dividend payment occurring on or prior to November 1, 2002, may be paid either in cash or by the issuance of additional shares of Preferred Stock with a liquidation preference equal to the amount of such dividends; thereafter, dividends will be paid in cash. Additional dividends will accumulate on the Preferred Stock at a rate per annum of 2% of the liquidation preference per share of the Preferred Stock payable quarterly in the event that a triggering event (as specified in the certificate of designations for the Preferred Stock and including a default on the Notes) occurs and is continuing. On February 1 and May 1, 2001 the quarterly dividends due on the Preferred Stock were paid through the issuance of additional Preferred Stock having a liquidation preference of $0.5 million each with terms identical to those of the Preferred Stock. The Company announced on July 17, 2001 that it would suspend payment of the quarterly dividend on its 13 1/2% Senior Payment-In-Kind Preferred Stock scheduled to be paid on August 1, 2001. As provided by the terms of the Preferred Stock, unpaid dividends will continue to accrue until paid. In addition, following the default on the Notes, additional dividends will accumulate on the Preferred Stock at a rate per annum of 2% of the liquidation preference per share of the Preferred Stock. As of September 30, 2001, the Company had a total arrearage with respect to dividends on the Preferred Stock in the amount of $495 thousand. In addition, as of that date, the estimated fair market value of the Preferred Stock was approximately $0.08 per share or approximately $47 14 thousand in the aggregate. The shares of Preferred Stock were valued at 1.2 times the closing market price of the common stock at September 30, 2001, as this value is reflective of past market values and no market quoted price was readily available for the Preferred Stock. 8. EMPLOYEE STOCK PURCHASE PLAN During the third quarter of 2001, the Company announced the suspension of its Employee Stock Purchase Plan in connection with its ongoing restructuring efforts. 9. MINORITY INTEREST 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 ICTI owned by such individual. On May 20, 2001, the individual exercised her right to exchange the Class Y shares of 997758 for 206,376 shares of the common stock of Source Media, Inc. 10. NOTE RECEIVABLE FROM STOCKHOLDER On May 20, 1993, the Company lent on a nonrecourse basis $0.8 million to the individual holding Class Y shares of 997758 bearing interest at a rate per annum of 2%, payable quarterly. The loan is currently secured by the individual's holding in certain shares of the Company's common stock. The unpaid principal and interest is due on May 20, 2002. During the second quarter of 2001 the Company recognized a charge of $872 thousand in "other income (expense), net" to fully reserve the note based upon the Company's assessment that the note is no longer viewed to be probable of collection. 11. 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. In connection with the formation of this venture, the Company issued warrants to Insight to purchase 4,596,786 shares of its common stock at $20 per share and sold 842,105 shares of its common stock to Insight for $12 million ($14.25 per share). On March 3, 2000, the joint venture conveyed its Interactive TV line of business to SourceSuite; and Source Media and Insight each sold their interests in the joint venture to Liberate in exchange for the issuance to each of Source Media and Insight of 886,000 shares of Liberate common stock and $4.4 million of cash. The Company and Insight each contributed $4.4 million of cash to SourceSuite in return for a 50% ownership in the joint venture. This transaction resulted in a gain for the Company of $75.0 million included in the nine 15 months ended September 30, 2000. The gain was calculated based on the cash received and the closing price of Liberate common stock on March 3, 2000 (the closing date) of $98.6875 per share, net of the Company's adjusted book basis in the joint venture investment of $16.9 million. The Company had net operating loss carry forwards in excess of the tax effect of this gain and, consequently, reported no current or deferred income tax expense. The following represents the unaudited pro forma results of operations of Source Media as if the prior joint venture with Insight and subsequent sale to Liberate and the formation of SourceSuite had occurred on January 1, 2000. The pro forma results below exclude the gain realized by the Company during the first quarter of 2000 in connection with the sale of its interest in the prior joint venture.
Nine Months Ended September 30, 2000 ------------------ (in thousands) Total revenues $ 14,312 Operating loss (5,455) Net loss attributable to common stockholders (7,598) Net loss per common share (0.44)
SourceSuite, which was formed on March 3, 2000, is managed by the Company pursuant to a management agreement, and operated pursuant to an operating agreement and an 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 two years. The Company has recorded its share of SourceSuite's results of operations using the equity method in the Consolidated Statement of Operations. Assets originally 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 is as follows (in thousands):
December 31, 2000 September 30, 2001 ----------------- ------------------ ASSETS: Current assets $ 3,670 $ 980 Software development costs 188 476 Property and equipment, net 600 516 Intangible assets, net 762 625 -------- -------- $ 5,220 $ 2,597 ======== ======== LIABILITIES AND MEMBERS' EQUITY: Current liabilities $ 1,204 $ 1,828 Members' equity 4,016 769 -------- -------- $ 5,220 $ 2, 597 ======== ========
16
Period from Three Months Three Months inception (March ended ended 3, 2000) through Nine Months ended Sept. 30, 2000 Sept. 30, 2001 Sept. 30, 2000 September 30, 2001 -------------- -------------- ---------------- ------------------ NET LOSS $(1,468) $ (978) $(4,351) $(3,647) ======= ======= ======= =======
12. 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. The Interactive TV business is operated through SourceSuite. The total 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. All revenues of the Company relate to the IT Network segment only.
Three months ended September 30, Nine months ended September 30, 2000 2001 2000 2001 ------- ------- ------- ------- (In thousands) (In thousands) Operating loss: IT Network $ (691) $ (96) $(2,853) $(1,051) Interactive TV -- -- -- -- Corporate (619) (1,261) (2,602) (3,624) ------- ------- ------- ------- Total operating loss $(1,310) $(1,357) $(5,455) $(4,675) ======= ======= ======= ======= Equity in losses of joint venture: Interactive TV $ (734) $ (488) $(3,443) $(1,823) ======= ======= ======= =======
December 31, 2000 September 30, 2001 ----------------- ------------------ (In thousands) Identifiable assets: IT Network $ 6,907 $ 3,456 Interactive TV -- -- Corporate 22,141 14,481 ------- ------- Total identifiable assets $29,048 $17,937 ======= ======= Investment in joint venture: Interactive TV $ 2,008 $ 389 ======= ======= Total assets $31,056 $18,326 ======= =======
17 13. RESTRUCTURING EXPENSES In the fourth quarter 2000, as part of the Company's continuing evaluation of its product lines, the Company decided to discontinue its front-of-book ("FOB") advertising services. The Company intends to continue to honor commitments on contracts in books that already have been published, resulting in a wind-down period through March 2002. As a result of this decision, in the fourth quarter of 2000, the Company recognized a charge of $0.2 million for the write-down of production equipment held for sale, which was included in cost of sales, and $0.1 million for non-cancelable lease costs which were included in selling, general and administrative expenses. In the first quarter of 2001, the Company incurred employee severance costs for 66 employees of approximately $0.2 million relating to its continuing restructuring efforts. All severance costs have been fully paid. Additionally, as part of the Company's efforts to evaluate strategic alternatives, including a potential merger, sale of assets or restructuring of the Company's balance sheet, the Company has incurred legal and other professional fees of $0.8 million and $2.1 million for the three and nine month periods ended September 30, 2001, respectively. These costs, along with the cost of severance, are included in restructuring expense in the Consolidated Statement of Operations. 14. FINANCIAL INFORMATION FOR RELATED ISSUERS AND GUARANTORS Source Media, Inc. and its wholly owned subsidiaries have operations organized as separate corporate subsidiaries. The Notes discussed in Note 6 represent debt securities that are fully and unconditionally guaranteed, jointly and severally by each of the Company's subsidiaries (the "Subsidiary Guarantors") other than Source Investments, Inc. ("Non-Guarantor Subsidiary"). However, the Liberate shares owned by Source Investments, Inc. have been pledged as collateral to secure payment of the Notes. The guarantees are senior obligations of the Subsidiary Guarantors and are secured by substantially all of the assets of the Subsidiary Guarantors. The following tables present the financial positions as of September 30, 2001 and December 31, 2000, as well as results of operations and cash flows for each of the three and nine month periods ended September 30, 2001 and 2000, combined into three categories: 1) the operations of Source Media, Inc., 2) Subsidiary Guarantors, and 3) Non-Guarantor Subsidiary: 18 SOURCE MEDIA, INC. CONDENSED CONSOLIDATING BALANCE SHEET SEPTEMBER 30, 2001 (IN THOUSANDS)
NON- SOURCE SUBSIDIARY GUARANTOR ASSETS MEDIA, INC. GUARANTORS SUBSIDIARY --------- --------- --------- Cash and cash equivalents ............................... $ -- $ 1,583 $ 7 Restricted cash ......................................... -- -- 3,138 Trade accounts receivable, less allowance for doubtful accounts ....................... -- 708 -- Related party receivables ............................... -- 1,119 -- Prepaid expenses and other current assets .............. -- 584 -- Investment in securities available for sale ............. -- -- 6,447 --------- --------- --------- Total current assets .................................... -- 3,994 9,592 Net property and equipment .............................. -- 861 -- Net intangible assets ................................... -- 1,257 -- Investment in SourceSuite LLC ........................... 389 -- -- Investment in SMI Holdings .............................. (191,798) 242,850 -- Investment in Source Investments, Inc. .................. 9,585 77,863 -- Other non-current assets ................................ 2,233 -- -- Intercompany ............................................ 193,699 (193,692) (7) --------- --------- --------- Total assets ............................................ $ 14,108 $ 133,126 $ 9,585 ========= ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY) Trade accounts payable .................................. $ -- $ 1,921 $ -- Accrued interest ........................................ 10,792 -- -- Other accrued liabilities ............................... -- 1,183 -- Unearned income ......................................... -- 1,114 -- Long-term debt in default ............................... 88,542 -- -- --------- --------- --------- Total current liabilities ............................... 99,334 4,218 -- Minority interests in consolidated subsidiaries ......... -- -- -- Note receivable and accrued interest from minority stockholder ............................. -- -- -- Senior redeemable payment-in-kind (PIK) preferred stock ................................. 9,090 -- -- Stockholders' equity (capital deficiency) ............... (94,316) 128,908 9,585 --------- --------- --------- Total liabilities and stockholders' equity (capital deficiency) ............................. $ 14,108 $ 133,126 $ 9,585 ========= ========= ========= ASSETS ELIMINATIONS CONSOLIDATED ------------ ----------- Cash and cash equivalents .................................. $ -- $ 1,590 Restricted cash ............................................ -- 3,138 Trade accounts receivable, less allowance for doubtful accounts .......................... -- 708 Related party receivables .................................. -- 1,119 Prepaid expenses and other current assets ................. -- 584 Investment in securities available for sale ................ -- 6,447 --------- --------- Total current assets ....................................... -- 13,586 Net property and equipment ................................. -- 861 Net intangible assets ...................................... -- 1,257 Investment in SourceSuite LLC .............................. -- 389 Investment in SMI Holdings ................................. (51,045) -- Investment in Source Investments, Inc. ..................... (87,448) -- Other non-current assets ................................... -- 2,233 Intercompany ............................................... -- -- --------- --------- Total assets ............................................... $(138,493) $ 18,326 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY) Trade accounts payable ..................................... $ -- $ 1,921 Accrued interest ........................................... -- 10,792 Other accrued liabilities .................................. -- 1,183 Unearned income ............................................ -- 1,114 Long-term debt in default .................................. -- 88,542 --------- --------- Total current liabilities .................................. -- 103,552 Minority interests in consolidated subsidiaries ............ -- -- Note receivable and accrued interest from minority stockholder ................................ -- -- Senior redeemable payment-in-kind (PIK) preferred stock .................................... -- 9,090 Stockholders' equity (capital deficiency) .................. (138,493) (94,316) --------- --------- Total liabilities and stockholders' equity (capital deficiency) ................................ $(138,493) $ 18,326 ========= =========
19 SOURCE MEDIA, INC. CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS THREE MONTHS ENDED SEPTEMBER 30, 2001 (IN THOUSANDS)
NON- SOURCE SUBSIDIARY GUARANTOR MEDIA, INC. GUARANTORS SUBSIDIARY ELIMINATIONS CONSOLIDATED ----------- ---------- ---------- ------------ ------------ Revenues .................................... $ -- $ 2,522 $ -- $ -- $ 2,522 Cost of sales ............................... -- 1,418 -- -- 1,418 ------- ------- ------- ------- ------- Gross profit ................................ -- 1,104 -- -- 1,104 Selling, general and administrative expenses .................................. -- 1,604 -- -- 1,604 Restructuring expense ....................... 692 58 -- -- 750 Amortization of intangible assets ........... -- 107 -- -- 107 ------- ------- ------- ------- ------- 692 1,769 -- -- 2,461 Operating loss .............................. (692) (665) -- -- (1,357) Interest income (expense), net .............. (3,895) 20 -- -- (3,875) Other expense ............................... -- -- (114) -- (114) Equity interest in losses of joint venture .. (488) -- -- -- (488) Equity interest in losses of subsidiaries ... (759) -- -- 759 -- ------- ------- ------- ------- ------- Net loss .................................... (5,834) (645) (114) 759 (5,834) Preferred stock (dividends) difference on conversion of preferred stock, net of dividend ............ (186) -- -- -- (186) ------- ------- ------- ------- ------- Net loss attributable to common stockholders .............................. $(6,020) $ (645) $ (114) $ 759 $(6,020) ======= ======= ======= ======= =======
20 SOURCE MEDIA, INC. CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS NINE MONTHS ENDED SEPTEMBER 30, 2001 (IN THOUSANDS)
NON SOURCE SUBSIDIARY GUARANTOR MEDIA, INC. GUARANTORS SUBSIDIARY ELIMINATIONS CONSOLIDATED ------------ ---------- --------- ------------ ------------ Revenues ...................................... $ -- $ 9,395 $ -- $ -- $ 9,395 Cost of sales ................................. -- 5,537 -- -- 5,537 -------- -------- -------- -------- -------- Gross profit .................................. -- 3,858 -- -- 3,858 Selling, general and administrative expenses .................................. -- 5,943 2 -- 5,945 Restructuring expense ......................... 2,040 227 -- -- 2,267 Amortization of intangible assets ............. -- 321 -- -- 321 -------- -------- -------- -------- -------- 2,040 6,491 2 -- 8,533 Operating loss ................................ (2,040) (2,633) (2) -- (4,675) Interest income (expense), net ................ (9,580) 147 -- -- (9,433) Other expense ................................. (872) -- (114) -- (986) Equity interest in losses of joint venture .... (1,823) -- -- -- (1,823) Equity interest in losses of subsidiaries ..... (2,602) -- -- 2,602 -- -------- -------- -------- -------- -------- Net loss ...................................... (16,917) (2,486) (116) 2,602 (16,917) Preferred stock (dividends) difference on conversion of preferred stock, net of dividend ...................................... (519) -- -- -- (519) -------- -------- -------- -------- -------- Net loss attributable to common stockholders .............................. $(17,436) $ (2,486) $ (116) $ 2,602 $(17,436) ======== ======== ======== ======== ========
21 SOURCE MEDIA, INC. CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS NINE MONTHS ENDED SEPTEMBER 30, 2001 (IN THOUSANDS)
NON- SOURCE SUBSIDIARY GUARANTOR MEDIA, INC. GUARANTORS SUBSIDIARY ELIMINATIONS CONSOLIDATED ------------ ---------- ---------- ------------ ------------ OPERATING ACTIVITIES Net cash used in operating activities ......... $ (2,036) $ (3,940) $ (2) $ -- (5,864) INVESTING ACTIVITIES Capital expenditures ...................... -- (120) -- -- (120) Redemption of short term investments ............................... -- -- 3,138 -- 3,138 Investment in SourceSuite ................. (200) -- -- -- (200) Intercompany .............................. 2,236 (2,229) (7) -- -- ------------ ------------ --------- -------- ------------ Net cash provided by (used in) investing activities .......................... 2,036 (2,349) 3,245 -- 2,818 FINANCING ACTIVITIES Transfer of cash to restricted brokerage account ............................. -- -- 3,138 -- (3,138) Net increase (decrease) in cash and cash equivalents .............................. -- (6,175) (9) -- (6,184) Cash and cash equivalents at end of period .... -- 7,774 -- -- 7,774 ------------ ------------ --------- -------- ------------ Cash and cash equivalents at end of period .... $ -- $ 1,599 $ (9) $ -- $ 1,590 ============ ============ ========= ======== ============
22 SOURCE MEDIA, INC. CONDENSED CONSOLIDATING BALANCE SHEET DECEMBER 31, 2000 (IN THOUSANDS)
NON- SOURCE SUBSIDIARY GUARANTOR ASSETS MEDIA, INC. GUARANTORS SUBSIDIARY ELIMINATIONS CONSOLIDATED ---------- ---------- ---------- ------------ ------------ Cash and cash equivalents .................................. $ -- $ 7,771 $ 3 $ -- $ 7,774 Trade accounts receivable, less allowance for doubtful accounts .......................... -- 1,402 -- -- 1,402 Related party receivables .................................. -- 390 -- -- 390 Prepaid expenses and other current assets .................. -- 1,759 -- -- 1,759 Investment in securities available for sale ................ -- -- 12,072 -- 12,072 --------- --------- --------- --------- --------- Total current assets ....................................... -- 11,322 12,075 -- 23,397 Net property and equipment ................................. -- 1,277 -- -- 1,277 Net intangible assets ...................................... -- 1,578 -- -- 1,578 Investment in SourceSuite LLC .............................. 2,008 -- -- -- 2,008 Investment in SMI Holdings ................................. (114,342) 165,387 -- (51,045) -- Investment in Source Investments, Inc. ..................... 12,075 75,373 -- (87,448) -- Other non-current assets ................................... 2,796 -- -- -- 2,796 Intercompany ............................................... 117,942 (117,942) -- -- -- --------- --------- --------- --------- --------- Total assets ............................................... $ 20,479 $ 136,995 $ 12,075 $(138,493) $ 31,056 ========= ========= ========= ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY) Trade accounts payable ..................................... $ -- $ 1,315 $ -- $ -- $ 1,315 Accrued interest ........................................... 1,771 -- -- -- 1,771 Other accrued interest ..................................... -- 2,020 -- -- 2,020 Unearned income ............................................ -- 4,267 -- -- 4,267 --------- --------- --------- --------- --------- Total current liabilities .................................. 1,771 7,602 -- -- 9,373 Long-term debt ............................................. 88,542 -- -- -- 88,542 Minority interests in consolidated subsidiaries ............ -- 3,840 -- -- 3,840 Note receivable and accrued interest from minority stockholder .................................. -- (865) -- -- (865) Senior redeemable payment-in-kind (PIK) preferred stock ...................................... 8,571 -- -- -- 8,571 Non-participating preferred stock .......................... -- -- -- -- -- Stockholders' equity ....................................... (78,405) 126,418 12,075 (138,493) (78,405) --------- --------- --------- --------- --------- Total liabilities and stockholders' equity (capital deficiency) ................................ $ 20,479 $ 136,995 $ 12,075 $(138,493) $ 31,056 ========= ========= ========= ========= =========
23 SOURCE MEDIA, INC. CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS THREE MONTHS ENDED SEPTEMBER 30, 2000 (IN THOUSANDS)
NON- SOURCE SUBSIDIARY GUARANTOR MEDIA, INC. GUARANTORS SUBSIDIARY ELIMINATIONS CONSOLIDATED ------------ ------------ ------------ ------------ ------------ Revenues .................................. $ -- $ 4,766 $ -- $ -- $ 4,766 Cost of sales ............................. -- 2,815 -- -- 2,815 ------------ ------------ ------------ ------------ ------------ Gross profit .............................. -- 1,951 -- -- 1,951 Selling, general and administrative expenses .................................. -- 2,677 -- -- 2,677 Amortization of intangible assets ......... -- 584 -- -- 584 ------------ ------------ ------------ ------------ ------------ -- 3,261 -- -- 3,261 Operating loss ............................ -- (1,310) -- -- (1,310) Interest (income) expense, net ............ (2,843) 169 -- -- (2,674) Equity interest in losses of joint venture (734) -- -- -- (734) Equity interest in losses of subsidiaries . (1,251) -- -- 1,251 -- Other expense (income), net ............... -- (110) -- -- (110) ------------ ------------ ------------ ------------ ------------ Net loss before extraordinary item ........ (4,828) (1,251) -- 1,251 (4,828) Extraordinary item-gain on extinguishments of debt ................... 1,709 -- -- -- 1,709 ------------ ------------ ------------ ------------ ------------ Net loss .................................. (3,119) (1,251) -- 1,251 (3,119) Preferred stock (dividends) difference on conversion of preferred stock, net of dividend .......... 1,763 -- -- -- 1,763 ------------ ------------ ------------ ------------ ------------ Net loss attributable to common stockholders .............................. $ (1,356) $ (1,251) $ -- $ 1,251 $ (1,356) ============ ============ ============ ============ ============
24 SOURCE MEDIA, INC. CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS NINE MONTHS ENDED SEPTEMBER 30, 2000 (IN THOUSANDS)
NON- SOURCE SUBSIDIARY GUARANTOR MEDIA, INC. GUARANTORS SUBSIDIARY ELIMINATIONS CONSOLIDATED ------------ ------------ ------------ ------------ ------------ Revenues ................................. $ -- $ 14,312 $-- $ -- $ 14,312 Cost of sales ............................ -- 9,060 -- -- 9,060 ------------ ------------ ------------ ------------ ------------ Gross profit ............................. -- 5,252 -- -- 5,252 Selling, general and administrative expenses ................................. -- 8,955 -- -- 8,955 Amortization of intangible assets ........ -- 1,752 -- -- 1,752 ------------ ------------ ------------ ------------ ------------ -- 10,707 -- -- 10,707 Operating loss ........................... -- (5,455) -- -- (5,455) Interest income (expense), net ........... (8,926) 632 -- -- (8,294) Equity interest in losses of joint venture (3,443) -- -- -- (3,443) Equity interest in losses of subsidiaries (6,196) -- -- 6,196 -- Gain on sale of interest in Joint Venture 74,977 -- -- -- 74,977 Other expense (income), net .............. -- (214) -- -- (214) ------------ ------------ ------------ ------------ Net loss before extraordinary item ....... 56,412 (5,037) -- 6,196 57,571 Extraordinary item-gain on extinguishments of debt .................. 4,239 -- -- -- 4,239 Cumulative effect of change in accounting principle ................................ -- (1,159) -- -- (1,159) ------------ ------------ ------------ ------------ ------------ Net loss ................................. 60,651 (6,196) -- 6,196 60,651 Preferred stock (dividends) difference on conversion of preferred stock, net of dividend ................................. 5,643 -- -- -- 5,643 ------------ ------------ ------------ ------------ ------------ Net loss attributable to common stockholders ............................. $ 66,294 $ (6,196) $ -- $ 6,196 $ 66,294 ============ ============ ============ ============ ============
25 SOURCE MEDIA, INC. CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS NINE MONTHS ENDED SEPTEMBER 30, 2000 (IN THOUSANDS)
NON- SOURCE SUBSIDIARY GUARANTOR MEDIA, INC. GUARANTORS SUBSIDIARY ELIMINATIONS CONSOLIDATED ----------- ----------- ----------- ------------ ------------ OPERATING ACTIVITIES Net cash used in operating activities ......... $ (5,493) $ 1,676 $ -- $ -- $ (7,169) INVESTING ACTIVITIES Capital expenditures ...................... -- (99) -- -- (99) Redemption of short-term investments ...... -- 2,500 -- -- 2,500 Redemption of restricted investments ...... 5,997 (222) -- -- 5,775 Proceeds from sale of joint venture ....... 4,392 -- -- 4,392 Investment in SourceSuite LLC ............. (4,392) -- -- -- (4,392) Intercompany .............................. (1,758) 1,758 -- -- -- ----------- ----------- ----------- ----------- ----------- Net cash provided by (used in) investing activities .......................... 4,241 3,937 -- -- 8,176 FINANCING ACTIVITIES Proceeds from issuance of common stock ................................... 1,254 -- -- -- 1,254 ----------- ----------- ----------- ----------- ----------- Net cash provided by financing activities...... 1,254 4,844 -- -- 1,254 Net increase (decrease) in cash and cash equivalents .............................. -- 2,261 -- -- 2,261 Cash and cash equivalents at beginning of period ........................... -- 10,910 -- -- 10,910 ----------- ----------- ----------- ----------- ----------- Cash and cash equivalents at end of period .... $ -- $ 13,171 $ -- $ -- $ 13,171 =========== =========== =========== =========== ===========
15. SUBSEQUENT EVENTS The Company failed to make the semi-annual interest payment due on its Notes on November 1, 2001. As of that date, overdue interest amounted to approximately $11.9 million. The Company continues to be in default on its Notes described in Note 6. Since September 30, 2001, the Company has sold 359,100 additional shares of Liberate stock at a realized loss of approximately $1.0 million. On November 7, 2001, the Company finalized its arrangements with the Note holders to place its remaining Liberate shares, and the net proceeds from any sales thereof, except for $2 million, into a controlled account pledged in favor of the indenture trustee and established in the name of Source Media, Inc., subject to the lien of the indenture trustee. See Footnote 1 above. Accordingly, we transferred into the controlled account approximately $5.1 million in cash proceeds from the sale of our Liberate shares and our remaining 288,200 Liberate shares held which had an aggregate market value of approximately $2.3 million, based on the November 7, 2001 closing price per share as quoted on Nasdaq. We do not have the ability to withdraw any shares or proceeds from the controlled account. 26 SOURCESUITE LLC BALANCE SHEETS (unaudited)
DECEMBER 31, SEPTEMBER 30, 2000 2001 ------------ ------------- (dollars in thousands) ASSETS Current Assets: Cash and cash equivalents ...................... $ 3,252 $ 164 Related party receivables ...................... 124 523 Prepaid expenses and other current assets ...... 294 293 -------- -------- Total current assets ...................... 3,670 980 Software development costs ......................... 188 476 Property and equipment: Computer equipment ............................. 825 883 Accumulated depreciation ....................... 225 367 -------- -------- Net property and equipment ......................... 600 516 Intangible assets: Goodwill ....................................... 915 915 Accumulated amortization ....................... 153 290 -------- -------- Net intangible assets .............................. 762 625 -------- -------- Total assets .............................. $ 5,220 $ 2,597 ======== ======== LIABILITIES AND MEMBERS' EQUITY Current Liabilities: Accounts payable ............................... $ 199 $ 108 Accrued liabilities ............................ 615 554 Payable to Source Media, Inc. .................. 390 1,166 -------- -------- Total current liabilities ................. 1,204 1,828 Members' equity: Contributed capital, 1,000,000 units authorized, issued and outstanding ....................... 9,967 10,367 Accumulated deficit ............................ (5,951) (9,598) -------- -------- Total members' equity ..................... 4,016 769 -------- -------- Total liabilities and members' equity ..... $ 5,220 $ 2,597 ======== ========
See accompanying Notes to Financial Statements 27 SOURCESUITE LLC STATEMENTS OF OPERATIONS (UNAUDITED)
PERIOD FROM INCEPTION THREE MONTHS ENDED THREE MONTHS ENDED (MARCH 3, 2000) TO NINE MONTHS ENDED SEPTEMBER 30, 2000 SEPTEMBER 30, 2001 SEPTEMBER 30, 2000 SEPTEMBER 30, 2001 ------------------ ------------------ --------------------- ------------------ (in thousands) (in thousands) Revenues ....................................... $ 24 $ 330 $ 24 $ 855 Cost of sales .................................. 628 407 1,027 1,556 ------- ------- ------- ------- (604) (77) (1,003) (701) Selling, general and administrative expenses ... 968 904 3,593 3,000 ------- ------- ------- ------- Operating loss ................................. (1,572) (981) (4,596) (3,701) Interest income ................................ 104 3 245 54 ------- ------- ------- ------- Net loss .............................. $(1,468) $ (978) $(4,351) $(3,647) ======= ======= ======= =======
See accompanying Notes to Financial Statements 28 SOURCESUITE LLC STATEMENT OF MEMBERS' EQUITY (UNAUDITED)
MEMBERSHIP UNITS MEMBER'S EQUITY ---------------- --------------- (dollars in thousands) BALANCE AT DECEMBER 31, 2000 ............ 1,000,000 $ 4,016 Net loss ................................ -- (3,647) Capital contribution from members ....... -- 400 --------- --------- BALANCE AT SEPTEMBER 30, 2001 ........... 1,000,000 $ 769 ========= =========
See accompanying Notes to Financial Statements 29 SOURCESUITE LLC STATEMENTS OF CASH FLOWS (unaudited)
PERIOD FROM INCEPTION (MARCH 3, 2000) NINE MONTHS THROUGH ENDED SEPT. 30, 2000 SEPT. 30, 2001 -------------- -------------- (in thousands) OPERATING ACTIVITIES Net loss ......................................... $(4,351) $(3,647) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation ................................. 27 142 Amortization of intangible assets ............ 106 137 Changes in operating assets and liabilities: Related party receivable ..................... 599 (399) Prepaid expenses and other current assets .... (315) (1) Trade accounts payable and accrued liabilities 84 (94) Related party payable ........................ (66) 720 ------- ------- Net cash used in operating activities ............ (3,913) (3,142) INVESTING ACTIVITIES Software development ........................... -- (288) Additions to property and equipment ............ (48) (58) ------- ------- Net cash used in investing activities ............ (48) (346) FINANCING ACTIVITIES Capital contribution from members -- 400 ------- ------- Net decrease in cash and cash equivalents ........ (3,961) (3,088) Cash and cash equivalents at beginning of period . 8,832 3,252 ------- ------- Cash and cash equivalents at end of period ....... $ 4,871 $ 164 ======= =======
See accompanying Notes to Financial Statements 30 SOURCESUITE LLC NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 1. DESCRIPTION OF BUSINESS SourceSuite LLC ("SourceSuite" or "the 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") (collectively, "the Members"). Source Media manages SourceSuite which provides interactive television programming applications and services, including our SourceGuide(TM) interactive program guide and our LocalSource(TM) interactive programming service. On November 17, 1999 Source Media contributed specific assets related to its VirtualModem(TM)" products and businesses, and Insight contributed $13 million in cash to a joint venture, each in exchange for a 50% interest in that joint venture. VirtualModem software is a "middleware" platform, or the software that permits a subscriber to interact with advertisements, programming and other services through a cable set-top box. On March 3, 2000, Source Media and Insight sold their interests in the joint venture to Liberate Technologies ("Liberate"). Liberate issued to each of Source Media and Insight 886,000 shares of Liberate common stock and $4.4 million of cash. This cash was contributed by Source Media and Insight to SourceSuite, which was formed prior to the completion of the transaction with Liberate. SourceSuite purchased from the joint venture the net assets and properties not related to the VirtualModem software and businesses, which were valued at $1.1 million. Accordingly, Liberate acquired all patents and technology underlying the VirtualModem software and business. Liberate granted the Company an exclusive perpetual license to use the patents and technology in connection with SourceGuide(TM). As a result, SourceSuite became a provider of applications and services other than middleware. Upon completion of the transactions on March 3, 2000, the net assets of SourceSuite consisted of $8.8 million in cash and $1.1 million in purchased net assets from the joint venture, allocated as follows (in thousands): Related party receivable ................. $ 1,081 Prepaid expenses and other current assets 47 Property and equipment ................... 189 Goodwill ................................. 915 Accrued liabilities ...................... (558) Related party payable .................... (539) ------- Net assets acquired .................. $ 1,135 =======
Liberate provides SourceSuite, without charge, specific software development services for the Interactive TV applications and services under a programming services agreement. The fair value of these software development services cannot be reasonably estimated. Liberate is 31 expected to deliver specific software components and technology pursuant to the agreement in the second half of 2001. In order to increase the distribution of SourceSuite's applications and services, SourceSuite entered into a preferred content provider agreement with Liberate on March 3, 2000 with an initial term of four years. Pursuant to this agreement, Liberate offers specified pricing discounts to its customers that agree to use SourceSuite's applications and services with the VirtualModem products. The agreement requires SourceSuite to reimburse Liberate for the pricing discounts offered as revenue is received from the customer. Since inception on March 3, 2000, SourceSuite has incurred a net loss of $9.6 million and its operating activities have used approximately $7.9 million in cash. SourceSuite is expected to continue to incur operating losses at least through 2001. SourceSuite's ability to continue operations through and beyond 2001 is dependent upon the availability of sufficient cash to meet its working capital, development, and other operational needs. As of September 30, 2001, SourceSuite's primary source of liquidity is its cash and cash equivalents of approximately $164 thousand; however, SourceSuite's remaining cash requirements for fiscal 2001 are expected to significantly exceed that amount. As a result, SourceSuite will be dependent upon capital contributions from Source Media and Insight to continue its operations. Source Media did not make the interest payment on its 12% Senior Secured Notes of approximately $5.3 million due on May 1, 2001. As of May 31, 2001, the indenture trustee of the Notes declared that the Company was in default of the Notes and the entire unpaid principal amount of the Notes and all accrued interest were due and payable immediately. In August 2001, the unofficial committee of the holders of Source Media's Senior Secured Notes and Source Media agreed in principle that Source Media would sell all of its 886,000 Liberate shares over the next few months. Source Media is finalizing arrangements to place its Liberate shares, and the net proceeds of any sales thereof, except for $2 million, into a controlled account pledged in favor of the indenture trustee and established in the name of Source Media, Inc., subject to the lien of the indenture trustee. Source Media will not have the ability to withdraw the Liberate shares, or any proceeds of sales thereof, from the controlled account. All shares and proceeds in the controlled account will be distributed automatically to the Note holders on December 31, 2001 unless the Note holders agree otherwise or judicial action is taken to suspend such distribution. Source Media expects to withhold $2 million from the controlled account to fund its operations and for investment in SourceSuite. In evaluating the funding requirements of SourceSuite, the Management Committee may explore the availability of outside debt or equity financing. If such financing is not available on appropriate terms, the Management Committee is likely to inform the Members of a need for additional capital contributions to fund operations (each a "Capital Call"). In the event of a Capital Call, Source Media and Insight are required to share in the additional contribution according to their respective ownership interests in SourceSuite. Source Media and Insight have agreed in principle to commit additional aggregate financing to SourceSuite of $1.6 million ($800 thousand each), to be advanced in increments through December 31, 2001. During the third quarter, additional capital of $400 thousand ($200 thousand each) of this commitment amount was contributed to SourceSuite by Source Media and Insight. In October 2001, another $400 thousand ($200 thousand each) capital contribution was made by both Source Media and 32 Insight. In addition, a significant portion of SourceSuite's projected revenues for fiscal 2001 will be derived from its service relationship with Insight. Source Media anticipates continuing losses, has a capital deficiency, and is currently in default on $88.5 million of long-term debt outstanding. These issues create substantial doubt as to the ability of Source Media to continue as a going concern. The dependence of SourceSuite upon capital contributions from Source Media, combined with SourceSuite's anticipated losses, creates substantial doubt about the ability of SourceSuite to continue as a going concern. The financial statements for SourceSuite do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that might result from the outcome of the uncertainty. Accordingly, the asset and liability carrying amounts do not purport to represent realizable values in the event of liquidation. 2. BASIS OF PRESENTATION The accompanying unaudited financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information. 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 for the periods indicated. Operating results for the three and nine months ended September 30, 2001 are not necessarily indicative of the results that may be expected for the year ending December 31, 2001. The balance sheet at December 31, 2000 has been derived from the audited financial statements at that date. 3. NEW ACCOUNTING PRONOUNCEMENTS FAS 141, Business Combinations and FAS 142, Goodwill and Other Intangible Assets were issued in July 2001 to be effective for all fiscal years beginning after December 15, 2001. FAS 141 eliminates the pooling-of-interests method of accounting for business combinations except for qualifying business combinations that were initiated prior to July 1, 2001. Under FAS 142 goodwill and indefinite lived intangibles are no longer amortized but are reviewed periodically for impairment. The Company will continue to amortize goodwill through the end of the year. Goodwill remaining at January 1, 2002 will no longer be amortized but will be evaluated annually for impairment. 4. RESTRICTION ON MEMBER EQUITY DISTRIBUTIONS Under SourceSuite's joint venture agreement, unless determined by the Management Committee of SourceSuite, there will be no distribution of equity to Members during the first two years of operation. 33 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 in accordance with SourceSuite's operating plan and a management agreement between Source Media and SourceSuite. As part of this arrangement, SourceSuite pays Source Media a management fee equal to 5% of gross operating revenues, as defined in the management agreement, on an annual basis. SourceSuite reimburses Source Media for the direct costs of the Interactive TV business and certain overhead costs. SourceSuite also purchases content for its LocalSource product from Source Media's IT Network division. These costs have been included in the payable to related parties and are reimbursed to Source Media on a periodic basis. Additionally, SourceSuite purchases certain hardware on behalf of Insight. These amounts are billed to Insight and included in related party receivables. SourceSuite provides Interactive TV applications and services to Insight pursuant to a letter of intent. Approximately 73% and 74% of SourceSuite's revenues for the three and nine months ended September 30, 2001, respectively, have been derived from its service relationship with Insight. 6. COMMITMENTS AND CONTINGENCIES From time to time, SourceSuite may consider asserting claims to protect its contractual, intellectual property and other rights and may become aware of claims threatened against it that may develop into litigation. SourceSuite has not asserted any claims and is not aware of any threatened claim that, if determined adversely to it, would have a material and adverse effect on its business or financial condition. Further, from time to time, SourceSuite is a party to routine litigation arising out of the ordinary course of business, none of which is expected to have a material and adverse effect on its business or financial condition. 7. SUBSEQUENT EVENTS During October 2001, additional capital of $400 thousand ($200 thousand each) was contributed to SourceSuite by Source Media and Insight. On November 7, 2001, Source Media finalized its arrangements with its Note holders to place its Liberate shares and the net proceeds from any sales thereof, except for $2 million, into a controlled account, as described further in Footnote 1. 34 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 Interactive Channel Technologies Inc. ("ICTI"), as well as its wholly owned non-operating subsidiary, Source Investments, Inc., and SourceSuite LLC ("SourceSuite"), a 50/50 joint venture with Insight Interactive LLC, a subsidiary of Insight Communications Company, Inc. ("Insight"). 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 risk factors discussed from time to time in our Annual Report on Form 10-K and other Securities and Exchange Commission filings that could cause actual results to differ materially from those projected in such forward-looking statements. Among the factors that could cause actual results to differ materially from our expectations are the impact of the September 11, 2001 terrorist attack in New York, 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, that we need to sell some of our assets or take other steps to recapitalize or reorganize our business and assets, our inability to utilize the proceeds of the sale of our Liberate shares without the approval of the holders of our Notes, our auditors have informed us that they believe there is substantial doubt about our ability to continue as a going concern, the need to litigate to protect our contractual and intellectual property rights from third-parties seeking to exploit our impaired financial condition, 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, a loss of our largest customer of our Interactive TV applications and service, 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, the potential that we may be subject to third party intellectual property claims, anti-takeover effects of our shareholder rights plan, stock volatility, the potential for significant dilution or elimination of shareholder interests if the Company merges, sells assets, raises new capital or restructures its balance sheet, our ability to attract and retain key 35 management personnel, government regulation and other risk factors discussed from time to time in our Annual Report on Form 10-K and other Securities and Exchange Commission filings. We caution you that the foregoing 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 risks, 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. GENERAL The following discussion should be read in conjunction with our Consolidated Financial Statements and related notes which are included elsewhere in this report. Source Media aggregates, produces and delivers rich media content across a range of communication platforms including the Internet, digital television, telephone-based voice portal systems, wireless and wireline telephone networks and automobile telematic systems. The Company also operates SourceSuite, a 50/50 joint venture between the Company and Insight, which provides interactive television programming applications and services, including its SourceGuide(TM) interactive program guide and its LocalSource(TM) interactive programming service. The Company categorizes these operations as its IT Network business and its Interactive TV business, respectively. In the fourth quarter 2000 and the first quarter 2001, we made significant decisions regarding the focus of our business in an effort to generate revenue opportunities. As a result, we have undertaken steps to focus on content opportunities rather than technology, to improve our distribution alliances and to position ourselves for future growth as revenue opportunities in the interactive television industry emerge. We are in the process of exiting low-margin business activities. In this regard, we have exited our front-of-book ("FOB") yellow page advertising services. These services generated monetary revenue of approximately $2.0 million and $6.0 million for the three and nine months ended September 30, 2000 and $0.9 million and $4.0 million for the three and nine months ended September 30, 2001. We intend to continue to honor FOB product commitments during a wind-down period through March 2002. Cost savings resulting from the discontinuance of the FOB product line will not be fully realized until 2002. As part of our continuing evaluation of the business throughout 2001, we have reduced the size of our work force at the Company and its IT Network subsidiary from 147 employees at December 31, 2000 to 96 at September 30, 2001 to contain expenses and have taken other measures to reduce costs such as renegotiating, extending payment terms under, or suspending payment on supplier contracts. These efforts have reduced selling, general and administrative expense to $1.6 million for the quarter ended September 30, 2001 from $2.7 million for the same period in 2000. We incurred legal and professional fees of approximately $2.1 million and employee severance costs of approximately $0.2 million for the nine months ended September 30, 2001 relating to our restructuring efforts. A summary of selected financial data follows: 36
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30, 2000 2001 2000 2001 ----------- -------- -------- ---------- (IN THOUSANDS) (IN THOUSANDS) Total revenues $ 4,766 $ 2,522 $ 14,312 $ 9,395 Total cost of sales 2,815 1,418 9,060 5,537 -------- -------- -------- -------- Gross profit 1,951 1,104 5,252 3,858 Gross margin % 41% 44% 37% 41% Total operating loss* $ (1,310) $ (607) $ (5,455) $ (2,408) Operating margin % (27%) (24%) (38%) (26%)
* Excluding restructuring expenses of $0.8 million and $2.3 million for the three and nine months ended September 30, 2001. We did not make our interest payment of $5.3 million due on May 1, 2001, triggering a default on our Notes. As a result of our continued default on the Notes, the indenture trustee of the Notes declared the entire unpaid principal amount of the Notes in the amount of $88.5 million due and payable immediately. Accordingly, the entire face amount of our outstanding Notes has become a current liability. In addition, the Company is obligated to pay interest on overdue principal and on overdue installments of interest at the rate of 2% per annum in excess of the 12% interest rates on the Notes. The Company has failed to make the interest payment due on its Notes on November 1, 2001 and continues to be in default on the Notes. As of that date, total overdue interest, including penalty amounts, was approximately $11.9 million. The Company has engaged Evercore Partners L.P. as its financial advisor to help it evaluate strategic alternatives, including the potential for a merger, sale of assets or restructuring of its balance sheet. The Company is cooperating with the holders of the Notes who have formed an unofficial committee as it works through this process. The Company, with the assistance of its financial advisor, continues to solicit potential financial and strategic partners and to enter into discussions regarding potential financing and other strategic transactions. As of the date hereof, the Company has not obtained any commitment for any such transactions. There can be no assurance that the Company will be able to obtain an agreement with respect to any financing or strategic transaction on terms acceptable to it, or at all. The foregoing factors raise substantial doubt about our ability to continue as a going concern. As a result of these activities, and for the reasons set forth under the caption "Forward Looking Information and Risk Factors," we do not believe our historical financial results of operations are necessarily indicative of future operating results. THREE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 Monetary revenues decreased 45% to $2.5 million for the three months ended September 30, 2001 from $4.6 million for the same period in 2000. The decrease was primarily driven by $1.8 million of decreased advertising sales, advertising services and systems management sales primarily due to our exiting the FOB advertising and internet advertising businesses and $0.4 37 million of decreased information services revenue, offset by an increase of $0.2 million in revenue from new content product sales over the same period in the prior year. Monetary cost of sales decreased 47% to $1.4 million for the three months ended September 30, 2001 from $2.6 million for the same period in 2000, primarily due to $0.8 million of reduced product costs due to discontinued products and decreased sales, and $0.5 million of other operational savings. Nonmonetary revenues and nonmonetary cost of sales decreased 92% to $15 thousand for the three months ended September 30, 2001. Nonmonetary sales accounted for 4% of revenues for the three months ended September 30, 2000 compared to a negligible percentage of revenues for the same period in 2001. This decrease is primarily due to the Company's decision to exit the FOB advertising business. Selling, general and administrative expenses decreased 40% to $1.6 million for the three months ended September 30, 2001 from $2.7 million for the same period in 2000. The decrease is primarily due to operational savings of $0.9 million and decreases in non-cash stock compensation expense of $0.2 million. Restructuring expense of $0.8 million during the three months ended September 30, 2001 includes legal and professional fees associated with evaluating the Company's strategic alternatives. Amortization of intangible assets decreased 82% to $0.1 million from $0.6 million for the three months ended September 30, 2001 primarily due to a $5.6 million write-down of goodwill and contract rights in the fourth quarter of 2000. Equity interest in losses of joint venture includes our share of the results of operations of SourceSuite recorded using the equity method. The decrease in the equity loss is attributable to increased revenues and decreased legal, severance and other operational expenses in SourceSuite for the three months ended September 30, 2001 as compared to the same period of 2000. SourceSuite began generating revenues in the third quarter of 2000. Interest expense increased 37% to $3.9 million for the three months ended September 30, 2001 from $2.8 million for the same period of 2000. This increase is due to the Company's obligation to pay penalty interest of 2% per annum (in excess of the 12% interest rates on the Notes) on overdue principle and overdue installments of interest. This expense is associated with a debt financing completed by the Company in October 1997 and described in detail in the Notes to Consolidated Financial Statements. Interest income decreased 88% to $20 thousand for the three months ended September 30, 2001 from $0.2 million for the same period in 2000 due to decreased cash balances. Preferred Stock dividend expense of $0.2 million and benefit of $1.8 million for the three months ended September 30, 2001 and 2000, relate to the Preferred Stock financing completed by the Company in October 1997 and described in the Notes to Consolidated Financial 38 Statements. The 2000 amount includes a benefit of $2.1 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. The benefit is partially offset by dividend expense of $0.3 million. Dividends are recorded at the fair market value of the shares. Dividend expense also includes expense associated with the accretion of Preferred Stock to its liquidation value of $25 per share. The decrease in expense is primarily attributable to the exchange in the second and third quarters of 2000 of Preferred Stock for common stock and a lower fair value for Preferred Stock, during the three months ended September 30, 2001. NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 Monetary revenues decreased 32% to $9.3 million for the nine months ended September 30, 2001 from $13.7 million for the same period of 2000. This decrease is primarily due to decreases of $3.9 million in advertising sales, advertising services and systems management sales primarily due to our exiting the FOB advertising and internet advertising business and decreased revenue of $1.1 million in information services offset by an increase of $0.6 million in revenue from new content product sales over the same period in 2000. Monetary cost of sales decreased 36% to $5.4 million for nine months ended September 30, 2001 from $8.4 million for the same period in 2000 primarily due to $1.8 million of reduced product cost due to discontinued products and decreased sales and other operational savings of $1.2 million primarily from the discontinuance of our FOB advertising sales business. Nonmonetary revenues and nonmonetary cost of sales decreased 80% to $0.1 million for the nine months ended September 30, 2001 from $0.6 million for the same period of 2000. Nonmonetary sales accounted for 1% of revenues for the nine months ended September 30, 2001 compared to 4% of revenues for the same period in 2000. This decrease is primarily due to the Company's decision to exit the FOB business. Selling, general and administrative expenses decreased 34% to $5.9 million for the nine months ended September 30, 2001 from $8.9 million for the same period in 2000. The decrease is primarily due to a decrease in non-cash stock compensation expense of $1.0 million and $2.0 million in cost reductions in other administrative expenses. Restructuring expense of $2.3 million for the nine months ended September 30, 2001 includes $2.1 million of legal and professional fees associated with the evaluation by the Company of its strategic alternatives, along with $0.2 million in severance costs connected to these efforts. Amortization of intangible assets decreased 82% to $0.3 million for the nine months ended September 30, 2001 from $1.8 million for the same period in 2000 primarily due to a $5.6 write-down of goodwill and contract rights in the fourth quarter of 2000. Gain on sale of interest in joint venture during the nine months ended September 30, 2000 was comprised of $75.0 million of gain recorded upon the sale of our interest in the prior 39 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 ventures includes our share of the results of operations of SourceSuite for the nine months ended September 30, 2001 compared with the period from inception through September 30, 2000, recorded using the equity method. The decreases in the equity loss is attributable to a smaller net loss in SourceSuite for the nine months ended September 30, 2001. This is primarily attributable to increased revenues and decreased legal, severance and other operational expenses in SourceSuite as compared to the prior period. SourceSuite began generating revenues in the third quarter of 2000. Interest expense increased 7% to $9.6 million for the nine months ended September 30, 2001 from $8.9 million in 2000. This increase is primarily due to the Company being obligated to pay penalty interest on overdue principal and overdue interest installments of 2% per annum (in excess of the 12% interest rates on the Notes). This increase is partially offset by a decrease due to the exchange of approximately $7.75 million of our Senior Secured notes for common stock in the second and third quarters of 2000. Interest income decreased 77% to $0.1 million for the nine months ended September 30, 2001 from $0.6 million in the prior year due to lower investment and cash balances. Preferred Stock dividends expense of $0.5 million in 2001 and benefit of $5.6 million in 2000 relate to the Preferred Stock financing completed by the Company in October 1997 and described in the Notes to Consolidated Financial Statements. The 2000 amount reflects a benefit of $6.8 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 dividend expense of $1.2 million for the nine months ended September 30, 2000 as compared to dividend expense of $0.5 million for the nine months ended September 30, 2001. Dividends are recorded at the fair market value of the preferred shares issued. Dividend expense also includes expense associated with the accretion of Preferred Stock to its liquidation value of $25 per share. LIQUIDITY AND CAPITAL RESOURCES At September 30, 2001, our primary source of liquidity was $1.6 million of cash. We also had $3.1 million of restricted cash. Pursuant to arrangements with the holders of our Notes described below, only $2 million of our restricted cash will be available to fund our operations. On November 7, 2001, we transferred into a controlled account described below approximately $5.1 million in cash proceeds from the sale of Liberate shares and our remaining 288,200 Liberate shares held which had an aggregate market value of approximately $2.3 million, based on the closing price per share as quoted on Nasdaq. We do not have the ability to withdraw any shares or proceeds from the controlled account and we have no access to any other sources of liquidity, including debt and equity financing facilities. We continue to experience substantial operating losses and net losses as a result of our 40 efforts to develop, deploy and support our IT Network business and to develop, conduct trials and commercially launch our Interactive TV business. We have reported both an operating loss and a net loss each year since our inception, including an operating loss of $4.7 million and a net loss attributable to common stockholders of $17.4 million for the nine months ended September 30, 2001. As of September 30, 2001, we had an accumulated deficit of $230.1 million. In addition, we will be required to make additional capital contributions to SourceSuite to continue its operations. We did not make our interest payment of $5.3 million due on May 1, 2001, triggering a default on our Notes. As a result of our continued default on the Notes, the indenture trustee of the Notes declared the entire unpaid principal amount of the Notes in the amount of $88.5 million due and payable immediately. Accordingly, the entire face amount of our outstanding Notes has become a current liability. In addition, the Company is obligated to pay interest on overdue principal and on overdue installments of interest at the rate of 2% per annum in excess of the 12% interest rate on the Notes. The Company has failed to make the interest payment due on its Notes on November 1, 2001 and continues to be in default on the Notes. As of that date, total overdue interest, including penalty amounts, was approximately $11.9 million. In August 2001, the unofficial committee of the holders of the Notes and the Company agreed in principle that the Company would sell all of its 886,000 Liberate shares over the next few months. On November 7, 2001, we finalized arrangements to place the remaining Liberate shares, and the net proceeds of any sales thereof, except for $2 million, into a controlled account pledged in favor of the indenture trustee and established in the name of Source Media, Inc., subject to the lien of the indenture trustee. We will not have the ability to withdraw the Liberate shares, or any proceeds of sales thereof, from the controlled account. All shares and proceeds in the controlled account will be distributed automatically to the Note holders on December 31, 2001 unless the Note holders agree otherwise or unless judicial action is taken to suspend such distribution. During the third quarter, we sold 238,700 Liberate shares yielding net proceeds of $3.1 million. The proceeds have been placed into the controlled account. Excluding these proceeds and the remaining Liberate shares, our primary source of liquidity as of September 30, 2001 was $1.6 million of cash. We and Insight have determined to commit additional aggregate financing to SourceSuite of $1.6 million ($0.8 million each), to be advanced in increments through the balance of 2001. During the third quarter, $0.4 million (0.2 million each) of the commitment amount was contributed to SourceSuite by us and Insight. If we are unable to successfully restructure our balance sheet prior to December 31, 2001, it may be very difficult for us to obtain sufficient additional funding to continue our operations. In particular, in such event, we would have to reach an agreement with our Note holders to obtain additional funds from the controlled account which otherwise will be distributed automatically to the Note holders on December 31, 2001. We cannot assure you that the holders of our Notes will agree to release any controlled funds or take any other steps with a view toward 41 continuing our operations. We have engaged Evercore Partners L.P. as financial advisors to help us evaluate strategic alternatives, including possible merger, sale of assets and restructuring our balance sheet. We are cooperating with the holders of the Notes who have formed an informal committee as we work through this process. With the assistance of our financial advisor, we continue to solicit potential financial and strategic transactions. As of the date hereof, we have not reached a binding commitment with respect to any such transaction. There can be no assurance that we will be able to obtain an agreement with respect to a financing or strategic transaction on terms acceptable to us, or at all. If we merge, sell a significant portion of our assets, raise additional funds through the issuance of equity or convertible debt securities, or reach an agreement to restructure our balance sheet with the holder of our Notes, the percentage ownership of our existing stockholders will be reduced significantly or eliminated. In order to consummate a merger, sale or financing transaction or to restructure our balance sheet we must satisfy our obligations to the holders of our Notes in a manner agreeable to them. The holders of our Notes, as our senior creditors, have significant influence in our restructuring process and may seek to use this leverage to obtain a significant ownership interest in the Company. There can be no assurances that we shall be successful in these efforts or reach an agreement on any plan of restructuring with the holders of our Notes or that we will be able to restructure our balance sheet on terms acceptable to us, or at all. If we fail to reach an agreement on a plan of restructuring with the holders of our Notes, it is likely that the Company will have to initiate proceedings seeking protection from its creditors. The foregoing factors raise substantial doubt about our ability to continue as a going concern. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that might result from the outcome of this uncertainty. Accordingly, the asset and liability carrying amounts do not represent realizable values in the event of liquidation. EFFECT OF INFLATION We believe that the effect of inflation has not been material during the nine-month periods ended September 30, 2000 and 2001, respectively. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. We are exposed to changes in interest rates related primarily to our Notes and Preferred Stock. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. At September 30, 2001, we had Notes outstanding having an aggregate principal amount of $88.5 million, due November 1, 2004, which bear interest at a fixed rate of 12% (exclusive of penalty interest of 2% per annum). The fair value of the Notes at September 30, 2001 is not readily determinable, however, is believed to be substantially less than 42 the fair market value of $17.7 million at December 31, 2000. The Company failed to make the approximately $5.3 million semi-annual interest payment on the Notes due May 1, 2001. As a result of our continued default on the Notes, on May 31, 2001, the indenture trustee of the Notes declared the entire unpaid principal amount of the Notes and all accrued interest due and payable immediately. See "Financial Condition" section of Note 1 to our financial statements for further discussion. The Company is obligated to pay interest on overdue principal and on overdue installments of interest at the rate of 2% per annum in excess of the 12% interest rate on the Notes. In addition, the Company failed to make the semi-annual interest payment due on its Notes on November 1, 2001 and continues to be in default on the Notes. As of that date, total overdue interest, including penalty amounts, was $11.9 million At September 30, 2001, we had Preferred Stock outstanding having a liquidation preference of $14.6 million, due November 1, 2007. The Preferred Stock has a fixed dividend rate of 13 1/2% and a penalty of 2% of the liquidation preference per share. As of September 30, 2001, the fair market value of the Preferred Stock was approximately $0.08 per share for an aggregate value of the outstanding Preferred Stock of $47 thousand. The shares of Preferred Stock were valued at 1.2 times the closing market price of the common stock at September 30, 2001, as this value is reflective of past market values as no market price was readily attainable. On March 3, 2000, we received 886,000 shares of Liberate common stock in exchange for our interest in our joint venture with Insight. The closing price per share of the Liberate common stock on March 3, 2000 was $98.6875, giving us a total original investment in Liberate common stock of approximately $87.4 million. There is significant market risk associated with price fluctuations of Liberate shares. In August 2001, the unofficial committee of holders of the Notes and the Company agreed in principle that the company would sell its 886,000 Liberate shares over the next few months. The Company is finalizing arrangements to place its Liberate shares, and the net proceeds of any sales thereof, except for $2 million, into a controlled account pledged in favor of the indenture trustee and established in the name of Source Media, Inc., subject to the lien of the indenture trustee. The Company will not have the ability to withdraw the Liberate shares, or any proceeds of sales thereof, from the controlled account. All shares and proceeds in the controlled account will be distributed automatically to the Note holders on December 31, 2001 unless the Note holders agree otherwise or judicial action is taken to suspend such distribution. During the third quarter, the Company sold 238,700 shares of its Liberate shares yielding net proceeds of $3.1 million. As of September 30, 2001, the closing price per share for Liberate common stock was $9.96 resulting in a total investment balance of $6.4 million. Subsequent to September 30, 2001, we sold 359,100 additional shares of Liberate stock for an aggregate value of $3.9 million, all of which has been placed into the controlled account discussed above. As of November 7, 2001, the remaining 288,200 shares of Liberate stock had a fair market value of $7.95 per share resulting in a total investment of $2.3 million. We invest our cash balance in money market funds and commercial paper rated A1, and P1, respectively. These securities are in U.S. dollars, with maturities of six months or less, are held to maturity and are not owned for trading purposes. Using this strategy, we have not experienced any losses due to interest rate risk, market risk or foreign exchange risk on our commercial paper investments, and we do not anticipate any such losses. 43 PART II - OTHER INFORMATION Item 1 - Legal Proceedings Reference is made to our Annual Report on Form 10-K for the year ended December 31, 2000, our Quarterly Reports on Form 10-Q for the preceeding quarters and to the Notes to SourceSuite's and our financial statements included in this report for a discussion of certain litigation. Item 2 - Changes in Securities and Use of Proceeds None. Item 3 - Defaults Upon Senior Securities The Company failed to make the approximately $5.3 million interest payment on the Notes due May 1, 2001. As a result of our continued default on the Notes, on May 31, 2001, the indenture trustee of the Notes declared the entire unpaid principal amount of the Notes and all accrued interest due and payable immediately. The Company continues to be in default on the Notes. The Company has suspended payments of the quarterly dividends on its 13 1/2% Senior Payment-In-Kind Preferred Stock. As provided by the terms of the Preferred Stock, unpaid dividends will continue to accrue until paid. In addition, following the default on the Notes, additional dividends will accumulate on the Preferred Stock at a rate per annum of 2% of the liquidation preference per share of the Preferred Stock. As of September 30, 2001, the Company had a total arrearage with respect to dividends on the Preferred Stock in the amount of $495 thousand. Item 5 - Other Information DOWNTURNS IN THE DIGITAL MEDIA, INTERACTIVE TELEVISION AND RELATED MARKETS MAY SIGNIFICANTLY DECREASE OUR REVENUES AND MARGINS. The market for our products depends on economic conditions affecting the broader digital media, interactive television and related markets. Downturns in these markets may cause cable operators and other digital service providers to delay or cancel digital media projects, reduce their overall or content-specific information technology budgets or reduce or cancel orders for our applications and content. In this environment, customers may experience financial difficulty, cease operations or fail to budget for the purchase of our applications and content. This, in turn, 44 may lead to longer sales cycles, delays in payment and collection, and price pressures, causing us to realize lower revenues and margins. In particular, capital spending in the digital media sector generally has decreased in the past 12 months, and many of our customers and potential customers have experienced declines in their revenues and operations. In addition, the terrorist attacks of September 11, 2001 have created an uncertain economic environment and we cannot predict the impact of these events, or of any related military action, on our customers or business. We believe that, in light of these events, some businesses may curtail or eliminate capital spending on digital media projects. If expenditures on digital media projects in our markets decline, we may be unable to continue our operations. 45 Item 6 - Exhibits and Reports on Form 8-K (a) Exhibits Exhibit 10.1 Amended and Restated Employment Agreement as of May 7, 2001 by and between Source Media Inc., IT Network and Philip Howort Exhibit 10.2 Securities Account Control Agreement, dated as of November 7, 2001. Exhibit 10.3 Letter of Agreement, dated as of November 7, 2001. (b) The following reports on Form 8-K were filed during the third quarter of 2001: On July 19, 2001, Source Media, Inc. filed a report on Form 8-K relating to an announcement that it was suspending payment of the quarterly dividend on its 13 1/2 % Senior Payment-In-Kind Preferred Stock scheduled to be paid on August 1, 2001. 46 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SOURCE MEDIA, INC. (Registrant) Date: November 14, 2001 By: /s/ Benjamin J. Douek ----------------------- Benjamin J. Douek Chief Financial Officer and Treasurer (Principal Financial Officer and Duly Authorized Officer) 47 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION - ------- ----------- Exhibit 10.1 Amended and Restated Employment Agreement as of May 7, 2001 by and between Source Media Inc., IT Network and Philip Howort Exhibit 10.2 Securities Account Control Agreement, dated as of November 7, 2001. Exhibit 10.3 Letter of Agreement, dated as of November 7, 2001.
EX-10.1 3 d92237ex10-1.txt AMENDED AND RESTATED EMPLOYMENT AGREEMENT Exhibit 10.1 Amended and Restated Employment Agreement as of May 7, 2001 by and between Source Media Inc., IT Network and Philip Howart AMENDED AND RESTATED EMPLOYMENT AGREEMENT, dated as of May 7, 2001, by and between SOURCE MEDIA, INC., a Delaware corporation (the "Company"), IT NETWORK, INC., a Delaware corporation and a wholly owned subsidiary of the Company (the "Subsidiary"), and PHILIP HOWORT (the "Employee"). WHEREAS, The Company desires to engage Employee to perform services for the Company, and Employee desires to perform such services, on the terms and conditions set forth below; and WHEREAS, The Company entered into an Employment Agreement, dated as of October 6, 2000 (the "Prior Employment Agreement") with Employee; and WHEREAS, The Subsidiary desires to engage Employee to perform services for the Subsidiary, and Employee desires to perform such services, on the terms and conditions set forth below; and WHEREAS, The Company and Employee desire to amend and restate the Prior Employment Agreement in its entirety. NOW, THEREFORE, in consideration of the mutual promises herein made and for other good and valuable consideration, receipt of which is hereby acknowledged, the parties hereto hereby agree to amend and restated the Prior Employment Agreement in its entirety as follows: 1. EMPLOYMENT. The Company hereby employs Employee as its Senior Vice President and the Subsidiary additionally employs Employee as its President and Chief Executive Officer, and Employee hereby accepts such employment, upon the terms and conditions hereinafter set forth. 2. TERM. The term (the "Term") of employment of Employee pursuant to this Agreement shall commence on May 7, 2001 and shall terminate on May 7, 2003. The Term shall automatically be renewed for successive one year periods unless either party gives the other written notice to the contrary at least 120 days prior to the end of the Term or any such renewal thereof. 3. DUTIES AND SERVICES. Employee shall devote his full time and best efforts to the business and affairs of the Company and the Subsidiary, and perform, in a competent manner, such executive and managerial functions and duties commensurate with his position as Senior Vice President of the Company, and as President and Chief Executive Officer of the Subsidiary, as the President of the Company may reasonably prescribe from time to time. Employee shall report directly to the President of the Company. The parties acknowledge that Employee will spend such time at the Company's offices in Dallas, Texas as is reasonably required to perform his functions and duties. The Company will not require Employee to relocate his home from the New York metropolitan area. 4. COMPENSATION. A. SALARY. For all services to be rendered by Employee hereunder, the Company shall pay Employee an annual base salary of $200,000. The Company shall pay Employee's salary in accordance with the Company's standard payroll practices as in effect from time to time, with appropriate deductions required by applicable laws, rules and regulations. B. DISCRETIONARY BONUS. On an annual basis, the Board of Directors of the Company shall consider a bonus payment to Employee based on his performance, and the Company's results of operations. The timing and amount of any such bonus payment shall be in the sole and absolute discretion of the Board of Directors. C. STOCK OPTION PARTICIPATION. Each of the Employee and the Company acknowledge that Employee has received a ten-year option to purchase 150,000 shares of the common stock, par value $.001 per share, of the Company. 5. EXPENSES. The Company shall reimburse Employee for all reasonable, ordinary and necessary expenses incurred on behalf of the Company by Employee, including reasonable expenses associated with rental cars and, subject to the approval of the President of the Company, a temporary residence in Dallas, Texas. Employee shall submit to the Company an expense report and receipts or other verification of expenses to be reimbursed in accordance with the Company's standard policies. 6. BENEFITS. Employee shall be entitled to such insurance and retirement plan benefits as are generally available to other senior management employees of the Company, pursuant to Company policy in effect from time to time, such as health insurance, disability and life insurance, and the right to participate in any retirement plans maintained by the Company. 7. VACATION AND SICK DAYS. Employee shall be entitled to fifteen (15) business days of paid vacation during each calendar year (pro-rated for periods shorter than a calendar year). Vacation and sick days shall be taken in accordance with the Company's published guidelines. 8. TERMINATION PROVISIONS. A. TERMINATION FOR CAUSE. Notwithstanding the provisions of Section 2 above, the Company, on two days' prior written notice, may terminate the employment of Employee for any of the following reasons (for "cause"), without the payment of any compensation to Employee, except accrued salary and vacation pay due for the period prior to the date of termination of employment: -2- (i) Employee shall be convicted of a felony or any crime involving an act of dishonesty, such as embezzlement, theft or larceny; (ii) Commission of theft from or fraud against the Company or the Subsidiary or any willful misconduct by Employee that is materially injurious to the financial condition or business reputation of the Company or the Subsidiary, including by reason of material breach by Employee of the provisions of this Agreement; and (iii) Willful and continued failure by the Employee to substantially perform his duties hereunder. B. TERMINATION BY THE COMPANY OTHER THAN FOR CAUSE, DEATH OR DISABILITY. (i) If the employment of Employee is terminated by the Company other than for cause, death or disability, the Company shall pay to Employee as severance, in equal monthly installments, the remaining base salary payments that Employee would have earned if he had continued his employment throughout the Term, and an amount equal to any accrued vacation pay on the date of termination of employment. Such payments shall cease in the event Employee obtains other employment following termination of employment by the Company; provided, however, that in the event the base salary payable to Employee by the Company on the date of termination exceeds the base salary payable to Employee by such new employer, the Company shall pay such excess, in equal monthly installments, through the expiration of the Term. (ii) The Company will continue life, medical, dental and disability coverage substantially identical to the coverage maintained by the Company for Employee and his dependents prior to termination of his employment, except to the extent such coverage may be changed in its application to all Company employees on a nondiscriminatory basis. Such coverage shall cease when Employee obtains other employment. C. TERMINATION ON ACCOUNT OF DISABILITY OR DEATH. (i) In the event Employee shall, during the term of this Agreement, become physically or mentally disabled so that he is unable, or can reasonably be expected to be unable, to perform his duties hereunder for a period of seventy five (75) consecutive days, or ninety (90) non-consecutive days within any twelve (12) month period, the Company shall have the right to terminate Employee's employment, provided that (a) the Company provides Employee with not less than five (5) days' prior written notice of the termination of his employment and (b) the Company makes the payments to Employee referred to in clause (ii) below. Any determination of disability shall be made by a physician selected by the Company and reasonably acceptable to Employee. (ii) In the event the Company terminates Employee's employment for disability as set forth in clause (i) above ("Disability Termination"), Employee shall be entitled to receive, in monthly installments, the base salary Employee would have received in the following three months. All payments made pursuant to this paragraph shall be made in accordance with the -3- Company's standard payroll practices as in effect from time to time, with appropriate deductions required by applicable laws, rules and regulations. In addition, the Company, at its expense, for a period of three months following the date of Disability Termination, will continue medical and dental insurance coverage substantially identical to the coverage maintained by the Company for Employee and his dependents prior to termination of employment, except to the extent such coverage may be changed in its application to all Company employees on a non-discriminatory basis. (iii) In the event of the death of Employee, the Company shall pay the estate of the Employee or his legal representative the accrued salary and vacation pay due for the period prior to the date of Employee's death. D. TERMINATION BY EMPLOYEE. (i) Notwithstanding the provisions of Section 2 above, Employee will be considered to have resigned his employment for "good reason" if the Company, without the express written consent of Employee, materially breaches this Agreement. (ii) In the event that Employee resigns from his employment for good reason, the Company shall be obligated to provide Employee with the severance payments, insurance coverage as required if the Company had terminated Employee other than for cause pursuant to Section 8B above. (iii) In the event that Employee resigns from his employment without good reason, the Company shall be obligated to provide Employee with the payments as required if the Company had terminated Employee for cause pursuant to Section 8A above. 9. REPRESENTATIONS AND WARRANTIES. Employee represents and warrants that Employee is not subject to or a party to any agreement, contract, covenant, order or other restriction which in any way prohibits, restricts or impairs Employee's ability to enter into this Agreement and carry out his duties and obligations hereunder. Each party hereto represents and warrants to the other that (i) it has the full legal right and power and all authority and approvals required to enter into, execute and deliver this Agreement and to perform fully all of its obligations hereunder; and (ii) this Agreement has been duly executed and delivered by it and constitutes a valid and binding obligation of such party, enforceable in accordance with its terms. 10. NON-COMPETITION AND SECRECY. 10.1 NO INTERFERENCE. For the period ending twelve (12) months after the later of (i) the termination of Employee's employment and (ii) the expiration of the Term, Employee shall not, whether for his own account or for the account of any other individual, partnership, firm, corporation or other business organization (other than the Company and its affiliates), intentionally solicit, endeavor to entice away from the Company or its affiliates, or otherwise interfere with the relationship of the Company or any of its affiliates with, any person who is employed by the Company or its affiliates at the time of the termination of Employee's employment and Employee will not interfere with relationship of the Company or any of its affiliates with any individual, partnership, firm, -4- corporation or other business organization with which the Company or its affiliates had any relationship while the Employee was employed by the Company. 10.2 SECRECY. Employee recognizes that the services to be performed by him hereunder are special, unique and extraordinary in that, by reason of his employment hereunder, he may acquire confidential information and trade secrets concerning the operation of the Company or any affiliate thereof, the use or disclosure of which could cause the Company and/or its affiliates substantial loss and damages which could not be readily calculated and for which no remedy at law would be adequate. Accordingly, Employee covenants and agrees with the Company and the Subsidiary that he will not at any time, except in performance of Employee's obligations to the Company and the Subsidiary hereunder or with the prior written consent of the Company, directly or indirectly, disclose any secret or confidential information that he may learn or has learned by reason of his association with the Company. The term "confidential information" includes, without limitation, information not previously disclosed to the public or to the trade with respect to the products, facilities, applications and methods, trade secrets and other intellectual property, systems, procedures, manuals, confidential reports, product price lists, customer lists, technical information, financial information (including the revenues, costs or profits associated with any of its products), business plans, prospects or opportunities but shall exclude any information already in the public domain. Notwithstanding anything to the contrary herein contained, Employee's obligation to maintain the secrecy and confidentiality of the confidential information under this Section 10 shall not apply to any such confidential information which is disclosed through any means other than as a result of any act by Employee constituting a breach of this Agreement or which is required to be disclosed under applicable law. 10.3 EXCLUSIVE PROPERTY. Employee hereby agrees to keep all such records in connection with Employee's employment as the Company and the Subsidiary may from time to time reasonably direct, and all such records shall be the sole and exclusive property of the Company and/or the Subsidiary, as the case may be. Upon termination of Employee's employment, Employee shall return to the Company and/or the Subsidiary, as the case may be, all confidential and/or proprietary information that exists in written or other physical form (and all copies thereof) under Employee's control. 10.4 INJUNCTIVE RELIEF. Without intending to limit the remedies available to the Company or the Subsidiary, Employee acknowledges that a breach of any of the covenants contained in this Section 10 may result in material irreparable injury to the Company and/or the Subsidiary for which there is no adequate remedy at law, that it will not be possible to measure damages for such injuries precisely and that, in the event of such a breach or threat thereof, the Company and/or the Subsidiary shall be entitled to seek to obtain a temporary restraining order and/or a preliminary injunction restraining Employee from engaging in activities prohibited by this Section 10 or such other relief as may be required to specifically enforce any of the covenants in this Section 10. 11. SECTION HEADINGS. The titles to the Sections of this Agreement are solely for the convenience of the parties and shall not be used to explain, modify, simplify, or aid in the interpretations of the provisions of this Agreement. -5- 12. NOTICES. All notices, demands and requests provided or permitted to be given pursuant to this Agreement, shall be given in writing, sent by certified mail, return receipt requested, and addressed as follows or to such other address so designated in the appropriate manner by the parties. All notices shall be deemed effective when mailed. Company: Source Media, Inc. 5400 LBJ Parkway Suite 680 Dallas, Texas 75240 Attention: Stephen W. Palley With a copy to: Robert L. Winikoff, Esq. Sonnenschein Nath & Rosenthal 1221 Avenue of the Americas New York, New York 10020 Employee: Philip Howort 131 Castle Heights Avenue Nyack, New York 10960 With a copy to: Jonathan Pillot, Esq. 62 Greene Street, 2nd Floor New York, New York 10012 13. ASSIGNMENT AND ASSUMPTION. The rights of each party under this Agreement are personal to that party and may not be assigned, delegated or transferred to any other person, firm, corporation, or other entity without the prior written consent of the other party, except that the Company may transfer its rights under this Agreement to any affiliate or other entity which succeeds, by contract or operation of law, to all or substantially all of the business of the Company and agrees in writing to assume the Company's obligations under this Agreement. 14. GOVERNING LAW. THIS AGREEMENT SHALL BE GOVERNED BY, CONSTRUED AND ENFORCED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK WITHOUT GIVING EFFECT TO THE CONFLICTS OF LAW PRINCIPLES OF THE LAWS OF SAID STATE. 15. ENTIRE AGREEMENT. This Agreement, and the stock option agreement evidencing the stock option referred to in paragraph 4C, shall constitute the entire agreement between the parties and any prior written or oral understanding or representation of any kind, or any oral communications shall not be binding upon either party except to the extent incorporated in this Agreement. This Agreement supercedes any and all prior agreements between the parties. -6- 16. MODIFICATION OF AGREEMENT. This Agreement can be modified only in writing and shall be binding only if executed with and under the same formality by the parties hereto or their duly authorized representatives. 17. NO WAIVER. The failure of either party to this Agreement to insist upon the performance of any of the terms and conditions of this Agreement, or the waiver of any breach of any of the terms and conditions of this Agreement, shall not be construed as thereafter waiving any such terms and conditions, but each same shall continue and remain in full force and effect as if no such forbearance or waiver had occurred. 18. EFFECT OF PARTIAL INVALIDITY. The invalidity or unenforceability of any provision or covenant of this Agreement shall not be deemed to affect the validity or enforceability of any other provision or covenant. In the event that any provision or covenant of this Agreement is held invalid or unenforceable, the same shall be deemed automatically modified to the minimum extent necessary to make such provision or covenant enforceable and the parties agree that the remaining provisions shall be deemed to be and to remain in full force and effect. 19. COUNTERPARTS. This Agreement may be executed in counterparts and all counterparts so executed shall constitute one and the same agreement. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first above written. SOURCE MEDIA, INC. By: ------------------------------ Stephen W. Palley, President and Chief Executive Officer IT NETWORK, INC. By: -------------------------------------- Stephen W. Palley, Authorized Signatory EMPLOYEE: -------------------------------------- PHILIP HOWORT -7- EX-10.2 4 d92237ex10-2.txt SECURITIES ACCOUNT CONTROL AGREEMENT Exhibit 10.2 Securities Account Control Agreement, dated as of November 7, 2001. SECURITIES ACCOUNT CONTROL AGREEMENT Securities Account Control Agreement, dated as of November 7, 2001, among SOURCE MEDIA, INC. (the "Company"), U.S. TRUST COMPANY OF TEXAS, N.A. (the "Secured Party"), as trustee under the Indenture, dated as of October 30, 1997, between the Company and the Secured Party, in its capacity as trustee thereunder, and U.S. TRUST COMPANY OF TEXAS, N.A., as securities intermediary (the "Securities Intermediary"). Capitalized terms used but not defined herein shall have the meanings assigned in the Security Agreement, dated as of October 30, 1997 (as heretofore amended or modified, the "Security Agreement"), made by the Company and the other Grantors listed therein in favor of the Secured Party, in its capacity as collateral agent for the ratable benefit of the holders of the 12% Senior Secured Notes due 2004 issued by the Company under the Indenture. All references herein to the "UCC" shall mean the Uniform Commercial Code as in effect from time to time in the State of New York. Section 1. Establishment of Securities Account. The Company hereby directs the Securities Intermediary to establish, and the Securities Intermediary hereby does establish, a securities account to be maintained by the Securities Intermediary as a securities intermediary in the name of "Source Media, Inc., Pledge Security Account, subject to the lien of U.S. Trust Company of Texas, N.A., as Trustee", (such account and any successor account the "Securities Account"). The Securities Intermediary hereby confirms and agrees that (i) the Securities Intermediary has established the Securities Account with account number 7651499, (ii) the Securities Account is an account to which a financial asset (as such term is defined in Section 8-102(a)(9) of the UCC) is or may be credited in accordance with this Securities Account Control Agreement and the Security Agreement, (iii) any item of property (whether U.S. Government Securities or investment property, financial asset, security, instrument or cash, as each such term is defined in the UCC) credited to the Securities Account shall be treated as a financial asset (within the meaning of Section 8-102(a)(9) of the UCC), (iv) all securities or other property underlying any financial assets credited to the Securities Account shall be registered in the name of the Securities Intermediary, endorsed to the Securities Intermediary or in blank or credited to another securities account maintained in the name of the Securities Intermediary and in no case will any financial asset credited to the Securities Account be registered in the name of the Company, payable to the order of the Company or specially endorsed to the Company except to the extent the foregoing have been specially endorsed to the Securities Intermediary or in blank, (v) for the purposes hereof "financial assets" shall include uninvested cash and U.S Government Securities, (vi) the Securities Account is a "securities account" as such term is defined in Section 8-501(a) of the UCC maintained on the books of the Securities Intermediary in the name of "Source Media, Inc., Pledge Securities Account, subject to the lien of U.S. Trust Company of Texas, N.A., as Trustee" and all property delivered to the Securities Intermediary pursuant to this Securities Account Control Agreement or the Security Agreement will be promptly credited to the Securities Account; (vii) the Company has deposited 288,200 shares of Common Stock of Liberate Technologies, Inc. (the "Liberate Stock") and $5,086,718.18 into the Securities Account; (viii) for the avoidance of doubt, the Securities Account and the financial assets carried therein including, without limitation, the Liberate Stock and any proceeds thereof , shall constitute Collateral for all purposes of the Security Agreement; (ix) the Securities Intermediary shall not change the name or account number of the Securities Account without the prior written consent of the Company and the Secured Party; and (x) the Securities Intermediary shall promptly deliver copies of all statements, confirmations and other correspondence concerning the Securities Accounts and/or any financial assets credited thereto simultaneously to each of the Company and the Secured Party at the address for each set forth in Section 9 of this Securities Account Control Agreement. Section 2. Entitlement Orders. For the purposes of this Securities Account Control Agreement, the Secured Party is an entitlement holder within the meaning of Section 8-102(a)(7) of the UCC. If at any time the Securities Intermediary shall receive any "entitlement order" (within the meaning of Section 8-102(a)(8) of the UCC), instruction or order issued by the Secured Party and relating to the Securities Account, the Securities Intermediary shall comply with such entitlement order, instruction or order without further consent by the Company or any other person. Unless notified to the contrary in writing by the Secured Party, the Securities Intermediary will not accept or comply with any entitlement orders, instructions, or orders issued by the Company or any other persons relating to the Securities Account or any of the financial assets contained therein, and will not Securities Account Control Agreement -1- distribute to the Company or any other persons any interest or other distributions on property in the Securities Account; provided, however, the Securities Intermediary shall accept any orders issued by the Company that solely direct the Securities Intermediary to sell securities in the Securities Account provided that the net proceeds of any such sale are immediately deposited and remain in the Securities Account subject to the terms of this Securities Account Control Agreement. The Company acknowledges that the Securities Account and the financial assets and all other property contained therein are Collateral which secure the Obligations. Section 3. Choice of Law. Both this Securities Account Control Agreement and the Securities Account (as well as the security entitlements related thereto) shall be governed by the laws of the State of New York, without regard to principles of conflicts of laws. Without limiting the foregoing, the "Securities Intermediary's jurisdiction" within the meaning of Section 8-110(e) of the UCC is and shall continue to be the State of New York. Section 4. Conflict with Other Agreements. There are no other agreements entered into between the Securities Intermediary, in its capacity as such, and the Company or the Secured Party with respect to the Securities Account or any securities entitlements or other financial assets credited thereto. In the event of any conflict between this Securities Account Control Agreement (or any portion thereof) and any other control agreement now existing or hereafter entered into by the Securities Intermediary in respect of the Securities Account, the terms of this Securities Account Control Agreement shall prevail. Neither the Securities Intermediary nor the Company will enter into any other agreement with respect to the Securities Account unless the Secured Party shall have provided prior written consent thereto. Neither the Securities Intermediary nor the Company will enter into any other agreement with respect to creation or perfection of any security interest in, or control of, security entitlements maintained in the Securities Account without the prior written approval of the Secured Party. Section 5. Subordination of Lien; Waiver of Set-Off. In the event that the Securities Intermediary has or subsequently obtains by agreement, operation of law or otherwise a security interest in the Securities Account, the Securities Intermediary hereby agrees that such security interest shall be subordinate to the security interest in the Securities Account of the Secured Party. The financial assets and other items deposited to the Securities Account will not be subject to deduction, set-off, banker's lien, or any other right in favor of any person other than the Secured Party (except that the Securities Intermediary may set off (i) all amounts due to the Securities Intermediary in respect of its customary fees and expenses for the routine maintenance and operation of the Securities Account, and (ii) the face amount of any checks or other items which have been credited to the Securities Account but are subsequently returned unpaid because of uncollected or insufficient funds). Section 6. Notice of Adverse Claims. Except for the claims and interest of the Secured Party and of the Company in the Securities Account, neither the Securities Intermediary nor the Company on the date hereof knows of any claim to, or security interest in, the Securities Account or in any "financial asset" (as defined in Section 8-102(a) of the UCC) credited thereto and does not know of any claim that any Person other than the Secured Party has been given "control" of the Securities Account or any such financial asset. If any person asserts any lien, encumbrance or adverse claim (including any writ, garnishment, judgment, warrant of attachment, execution or similar process and any claim of "control") against any of the Securities Account or in any financial asset carried therein, the Securities Intermediary will promptly notify the Secured Party and the Company thereof. Section 7. Amendments. No amendment or modification of this Securities Account Control Agreement shall be binding on any parties hereto unless it is in writing and is signed by all of the parties hereto. Section 8. Successors. The terms of this Securities Account Control Agreement shall be binding upon, and shall inure to the benefit of, the parties hereto and their respective corporate successors or heirs and personal representatives. Neither the Company nor the Securities Intermediary may assign their rights hereunder without the express written consent of the Secured Party. Securities Account Control Agreement -2- Section 9. Notices. All notices and other communications required or permitted to be given or made under this Securities Account Control Agreement shall be in writing and shall be deemed conclusively to have been duly given: (a) on the day of hand delivery; (b) when transmitted by telecopy with verbal confirmation of receipt by the telecopy operator to the telecopy number set forth below; and (c) one Business Day following the day timely delivered to a next-day air courier addressed as set forth below: To the Securities Intermediary: --------------------- --------------------- --------------------- Attention: To the Secured Party: U.S. TRUST COMPANY OF TEXAS, N.A. 2001 Ross Avenue Suite 2700 Dallas, Texas 75201 Attention: John C. Stohlmann With a copy to: HAYNES & BOONE, LLP 201 Main Street, Suite 2200 Fort Worth, Texas 76102 Attention: William D. Greenhill Telecopy: 817-348-2321 To the Company SOURCE MEDIA, INC. 5601 Executive Drive, Suite 200 Irving, Texas 75038 Attention: General Counsel with a copy to: SONNENSCHEIN NATH & ROSENTHAL 1221 Avenue of the Americas New York, New York 10020 Attention: Robert Winikoff Telecopy: (212) 768-6800 or at such other address as the specified entity most recently may have designated in writing in accordance with this Section. Section 10. Termination. The rights and powers granted herein to the Secured Party have been granted in order to perfect its security interests in the Securities Account, are powers coupled with an interest and will neither be affected by the bankruptcy of the Company nor by the lapse of time. The obligations of the Securities Intermediary hereunder shall continue in effect until the security interest of the Secured Party in the Securities Account has been terminated pursuant to the terms of the Security Agreement and the Secured Party has notified the Securities Intermediary of such termination in writing. Section 11. Representations, Warranties and Covenants of the Securities Intermediary. The Securities Intermediary hereby makes the following representations, warranties and covenants: (a) the Securities Account has been established as set forth in this Securities Account Control Agreement and will be maintained in Securities Account Control Agreement -3- the manner set forth herein until the termination of this Securities Account Control Agreement; and (b) this Securities Account Control Agreement is the legal, valid and binding obligation of the Securities Intermediary. Section 12. Counterparts. This Securities Account Control Agreement may be executed in any number of counterparts, all of which shall constitute one and the same instrument, and any party hereto may execute this Securities Account Control Agreement by signing and delivering one or more counterparts. IN WITNESS WHEREOF, the undersigned have executed this Securities Account Control Agreement as of the date first written above. SOURCE MEDIA, INC. By: ------------------------------------- Name: Title: U.S. TRUST COMPANY OF TEXAS, N.A., as Trustee in its capacity as collateral agent under the Security Agreement By: ------------------------------------ Name: John C. Stohlmann Title: Vice President Acknowledged and Agreed as of the date first above written: - -----------------------------------, as Securities Intermediary By: ---------------------------------- Name: Title: Securities Account Control Agreement -4- EX-10.3 5 d92237ex10-3.txt LETTER OF AGREEMENT Exhibit 10.3 Letter of Agreement, dated as of November 7, 2001. November 7, 2001 Reference is made to (i) that certain Indenture dated October 30, 1997 (as amended by the First Supplemental Indenture dated November 1, 1999, and the Second Supplemental Indenture dated February 15, 2000, the "Indenture") between Source Media, Inc. (the "Company") as issuer, and U.S. Trust Company of Texas, N.A., as trustee (the "Trustee") for the Company's 12% Senior Secured Notes due 2004(the "Notes"), (ii) that certain Security Agreement dated October 30, 1997 (the "Security Agreement") entered into by the Company, SMI Holdings, Inc., IT Network, Inc., Interactive Channel, Inc., and Cable Share (U.S.) Limited in favor of the Trustee in its capacity as collateral agent (the "Collateral Agent"), (iii) that certain Securities Account Control Agreement, dated November 7, 2001 (the "Control Agreement") among the Company, the Trustee, and the Securities Intermediary (as defined in the Control Agreement) that establishes a Securities Account (as defined therein) (the "Account"). Capitalized terms used herein but not otherwise defined herein shall have the meanings ascribed to such terms in the Indenture. The undersigned are beneficial owners (the "Holders") of the Notes issued pursuant to the Indenture. This Agreement confirms that (a) the Company originally held 886,000 shares of common stock of Liberate Technologies, Inc. (the "Liberate Stock"); and (b) the undersigned Holders, which hold in the aggregate not less than 75 % of the aggregate outstanding principal amount of the Notes, and the Company have agreed, and the Holders will direct the Trustee, as follows: (1) The Liberate Stock and any and all proceeds received therefrom (net of brokerage commissions and taxes, if any) (the "Proceeds") through the date hereof, shall be immediately deposited into the Account. The Liberate Stock shall be sold and all Proceeds shall be deposited directly into the Account. Notwithstanding the foregoing, the Company may withhold and not deposit into the Account Two Million Dollars ($2,000,000) of the Proceeds. The $2,000,000 of such Proceeds shall be used to fund the Company's operations through December 31, 2001 including, without limitation, the Company's obligations, if any, to make one or more capital contributions to SourceSuite LLC. (2) Upon the occurrence of a Distribution Event (as defined below), the Trustee, unless directed to the contrary in writing by the Holders, will automatically and without further notice to any party withdraw all cash, securities, and other assets in the Account and distribute such cash, securities, and other assets in accordance with the Indenture. A "Distribution Event" means the earlier to occur of (i) December 31, 2001; or (ii) an agreement in writing between the Company's financial advisors, Evercore Partners, and the Holder's financial advisors, Houlihan Lokey Howard & Zukin Capital ("Houlihan"), that neither a sale of all or substantially all of the Company's assets nor an investment in the Company or Source Suite LLC (in an amount sufficient in the opinion of the management of the Company to fund the Company's business plan as previously disclosed to Houlihan) can be consummated. (3) The undersigned Holders agree that they will not directly or indirectly authorize or instruct the Trustee to take any action that would cause a withdrawal from the Account prior to the occurrence of a Distribution Event. The Company agrees and acknowledges that upon commencement of a case under any Bankruptcy Law, nothing herein is, or shall be deemed to (i) be a consent by the Holders or the Trustee or any other person to the use by the Company of the Liberate Stock or the Proceeds for any purpose whatsoever, including without limitation, as cash collateral under Section 363 of the Bankruptcy Code, or (ii) in any way affect, waive, or otherwise impair any of the rights and remedies of the Holders under the Indenture, the Security Agreement, the Control Agreement or otherwise, including, without limitation, the right to direct the Trustee in any way. The Holders agree that nothing in this letter prevents the Company from commencing a case under title 11 of the United States Code. Each of the undersigned hereby represents and warrants that it is the beneficial owner of the Notes referred to adjacent to its respective name as set forth on the signature pages hereto. -2- The Company agrees and acknowledges that nothing herein (or the transactions and agreements contemplated hereby) shall in any way be construed as a waiver by the Holders or the Trustee of any Event of Default under the Indenture. Except as provided in this Agreement, the Company and the Holders hereby reserve all of their rights and remedies under the Indenture, Security Agreement, and the Control Agreement. This Agreement shall not be assigned by any party hereto and any attempted assignment shall be null and void. Notwithstanding the foregoing, if any undersigned Holder sells, assigns, conveys, transfers or otherwise disposes of the Notes it holds, such Holder may assign this Agreement provided that such Holder shall cause such purchaser, assignee, or transferee to agree and adhere to the terms of this Agreement by executing a counterpart signature page hereto. This Agreement may not be amended without the prior written consent of the Company, and the undersigned Holders. This Agreement shall be governed by the laws of the State of New York. This Agreement may be executed by each signatory in separate counterparts and the Trustee is hereby instructed to accept the signature pages of such counterparts. Facsimile signatures shall be deemed to be original signatures for all purposes hereunder. [Signature pages follow.] NAME OF HOLDER: PRINCIPAL AMOUNT OF NOTES OWNED BY SUCH HOLDER: - ---------------------- By: $---------------------------- Name: Title: NAMES OF PARTICIPANT(S), IF ANY, WHERE NOTES ARE HELD BY SUCH HOLDER: ----------------------------- ----------------------------- ----------------------------- -3- SOURCE MEDIA, INC. By: -------------------------- Name: Title: SMI HOLDINGS, INC. By: -------------------------- Name: Title: IT NETWORK, INC. By: -------------------------- Name: Title: INTERACTIVE CHANNEL, INC. By: -------------------------- Name: Title: CABLESHARE (U.S.) LIMITED By: -------------------------- Name: Title: -4- -----END PRIVACY-ENHANCED MESSAGE-----