<PAGE>   1

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                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549


                                  FORM 10-K/A



                                AMENDMENT NO. 1

                ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                      THE SECURITIES EXCHANGE ACT OF 1934

                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999

                        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 No.)


                                5400 LBJ FREEWAY
                                   SUITE 680
                              DALLAS, TEXAS 75240
                    (Address of principal executive offices)

       Registrant's telephone number, including area code: (972) 701-5400

        Securities registered pursuant to Section 12(b) of the Act: NONE

          Securities registered pursuant to Section 12(g) of the Act:

                    COMMON STOCK, PAR VALUE $.001 PER SHARE
                                (TITLE OF CLASS)

     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 [ ]

     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.  [ ]

     Aggregate market value of Common Stock held by non-affiliates as of March
24, 2000: $241,812,014.

     Number of shares of Common Stock outstanding as of March 24, 2000:
16,188,252.


                   DOCUMENTS INCORPORATED BY REFERENCE: NONE


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     The following items of Source Media, Inc.'s Annual Report on Form 10-K for
the fiscal year ended December 31, 1999 are hereby amended. Each such item is
set forth herein in its entirety, as amended.



                                    PART II


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA


     The Report of Independent Auditors, and our consolidated financial
statements and the notes thereto appear on pages 4 through 28 of this Report.



     The Report of Independent Auditors, and the consolidated financial
statements of SourceSuite LLC and the notes thereto appear on pages 29 through
37 of this Report.



                                    PART IV


ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

     (a) The following documents are filed as a part of this report:

     (1) Financial Statements included in Item 8 herein:

          (A) Report of Independent Auditors with respect to Source Media, Inc.

             Covered by Report of Independent Auditors:

             Consolidated Balance Sheets at December 31, 1998 and 1999

             Consolidated Statements of Operations for the years ended December
        31, 1997, 1998, 1999

             Consolidated Statements of Stockholders' Equity (Capital
        deficiency) for the years ended December 31, 1997, 1998, 1999

             Consolidated Statements of Cash Flows for the years ended December
        31, 1997, 1998, 1999

             Notes to Consolidated Financial Statements

          (B) Report of Independent Auditors with respect to SourceSuite LLC

             Covered by Report of Independent Auditors:

             Consolidated Balance Sheet at December 31, 1999

             Consolidated Statement of Operations for the period from Inception
        (November 17, 1999) through December 31, 1999

             Statement of Members' Equity for the period from Inception
        (November 17, 1999) through December 31, 1999

             Statement of Cash Flows for the period from Inception (November 17,
        1999) through December 31, 1999

             Notes to Consolidated Financial Statements

     (2) Financial Statement Schedules included in Item 8 herein:

       All schedules for which provision is made in the applicable accounting
       regulations of the Securities and Exchange Commission are presented in
       the consolidated financial statements or are not required under the
       related instructions or are inapplicable or immaterial in relation to the
       consolidated financial statements and, therefore, have been omitted.

                                       2
<PAGE>   3

     (3) Exhibits:

       The information required by this Item 14(a)(3) is set forth in the Index
       to Exhibits accompanying this Annual Report on Form 10-K.

     (b) Reports on Form 8-K filed during the quarter ended December 31, 1999:

          November 17, 1999 -- Reported the transfer of the VirtualModem(TM) and
     Interactive TV products and businesses to our joint venture with Insight
     Interactive in exchange for a 50% ownership interest in the joint venture.
     The report also contained the following financial statements:

             Unaudited Pro Forma Consolidated Balance Sheet As of September 30,
        1999

             Unaudited Pro Forma Consolidated Statement of Operations For the
        Nine Months Ended September 30, 1999

             Unaudited Pro Forma Consolidated Statement of Operations For the
        Year Ended December 31, 1998

             Unaudited Pro Forma Consolidated Statement of Operations For the
        Year Ended December 31, 1997

             Unaudited Pro Forma Consolidated Statement of Operations For the
        Year Ended December 31, 1996

                                       3
<PAGE>   4

                         REPORT OF INDEPENDENT AUDITORS

Board of Directors and Stockholders
of Source Media, Inc.

     We have audited the accompanying consolidated balance sheets of Source
Media, Inc. (the Company) as of December 31, 1998 and 1999, and the related
consolidated statements of operations, stockholders' equity (capital
deficiency), and cash flows for each of the three years in the period ended
December 31, 1999. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

     We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

     In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Source Media,
Inc., at December 31, 1998 and 1999, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1999, in conformity with accounting principles generally accepted
in the United States.

                                                /s/ ERNST & YOUNG LLP

Dallas, Texas
March 3, 2000

                                       4
<PAGE>   5

                               SOURCE MEDIA, INC.

                          CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                              DECEMBER 31,   DECEMBER 31,
                                                                  1998           1999
                                                              ------------   ------------
                                                                    (IN THOUSANDS)
<S>                                                           <C>            <C>
                                         ASSETS

Current Assets:
  Cash and cash equivalents.................................   $  11,662      $  10,910
  Short-term investments....................................          --          2,500
  Restricted investments....................................      11,716          5,997
  Trade accounts receivable, less allowance for doubtful
    accounts of $387 and $605 in 1998 and 1999,
    respectively............................................       3,596          1,643
  Related party receivables.................................          --          1,458
  Prepaid expenses and other current assets.................       1,384          1,068
                                                               ---------      ---------
        Total current assets................................      28,358         23,576
Property and equipment:
  Production equipment......................................       6,050          4,511
  Computer equipment........................................       3,273          3,612
  Other equipment...........................................       1,150          1,612
  Furniture and fixtures....................................         660            656
                                                               ---------      ---------
                                                                  11,133         10,391
Accumulated depreciation....................................       6,733          7,957
                                                               ---------      ---------
Net property and equipment..................................       4,400          2,434
Intangible assets:
  Patents...................................................      14,945             --
  Goodwill..................................................       6,698          3,688
  Contract rights...........................................      11,933         11,933
                                                               ---------      ---------
                                                                  33,576         15,621
Accumulated amortization....................................      14,557          6,119
                                                               ---------      ---------
Net intangible assets.......................................      19,019          9,502
Investment in joint venture.................................          --         18,669
Other non-current assets....................................       4,812          3,835
                                                               ---------      ---------
        Total assets........................................   $  56,589      $  58,016
                                                               =========      =========

                LIABILITIES AND STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY)

Current Liabilities:
  Trade accounts payable....................................   $   2,501      $     955
  Accrued interest..........................................       2,000          1,991
  Accrued payroll...........................................         540            591
  Other accrued liabilities.................................       1,619          3,706
  Unearned income...........................................       1,750          1,925
                                                               ---------      ---------
        Total current liabilities...........................       8,410          9,168
Long-term debt..............................................     100,000         96,250
Minority interests in consolidated subsidiaries.............       3,840          3,840
Note receivable and accrued interest from minority
  stockholder, net of discount of $53 and $12 in 1998 and
  1999, respectively........................................        (780)          (837)
                                                               ---------      ---------
                                                                   3,060          3,003
Senior redeemable payment-in-kind (PIK) preferred stock, $25
  dollar per share liquidation preference, $.001 par value,
  net of discount; Authorized shares -- 1,712; Issued and
  outstanding shares 914 and 1,043 in 1998 and 1999,
  respectively..............................................      16,628         18,467
Non-participating preferred stock, $25 dollar per share
  liquidation preference, $.001 par value; Authorized and
  issued -- 1 single share
Stockholders' equity (capital deficiency):
  Common stock, $.001 par value:
    Authorized shares -- 50,000; 13,201 and 16,278 issued
     and outstanding in 1998 and 1999, respectively.........          13             16
  Less treasury stock, at cost -- 280 and 268 shares in 1998
    and 1999, respectively..................................      (2,770)        (2,647)
  Capital in excess of par value............................      80,269        120,883
  Accumulated deficit.......................................    (148,943)      (187,124)
  Notes receivable and accrued interest from stockholders...         (78)            --
                                                               ---------      ---------
        Total stockholders' equity (capital deficiency).....     (71,509)       (68,872)
                                                               ---------      ---------
        Total liabilities and stockholders' equity (capital
        deficiency).........................................   $  56,589      $  58,016
                                                               =========      =========
</TABLE>

          See accompanying Notes to Consolidated Financial Statements.

                                       5
<PAGE>   6

                               SOURCE MEDIA, INC.

                     CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                                      YEAR ENDED DECEMBER 31,
                                                              ---------------------------------------
                                                                 1997          1998          1999
                                                              -----------   -----------   -----------
                                                               (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                           <C>           <C>           <C>
Monetary revenues...........................................   $ 12,387      $ 24,352      $ 19,147
Nonmonetary revenues........................................      6,044         1,756         1,823
                                                               --------      --------      --------
          Total revenues....................................     18,431        26,108        20,970
Monetary cost of sales......................................      8,611        12,674        13,164
Nonmonetary cost of sales...................................      6,044         1,756         1,823
                                                               --------      --------      --------
          Total cost of sales...............................     14,655        14,430        14,987
                                                               --------      --------      --------
Gross profit................................................      3,776        11,678         5,983
Selling, general and administrative expenses................     19,599        24,772        23,714
Impairment of intangible assets.............................         --        25,936            --
Amortization of intangible assets...........................      4,987         6,320         4,713
Research and development expenses...........................      3,680         3,410         2,578
                                                               --------      --------      --------
                                                                 28,266        60,438        31,005
                                                               --------      --------      --------
Operating loss..............................................    (24,490)      (48,760)      (25,022)
Interest expense............................................      5,234        12,830        12,819
Interest income.............................................       (737)       (1,933)         (828)
Equity interest in losses of joint venture..................         --            --         1,013
Other expense (income)......................................        (53)          (27)          155
Minority interest on earnings (losses) of consolidated
  subsidiaries..............................................         (9)           --            --
                                                               --------      --------      --------
Net loss before extraordinary item..........................    (28,925)      (59,630)      (38,181)
Extraordinary loss -- early extinguishment of debt..........      3,456            --            --
                                                               --------      --------      --------
Net loss....................................................    (32,381)      (59,630)      (38,181)
Preferred stock dividends...................................        416         2,996         1,838
Net loss attributable to common stockholders................   $(32,797)     $(62,626)     $(40,019)
                                                               ========      ========      ========
Basic and diluted net loss per common share:
Net loss attributable to common stockholders before
  extraordinary item........................................   $  (2.58)     $  (5.21)     $  (2.93)
Extraordinary item..........................................      (0.30)           --            --
                                                               --------      --------      --------
Net loss attributable to common stockholders................   $  (2.89)     $  (5.21)     $  (2.93)
                                                               ========      ========      ========
Weighted average common shares outstanding..................     11,354        12,012        13,679
                                                               ========      ========      ========
</TABLE>

          See accompanying Notes to Consolidated Financial Statements

                                       6
<PAGE>   7

                               SOURCE MEDIA, INC.

      CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY)

<TABLE>
<CAPTION>
                                                                                         NOTES            TOTAL
                               COMMON STOCK                CAPITAL IN                  RECEIVABLE     STOCKHOLDERS'
                              ---------------   TREASURY   EXCESS OF    ACCUMULATED       FROM       EQUITY (CAPITAL
                              SHARES   AMOUNT    STOCK     PAR VALUE      DEFICIT     STOCKHOLDERS     DEFICIENCY)
                              ------   ------   --------   ----------   -----------   ------------   ----------------
                                                                  (IN THOUSANDS)
<S>                           <C>      <C>      <C>        <C>          <C>           <C>            <C>
BALANCE AT DECEMBER 31,
  1996......................  10,327    $10     $(3,758)    $ 60,816     $ (56,932)      $(110)          $     26
Issuance of common stock
  upon exercise of stock
  options...................     219      1        (317)       1,352            --          --              1,036
Acquisition of remaining
  minority interest in
  ICTI......................   1,390      1          --       10,384            --          --             10,385
Issuance of warrants for
  services provided.........      --     --          --          280            --          --                280
Issuance of warrants with
  Aggregate Tranche Notes...      --     --          --        2,823            --          --              2,823
Issuance of warrants
  associated with Units.....      --     --          --        5,529            --          --              5,529
Other.......................      33     --          --          299            --          11                310
Net loss....................      --     --          --           --       (32,381)         --            (32,381)
Preferred Stock Dividends...      --     --          --         (416)           --          --               (416)
                              ------    ---     -------     --------     ---------       -----           --------
BALANCE AT DECEMBER 31,
  1997......................  11,969     12      (4,075)      81,067       (89,313)        (99)           (12,408)
                              ======    ===     =======     ========     =========       =====           ========
Issuance of common stock
  upon exercise of stock
  options...................      94     --          --          641            --          --                641
Issuance of stock for legal
  settlements...............      --     --         867         (244)           --          --                623
Issuance of stock for
  employee stock plan.......      --     --         438         (253)           --          --                185
Exercise of warrants........     959      1          --           --            --          --                  1
Stock Compensation..........      --     --          --        2,054            --          --              2,054
Other.......................      --     --          --           --            --          21                 21
Net loss....................      --     --          --           --       (59,630)         --            (59,630)
Preferred Stock Dividends...      --     --          --       (2,996)           --          --             (2,996)
                              ------    ---     -------     --------     ---------       -----           --------
BALANCE AT DECEMBER 31,
  1998......................  13,022     13      (2,770)      80,269      (148,943)        (78)           (71,509)
                              ======    ===     =======     ========     =========       =====           ========
Issuance of common stock
  upon exercise of stock
  options...................     605     --          --        6,752            --          --              6,752
Sale of common stock........     842      1          --       11,999            --          --             12,000
Issuance of stock for
  employee stock plan.......      --     --         123           51            --          --                174
Exercise of warrants........   1,809      2          --        7,444            --          --              7,446
Stock Compensation..........      --     --          --        1,057            --          --              1,057
Issuance of warrants related
  to formation of joint
  venture...................      --     --          --       13,800            --          --             13,800
Issuance of warrants........      --     --          --        1,350            --          --              1,350
Other.......................      --     --          --           --            --          78                 78
Net loss....................      --     --          --           --       (38,181)         --            (38,181)
Preferred Stock Dividends...      --     --          --       (1,839)           --          --             (1,839)
                              ------    ---     -------     --------     ---------       -----           --------
BALANCE AT DECEMBER 31,
  1999......................  16,278    $16     $(2,647)    $120,883     $(187,124)      $  --           $(68,872)
                              ======    ===     =======     ========     =========       =====           ========
</TABLE>

          See accompanying Notes to Consolidated Financial Statements

                                       7
<PAGE>   8

                               SOURCE MEDIA, INC.

                     CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                 YEAR ENDED DECEMBER 31,
                                                              ------------------------------
                                                                1997       1998       1999
                                                              --------   --------   --------
                                                                      (IN THOUSANDS)
<S>                                                           <C>        <C>        <C>
OPERATING ACTIVITIES
Net Loss....................................................  $(32,381)  $(59,630)  $(38,180)
Adjustments to reconcile net loss to net cash used in
  operating activities:
  Impairment of intangible assets...........................        --     25,936         --
  Depreciation..............................................     2,314      2,540      2,599
  Amortization of intangible assets.........................     4,987      6,320      4,713
  Stock compensation........................................        --      2,054      1,057
  Write-off of analog set-top boxes.........................     1,999         --         --
  Non-cash interest expense.................................     2,969        833        829
  Non-cash interest income..................................        --       (982)      (281)
  Provision for losses on accounts receivable...............       195      1,077        250
  Extinguishment of debt....................................     3,456         --         --
  Warrants issued for services provided.....................       279         --         --
  Issuance of common stock in litigation settlement.........       299        623         --
  Equity investment in losses of joint venture..............        --         --      1,013
  Other, net................................................       260        (62)       (57)
Changes in operating assets and liabilities:
  Trade accounts receivable.................................    (2,035)    (1,876)     1,703
  Related party receivable..................................        --         --     (1,458)
  Prepaid expenses and other current assets.................       324        (94)         2
  Deferred expenses.........................................      (261)       544        315
  Trade accounts payable and accrued liabilities............       312      1,586        583
  Accrued interest..........................................     1,894         --         --
  Unearned income...........................................        48     (2,274)       175
                                                              --------   --------   --------
Net cash used in operating activities.......................   (15,341)   (23,405)   (26,737)
INVESTING ACTIVITIES
  Capital expenditures......................................    (2,675)    (1,510)    (1,235)
  Redemption of short-term investments......................        --     27,682         --
  Restricted investments....................................   (22,189)        --      6,000
  Acquisition of equipment and contract rights..............    (1,350)        --         --
  Purchase of short-term investments........................   (15,615)        --     (2,500)
  Acquisition of Brite......................................   (35,550)        --         --
  Acquisition of VNN........................................    (9,000)        --         --
  Capitalized acquisition costs.............................      (262)        --       (478)
                                                              --------   --------   --------
Net cash provided by (used in) investing activities.........   (86,641)    26,172      1,787
FINANCING ACTIVITIES
  Net proceeds from issuance of long-term debt..............    94,548         --         --
  Net proceeds from issuance of Second Tranche Note.........    13,923         --         --
  Payments on debt..........................................   (21,987)        --         --
  Net proceeds from issuance of preferred stock and
    warrants................................................    18,810         --         --
  Proceeds from issuance of common stock upon exercise of
    stock options and warrants..............................     1,035        641     11,971
  Proceeds from issuance of common stock....................        --         --     12,000
  Other.....................................................      (219)      (177)       227
                                                              --------   --------   --------
Net cash provided by financing activities...................   106,110        464     24,198
                                                              --------   --------   --------
Net increase (decrease) in cash and cash equivalents........     4,128      3,231       (752)
Cash and cash equivalents at beginning of period............     4,303      8,431     11,662
                                                              --------   --------   --------
Cash and cash equivalents at end of period..................  $  8,431   $ 11,662   $ 10,910
                                                              ========   ========   ========
Supplemental disclosures of cash flow information
  Cash paid during the period for interest on long-term
    debt....................................................  $    286   $ 12,066   $ 12,000
                                                              ========   ========   ========
  Long-term debt cancelled as part of exercise of
    warrants................................................  $     --   $     --   $  3,750
                                                              ========   ========   ========
  Value of warrants issued to Insight Interactive
    capitalized as investment in joint venture..............  $     --   $     --   $ 13,800
                                                              ========   ========   ========
</TABLE>

          See accompanying Notes to Consolidated Financial Statements

                                       8
<PAGE>   9

                               SOURCE MEDIA, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                               DECEMBER 31, 1999

1. COMPANY DESCRIPTION AND HISTORY

     Source Media, Inc. (the "Company") operates through its subsidiaries SMI
Holdings, Inc. ("Holdings"), IT Network, Inc. ("IT Network"), Interactive
Channel, Inc. ("Interactive Channel"), and Interactive Channel Technologies Inc.
("ICTI"); in two business segments: IT Network and Interactive TV. Effective
November 17, 1999 the operations of the Interactive TV business were conducted
through a joint venture with Insight Interactive LLC ("Insight"), SourceSuite
LLC ("SourceSuite"); and its wholly owned subsidiary, SourceSuite Canada, Inc.,
which the Company manages. (See Note 14 -- Equity in SourceSuite Joint Venture
and Note 16 -- Subsequent Events). The Company accounts for its investment in
the joint venture under the equity method.

     IT Network sells advertising and related support services to clients who
sponsor a promotional message with interactive content supplied or otherwise
managed by IT Network. IT Network's products and services are distributed
primarily through the Company's Publisher Partners which include Yellow Page
directories and daily newspapers. IT Network's products and services are
available in North America, Hawaii and the Caribbean. Products and services are
also promoted and distributed over radio, television and the Internet.

     The Company's Interactive TV business had developed proprietary software
and interactive programming services that can enable digital, two-way television
systems equipped with digital (or advanced analog) set-top boxes to deliver
two-way, interactive programming with the touch of a set-top remote or the use
of a wireless keyboard. The Interactive TV business includes the results of the
Interactive Channel and ICTI subsidiaries and the Company's 50% equity interest
in the results of SourceSuite from November 17, 1999.

     Holdings (formerly known as IT Network) was incorporated on July 19, 1988,
as a Colorado corporation and subsequently on July 23, 1991, reincorporated in
Texas. On June 23, 1995, Holdings merged into a wholly-owned subsidiary of HB
Communications Acquisition Corp. ("HBAC") and Holdings' outstanding common stock
and preferred stock were converted into an aggregate 6,696,992 shares of the
Company's common stock. In connection with the merger, HBAC changed its name to
Source Media, Inc.

2. SIGNIFICANT ACCOUNTING POLICIES

  Principles of Consolidation

     The consolidated financial statements include the accounts of the Company,
its wholly-owned subsidiaries: Holdings, IT Network, Interactive Channel and
Holdings' wholly-owned Canadian subsidiaries, ICTI and 997758 Ontario Inc.
("997758"). Additionally all material inter-company amounts and transactions
have been eliminated. Certain amounts from prior year financial statements have
been reclassified to conform to the current year's presentation.

  Equity Investment in Joint Venture

     The Company recorded its share of SourceSuite's results of operations on
the equity method in the Consolidated Statement of Operations.

  Related Party Transactions

     The Company manages the day to day operations of SourceSuite within the
terms of SourceSuite's operating plan. As part of this arrangement, the Company
is reimbursed for direct costs of the Interactive TV business and certain
overhead costs. These costs are included in the receivable from related parties
and are reimbursed to the Company by SourceSuite on a regular basis.

                                       9
<PAGE>   10
                               SOURCE MEDIA, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

  Use of Estimates

     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.

  Minority Interests in Consolidated Subsidiaries

     Minority interests in consolidated subsidiaries represent the minority
stockholders' proportionate shares of the equity of 997758. At December 31, 1998
and 1999, the Company owned 100% of the voting Class X shares of 997758, while
an individual owned 100% of the Class Y nonvoting shares of 997758, as more
fully discussed in Note 8 -- Stock Options, Warrants, Employee Stock Purchase
Plan and Retirement Plan.

  Cash and Cash Equivalents

     The Company classifies all highly liquid investments with original
maturities of three months or less as cash equivalents. These investments are
recorded at cost, which approximates market.

  Monetary Revenue Recognition

     IT Network earns monetary revenues by selling advertising and related
support services to clients who sponsor a promotional message with interactive
content supplied primarily by IT Network. The products and services are
distributed primarily through certain Regional Bell Operating Companies or their
affiliates or other Publisher Partners. Monetary revenues and associated costs
relating to print ads appearing in Yellow Pages are recognized at the time of
distribution by the Directory Publishers. For certain contracts, where an
obligation exists to service the advertisement for the contract period, a
portion of the revenue is deferred and amortized on a straight-line basis over
the term of the respective contracts, beginning at the time of the annual
distribution of the applicable local Yellow Pages directory, or at the
applicable contract start date, if later, and continuing to the end of the term
of the respective contracts, which is typically from 3 to 12 months. The Company
also earns monetary revenues from sales of voice information services to certain
Publisher Partners. Monetary revenues relating to non-Yellow Pages products,
including Streaming Audio and Internet LocalSource(SM) sales are also recognized
over the contract period as the services are performed.

  Nonmonetary Revenue Recognition

     In many of its markets, IT Network has entered into nonmonetary barter
agreements with local television and radio stations. These media sponsors
provide IT Network with advertising time on their stations and update local
news, weather and sports programming in exchange for promotional messages and
print advertisements. Revenues and cost of sales associated with these
nonmonetary barter transactions are included in the Company's consolidated
statements of operations at the estimated fair value of the on-air
advertisements and information content provided to the Company by media
sponsors.

     Nonmonetary revenues and cost of sales are recognized on a straight-line
basis over the terms of the respective contracts. The Company was obligated to
provide future services and was entitled to receive future advertising and
information content of $1.8 million and $0.3 million at December 31, 1999 and
1998, respectively.

  Property and Equipment

     Property and equipment are recorded at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of the assets. Computer
equipment is depreciated over a three-year period. Production and other
equipment are depreciated over a five-year period. Furniture and fixtures are
depreciated over a seven-year period.


                                       10
<PAGE>   11
                               SOURCE MEDIA, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

  Intangible Assets

     Intangible assets are amortized using the straight-line method over the
following estimated useful lives: patents -- five years; contract
rights -- three to seven years; and goodwill -- five years.

     The carrying value of intangible assets is reviewed for impairment whenever
events or changes in circumstances indicate that there may be an impairment. If
the review indicates that any of the intangibles will not be recoverable, as
determined by an analysis of undiscounted cash flows, the intangible asset will
be reduced to its estimated fair value. Subsequent to the Brite acquisition (See
Note 5 -- Acquisitions), the Company learned that former Brite and IT Network
employees had formed a company to service many of the former Brite clients. As a
result, several former Brite customers cancelled or did not renew their
contracts with IT Network. The Company reviewed the valuation of the acquired
assets recorded at the time of the acquisition, and found these assets to be
impaired. As a result of the financial analysis of the expected discounted
future cash flows of the remaining customer base, the Company recorded a $25.9
million ($2.16 per share) non-cash write-down of the Brite contract rights,
non-compete agreement and goodwill in the second quarter of 1998.

  Advertising Costs

     The Company expenses the costs of advertising as incurred. Advertising
expenses were $0.4 million, $0.4 million and $0.2 million for the years ended
December 31, 1997, 1998 and 1999, respectively.

  Translation of Foreign Currencies

     The financial positions and results of operations of ICTI and 997758 are
measured using local currency (Canadian dollar) as the functional currency.
Assets and liabilities of these subsidiaries are translated at the exchange rate
in effect at each balance sheet date. Statement of operations accounts are
translated at the average rate of exchange prevailing during the year.
Translation adjustments and foreign currency gains and losses have not been
significant and, accordingly, have not been separately presented.

  Computation of Net Loss Per Common Share

     Net loss per common share is calculated in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share". Diluted
earnings per share have not been presented because the options and warrants are
anti-dilutive.

  Stock Options

     The Company accounts for employee and director stock option grants in
accordance with Accounting Principles Board Opinion No. 25, "Accounting For
Stock Issued to Employees" ("APB 25") and related Interpretations. Under APB 25,
no compensation expense is recognized for stock option grants to employees and
directors if the exercise price of the Company's stock option grants is at or
above the fair market value of the underlying stock on the date of grant as more
fully described in Note 8 -- Stock Options, Warrants, Employee Stock Purchase
Plan and Retirement Plan.

     On January 2, 1998, the Company granted stock options to its employees. The
options fully vest on January 2, 2004. If certain target stock prices are met,
the vesting accelerates. As a portion of the underlying shares for these options
had not been authorized by the common stockholders at the date of grant, the
portion of unauthorized options were treated as a variable compensation plan
through July 28, 1998, when the stockholders authorized the shares. The Company
has recognized stock compensation expense of $2.1 million and $1.1 million in
selling, general and administrative expense for the years ended December 31,
1998 and 1999, respectively.

                                       11
<PAGE>   12
                               SOURCE MEDIA, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     In 1999, the option price of the stock for shares granted in excess of
authorized shares was less than the price on the date the shares were authorized
by the shareholders, therefore, no variable compensation expense was recorded on
the 1999 grant.

  New Accounting Pronouncements

     Financial Accounting Statement 133, Accounting for Derivative Instruments
and Hedging Activities was issued in June 1998, amended by FAS 137, to be
effective for all fiscal quarters of fiscal years beginning after June 15, 2000.
The Company has not yet adopted or assessed the implications of this statement.
The Company also considered the effects of the SEC Staff Accounting Bulletin No.
101, Revenue Recognition, and believes it is in compliance with this statement.

3. COMMITMENTS AND CONTINGENCIES

     ICTI and Holdings filed a patent infringement suit against WorldGate
Communications, Inc. in federal district court in Delaware in May 1998. In June
1998, WorldGate filed a Counterclaim against the plaintiffs and the Company for,
among other things, unfair competition, interference with contract and trade
secret misappropriation. The Counterclaim defendants denied the allegations in
the Counterclaim. The relevant patents and this litigation were assumed by
Liberate Technologies ("Liberate") as part of the sale of SourceSuite. (See Note
16 -- Subsequent Events). Liberate agreed to defend the Company against
WorldGate's counterclaims.

     On August 21, 1998, the first of fourteen class action complaints were
filed against the Company and certain of its present and former officers and
directors in the United States District Court for the Northern District of Texas
asserting violations of sections 10(b) and 20(a) of the Securities Exchange Act
of 1934 and Rule 10-b5 promulgated thereunder. The fourteen complaints were
consolidated into the first filed case. Plaintiffs filed an amended complaint on
March 3, 1999. The plaintiffs sought damages in an unspecified amount. On
November 12, 1999, the Court set a series of deadlines for the disposition of
the case ending with the trial set for October 2, 2000. The Company believes
this case is totally without merit and intends to vigorously defend itself and
its officers and directors.

     On October 6, 1998, Advanced Interactive, Inc. filed a complaint in U.S.
District Court for the Northern District of Illinois, Eastern Division, against
ICTI and the following companies: Matsushita Electric Corporation, Matsushita
Electric Industrial Co., Ltd., Sharp Electronics Corp., Sharp Corp., Thomson
Consumer Electronics, Toshiba Consumer Products, Inc., Toshiba American, Inc.,
Toshiba Corporation, General Instruments Corp., Scientific Atlanta, Inc., ATI
Technologies, Inc., ADS Technologies Inc., Gateway 2000, Inc., STB Systems,
Inc., Hauppauge Computer Works, Inc., WebTV Networks, Inc. and WorldGate
Communications, Inc. (collectively the "Defendants"). Advanced Interactive
alleges that ICTI infringed two claims of one of its patents by manufacturing,
using and/or selling or offering to sell "Sourceware(TM) ChannelLink(TM). The
same allegation is made against each Defendant for its particular product or
service. The Plaintiff seeks damages, but makes no claims against the patents of
ICTI or any other Defendant. ICTI, and each of the Defendants, have filed an
Answer and have collectively joined the Motion for Partial Summary Judgment
submitted by Matsushita Electric Corporation of America, Sharp Electronics
Corp., Sharp Corp. and the Toshiba Defendants. On May 12, 1999 the court denied
Advanced Interactive's Motion for summary Judgement of Infringement. On February
17, 2000, the court granted the Defendants' collective Motion for Partial
Summary Judgment on patent claims interpretation. This case was transferred to
SourceSuite and subsequently became the responsibility of SourceSuite
Acquisition on March 3, 2000 (See Note 16 -- Subsequent Events). The Company
believes this case is totally without merit and intends to vigorously defend
itself.

     In addition, the Company is aware of certain claims against the Company
that have not developed into litigation, or if they have, are dormant, and in
any case are not expected to have a material adverse affect on

                                       12
<PAGE>   13
                               SOURCE MEDIA, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

the Company. Further, the Company is party to ordinary routine litigation, none
of which is expected to have a material adverse effect on the Company's results
of operations or its financial condition.

     As part of the Company's review of its booking performance against customer
sales guarantees, the Company anticipated a shortfall on several contracts. In
connection with these guarantees, the Company recorded an accrued liability of
$1.6 million in 1999. The related expense was included in cost of sales. All
contracts with sales guarantees expire in the first quarter of 2000. These sales
guarantees are fully accrued.

     The Company has employment agreements with two executives. The agreements
provide that the Company will pay a base salary amount and grant stock options
over a set term to the employees. In the event of a termination without cause,
the Company remains obligated to make certain payments as defined in the
agreements. One contract expires in 2001 and the other in 2002.

     In 1999, the company entered into severance agreements totaling $0.6
million with certain executives that provide for salary continuation for up to
six months and Company payment of health insurance premiums.

4. SHORT-TERM AND RESTRICTED INVESTMENTS

     The Company held certain short-term investments in 1999, which consisted of
securities that were held to maturity, and other highly liquid investments with
maturities of three months or less, which were classified as cash equivalents.
In 1998, all investments were highly liquid investments with maturities of three
months or less and, therefore, are classified as cash equivalents.

     In connection with the October 1997 offering of Senior Secured Notes, as
more fully described in Note 6 -- Long-term Debt, the Company placed
approximately $22.6 million of the net proceeds from the offering, representing
funds sufficient, together with interest thereon, to pay the first four interest
payments on the Senior Secured Notes, into an Interest Escrow Account (the
"Escrow Account") for the benefit of the holders of the Senior Secured Notes.
Additionally, in November 1999 the Company placed another $6.0 million in to the
Escrow Account from proceeds received in the transaction with Insight. As of
December 31, 1999, the Escrow Account, including accrued interest, totaled $6.0
million. Until disbursed in accordance with the Escrow and Disbursement
Agreement relating to the Escrow Account, the Escrow Account is designed to
secure a portion of the Company's obligations under the Senior Secured Notes.
Funds will be disbursed from the Escrow Account only to pay interest on the
Notes and, upon certain repurchases or redemptions of the Senior Secured Notes,
to pay principal of and premium, if any, thereon. Management has the intent and
ability to hold the securities in the Escrow Account to maturity. These
investments are carried at amortized cost and are summarized as follows as of
December 31, 1999:

<TABLE>
<CAPTION>
                                                                        GROSS
                                                          AMORTIZED   UNREALIZED    FAIR
                                                            COST        GAINS      VALUE
                                                          ---------   ----------   ------
                                                                  (IN THOUSANDS)
<S>                                                       <C>         <C>          <C>
U.S. Government agencies................................   $   94        $ 1       $   95
Corporate obligations...................................    5,865         37        5,902
                                                           ------        ---       ------
Restricted investments..................................   $5,959        $38       $5,997
                                                           ======        ===       ======
</TABLE>

     Fair values of the securities are based on market prices or dealer quotes.
All securities mature before May 1, 2000.

5. ACQUISITIONS

     In January 1997, the Company acquired all of the outstanding shares of ICTI
held by minority interest shareholders in exchange for 1,390,000 shares of the
Company's common stock, making ICTI a wholly-owned subsidiary of the Company.
The Company also issued options to purchase 177,000 shares of the Company's

                                       13
<PAGE>   14
                               SOURCE MEDIA, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

common stock at exercise prices ranging from $1.43 to $4.96 per share to certain
employees and directors of ICTI in exchange for their outstanding options to
purchase ICTI common shares. Cash expenses related to the acquisition were
approximately $0.8 million. The aggregate purchase price for the acquisition of
the ICTI minority interest was approximately $11.3 million, and the acquisition
was accounted for by the purchase method of accounting. The purchase price was
allocated to patents, which are being amortized over a five year period.

     On October 30, 1997, the Company acquired certain of the electronic
publishing assets of Brite Voice Systems, Inc. ("Brite") for a purchase price of
approximately $35.6 million. The Brite acquisition has been accounted for by the
purchase method of accounting and the purchase price was allocated to equipment,
contract rights and goodwill based on the estimated fair values of the assets at
the date of acquisition. (See Note 2 -- Significant Accounting Policies for a
description of events subsequent to the date of acquisition.)

     Also on October 30, 1997, the Company acquired certain assets of Voice News
Network, Inc. ("VNN"), a subsidiary of Tribune Media Services, Inc., a unit of
Tribune Company, for a purchase price of $9.0 million. The VNN acquisition has
been accounted for by the purchase method of accounting and the purchase price
was allocated to equipment, contract rights and goodwill based on the estimated
fair values of the assets at the date of acquisition.

     The operating results of Brite and VNN are included in the Company's
results from the date of acquisition. The following table represents the
unaudited pro forma results of operations as if the acquisitions of ICTI, Brite
and VNN had occurred on January 1, 1996, after giving effect to certain
adjustments, including minority interest in earnings (losses) of consolidated
subsidiaries, interest expense, preferred stock dividends and amortization of
intangibles resulting from the allocation of the purchase price.

<TABLE>
<CAPTION>
                                                        YEAR ENDED
                                                    DECEMBER 31, 1997
                                               ----------------------------
                                                      (IN THOUSANDS,
                                                 EXCEPT PER SHARE AMOUNT)
<S>                                            <C>
Total revenues...............................            $ 31,637
Operating loss...............................             (28,789)
Net loss.....................................             (40,778)
Net loss attributable to common
  stockholders...............................             (43,904)
Net loss per common share....................               (3.87)
</TABLE>

Pro forma results presented above are not necessarily indicative of what
actually would have occurred if the acquisitions had been consummated as of
January 1, 1997, and are not intended to be a projection of future results or
trends.

6. LONG-TERM DEBT

     On April 3, 1996, the Company issued a senior note (the "First Tranche
Note") in the principal amount of $5.0 million and a warrant (the "First Tranche
Warrant") which entitled the holder to purchase 500,000 shares of the Company's
common stock at a purchase price of $10.21 per share. On September 30, 1996 and
March 31, 1997, the Company issued additional senior notes in the amounts of
$0.3 million and $0.4 million, respectively, for the payment of interest on the
First Tranche Note. The First Tranche Note and the additional senior notes
(collectively, the "Aggregate First Tranche Notes") were due on March 31, 2001
and bore interest at the rate of 13% per annum through March 31, 1998 and 12%
thereafter. The estimated fair market value at the date of issuance of the First
Tranche Warrant of $0.7 million was credited to capital in excess of par value
and the First Tranche Note was recorded at a corresponding discount. The
discount on the First Tranche Note was being amortized to interest expense using
the effective interest rate method over the stated term of the First Tranche
Note, resulting in an effective interest rate of 16.2%.

                                       14
<PAGE>   15
                               SOURCE MEDIA, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     On April 9, 1997, the Company received cash proceeds of $15.0 million upon
the issuance of additional senior notes (the "Second Tranche Notes") in the
principal amount of $15.0 million and warrants (the "Second Tranche Warrants")
which entitled the holders thereof to purchase in the aggregate 2,000,000 shares
of the Company's common stock at a purchase price of $6.00 per share at any time
until their expiration on March 31, 2004. The estimated fair market value of the
Second Tranche Warrants of $1.7 million at the date of issuance was credited to
capital in excess of par value and the Second Tranche Notes were recorded at a
corresponding discount. The discount on the Second Tranche Notes was being
amortized to interest expense using the effective interest rate method over the
stated terms of the Second Tranche Notes resulting in an effective interest rate
of 15.4%. Additionally, in connection with the issuance of the Second Tranche
Notes and the Second Tranche Warrants, the Aggregate First Tranche Notes and the
First Tranche Warrant were amended and restated to terms identical to those of
the Second Tranche Notes and the Second Tranche Warrants, respectively. The
amended Aggregate First Tranche Notes and the Second Tranche Notes were due on
March 31, 2002 and bore interest at the rate of either: (i) 12% per annum
through March 31, 1999 if paid in cash, or (ii) 13% per annum through March 31,
1999 if paid through the issuance of additional notes, and 12% thereafter. On
September 30, 1997 the interest due was paid through the issuance of additional
notes, with terms identical to those of the Second Tranche Notes, in the amount
of approximately $1.3 million and warrants to purchase approximately 165,000
shares of common stock in payment of the interest accrued on the Aggregate First
Tranche Notes and the Second Tranche Notes. The estimated fair market values of
the notes and warrants issued in lieu of a cash interest payment on September
30, 1997 were approximately $1.1 million and $1.1 million, respectively, which
were recorded as interest expense during 1997.

     The amendment of the Aggregate First Tranche Notes and First Tranche
Warrant was accounted for as the extinguishment and replacement of the existing
senior notes and the cancellation of the existing warrants and issuance of new
warrants due to the significance of the modification to the terms of the senior
notes and warrants. The extinguishment resulted in a loss of approximately $0.3
million, which was included in other (income) expense during the second quarter
of 1997.

     In connection with the issuance of the Senior Secured Notes (the "Senior
Secured Notes", or the "Notes"), the Company used $22.2 million of the proceeds
received to pay off the amended Aggregate First Tranche Notes and the Second
Tranche Notes, including accrued interest thereon, and the notes issued on
September 30, 1997 in lieu of a cash interest payment. The early extinguishment
of these notes resulted in a charge to earnings of approximately $3.5 million
related to unamortized discount on the Second Tranche Notes and unamortized
issuance costs which were recorded as an extraordinary item in 1997. The
proceeds were also used in part to complete the Company's acquisitions of
certain assets more fully described in Note 5 -- Acquisitions.

     On October 30, 1997, the Company issued Senior Secured Notes in the
principal amount of $100 million, which bear interest at the rate of 12% per
annum through November 1, 2004. Interest on the Notes is payable semi-annually
on May 1 and November 1 of each year commencing on May 1, 1998, to holders of
record at the close of business on April 15th or October 15th immediately
preceding the interest payment date. The Company placed approximately $22.6
million of the net proceeds from the offering, representing funds sufficient,
together with interest thereon, to pay the first four interest payments on the
Notes, into the Escrow Account. Additionally, the Company placed in escrow $6.0
million in November 1999 from proceeds received in the transaction with Insight.
Interest payments of $12.1 million and $12.0 million were made in 1998 and 1999,
respectively. As discussed in Note 4 -- Short-term and Restricted Investments,
$6.0 million remains in escrow at December 31, 1999 to pay the interest due in
May 2000.

     The Notes are fully and unconditionally guaranteed, jointly and severally,
by each of the Company's subsidiaries (the "Subsidiary Guarantors"). The
guarantees are senior obligations of the Subsidiary Guarantors and are secured
by substantially all of the assets of the Subsidiary Guarantors. The guarantees
rank pari passu in right of payment with all existing and future senior
indebtedness of the Subsidiary Guarantors and

                                       15
<PAGE>   16
                               SOURCE MEDIA, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

rank senior in right of payment to all existing and future subordinated
obligations of the Subsidiary Guarantors. The guarantees may be released upon
the occurrence of certain events. The guarantee executed by IT Network contains
a covenant that restricts payments of dividends on its capital stock to an
amount sufficient to cover debt service on the Notes, redemptions or repurchases
of the Notes or the Preferred Stock, dividends on the Preferred Stock and
corporate overhead. The assets of the Company consist solely of investments in
its subsidiaries and SourceSuite and invested proceeds from the Notes and the
Preferred Stock and related warrants. Financial statements for the Subsidiary
Guarantors and the parent, Source Media, Inc., on a non-consolidated basis, are
not presented because management has determined that they would not be material
to investors. In conjunction with the formation of the joint venture with
Insight, the Company pledged its membership units in the joint venture as
collateral to secure payments on the Notes.

     On December 13, 1999, $3.75 million of Notes were tendered to the Company
and additional cash received in exchange for an exercise of warrants to purchase
shares of common stock. Except as described below, the Company may not redeem
the Notes prior to November 1, 2001. On or after such date, the Company may
redeem the Notes, in whole or in part, at any time, at various redemption prices
set forth in the indenture governing the Notes, together with accrued and unpaid
interest, if any, to the date of redemption. In addition, at any time and from
time to time on or prior to November 1, 2000, the Company may, subject to
certain requirements, redeem up to 35% of the aggregate principal amount of the
Notes with the cash proceeds of one or more equity offerings at a redemption
price equal to 112% of the principal amount to be redeemed, together with
accrued and unpaid interest, if any, to the date of redemption, provided, that,
at least $65.0 million of the aggregate principal amount of the Notes remain
outstanding immediately after each such redemption. The Notes are not subject to
any sinking fund requirement. Upon the occurrence of a change in control, the
Company will be required to make an offer to repurchase the Notes at a price
equal to 101% of the principal amount thereof, together with accrued and unpaid
interest, if any, to the date of the repurchase. The indenture contains certain
covenants including, but not limited to, limitations on indebtedness, restricted
payments, liens, restrictions on distributions from restricted subsidiaries,
sales of assets and subsidiary stock, affiliate transactions, issuances of
capital stock of restricted subsidiaries and sale/leaseback transactions. See
Note 16 -- Subsequent Events for additional information. As of December 31,
1999, the dealer quoted value of a Note was $0.56 per dollar face value
resulting in an aggregate fair market value of approximately $53.9 million.

7. SENIOR PIK PREFERRED STOCK

     On October 30, 1997, the Company issued 800 units (the "Units") for an
aggregate purchase price of $20 million, each Unit consisting of 1,000 shares of
non-voting Senior Preferred Stock (the "Preferred Stock") with a liquidation
preference of $25.00 per share and 558.75 warrants (the "October 1997
Warrants"). Each October 1997 Warrant entitles the holder to purchase one share
of the Company's common stock at a purchase price of $0.01 per share. In the
aggregate, the October 1997 Warrants represent the right to purchase 447,000
shares of common stock. The Units were sold in connection with the Company's
acquisitions of certain assets more fully described in Note 5 -- Acquisitions.

     Dividends on the Preferred Stock are payable quarterly on each February 1,
May 1, August 1 and November 1, commencing February 1, 1998, at a rate of
13 1/2% of the liquidation preference per share. At the Company's option, any
dividend payment occurring on or prior to November 1, 2002 may be paid either in
cash or by the issuance of additional shares of Preferred Stock with a
liquidation preference equal to the amount of such dividends; thereafter,
dividends will be paid in cash. The certificate of designation governing the
sale of the Units limits the amount of cash dividends that may be paid on the
Preferred Stock. At any time and from time to time on or prior to November 1,
2000, the Company may, subject to certain requirements, redeem up to 35% of the
aggregate liquidation value of the Preferred Stock with the cash proceeds of one
or more equity offerings at a redemption price equal to 113 1/2% of the
liquidation preference thereof, plus accumulated dividends, on the date of
redemption. After November 1, 2000 and prior to November 1, 2002,

                                       16
<PAGE>   17
                               SOURCE MEDIA, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

the Preferred Stock is not redeemable. On or after November 1, 2002, the Company
may redeem the Preferred Stock, in whole or in part, at any time, at various
redemption prices, plus accumulated and unpaid dividends, to the date of
redemption. Upon the occurrence of a change in control, the Company will be
required to make an offer to purchase the outstanding shares of the Preferred
Stock at a price equal to 101% of the liquidation preference thereof, plus
accumulated and unpaid dividends, to the date of purchase. The Preferred Stock
will be subject to mandatory redemption in whole on November 1, 2007, at a price
equal to 100% of the then effective liquidation preference thereof, plus,
without duplication, all accrued and unpaid dividends to the date of redemption.
The certificate of designation contains certain covenants including, but not
limited to, limitations on indebtedness, restricted payments, affiliate
transactions, issuances of capital stock of restricted subsidiaries and
sale/leaseback transactions. See Note 16 -- Subsequent Events for addition
information.

     The Preferred Stock ranks senior to all classes of common stock and to each
other class of capital stock or series of preferred stock with respect to
dividend rights and rights on liquidation, winding-up and dissolution of the
Company. The Preferred Stock is non-voting except in certain circumstances. The
Company may not authorize any new class of preferred stock that ranks senior or
pari passu to the Preferred Stock without the approval of the holders of at
least a majority of the shares of Preferred Stock then outstanding, voting or
consenting, as the case may be, as one class, provided, however, that the
Company may issue additional shares of Preferred Stock to satisfy dividend
payments on outstanding shares of Preferred Stock; and further provided that the
Company may issue shares of preferred stock ranking pari passu with the
Preferred Stock if after giving effect thereto, the Consolidated Coverage Ratio,
as defined in the certificate of designation, is greater than 1.7 to 1.0.

     The estimated fair market value of the October 1997 Warrants, which was
estimated to be approximately $5.5 million, was credited to capital in excess of
par value and the Preferred Stock was recorded at a corresponding discount.
Additionally, $1.2 million of issuance costs were recorded on the Preferred
Stock. The discount and issuance costs on the Preferred Stock are being accreted
as additional preferred stock dividends using the effective dividend rate method
over a ten year period, resulting in an effective dividend rate of 19.9%. As of
December 31, 1999, the dealer quoted fair market value of the Preferred Stock
was $14.00 per share for an aggregate value of $14.6 million.

     During 1999, the quarterly dividends due on the Preferred Stock were paid
through the issuance of additional Preferred Stock having an aggregate
liquidation preference of $3.2 million with terms identical to those of the
Preferred Stock. The estimated fair market value of the stock issued in lieu of
a cash payment on the respective dividend dates totaled $1.8 million which was
recorded as preferred stock dividends.

     In 1999 a new Non-Participating Preferred Stock was issued in connection
with the closing of the transaction to form the joint venture with Insight. One
share was authorized and issued to Insight. The new share of preferred stock has
a par value of $.001 per share and entitles Insight to designate a certain
number of members of the Board of Directors (based on Insight's ownership
percentage of Source Media, Inc. common stock), committee representation and
preemptive rights to maintain its ownership percentage. The share may not be
transferred without the written consent of the Company and is subject to
mandatory redemption in the event that the holder owns less than two and
one-half percent of the voting stock of the Company on a fully diluted basis.

8. STOCK OPTIONS, WARRANTS, EMPLOYEE STOCK PURCHASE PLAN AND RETIREMENT PLAN

  Stock Options

     In 1999, the Company adopted the 1999 Stock Option Plan (the "1999 Plan").
The 1999 Plan provides for the grant of Incentive Stock Options to purchase
shares of common stock only to officers and key employees of the Company and
it's subsidiaries. Non-qualified stock options and stock appreciation rights may

                                       17
<PAGE>   18
                               SOURCE MEDIA, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

be granted to officers and employees as well as agents, directors and
consultants of the Company. Options granted have a term not to exceed 10 years
and, if the optionee already owns more than 10% of the Company's common stock,
the incentive options cannot exceed 5 years. The total number of shares with
respect to which options and stock appreciation rights may be granted under the
1999 Plan is 1,600,000 shares.

     In 1995 the Company adopted the 1995 Performance Equity Plan (the "Equity
Plan"). The Equity Plan provides for the grant of options to purchase shares of
the Company's common stock to employees, officers, directors, and consultants of
the Company and its subsidiaries, including Holdings, IT Network and Interactive
Channel. Options granted pursuant to the Equity Plan have a term of ten years
from the date of grant and generally vest over four or five years. The Equity
Plan, as amended, authorizes the granting of awards (stock options, stock
appreciation rights, restricted stock, deferred stock, stock reload options, and
other stock-based awards, as defined), the exercise of which would allow up to
an aggregate of 2,957,589 shares of the Company's common stock to be acquired.
The Company does not intend to grant any additional options under this plan. An
amendment to this Equity Plan, approved by shareholders, allows for any
authorized shares in excess of options granted and outstanding to be granted
under the 1999 Plan. Forfeited shares are canceled under the 1995 plan and
assigned as authorized under the 1999 plan.

     In 1989, the Company established a qualified incentive employee stock
option plan. Options granted in 1989 and 1990 have a term of ten years from the
date of grant and vested over a three year period. During 1991 and 1993, the
Company established additional qualified incentive employee stock option plans
whereby granted options have a term of ten years from the date of grant and vest
over a five year period. The Company does not intend to grant any additional
options under these plans and, accordingly, all remaining options available for
grant under such plans are assumed to be canceled.

     The following table is a summary of stock option activity under the
employee stock option plans during the years ended December 31, 1997, 1998, and
1999:

<TABLE>
<CAPTION>
                                                                                                              WEIGHTED
                                                                                                              AVERAGE
                                    OPTIONS AVAILABLE   SHARES UNDER    AGGREGATE    OPTIONS OR EXERCISE   EXERCISE PRICE
EMPLOYEE STOCK OPTION ACTIVITY          FOR GRANT          OPTION         PRICE        PRICE PER SHARE       PER SHARE
------------------------------      -----------------   ------------   -----------   -------------------   --------------
<S>                                 <C>                 <C>            <C>           <C>                   <C>
BALANCE AT DECEMBER 31, 1996......             --        1,061,744     $ 9,923,401      $0.74-$11.50            9.35
  Options authorized..............        500,000               --              --                --              --
  Options granted.................       (176,000)         176,000       1,280,700        6.41-13.31            7.28
  Options exercised...............             --          (90,803)       (758,755)       0.74-10.40            8.36
  Options canceled -- 1995 Plan...        149,324         (149,324)     (1,376,794)       6.41-11.12            9.22
  Options canceled -- Other
    plans.........................             --          (21,910)       (204,820)        3.72-9.77            9.35
                                       ----------        ---------     -----------      ------------           -----
BALANCE AT DECEMBER 31, 1997......        473,324          975,707       8,863,732        0.74-13.31            9.08
  Options authorized..............        575,000               --              --                --              --
  Options granted.................     (1,068,201)       1,068,201       9,357,781        6.28-14.00            8.76
  Options exercised...............             --          (51,888)       (469,317)       0.74-11.12            9.04
  Options canceled -- 1995 Plan...         38,653          (38,653)       (353,452)       6.41-11.12            9.14
  Options canceled -- Other
    Plans.........................             --           (9,898)        (96,272)        3.72-9.77            9.73
                                       ----------        ---------     -----------      ------------           -----
BALANCE AT DECEMBER 31, 1998......         18,776        1,943,469      17,302,472        3.72-14.00            8.90
  Options Authorized..............      2,582,589               --              --                --              --
  Options Granted.................     (1,276,965)       1,276,965      19,177,596        6.63-16.63           15.02
  Options Exercised...............             --         (579,076)     (4,980,295)       3.72-13.31            8.60
  Options Cancelled -- 1995
    Plan..........................        248,285         (248,285)     (2,744,506)       6.41-16.63           11.05
  Options Cancelled -- Other
    Plans.........................             --             (469)         (4,581)             9.77            9.77
                                       ----------        ---------     -----------      ------------           -----
BALANCE AT DECEMBER 31, 1999......      1,572,685        2,392,604     $28,750,686      $3.72-$16.63           12.02
                                       ==========        =========     ===========      ============           =====
</TABLE>

     During 1995, the Company adopted the 1995 Nonqualified Stock Option Plan
for Non-Employee Directors (the "Directors' Plan"). The Directors' Plan provides
for the automatic annual grant to each non-employee director of the Company an
option to purchase 3,000 shares of common stock. Options granted

                                       18
<PAGE>   19
                               SOURCE MEDIA, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

under the Directors' Plan have an exercise price equal to the fair market value
of the common stock (calculated as the average of the closing prices for the
five trading days prior to the grant date) and are exercisable at any time from
the date of grant until the fifth anniversary thereof. The Directors' Plan, as
amended on May 21, 1997, provides for the grant of options to purchase up to
300,000 shares of common stock. The following table is a summary of stock option
activity under the Directors' Plan during the years ended December 31, 1997,
1998, and 1999:

<TABLE>
<CAPTION>
DIRECTORS' PLAN                    OPTIONS    SHARES                    OPTION OR      WEIGHTED AVERAGE
STOCK OPTION                      AVAILABLE    UNDER    AGGREGATE       EXERCISE        EXERCISE PRICE
ACTIVITY                          FOR GRANT   OPTION      PRICE      PRICE PER SHARE      PER SHARE
---------------                   ---------   -------   ----------   ---------------   ----------------
<S>                               <C>         <C>       <C>          <C>               <C>
BALANCE AT DECEMBER 31, 1996....    60,000     30,000   $  318,300    $10.43-$10.89         $10.61
Options authorized..............    50,000         --           --               --             --
Options granted.................   (15,000)    15,000       88,650             5.91           5.91
                                   -------    -------   ----------    -------------         ------
BALANCE AT DECEMBER 31, 1997....    95,000     45,000      406,950      5.91- 10.89           9.04
Options granted.................   (33,000)    33,000      617,670     13.77- 22.84          18.72
Options exercised...............        --     (6,000)     (63,938)    10.43- 10.89          10.66
                                   -------    -------   ----------    -------------         ------
BALANCE AT DECEMBER 31, 1998....    62,000     72,000      960,682      5.91- 22.84          13.34
Options Granted.................   (18,000)    18,000      237,384            13.19          13.19
Options Exercised...............        --    (12,000)    (127,875)    10.43- 10.89          10.66
                                   -------    -------   ----------    -------------         ------
BALANCE AT DECEMBER 31, 1999....    44,000     78,000   $1,070,191    $ 5.91-$22.84         $13.72
                                   =======    =======   ==========    =============         ======
</TABLE>

     Pursuant to an agreement, each of the 176,958 options for ICTI common
shares outstanding at the effective time of the acquisition of the remaining
minority interest of ICTI was exchanged for an option (a "Replacement Option")
to purchase shares of common stock of Source Media. During 1999, 11,963
Replacement Options were exercised at a weighted average exercise price of
$4.15. As of December 31, 1999, the remaining options represent the right to
purchase 23,928 shares of common stock at a weighted average exercise price of
$4.10 per share.

     Certain additional information for all outstanding options as of December
31, 1999, is being presented based on a range of exercise prices as follows:

<TABLE>
<CAPTION>
                                                              EXERCISE PRICES
                                                $3.97-$4.15    $5.91-$16.63       $22.84
                                                -----------   ---------------   -----------
<S>                                             <C>           <C>               <C>
Number of outstanding options.................       23,928      2,440,604           18,000
Weighted average exercise price of outstanding
  options.....................................  $      4.10     $    11.95      $     22.84
Weighted average remaining life...............   6.38 years      8.4 years       8.58 years
Number of options exercisable.................       23,928      1,198,199           18,000
Weighted average exercise price of options
  exercisable.................................  $      4.10     $    10.60      $     22.84
</TABLE>

     As required by the Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("FAS 123"), pro forma information
regarding net loss and loss per share has been determined as if the Company had
accounted for employee and director stock options granted subsequent to December
31, 1994 under the fair value method provided for under FAS 123. The fair value
for the stock options granted to directors, officers and key employees of the
Company on or after January 1, 1995 was

                                       19
<PAGE>   20
                               SOURCE MEDIA, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

estimated at the date of the grant using the Black-Scholes option pricing model
with the following weighted-average assumptions:

<TABLE>
<CAPTION>
                                                         1997        1998        1999
                                                       ---------   ---------   ---------
<S>                                                    <C>         <C>         <C>
Risk-free interest rate..............................      6.21%       5.31%       4.83%
Expected dividend yield..............................      0.00%       0.00%       0.00%
Expected volatility..................................        30%         76%        104%
Expected lives.......................................  4.0 years   2.7 years   2.6 years
</TABLE>

     The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.

     The weighted-average fair value of stock options granted during the years
ended December 31, 1997, 1998 and 1999 was $2.55, $4.50, and $9.35,
respectively. For purposes of the pro forma disclosures, the estimated fair
value of stock options granted from January 1, 1995 through December 31, 1999
have been amortized to expense over the vesting period. The Company's pro forma
information for FAS 123 follows (in thousands, except for loss per common share
information):

<TABLE>
<CAPTION>
                                                                    1997      1998      1999
                                                                   -------   -------   -------
<S>                                                  <C>           <C>       <C>       <C>
Net loss attributable to common stockholders.......  As reported   $32,797   $62,626   $40,019
                                                     Pro forma      33,471    64,271    44,548
Net loss per common share..........................  As reported      2.89      5.21      2.93
                                                     Pro forma        2.95      5.35      3.26
</TABLE>

  Warrants

     The Company has issued warrants for the purchase of shares of its common
stock from time to time in connection with various financing transactions and
for advisory and consulting services provided to the Company. The majority of
the warrants provide for registration rights. As of December 31, 1999,
outstanding warrants for the purchase of common stock of the Company were:

<TABLE>
<CAPTION>
SHARES ISSUABLE   EXERCISE PRICE
 UPON EXERCISE      PER SHARE      EXPIRATION DATE
---------------   --------------   ---------------
<S>               <C>              <C>
   1,025,013          $ 6.00             May 2000
     100,000            6.41             May 2000
   2,253,863(1)        11.00            June 2000
      83,085           10.80        February 2001
     147,394           10.50        December 2002
      85,878            6.00           March 2004
         175            4.38            June 2007
     450,000           20.00        November 2004
   4,596,786           20.00        November 2004
     210,649            0.01        November 2007
   ---------
   8,952,843
   =========
</TABLE>

                                       20
<PAGE>   21
                               SOURCE MEDIA, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

---------------

(1) In the event the sales price of the Company's common stock equals or exceeds
    $20.00 per share for 20 consecutive trading days, the Company will have the
    right to call warrants representing 2,253,863 common shares upon 20 days
    written notice at a price of $11.00 per share.

  997758 Class Y Stock Exchange Rights

     On September 24, 1992, the Company's subsidiary, 997758, entered into an
agreement with an individual to issue shares of 997758's nonvoting Class Y
shares in exchange for Class A Subordinate Voting Shares and Class B Multiple
Voting Shares of ICTI owned by such individual. The individual has the right at
any time through May 20, 2000, to exchange any or all of the Class Y shares of
997758 for up to an aggregate of 206,376 shares of the Company's common stock.
Each exercise of the exchange rights shall include at least Cdn $150,000 in
value of Class Y shares of 997758 being exchanged for the Company's common
stock. Subsequent to year end, the right to exchange was extended until May 20,
2001.

  Shares Reserved for Future Issuance

     As of December 31, 1999, common shares reserved for future issuance were as
follows:

<TABLE>
<CAPTION>
                                                            NUMBER OF
SECURITY                                                 RESERVED SHARES
--------                                                 ---------------
<S>                                                      <C>
Warrants...............................................     8,952,843
Stock options..........................................     2,482,532
Employee stock purchase plan...........................        45,036
997758 Class Y Stock exchange rights...................       206,376
                                                           ----------
                                                           11,686,787
                                                           ==========
</TABLE>

  Employee Stock Purchase Plan and Retirement Plan

     During July 1996, the Company's Board of Directors adopted the Employee
Stock Purchase Plan (the "Plan"), which was approved by the Company's
stockholders at the 1997 annual meeting. Under the Plan, eligible employees may
purchase shares of the Company's common stock at a discount through voluntary
monthly payroll deductions with a maximum contribution being 10% of an eligible
employee's salary, beginning in September 1996. Semi-annually, on June 30 and
December 31, participant account balances are used to purchase shares at the
lesser of 85 percent of the fair market value of the common stock on either the
first or last day of the subscription period. In connection with the Plan, the
Company has set aside 100,000 shares of common stock held in treasury. On June
30, 1999 and December 31, 1999, 6,857 shares and 5,664 shares of common stock
were purchased by employees at prices of $14.13 per share and $13.60 per share,
respectively.

     The Company sponsors a defined contribution plan covering substantially all
employees; the plan is qualified under Section 401(k) of the Internal Revenue
Code. Under the provisions of the plan, eligible participating employees may
elect to contribute up to the maximum amount of tax deferred contribution
allowed by the Internal Revenue Code.

  Anti-Dilution Provisions

     Certain of the warrants to purchase common stock contain anti-dilution
provisions whereby the exercise price and the number of shares exercisable
pursuant to the warrants may be adjusted from time to time upon the occurrence
of certain events. In connection with such provisions, warrants to purchase
1,034,687 shares of common stock at a purchase price of $7.44 per share were
adjusted to provide for the purchase of the same number of shares at a purchase
price of $6.00 per share, and warrants to purchase 28,302 shares of common

                                       21
<PAGE>   22
                               SOURCE MEDIA, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

stock at a purchase price of $10.60 per share were adjusted to provide for the
purchase of 68,498 shares at a purchase price of $4.38 per share upon the
issuance of common stock in connection with the ICTI acquisition discussed in
Note 5 -- Acquisitions and the amendment to the First Tranche Warrant and
issuance of the Second Tranche Warrants discussed in Note 6 -- Long-term Debt,
respectively.

9. NOTES RECEIVABLE FROM STOCKHOLDERS

     On May 20, 1993, the Company loaned $0.8 million to the individual holding
Class Y shares of 997758, which note is secured by the individual's holdings in
997758 and bears interest at a rate per annum of 2%, payable quarterly. The
unpaid principal and interest become due on May 20, 2000. Subsequent to year end
the due date on the Note was extended until May 20, 2001. The Company recorded a
discount to reflect the difference between the actual interest rate and a
reasonable market rate (10%) and increased goodwill accordingly. The note and
accrued interest, net of the unamortized discount of $0.1 thousand and $0.5
thousand as of December 31, 1999 and 1998, respectively, are reflected as a
reduction of minority interests in the accompanying consolidated balance sheet.

     On June 30, 1993, the Company loaned $0.1 million to an officer, director
and stockholder. This loan bore interest at the rate of 10% per annum, with the
principal amount and accrued interest due and payable on May 31, 1999. All
amounts due were received on May 31, 1999.

10. LEASES

     The Company leases office space and various office equipment under
operating leases. Rent expense was $0.9 million, $1.1 million and $1.1 million
for the years ended December 31, 1997, 1998, and 1999, respectively.

     At December 31, 1999, aggregate amounts of future minimum payments under
lease commitments are as follows:

<TABLE>
<CAPTION>
                                                            OPERATING
                                                              LEASES
                                                          --------------
                                                          (IN THOUSANDS)
<S>                                                       <C>
2000....................................................      $  809
2001....................................................         263
2002....................................................          14
2003....................................................           6
                                                              ------
          Total future minimum lease payments...........      $1,092
                                                              ======
</TABLE>

                                       22
<PAGE>   23
                               SOURCE MEDIA, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

11. INCOME TAXES

     For the years ended December 31, 1997, 1998 and 1999, the Company had no
provision or benefit for income taxes because the deferred benefit from the
operating losses was offset by an increase in the valuation allowance of $4.1
million, $18.3 million and $9.9 million, respectively. Significant components of
the Company's deferred tax assets and liabilities are as follows:

<TABLE>
<CAPTION>
                                                 1997           1998           1999
                                             ------------   ------------   ------------
<S>                                          <C>            <C>            <C>
Deferred tax liabilities:
Tax over book depreciation.................  $   (548,386)  $   (523,243)  $   (353,932)
Book over tax basis in investment in joint
  venture..................................            --             --     (3,909,790)
Other......................................       (11,156)        (7,706)       (19,707)
                                             ------------   ------------   ------------
          Total deferred tax liabilities...      (559,542)      (530,949)    (4,283,429)
Deferred tax assets
  Net operating loss carryforwards.........    24,136,650     32,431,574     46,376,006
  Investment tax credits...................       801,712        488,025        459,279
  Unearned income..........................     1,491,716        787,065        712,132
  Book over tax amortization of
     intangibles...........................       414,831     10,420,726     10,290,481
  Reserve for fixed asset impairment.......       739,763        739,763             --
  Accrued expenses.........................        61,248        927,397      1,527,482
  Other....................................        56,967        143,312        227,303
                                             ------------   ------------   ------------
          Total deferred tax assets........    27,702,887     45,937,862     59,592,683
Valuation allowance for deferred tax
  assets...................................   (27,143,345)   (45,406,913)   (55,309,254)
                                             ------------   ------------   ------------
Net of valuation allowance.................       559,542        530,949      4,283,429
                                             ------------   ------------   ------------
Net deferred tax asset.....................  $         --   $         --   $         --
                                             ============   ============   ============
</TABLE>

     At December 31, 1999, the Company had net operating loss carryforwards of
approximately $124.5 million for United States income tax purposes, that expire
in 2003 through 2019, which may be used to reduce future United States taxable
income. The Tax Reform Act of 1986 imposes limitations on the use of net
operating loss carryforwards if certain stock ownership changes occur. An
ownership change occurred in 1995 that caused utilization of $23.1 million of
the Company's net operating losses to be limited to approximately $9.0 million
in a given year.

     At December 31, 1999, ICTI had net operating loss carryforwards for
Canadian income tax purposes of approximately Cdn $0.7 million, expiring in 2000
through 2003, which may be used to reduce future Canadian taxable income of
ICTI. ICTI also has available at December 31, 1999 investment tax credits
totaling Cdn $0.8 million, expiring in 2000 through 2002. At December 31, 1999,
ICTI had net operating loss carryforwards for Ontario Provincial income tax
purposes of approximately Cdn $0.5 million, expiring in 2002 through 2003, which
may be used to reduce future Ontario taxable income of ICTI.

     Certain transactions between ICTI and its subsidiaries in March 1997
resulted in taxable income of approximately $7.0 million in the United States
and Canada and the utilization of net operating losses in both countries in
1997. Certain transactions between ICTI and its subsidiaries in 1998 resulted in
utilization of approximately Cdn $4.0 million of Canadian net operating loss
carryforwards.

                                       23
<PAGE>   24
                               SOURCE MEDIA, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

12. CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMERS

     The Company performs ongoing credit evaluations of its customers and does
not require collateral. Overall concentrations of credit risk with respect to
receivables, except for the customers discussed below, are limited because of
the large number of customers in the Company's customer base, the relatively
small dollar amount of individual customer balances and their dispersion across
many different industries and geographic areas. The Company maintains an
allowance for doubtful accounts which was $0.6 million and $0.4 million as of
December 31, 1999 and 1998, respectively, to reserve for potential credit
losses, which have historically been within management's expectations.
Write-offs against the accounts receivable reserve totaled $0.9 million in 1999.

     As of December 31, 1999 and 1998, balances due from BellSouth Advertising
and Publishing represented 16% and 21%, respectively, of the Company's accounts
receivable. No other customer represented more than 10% of the Company's
accounts receivable as of December 31, 1999 or 1998.

     For the years ended December 31, 1999 and 1998, a major customer accounted
for 18% and 12% of monetary revenue, respectively. For the year ended December
31, 1997, this major customer accounted for 11% of the monetary revenues while
another major customer accounted for 10% of monetary revenues. No other customer
accounted for greater than 10% of monetary revenues for any of the three years
ended December 31, 1999.

13. MANAGEMENT PLANS

     The Company has reported a net loss of approximately $38.2 million for the
year ended December 31, 1999, incurred accumulated losses from inception to
December 31, 1999 aggregating to approximately $187.1 million, and reported
negative cash flows from operations for the year ended December 31, 1999 of
approximately $26.7 million and a capital deficiency of $68.9 million. The
Company's 2000 operating plan contemplates focusing activities to expand
revenues at the Company's IT Network division through expansion into the
internet business and successfully expanding its interactive program guide and
programming services for its Interactive TV business. Based on its plans,
management expects to be able to fund its operations and meet its current
maturing obligations through the end of 2000; however, there can be no assurance
that the Company will be successful in its efforts to grow revenues or expand
its distribution of Interactive TV products.

14. EQUITY IN SOURCESUITE JOINT VENTURE

     On November 17, 1999 the Company completed the creation of a joint venture,
SourceSuite LLC, with Insight to conduct the business of its former
VirtualModem(TM) and Interactive TV lines of business. The investment in
SourceSuite LLC is 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 SourceSuite. Insight contributed
$13 million in cash to SourceSuite in exchange for a 50% interest. The joint
venture is managed by the Company within the terms of the operating agreement
and the annual operating plan approved by the Management Committee. Special
actions by SourceSuite require approval of a four member management committee
with equal representation, by both Source Media and Insight, on the Management
Committee. The Operating Agreement of SourceSuite restricts any distribution of
equity to members for a period of three years.

     The Company recorded its share of SourceSuite's results of operations using
the equity method in the Consolidated Statement of Operations. Assets of the
Company which were transferred to SourceSuite were reclassified at their
historical net book value, to the investment in joint venture account in the
Consolidated Balance Sheet. In addition, the value of warrants issued to Insight
as part of the transaction have been

                                       24
<PAGE>   25
                               SOURCE MEDIA, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

included in the investment in the joint venture account. The fair value of these
warrants were valued at $13.8 million using a Black-Scholes model.

     Assets contributed to SourceSuite have been valued within SourceSuite at
fair value based on the cash received by SourceSuite from Insight for a 50%
interest in the joint venture.

     A summary of the difference between the investment and the underlying
equity interest in the net assets of the joint venture at December 31, 1999 is
as follows:

<TABLE>
<S>                                                          <C>
50% of joint venture net assets...........................   $12,296
Less: step-up of assets contributed to the joint venture
  not reflected by Source Media...........................    (7,560)
Plus: Additional investment resulting from the issuance of
  warrants to the joint venture partner and transaction
  closing cost............................................    13,933
                                                             -------
Investment in joint venture balance at December 31,
  1999....................................................   $18,669
                                                             =======
</TABLE>

     The Company records amortization of the assets contributed to the joint
venture on its historical basis. The warrants issued to the joint venture
partner are amortized over five years.

     Summary financial data of SourceSuite at December 31, 1999 is as follows
(in thousands):

<TABLE>
<S>                                                          <C>
ASSETS:
  Current Assets..........................................   $13,150
  Property and Equipment, net.............................       588
  Intangible assets, net..................................    13,834
                                                             -------
                                                             $27,572
                                                             =======

LIABILITIES AND MEMBERS' EQUITY:
  Current liabilities.....................................   $ 1,981
  Deferred taxes..........................................       999
  Members' equity.........................................    24,592
                                                             -------
                                                             $27,572
                                                             =======
NET LOSS:
  Net loss before taxes...................................   $(2,192)
  Income tax benefit......................................       784
                                                             -------
  Net loss................................................   $(1,408)
                                                             =======
</TABLE>

15. SEGMENT REPORTING

     In accordance with SFAS 131, the Company has identified two reportable
operating segments, IT Network and Interactive TV, for disclosure purposes.
These two segments are regularly reviewed by the Company's management for
determination of the allocation of resources to these businesses.

     IT Network sells advertising and related support services to clients who
sponsor a promotional message with interactive content supplied primarily by IT
Network.

     The Interactive TV business had developed proprietary software and
interactive programming services that can enable digital, two way television
systems equipment with digital (or advanced analog) set-top boxes to deliver
two-way, interactive programming with the touch of a set-top remote or the use
of a wireless keyboard. The Interactive TV business includes the results of the
Interactive Channel and ICTI subsidiaries and the Company's 50% equity interest
in the results of SourceSuite from November 17, 1999.

                                       25
<PAGE>   26
                               SOURCE MEDIA, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     The total revenues, expenses and assets by reportable operating segments
are used in the Company's operations and do not include general corporate
overhead and assets not allocated to the operating units. These assets and
expenses have been separately disclosed for reconciliation purposes.

     The following are operating results and certain other information by
business segment:

<TABLE>
<CAPTION>
                                                                 YEAR ENDED DECEMBER 31,
                                                              ------------------------------
                                                                1997       1998       1999
                                                              --------   --------   --------
                                                                      (IN THOUSANDS)
<S>                                                           <C>        <C>        <C>
Monetary revenues:
  IT Network................................................  $ 12,082   $ 24,244   $ 19,105
  Interactive TV............................................       305        108         42
                                                              --------   --------   --------
          Total monetary revenues...........................  $ 12,387   $ 24,352   $ 19,147
                                                              ========   ========   ========
Nonmonetary revenues:
  IT Network................................................  $  6,044   $  1,756   $  1,823
  Interactive TV............................................        --         --         --
                                                              --------   --------   --------
          Total nonmonetary revenues........................  $  6,044   $  1,756   $  1,823
                                                              ========   ========   ========
Net revenues:
  IT Network................................................  $ 18,126   $ 26,000   $ 20,928
  Interactive TV............................................       305        108         42
                                                              --------   --------   --------
          Total net revenues................................  $ 18,431   $ 26,108   $ 20,970
                                                              ========   ========   ========
Operating loss:
  IT Network................................................  $   (163)  $(29,475)  $ (6,145)
  Interactive TV............................................   (19,892)   (11,325)    (9,017)
  Corporate.................................................    (4,435)    (7,960)    (9,860)
                                                              --------   --------   --------
          Total operating loss..............................  $(24,490)  $(48,760)  $(25,022)
                                                              ========   ========   ========
Equity interest in loss of joint venture:
  Interactive TV............................................  $     --   $     --   $ (1,013)
                                                              ========   ========   ========
Identifiable assets:
  IT Network................................................  $ 51,374   $ 19,408   $ 15,474
  Interactive TV............................................     9,959      8,401     20,675
  Corporate.................................................    52,169     28,780     21,867
                                                              --------   --------   --------
          Total identifiable assets.........................  $113,502   $ 56,589   $ 58,016
                                                              ========   ========   ========
Depreciation and amortization:
  IT Network................................................  $  2,835   $  5,684   $  4,329
  Interactive TV............................................     4,466      2,925      2,765
  Corporate.................................................        --        251        218
                                                              --------   --------   --------
          Total depreciation and amortization...............  $  7,301   $  8,860   $  7,312
                                                              ========   ========   ========
Equity in joint venture:
  Interactive TV............................................  $     --   $     --   $ 18,669
                                                              ========   ========   ========
Capital expenditures:
  IT Network................................................  $  2,838   $    993   $    643
  Interactive TV............................................     1,944        432        570
  Corporate.................................................        --         85         22
                                                              --------   --------   --------
          Total capital expenditures........................  $  4,782   $  1,510   $  1,235
                                                              ========   ========   ========
</TABLE>

                                       26
<PAGE>   27
                               SOURCE MEDIA, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

16. SUBSEQUENT EVENTS

  Transaction with Liberate

     On March 3, 2000, the Company and Insight sold their respective interests
in their joint venture to Liberate in exchange for the issuance to each of the
Company and Insight of 886,000 shares of common stock in Liberate. Prior to the
sale of the joint venture, cash equal to the value of the retained business was
contributed by the joint venture to a new joint venture, originally called
SourceSuite Acquisition LLC, of which the Company and Insight Interactive now
each own 50%. The new joint venture used these funds to purchase the retained
business, which includes the interactive programming guide and related content
business, from the original joint venture. The Company will act as manager of
the new joint venture and carry out the interactive programming guide and
related content business within the operating plan established by the Management
Committee. Additionally, the Company and Insight will be required to provide
additional funding to SourceSuite Acquisition LLC in the event of a capital call
by SourceSuite Acquisition LLC.

     Following the merger, Liberate will provide to SourceSuite Acquisition LLC,
without charge, specific software development services for the Interactive
Channel products under a programming services agreement. SourceSuite Acquisition
LLC entered into a preferred content provider agreement with Liberate which
allows Liberate to offer pricing incentives to its customers that use
SourceSuite Acquisition LLC's local content services with the Virtual Modem
products.

     After the completion of the sale to Liberate, the original joint venture
changed it name from SourceSuite LLC to Liberate Technologies LLC and the new
joint venture changed its name from SourceSuite Acquisition LLC to SourceSuite
LLC.

     The following pro forma condensed balance sheet reflects the Company's sale
of its investment in SourceSuite as if the transaction was consummated as of
December 31, 1999. For pro forma purposes, the investment in Liberate stock was
valued at $98.6875 per share, the closing price per share on the date of sale,
March 3, 2000.

<TABLE>
<CAPTION>
                                                             AS OF
                                                          DECEMBER 31,
                                                              1999
                                                          ------------
<S>                                                       <C>
Current Assets..........................................    $110,432
Total Assets............................................     131,145
Stockholder equity......................................       4,257
</TABLE>

     The following pro forma condensed statement of operations gives effect to
the Insight and Liberate transactions as if they had occurred on January 1,
1998.

<TABLE>
<CAPTION>
                                                               YEAR ENDED     YEAR ENDED
                                                              DECEMBER 31,   DECEMBER 31,
                                                                  1998           1999
                                                              ------------   ------------
<S>                                                           <C>            <C>
Pro forma net sales.........................................    $ 26,001       $ 20,928
Pro forma operating loss....................................     (35,492)       (12,128)
Pro forma net loss attributable to common shareholders......     (52,454)       (29,892)
Pro forma basic and dilutive loss per common share..........       (4.08)         (2.06)
</TABLE>

                                       27
<PAGE>   28
                               SOURCE MEDIA, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

  Proposed Exchange

     Subsequent to year end, the Company announced proposals to exchange common
stock for its Senior Secured Notes and Preferred Stock. Under the proposal to
exchange Notes, up to 50 shares of common stock would be exchanged for each
$1,000 in principal amount of the Notes held with the actual number of shares to
be determined by the average closing price of the common stock based on certain
closing price ranges. Under the proposal to exchange Preferred Stock, up to 50
shares of common stock would be exchanged for each $1,000 of liquidation
preference on the Preferred Stock held with the actual number of shares to be
determined by the average close price of the common stock based on certain
closing price ranges. The exchange offers, if made, will be subject to certain
conditions.

                                       28
<PAGE>   29

                         REPORT OF INDEPENDENT AUDITORS

Members and Management Committee
SourceSuite, LLC

     We have audited the accompanying consolidated balance sheet of SourceSuite,
LLC (the Company) at December 31, 1999, and the related consolidated statement
of operations and members' equity and cash flows for the period from inception
(November 17, 1999) through December 31, 1999. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.

     We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.

     In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of SourceSuite,
LLC at December 31, 1999, and the consolidated results of its operations and its
cash flows for the period from inception (November 17, 1999) through December
31, 1999 in conformity with accounting principles generally accepted in the
United States.

                                                  /s/ ERNST & YOUNG LLP

Dallas, Texas
March 3, 2000

                                       29
<PAGE>   30

                                SOURCESUITE, LLC

                           CONSOLIDATED BALANCE SHEET
                               DECEMBER 31, 1999
                             (DOLLARS IN THOUSANDS)

<TABLE>
<S>                                                            <C>
                                ASSETS

Current assets:
  Cash and cash equivalents.................................   $13,078
  Prepaid expenses and other current assets.................        72
                                                               -------
          Total current assets..............................    13,150
Property and equipment:
  Computer and production equipment.........................       666
  Accumulated depreciation..................................       (78)
                                                               -------
Net property and equipment..................................       588
Intangible assets:
  Patents...................................................    12,396
  Goodwill..................................................     1,793
                                                               -------
                                                                14,189
  Accumulated amortization..................................      (355)
                                                               -------
Net intangible assets.......................................    13,834
                                                               -------
          Total assets......................................   $27,572
                                                               =======

                   LIABILITIES AND MEMBERS' EQUITY

Current liabilities:
  Accounts payable..........................................   $    59
  Accrued liabilities.......................................       464
  Payable to Source Media, Inc. ............................     1,458
                                                               -------
          Total current liabilities.........................     1,981
Deferred taxes..............................................       999
Members' equity:
  Contributed capital, 1,000,000 units authorized and
     outstanding............................................    26,000
  Accumulated deficit.......................................    (1,408)
                                                               -------
          Total members' equity.............................    24,592
                                                               -------
          Total liabilities and members' equity.............   $27,572
                                                               =======
</TABLE>

                            See accompanying notes.

                                       30
<PAGE>   31

                                SOURCESUITE, LLC

                      CONSOLIDATED STATEMENT OF OPERATIONS
      PERIOD FROM INCEPTION (NOVEMBER 17, 1999) THROUGH DECEMBER 31, 1999
                                 (IN THOUSANDS)

<TABLE>
<S>                                                           <C>
Revenues....................................................     $    --
Operating expenses:
  Selling, general and administrative expenses..............       1,538
  Research and development expenses.........................         377
  Amortization of intangible assets.........................         355
                                                                 -------
          Total operating expenses..........................       2,270
                                                                 -------
Operating loss..............................................      (2,270)
Interest income.............................................          78
                                                                 -------
Net loss before taxes.......................................      (2,192)
Income tax benefit..........................................         784
                                                                 -------
Net loss....................................................     $(1,408)
                                                                 =======
</TABLE>

                            See accompanying notes.

                                       31
<PAGE>   32

                                SOURCESUITE, LLC

                          STATEMENT OF MEMBERS' EQUITY
      PERIOD FROM INCEPTION (NOVEMBER 17, 1999) THROUGH DECEMBER 31, 1999

<TABLE>
<CAPTION>
                                                              MEMBERSHIP    MEMBERS'
                                                                 UNITS       EQUITY
                                                              -----------   ---------
                                                              (DOLLARS IN THOUSANDS)
<S>                                                           <C>           <C>
Sale of membership units on November 17, 1999...............   1,000,000     $26,000
Net loss....................................................          --      (1,408)
                                                               ---------     -------
December 31, 1999...........................................   1,000,000     $24,592
                                                               =========     =======
</TABLE>

                            See accompanying notes.

                                       32
<PAGE>   33

                                SOURCESUITE, LLC

                            STATEMENT OF CASH FLOWS
      PERIOD FROM INCEPTION (NOVEMBER 17, 1999) THROUGH DECEMBER 31, 1999
                                 (IN THOUSANDS)

<TABLE>
<S>                                                           <C>
OPERATING ACTIVITIES
Net loss....................................................     $(1,408)
Adjustments to reconcile net loss to net cash provided by
  operating activities:
  Depreciation..............................................          78
  Amortization of intangible assets.........................         355
  Changes in operating assets and liabilities:
     Prepaid expenses and other current assets..............         (23)
     Deferred taxes.........................................        (794)
     Accounts payable and accrued liabilities...............         507
     Related party payable..................................       1,458
                                                                 -------
Net cash provided by operating activities...................         173
INVESTING ACTIVITY
Capital expenditures........................................         (95)
                                                                 -------
Net cash used in investing activity.........................         (95)
FINANCING ACTIVITY
Proceeds from sale of membership units......................      13,000
                                                                 -------
Cash provided by financing activity.........................      13,000
                                                                 -------
Net increase in cash and cash equivalents...................      13,078
Cash and cash equivalents at beginning of period............          --
                                                                 -------
Cash and cash equivalents at end of period..................     $13,078
                                                                 =======
Non-cash investing and financing activities:
  Net assets contributed to SourceSuite in exchange for
     membership units.......................................     $13,000
                                                                 =======
</TABLE>

                            See accompanying notes.

                                       33
<PAGE>   34

                                SOURCESUITE, LLC

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
      PERIOD FROM INCEPTION (NOVEMBER 17, 1999) THROUGH DECEMBER 31, 1999

1. DESCRIPTION OF BUSINESS

     SourceSuite, LLC ("SourceSuite" or "Company"), a Delaware limited liability
company, was formed on November 17, 1999 as a joint venture between Source
Media, Inc.("Source Media") and Insight Interactive, LLC ("Insight"). Source
Media conveyed certain assets related to its "VirtualModem(TM)" and "Interactive
Channel" products and businesses and Insight contributed $13 million in cash to
SourceSuite in exchange for each owning a 50% interest in SourceSuite. On March
3, 2000, Insight and Source Media sold their respective interests in SourceSuite
to Liberate Technologies ("Liberate"). (See Note 8 -- Subsequent Events.)

     SourceSuite operates primarily in the United States while technological
development efforts are performed by its Canadian subsidiary, SourceSuite
Canada, Inc.

     SourceSuite will continue the development of the proprietary software
contributed to SourceSuite by Source Media and will provide interactive
programming services that can enable digital, two-way television systems
equipped with digital (or advanced analog) set-top boxes to deliver two-way,
interactive programming with the touch of a set-top remote or the use of a
wireless keyboard.

2. ACCOUNTING POLICIES

  Principles of Consolidation

     The consolidated financial statements include the accounts of the Company
and its wholly owned Canadian subsidiary, SourceSuite Canada, Inc. All material
inter-company amounts and transactions have been eliminated.

  Basis of Presentation

     Assets contributed to the joint venture by Source Media have been valued at
the fair value on the date of contribution based on contribution of cash for an
equal ownership percentage by Insight.

  Use of Estimates

     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.

  Cash and Cash Equivalents

     The Company classifies all highly liquid investments with original
maturities of three months or less as cash equivalents. These investments are
recorded at cost, which approximates market.

  Computer and Production Equipment

     Computer and production equipment are recorded at cost. Depreciation is
computed using the straight-line method over the estimated useful lives (three
to five years) of the assets.

  Intangible Assets

     Goodwill resulted from the establishment of a deferred tax liability from
the basis difference between book and tax for the assets contributed to the
joint venture. Intangible assets are patents which were recorded at a fair value
based on contribution of cash for an equal ownership interest by the other
investor less the fair

                                       34
<PAGE>   35
                                SOURCESUITE, LLC

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

value of computer and production equipment assets also received. Intangible
assets are amortized using the straight-line method over an estimated useful
life of five years.

     The carrying value of intangible assets is reviewed for impairment whenever
events or changes in circumstances indicated that there may be an impairment. If
the review indicates that any of the intangibles will not be recoverable, as
determined by an analysis of undiscounted cash flows, the intangible asset will
be reduced to its estimated fair value.

  Translation of Foreign Currencies

     The financial position and results of operations of SourceSuite Canada are
measured using local currency (Canadian dollar) as the functional currency and
are translated to U.S. dollars in these consolidated financial statements.
Assets and liabilities of this subsidiary are translated at the exchange rate in
effect at each balance sheet date. Statement of operations accounts are
translated at the average rate of exchange prevailing during the year.
Translation adjustments and foreign currency gains and losses have not been
significant and accordingly, have not been separately presented.

  Research and Development

     Research and development costs are expensed as incurred.

  Comprehensive Income

     There are no significant comprehensive income items, therefore,
comprehensive income is equal to net income and not separately shown on the
Consolidated Statement of Operations.

3. INCOME TAXES

     Significant components of the income tax benefit are as follows (in
thousands):

<TABLE>
<S>                                                            <C>
Current tax expense:
  Foreign...................................................   $  10
Deferred tax expense (benefit):
  Federal...................................................    (697)
  State.....................................................     (97)
                                                               -----
          Total.............................................   $(784)
                                                               =====
</TABLE>

     The reconciliation of income tax computed at the US federal statutory rates
to income tax benefit is (in thousands):

<TABLE>
<S>                                                            <C>
Benefit at US statutory rate................................   $(745)
State income taxes (net of federal effect)..................     (66)
Foreign taxes...............................................      10
Nondeductible goodwill amortization.........................      17
                                                               -----
                                                               $(784)
                                                               =====
</TABLE>

                                       35
<PAGE>   36
                                SOURCESUITE, LLC

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax liabilities and assets as of December 31, 1999 are as
follows (in thousands):

<TABLE>
<S>                                                           <C>
Deferred tax liabilities:
  Patents..................................................   $1,750
Deferred tax assets:
  Accrued expenses.........................................      167
  Net operating loss.......................................      584
                                                              ------
          Total deferred tax assets........................      751
                                                              ------
Net deferred tax liabilities...............................   $  999
                                                              ======
</TABLE>

4. MEMBERS' EQUITY

     Distribution of equity to members is restricted by the Company's Operating
Agreement for a period of three years.

5. RELATED PARTY TRANSACTIONS

     As part of the joint venture agreement between Source Media and Insight,
Source Media manages the day to day operations of SourceSuite within the terms
of SourceSuite's operating plan. As part of this arrangement, SourceSuite
reimburses Source Media for the direct costs of the Interactive TV business and
certain overhead costs. These costs amounted to $1.5 million for the period
ended December 31, 1999 and are included in the payable to related parties and
are reimbursed to Source Media on a regular basis.

6. COMMITMENTS AND CONTINGENCIES

     Upon formation of the joint venture, SourceSuite assumed the responsibility
for the following litigation from Source Media:

     Interactive Channel Technologies, Inc. ("ICTI") and SMI Holdings, Inc.
(subsidiaries of Source Media), filed a patent infringement suit against
Worldgate Communications, Inc. ("Worldgate") in federal district court in
Delaware in May 1998. In June 1998, Worldgate filed a Counterclaim against the
plaintiffs and Source Media for, among other things, unfair competition,
interference with contract and trade secret misappropriation. The Counterclaim
defendants denied the allegations in the Counterclaim. Subsequent to year-end,
the relevant patents and this litigation were assumed by Liberate as part of the
sale of SourceSuite.

     On October 6, 1998, Advanced Interactive, Inc. filed a complaint in U.S.
District Court for the Northern District of Illinois, Eastern Division, against
ICTI and the following companies: Matsushita Electric Corporation, Matsushita
Electric Industrial Co., Ltd., Sharp Electronics Corp., Sharp Corp., Thomson
Consumer Electronics, Toshiba Consumer Products, Inc., Toshiba American, Inc.,
Toshiba Corporation, General Instruments Corp., Scientific Atlanta, Inc., ATI
Technologies, Inc., ADS Technologies Inc., Gateway 2000, Inc., STB Systems,
Inc., Hauppauge Computer Works, Inc., WebTV Networks, Inc. and WorldGate
Communications, Inc. (collectively the "Defendants"). Advanced Interactive, Inc.
alleges that ICTI infringed two claims of one of its patents by manufacturing,
using and/or selling or offering to sell Sourceware(TM) ChannelLink(TM). The
same allegation is made against each Defendant for its particular product or
service. The Plaintiff seeks damages, but makes no claims against the patents of
ICTI or any other Defendant. ICTI, and each of the Defendants, have filed an
Answer and have collectively joined the Motion for Partial Summary Judgment
submitted by Matsushita Electric Corporation of America, Sharp Electronics
Corp., Sharp Corp. and the Toshiba Defendants. On May 12, 1999 the court denied
Advanced Interactive Inc.'s

                                       36
<PAGE>   37
                                SOURCESUITE, LLC

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Motion for summary Judgement of Infringement. On February 17, 2000, the court
granted the Defendants' collective Motion for Partial Summary Judgment on patent
claims interpretation. This case was transferred to SourceSuite under the terms
of the joint venture agreement and subsequently became the responsibility of
SourceSuite Acquisition LLC on March 3, 2000 (See Note 8 -- Subsequent Events).

7. YEAR 2000 DISCLOSURES (UNAUDITED)

     SourceSuite is dependent upon the computer systems of Source Media. The
Year 2000 issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Any of the Source Media
computer programs or hardware that have date-sensitive software or embedded
chips may recognize a date using "00" as the year 1900 rather than the year
2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary inability
to process transactions, send invoices, or engage in similar normal business.

     Based on assessments made by Source Media, it was determined that certain
of its software and hardware would be required to be modified or replaced so
that those systems will properly utilize dates beyond December 31, 1999. Source
Media has informed SourceSuite that all required modifications or replacements
of existing software and certain hardware have been completed and no Year 2000
issues were encountered.

     To date, Source Media is not aware of any external agent with a Year 2000
issue that would materially impact the Company's results of operations,
liquidity, or capital resources. However, Source Media has no means of ensuring
that external agents are or will continue to be Year 2000 compliant. The effect
of noncompliance by external agents is not determinable.

     Source Media utilized both internal and external resources to reprogram,
replace, test and implement the software and operating equipment for Year 2000
modifications. No costs of modification were incurred by SourceSuite.

8. SUBSEQUENT EVENTS

  Transaction With Liberate Technologies

     On March 3, 2000 Source Media and Insight sold their respective interests
in SourceSuite to Liberate in exchange for the issuance of 886,000 shares of
common stock in Liberate to both Source Media and Insight. Prior to the sale of
SourceSuite, cash equal to the value (as determined by an independent appraisal)
of the retained business, consisting of the interactive programming guide and
related content business, was contributed by SourceSuite to SourceSuite
Acquisition LLC, of which Source Media and Insight each own 50%. SourceSuite
Acquisition LLC used these funds to purchase the retained business from
SourceSuite, which comprised fixed assets with a net book value of approximately
$200,000 and certain accrued liabilities, for $1.1 million. After the closing of
the sale, the Company changed its name to Liberate Technologies LLC and
SourceSuite Acquisition LLC changed its name to SourceSuite, LLC.

                                       37
<PAGE>   38

                                   SIGNATURES


     Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this amendment to be signed on its behalf by the
undersigned, thereunto duly authorized.


                                            SOURCE MEDIA, INC.

                                                  /s/ STEPHEN W. PALLEY
                                            ------------------------------------
                                                     Stephen W. Palley
                                             President, Chief Executive Officer
                                                        and Director


Date: April 14, 2000


                                       38
<PAGE>   39


                                INDEX TO EXHIBITS

<TABLE>
<CAPTION>
Exhibit Number      Description
<S>                 <C>
3.1                 Restated Certificate of Incorporation, as amended**

3.2                 Bylaws, as amended**


4.1                 Form of Common Stock Certificate (filed as Exhibit 4.1 to
                    the Company's Registration Statement on Form S-1 (No.
                    33-97564), and incorporated herein by reference)

4.2                 Certificate of Designation for Senior PIK Preferred Stock,
                    as amended**

4.3                 Certificate of Designations for Non-Participating Preferred
                    Stock (filed as Exhibit D to the Company's Statement on
                    Schedule 14A filed September 24, 1999, and incorporated
                    herein by reference)

4.4                 Indenture dated as of October 30, 1997 among the Company,
                    its subsidiaries parties thereto and U. S. Trust Company of
                    Texas, N.A. (filed as Exhibit 4.1 to the Company's Current
                    Report on Form 8-K dated October 30, 1997, and incorporated
                    herein by reference)

4.5                 First Supplemental Indenture dated as of November 1, 1999
                    among the Company, its subsidiaries parties thereto and U.S.
                    Trust Company of Texas, N.A.**

4.6                 Second Supplemental Indenture dated as of February 15, 2000
                    among the Company, its subsidiaries parties thereto and U.S.
                    Trust Company of Texas, N.A.**

4.7                 Rights Agreement dated as of April 24, 1998 between the
                    Company and ChaseMellon Shareholder Services, L.L.C.**

10.1                Form of Guarantee for domestic subsidiaries (filed as
                    Exhibit 10.29 to the Company's Registration Statement on
                    Form S-4, as amended (No. 333-42017), and incorporated
                    herein by reference)

10.2                Form of Guarantee for foreign subsidiaries (filed as Exhibit
                    10.30 to the Company's Registration Statement on Form S-4,
                    as amended (No. 333-42017), and incorporated herein by
                    reference)

10.3                Contribution Agreement by and among Insight Interactive,
                    LLC, the Company and Newco, LLC dated July 29, 1999 (filed
                    as Exhibit B to the Company's Statement on Schedule 14A
                    filed September 24, 1999, and incorporated herein by
                    reference)

10.4                Common Stock and Warrants Purchase Agreement between the
                    Company and Insight Interactive, LLC dated as of July 29,
                    1999 (filed as Exhibit C to the Company's Statement on
                    Schedule 14A filed September 24, 1999, and incorporated
                    herein by reference)

10.5                Warrant Agreement dated as of October 30, 1997 between the
                    Company and ChaseMellon Shareholder Services, L.L.C. (filed
                    as Exhibit 4.3 to the Company's Current Report on Form 8-K
                    dated October 30, 1997, and incorporated herein by
                    reference)

10.6                Stock Purchase Warrant dated November 17, 1999 between the
                    Company and Insight Interactive, LLC**

10.7                Stock Purchase Warrant dated November 17, 1999 between the
                    Company and Lazard Freres & Co., LLC**
</TABLE>








<PAGE>   40


<TABLE>
<CAPTION>
<S>                 <C>
10.8                Merger Agreement and Plan of Reorganization dated as of
                    January 12, 2000 by and among Liberate Technologies,
                    SourceSuite LLC, the Company, Insight Communications, Inc.,
                    Insight Interactive LLC, SourceSuite Acquisition LLC and
                    Liberate Acquisition Co., LLC (filed as Exhibit 10.10 to the
                    Company's Registration Statement on Form S-4 (no. 33-95023),
                    and incorporated herein by reference)

10.9*               1995 Performance Equity Plan, as amended and restated
                    effective as of June 10, 1998 (filed as Exhibit 10.17 to the
                    Company's Report on Form 10-K for the Year Ended December
                    31, 1998, and incorporated herein by reference)

10.10*              1995 Nonqualified Stock Option Plan for Non-Employee
                    Directors (filed as Exhibit 10.32 to the Company's
                    Registration Statement on Form S-1 (no. 33-90482), and
                    incorporated herein by reference)

10.11*              1999 Stock Option Plan (filed as Exhibit A to the Company's
                    Statement on Schedule 14A filed September 24, 1999, and
                    incorporated herein by reference)

10.12*              Employment Agreement dated as of March 11, 1999 between the
                    Company and Victoria Hamilton (filed as Exhibit 10.1 to the
                    Company's Report on Form 10-Q for the Quarter Ended March
                    31, 1999, and incorporated herein by reference)

10.13*              Employment Agreement dated as of March 29, 1999 between the
                    Company and Stephen W. Palley (filed as Exhibit 10.2 to the
                    Company's Report on Form 10-Q for the Quarter Ended March
                    31, 1999, and incorporated herein by reference)

10.14*              Employment Agreement dated as of June 10, 1996 between the
                    Company and W. Thomas Oliver (filed as Exhibit 10.3 to the
                    Company's Report on Form 10-Q for the Quarter Ended March
                    31, 1999, and incorporated herein by reference)

10.15*              Employment Agreement dated as of June 17, 1999 between the
                    Company and Howard Gross**

10.16*              Form of Severance Agreement dated March 29, 1999 between the
                    Company and Timothy P. Peters, John Reed and Maryann Walsh**

21.1                Subsidiaries**

23.1                Consent of Ernst & Young LLP

27.1                Financial Data Schedule**

*  Management Contract or Compensatory Plan

** Previously filed with this Annual Report on Form 10-K.
</TABLE>