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================================================================================

                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K

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

                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000

                         COMMISSION FILE NUMBER: 0-21894

                               SOURCE MEDIA, INC.
             (Exact Name of Registrant as Specified in its Charter)

        DELAWARE                                        13-3700438
(State of incorporation)                    (I.R.S. Employer Identification 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
23, 2001: $4,420,392.

     Number of shares of Common Stock outstanding as of March 23, 2001:
17,681,566.

                      DOCUMENTS INCORPORATED BY REFERENCE:

     LISTED BELOW ARE DOCUMENTS PARTS OF WHICH ARE INCORPORATED HEREIN BY
REFERENCE AND THE PART OF THIS REPORT INTO WHICH THE DOCUMENT IS INCORPORATED.

     PROXY STATEMENT FOR THE 2001 ANNUAL MEETING OF STOCKHOLDERS - PART III

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                                     PART I

ITEM 1. BUSINESS.

     Unless the context otherwise requires, all references to "we", "us" or
"our" include Source Media, Inc., its subsidiaries and SourceSuite LLC
("SourceSuite"), a joint venture with Insight Interactive LLC, a subsidiary of
Insight Communications Company, Inc. ("Insight").

GENERAL

     We produce, sell and deliver rich media content across a range of
communications platforms including the Internet, digital television,
telephone-based voice portal systems, and wireless and wireline telephone
networks. We also operate SourceSuite LLC, a 50/50 joint venture between us and
Insight Interactive, which provides interactive television programming
applications and services, including our SourceGuide(TM) interactive program
guide and our LocalSource(TM) interactive programming service. We categorize
these operations as our IT Network business and our Interactive TV business,
respectively.

     We have experienced significant changes in our Interactive TV business
since the beginning of 1999. In November 1999, we contributed this business,
including the assets and properties related to the VirtualModem software and
associated businesses, to a 50/50 joint venture with Insight Interactive.
VirtualModem software is a "middleware" platform, or the software which permits
a subscriber to interact with advertisements, programming and other services
through a cable set-top box. Insight Interactive contributed $13 million of
equity financing to the joint venture and purchased 842,105 shares of our common
stock for $12 million. We also issued to Insight Interactive warrants to
purchase 4,596,786 additional shares of our common stock at $20 per share. On
March 3, 2000, we and Insight Interactive sold the VirtualModem middleware and
associated businesses component of the Interactive TV business by selling our
interests in the joint venture to Liberate Technologies ("Liberate") in exchange
for the issuance to each of us and Insight Interactive of 886,000 shares of
Liberate common stock and other consideration. Prior to the completion of that
sale, we formed SourceSuite and transferred to SourceSuite the assets and
properties not related to VirtualModem. Accordingly, Liberate acquired all
patents and technology underlying the VirtualModem software and businesses.
Liberate granted us an exclusive, perpetual license to use the patents and
technology in connection with SourceGuide. We also retained ownership of the
source code for the Interactive TV applications developed as of the date of the
transaction with Liberate. As a result, our Interactive TV business became a
provider of applications and services other than middleware.

     These transactions are described in more detail below under "Organizational
History."

     We are a Delaware corporation formed in 1993. Our principal offices are
located at 5400 LBJ Freeway, Dallas, Texas 75240 and our telephone number is
(972) 701-5400.

RECENT DEVELOPMENTS

     On March 29, 2001, we announced that we and our financial advisor, UBS
Warburg LLC, had initiated discussions with the holders of our 12% Senior
Secured Notes ("Notes") and 13 1/2% Senior PIK Preferred Stock ("Preferred
Stock") about forming an informal committee to discuss possible restructuring
alternatives. Interest payments under our Notes are due on May 1, 2001 and
November 1, 2001 of approximately $5.3 million each. In the event that we are
unable to complete a restructuring or alternative financing, our only source of
additional funds to make the interest payments will be from operations. As of
December 31, 2000, we had $7.8 million in cash and cash equivalents available,
along with our shares of Liberate common stock, which had a value on that date
of $12.1 million. As of March 23, 2001, our shares of Liberate common stock had
a value of $7.0 million.

INTERACTIVE TV

     Our aim is to become the leading provider of interactive local information
and entertainment applications and services to the interactive television
industry. Interactive television, or Interactive TV, generally refers to the
applications and services that allow television viewers to interact with
advertisements, programs or other content through their television sets, usually
by using a conventional television remote control, or a keyboard for
applications that require more user input such as e-mail. Under our management,
SourceSuite develops and delivers Interactive TV applications and services,
including our SourceGuide(TM) interactive program guide and our LocalSource(TM)
interactive programming service to cable system and other platform operators.


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     We believe that our applications and services are well positioned to
capture emerging revenue opportunities in interactive television. We believe
revenue opportunities are currently developing in the form of subscription fees
derived from cable and other platform operators and, to a lesser extent,
transaction fees from commercial advertisers and television commerce or
"t-commerce" merchants. In particular, cable and other platform operators
currently pay us subscription fees for our Interactive TV applications and
services. We are designing our applications and services to make page space
available for targeted banner advertising and other promotions.

     The strategic focus of our Interactive TV business is to provide compelling
value for television viewers, cable and other platform operators, commercial
advertisers and t-commerce merchants. We believe our Interactive TV applications
and services provide subscribers with a television experience that is enhanced
with interactivity, enriched with information and designed to be easy to use. We
believe our applications and services can provide cable and other platform
operators with the ability to offer interactivity to their subscribers, increase
subscriber loyalty and capture incremental revenue streams from shared
advertising and online transaction fees with a smaller investment compared to
competitive product offerings. Further, we are designing our applications and
services to augment the value of commercial advertisements placed in them by
enabling advertisers to target and measure the effectiveness of their
advertising. For example, we believe that through our continuing development
efforts, our interactive local information and entertainment programming service
will provide a robust forum for local commercial advertisers and t-commerce
merchants to reach their target audiences.

Applications and Services

     Our Interactive TV applications and services include:

SourceGuide. Our SourceGuide(TM) interactive program guide provides viewers with
a navigational tool for television program listings. The program guide presents
information related to particular programming in an interactive menu-driven
format. By allowing viewers to access program guide screens and to search by
channel or time of program schedules, SourceGuide enables viewers to navigate
and tune to broadcast and cable channels. In particular, SourceGuide provides
the following features:

     o    Friendly screen format: SourceGuide displays programming by channel
          and/or time and allows 8 program listings per screen. In addition,
          with the press of a button on the remote control, viewers can read
          detailed program information and descriptions.

     o    Program Sorting: SourceGuide displays program titles, times and other
          information by themes, including movies, sports, and music, allowing
          viewers to quickly find the programming they desire.

     o    Information Bar: SourceGuide includes an on-screen information bar
          that allows viewers to navigate the program guide while watching
          television programming.

     o    Other Interactive Features: SourceGuide also includes other
          interactive features:

          o    Parental Control: This feature allows parents to activate a
               "parental control" block in order to prevent children from
               watching programming considered inappropriate by a parent;

          o    Program Favorites: This feature allows viewers to select and more
               quickly access their favorite channels and programming with the
               press of a button; and


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          o    Reminders: This feature allows viewers to set on-screen reminders
               to notify them when a desired program is starting on a particular
               channel.

LocalSource. Our LocalSource(TM) interactive programming service is designed to
provide information and entertainment content specific to a local area and
useful to the subscriber. LocalSource also provides a platform for interaction
between customers, advertisers, sponsors, merchants and direct marketers.
LocalSource programming features three basic categories:

     o    Local News, Weather and Sports and More: Recent local news, weather
          and sports are available as well as horoscopes and soap opera digests.
          Interactive navigation leads the viewer to regional, national and
          world news as well. Local business activity plus the market summary
          and quotes from the NYSE, NASDAQ, bond and international markets are
          also available to LocalSource viewers.

     o    Local Community Information: This service provides both local and
          national information and web-links to businesses and lottery results
          and other topics of local community interest. This service also
          provides information on other local topics such as schools, religion,
          town hall and transportation.

     o    Local Entertainment Guides: This service is a source for current local
          community information such as menus and guides for local restaurants,
          cinema listings and community events.

     o    Other Interactive Features: From time to time, we may develop and
          introduce additional interactive features into LocalSource. For
          example, LocalSource currently includes interactive programming for
          children in our KidZone category. We have also developed interactive
          games, including, a graphics-based version of the BlackJack card game.

Technology

     SourceGuide and LocalSource currently operate in connection with the
Liberate Compact TV software platform which is based on the VirtualModem patents
and technology. VirtualModem is patented server-based technology platform
originally developed by our subsidiary, Interactive Channel Technologies, Inc.,
and sold to Liberate in March 2000. A server-based technology enables the
real-time, two-way transfer of application data from a central server to a
client software application that resides in a device such as a cable set-top
box, referred to as a "client." The Liberate Compact TV platform is often
referred to as "middleware," or the client and server software upon which
interactive television applications operate in cable set-top boxes. Middleware,
together with the basic operating system software inside a cable set-top box,
enables subscribers to interact with advertisements, programs and other content
through the set-top box.

     SourceGuide and LocalSource currently require three basic components: a
server located at the headend of the cable operator's system, a digital or
advanced analog cable set-top box with an installed Liberate middleware
platform, and a remote control. SourceGuide and LocalSource currently function
only on the Motorola DCT2000 digital cable set-top boxes. In a typical system,
Liberate provides and maintains the server located at the headend of the cable
operator's system. The cable operator provides the cable set-top box and the
remote control for subscribers. We work together with Liberate and the customer
to support the integration of our applications and services with the components,
software and services not provided by us.

     Liberate Programming Services

     In connection with our sale of the VirtualModem technology to Liberate, we
entered into a


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programming services agreement, pursuant to which Liberate assists us, on a
work-for-hire basis, in the development of our Interactive TV applications and
services. Under this agreement Liberate also granted us an exclusive, perpetual
license to use the patents and technology in connection with SourceGuide and a
non-exclusive, perpetual license to use the patents and technology in connection
with LocalSource and all other Interactive TV applications and services other
than SourceGuide. Further, Liberate agreed to assist us, without charge, in the
development of the technology that implements the functionality of SourceGuide.
Liberate also agreed, at no cost to us, to continue the development of specific
features of the VirtualModem technology to support our Interactive TV
applications and services. Liberate is expected to deliver to us specific
software components and technology related to SourceGuide in the first half of
2001.

Distribution

     In order to offer Interactive TV applications and services in a particular
market, we must negotiate a programming services agreement with the incumbent
cable television or other system operator serving the market. These agreements
authorize the system operator to distribute and promote our Interactive TV
applications and services to their subscribers and often contain terms and
conditions regarding software licensing, pricing, revenue sharing and joint
marketing arrangements. In particular, our programming services agreements
typically provide for system operators to pay us a per-subscriber fee for the
right to license and distribute our Interactive TV applications and services to
their subscribers.

     We have programming services arrangements with the following cable
television system operators to distribute our Interactive TV applications and
services.

          Insight Communications Company, Inc. We currently have a letter of
     intent with Insight Communications Company, Inc., the eighth largest cable
     television system operator in the United States based on customers served.
     Pursuant to the terms of this arrangement, Insight Communications began
     introducing our interactive programming services to its subscribers in the
     second quarter of 1999. Since September 2000, Insight Communications has
     paid us a fee based on the number of subscribers receiving our Interactive
     TV applications and services. We agreed to share with Insight
     Communications a percentage of advertising and other revenues from
     Interactive TV generated through Insight Communications' cable systems. As
     of year-end, 100,000 digital subscribers in Insight Communications' cable
     systems in four states were using SourceGuide, and local interactive
     programming portal, LocalSource. We are taking steps to enter into a
     programming services agreement to replace our letter of intent with Insight
     and intend to enter into an agreement in the first half of 2001.

          Cablevision Systems Corporation. We currently have a programming
     services agreement with Cablevision Systems Corporation. Cablevision is one
     of the leading entertainment, media and telecommunications companies and
     currently operates Rainbow Media Holdings, Inc., Madison Square Garden and
     New York's famed Radio City Music Hall. Our agreement with Cablevision
     makes SourceGuide available to subscribers in Cablevision's Boston,
     Massachusetts system. We believe Cablevision is near completion in the
     process of transferring the assets and properties of its Boston,
     Massachusetts system to AT&T Corporation. As a result, we expect our
     programming services agreement to be transferred to AT&T Corporation and to
     continue on the same terms.

     We also have programming services agreements with companies that compete
with cable television system operators and provide voice, video and data
communications and television services across high-speed broadband connections.
These companies are often referred to as "overbuilders" because they are
building cable network infrastructure in markets that already have incumbent
cable system operators. We have programming services agreements with the
following overbuilders:


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          Everest Communications Inc. Everest Connections Corporation is a part
     of Everest Global Technologies Group, LLC and is affiliated with GLA
     Network Technologies, a privately held St. Louis-based telecommunications
     consultant and network engineering firm, and Utilicorp, a Kansas City
     utility corporation. Our agreement with Everest makes SourceGuide and
     LocalSource available to Everest's customers in the Kansas City metro area.

          Grande Communications Inc. Grande Communications, Inc. is currently
     building a deep fiber broadband network to homes and businesses. The
     company plans to deliver high-speed Internet access, local and long
     distance phone and cable television entertainment services over its own
     broadband network to communities in Texas. Grande's service area is
     expected to include the Houston metro area, the Austin metro area, San
     Marcos, New Braunfels and San Antonio. Our agreement with Grande is
     expected to make SourceGuide and LocalSource available to Grande's
     customers in the Austin metro area as well as San Marcos, New Braunfels,
     and San Antonio in the first half of 2001.

          WideOpenWest Networks LLC. WideOpenWest Networks LLC is building fiber
     optic networks that offer high-speed connections to the Internet, digital
     cable television and broadband telephone services in several Western
     markets. Our agreement with WideOpenWest is expected to make SourceGuide
     and LocalSource available to WideOpenWest customers in the Denver
     metropolitan area in early 2001.

     We also have explored relationships with specific technology partners to
gain distribution for our Interactive TV applications and services, including
the following:

          Liberate Technologies. Liberate is a leading provider of a middleware
     platform for delivering Internet-enhanced content and applications to
     information appliances, such as cable television set-top boxes, game
     consoles, smart phones and personal digital assistants. Its software allows
     network operators, such as telecommunications companies, cable and
     satellite television operators, Internet service providers and information
     appliance manufacturers to provide consumers access to Internet-based
     applications and services.

          We are a "preferred content provider" to Liberate under a preferred
     content provider agreement. This agreement requires Liberate to use
     commercially reasonable efforts to introduce us to Liberate's cable
     operator customers and to jointly offer proposals to customers interested
     in deploying products that use VirtualModem technology. Liberate also has
     agreed to offer a special marketing incentive credit, in the form of a
     discount from Liberate's standard prices, to cable operators that use
     VirtualModem products and also agree to use our Interactive TV applications
     and services. Liberate has agreed not to give the same special marketing
     incentive credit to its cable system operators that use applications and
     services competitive with ours. In addition, where a cable system operator
     has received a special marketing incentive credit from Liberate for using
     our Interactive TV applications and service, we will pay Liberate, for a
     period of four years, a percentage of any per-subscriber carriage fee paid
     by that customer to us approximately equal to the percentage of the price
     discount offered by Liberate as a special marketing incentive credit.

     From time to time we may also pursue relationships and enter into
discussions with third-party advisors or promoters to gain distribution for our
Interactive TV applications and services. These relationships typically are
limited to success with specific customers and, among other things, may require
us to pay commissions or issue warrants exercisable for shares of our common
stock.


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Competition

     Interactive television generally refers to services that allow the viewer
to interact with advertisements, programs or other content through the
television set, usually by using a conventional television remote control, or a
keyboard for applications that require more user input such as e-mail. The
revenue sources for interactive television are primarily subscription fees,
advertising and television commerce, or "t-commerce." The interactive television
industry has continued to experience rapid technological change and competitive
developments. Many new competitors have appeared which offer a variety of
applications, services and technologies. Some of these applications and services
compete directly with ours while others have qualities that we believe are
complementary to our applications and services.

     Interactive television can be broken down into three general service
categories: enhanced television services, Internet over television, and
personalized television. Enhanced television services, which include interactive
program guides, generally allow viewers to scan programming and obtain more
information and request products or information to be sent to their homes.
Internet over television services enable viewers to browse and interact with
Internet content through their television. Personalized television allows
viewers to "personalize" their viewing experience. Two examples of personalized
television are video-on-demand ("VOD") and personal video recording ("PVR"). VOD
allows television viewers to order specific programs when they want them and PVR
lets viewers pause, rewind, and replay television programming, as well as record
programs.

     SourceGuide competes with other interactive program guides and enhanced
television services, as well as information regarding TV program listings and
descriptions available on- and off-line. The largest interactive program guide
provider is Gemstar - TV Guide International, or Gemstar, which provides a
patented interactive program guide. Gemstar recently announced a 10-year
agreement with Charter Communications, Inc. to deploy its program guide to
Charter's cable subscribers and a 20-year deal with Comcast Corporation. In
addition, DIVA Systems Corporation offers a program guide. Program schedule
information and descriptions are also available through newspapers and other
sources. For example, Gemstar also distributes TV Guide magazine to a large
number of households and newsstands and provides customized monthly program
guides for cable and satellite operators. We believe that because SourceGuide
uses a server-based technology, SourceGuide offers system operators a more
dynamic way to transfer content and other data to viewers than program guide
applications that rely on non-server-based technology, including the Gemstar
program guide. We also believe that SourceGuide offers a more convenient method
of satisfying viewer demand for program information than other on and off-line
providers because it is always available, continually refreshed and interactive.

     SourceGuide also faces competition from program guide technology supported
by a consortium of large cable system operators known as the TV Gateway. TV
Gateway, which includes Adelphia Communications Corp., Charter Communications
Inc., Comcast Corporation, Cox Communications Inc. and WorldGate Communications
as partners, has announced plans to deploy an interactive program guide using
technology developed by WorldGate Communications. We believe the threat posed by
the TV Gateway consortium may be mitigated by Gemstar's recently announced
agreements with Charter Communications, Inc. and Comcast Corporation to deploy
the Gemstar program guide in the cable systems of those operators. Further, we
and Liberate have been involved in patent litigation with WorldGate regarding
WorldGate's interactive TV services. We believe that our exclusive rights to a
robust patent portfolio for server-based interactive program guide technology
will continue to provide us with a distinct competitive advantage as competition
increases for interactive program guide applications.


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     In the interactive television arena, LocalSource competes with local
information offerings from eLocal Network and Cablesoft Corporation, which was
recently acquired by OpenTV. Other national competitors in the local information
arena include AOL Time Warner's DigitalCity.com, Ticketmaster's CitySearch.com,
and RealCities.com, which is maintained by KnightRider.com, as well as Comcast
Corporation's In Your Town(TM), all of which are distributed on the World Wide
Web and are not designed expressly for interactive television. WorldGate
Communications also provides local information as part of its Internet on TV
service. In addition, there are numerous regional and metropolitan-specific
Internet sites that provide local news and information.

IT NETWORK

     Our IT Network business focuses on the production, sale and delivery of
rich media content, such as audio and text programming, across a range of
communications platforms including the Internet, digital television,
telephone-based voice portals, and wireless and wireline telephone networks.
Rich media content generally refers to information and entertainment content
that can be transferred and displayed or heard via the Internet and other
current and emerging communication devices. Streaming media, which refers to the
simultaneous transfer and display of the sound and images on the World Wide Web,
has become an increasingly popular form of rich media content. A user can listen
to and watch streaming media while it is being transmitted from the World Wide
Web to their Internet browser, instead of waiting minutes or hours for it to be
fully downloaded.

     Prior to December 31, 2000, our IT Network business also was engaged in the
provision of interactive advertising services to commercial advertisers through
yellow page telephone books. Generally, our IT Network interactive advertising
services were promoted by advertisements in a web site operated by us and by
print advertisements in yellow page telephone books distributed by our yellow
pages publisher partners. The print advertising directed consumers to
interactive information services that could be accessed over the telephone and
via the Internet. For example, telephone users could navigate to specific topics
by entering a four-digit code and often connect directly to an advertiser at the
push of a button. In the agreements with our publisher partners, we typically
purchased advertising inventory and retained the related advertising revenue or
sold advertising. We also entered into revenue sharing arrangements with yellow
page publisher. Under these agreements our revenue share depended on the level
of advertiser management, system management and information content services
provided to the yellow pages publisher partner and the amount charged for
services. We discontinued our front-of-book yellow page advertising services as
of December 31, 2000, subject to fulfilling our obligations to our commercial
advertisers with respect to the current circulation of yellow pages telephone
books. As a result, our IT Network business now focuses on the production, sale
and delivery of rich media content. For the year ended December 31, 2000,
front-of-book yellow page advertising comprised 45% of our consolidated monetary
revenues.

     Our emphasis on the production, sale and delivery of rich media content
reflects our aim of becoming a leading provider of private label rich media
content across all communications platforms. We believe demand for rich media
content, including our private-label rich media content, is growing and that the
market has experienced the following developments:

          o    An increasing desire among platform operators to control the
               brand experience. We believe private label content gives platform
               operators the opportunity to offer news, weather, sports,
               finance, entertainment and other compelling rich media content
               under their own brand, rather than diluting or fragmenting their
               brand by using content from multiple branded content providers.


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          o    The emerging desire for platform operators to offer their
               end-users access anywhere, anytime, from any device. We believe
               platform operators are broadening their networks to generate
               greater user loyalty. For example, America Online which is well
               known for its Internet portal service has also developed services
               for several other platforms including, AOL TV, an interactive TV
               service, and an AOL Voice Portal, which provides rich media to
               users through wireless devices.

          o    The increasing success of Application Service Providers (ASP's).
               Application service providers generally are providers of vertical
               services, including content, to businesses. We believe ASPs are
               seeking to leverage relationships with content providers to
               provide turnkey solutions for platform operators. We believe this
               model has been particularly effective in the wireless and
               telephone-based voice portal platforms, where our IT Network
               business is aggressively seeking to leverage relationships with
               successful ASP's.

Products and Services

     Rich Media Content. We offer a variety of audio and text reports for
delivery across all platforms each day. Our programming typically is provided
without our brand name so it appears to originate from our customers' web sites
or other platforms and can be incorporated into a branded content offering by
our customers. Our programming comprises a variety of dynamic programs that are
frequently updated and other consumer information resources that updated less
often. Dynamic programming includes news, weather, sports, financial,
horoscopes, soap opera updates, lottery results and other entertainment
features, which are updated as appropriate. Our consumer information resources
provide local consumers with general information on a wide array of topics that
include health, law, finance and home repair. We currently categorize our
programming by 17 content channels: News, Sports, Financial, Entertainment,
Canadian, Text, Health, Legal, Auto, Lifestyle, Outdoor Recreation, Home,
Technology, Women's, Spanish-Language, Employment, and Personal Finance. We may
also agree to produce custom content channels at the request of our customers.

     Audiotex. We are the largest producer of interactive audiotex content for
newspaper publishers. Audiotex generally refers to information in audio format
related to articles or other text in a print publication that can be heard in
audio format via telephone. We produce a variety of audio reports each day,
which are transmitted via satellite to our newspaper publisher customers. Our
newspaper publisher customers offer our audio reports to their readers via
telephone often with no charge to callers. We typically provide audio reports to
newspaper publishers for a license and distribution fee. The fee is determined
by the amount and type of content purchased, the size of the market and the
circulation of the newspaper.

     Other Services. We provide other services including advertiser management
and system management. The advertiser management service provides advertising
clients with call statistics and updates for their voice information
advertisements on a regular basis. The systems management service provides
technical support and maintenance of voice information systems for many of our
publisher partners.


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Distribution

     We distribute our programming primarily through the Internet, digital
television, telephone-based voice portal systems, and wireless and wireline
telephone networks in accordance with separate agreements with each of our
customers. The agreements typically provide for an annual fee based upon the
number of end-users to which our programming is made available.

     We have also explored non-exclusive relationships with resellers and other
third-party agents to market and solicit customers for our rich media content.
For example, we have an agreement with a Japan-based representative and
distribution agent to promote our audio and text programming to wireless
carriers in Japan for a commission. Under this agreement we provide our audio
and text programming to the distribution agent who is then solely responsible
for transmission of the content to the customer. Our distribution agent also is
responsible for the collection of revenue from the customer and payment to us.

Technology

     News, sports, financial, entertainment, other content and advertiser
messages are edited and produced in our production studios. Copywriters prepare
written scripts from information obtained under contract from various
newsgathering and other services. The written scripts are then used to produce
professional voice recordings often with mixed background music. Finished audio
recordings are encoded in various formats, including RealPlayer(TM) and Windows
Media(TM). We deliver our programming to our customers primarily by Internet and
through our connection to a digital satellite network. In particular, we may
deliver programming to our customers by the following methods:

          o Internet: When we distribute our programming to our Internet
          customers, we typically provide a link to one of our web servers where
          our programming resides and is regularly updated. Our Internet
          customers use streaming media technology to enable their end-users to
          retrieve and play our audio programming. Streaming media technology
          includes various Internet browser "plug-in" software applications that
          enable end-users to view rich media encoded in specific formats.

          o Digital Television: SourceSuite is currently our only digital
          television customer. SourceSuite typically receives our programming
          via an Internet server. In particular, SourceSuite stores files
          containing our programming and helps enable cable subscribers to
          access and play our audio programming through the television in
          connection with our Interactive TV applications and services.

          o Voice Portals: We typically transmit our programming via file
          transfer protocol, or FTP, to our voice portal customers' FTP servers.
          Our voice portal customers store files containing our programming and
          use voice-activated telephone systems to enable their end-users to
          retrieve and play our audio programming via the telephone.

          o Telephone Networks: Our wireless and other telephone customers
          typically receive our programming via file transfer protocol to their
          FTP servers. Our wireless and wireline customers store files
          containing our programming and enable their end-users to hear our
          audio programming via their telephone, or view a text version of our
          audio programming on browser-enabled phones, by entering codes
          associated with each content category.

          o Audiotex: Our newspaper publisher customers using our audiotex
          services typically receive our audiotex services through satellite
          distribution network delivery. In particular, our finished audio
          programs are transmitted to the local voice information systems of our


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          audiotex customers through satellite distribution. Our audiotex
          customers designate a telephone number and code for readers to dial in
          order to access additional information associated with articles in
          their newspapers. Multiple telephone lines are connected to each local
          voice information system to process local incoming calls without
          charge to callers.

Competition

     The market for the production, sale and delivery of rich media is becoming
increasingly more competitive. In particular, there are several companies that
currently produce or have the capability of producing streaming media content.
Many of these companies have greater resources than us and have well-known brand
names associated with their content. Generally, however, we believe rich media
customers will have a combination of branded and private label content on their
platforms. We believe that the provision of branded content may involve a higher
cost structure than the provision of unbranded content, which may give us a
competitive advantage in the market. For example, we generally make our content
available for distribution upon payment of a license fee by our customers. In
contrast, we believe many providers of branded content pay substantial fees to
platform operators for distribution of their content.

EMPLOYEES

     As of March 23, 2001, we had a total of 141 full and part-time employees.
None of our employees is subject to a collective bargaining agreement. We have
experienced no work stoppages, and we believe that we have good relations with
our employees.

REGULATORY MATTERS

     The telecommunications and cable television industries are subject to
extensive regulation by federal, state and local government agencies. Existing
regulations were substantially affected by the passage of the Telecommunications
Act of 1996. This legislation was implemented in administrative proceedings
conducted by the Federal Communications Commission and state regulatory
agencies. Most current regulatory and legislative activity addresses how cable
television companies may enter new lines of business, the manner in which they
can participate in new lines of business and the rates they can charge
consumers. For example, cable television companies are now permitted to provide
telephone service. The federal and state administrative proceedings may also
affect the nature and extent of competition that will be encountered by us.

     Although there are currently few laws and regulations directly applicable
to the Internet, it is likely that new laws and regulations will be adopted in
the United States and elsewhere covering issues such as music licensing,
broadcast license fees, copyrights, privacy, pricing, sales taxes and
characteristics and quality of Internet services. There are many laws,
regulations and policies, both existing and proposed, at all levels of
government that may impact, in varying degrees, the manner in which we market
and deliver our applications and services. It is possible that governments will
enact legislation that may be applicable to our operations in areas such as
content, network security, encryption and the use of key escrow, data and
privacy protection, electronic authentication or "digital" signatures, illegal
and harmful content, access charges and retransmission activities. Moreover, the
applicability to the Internet of existing laws governing issues such as property
ownership, content, taxation, defamation and personal privacy is uncertain. The
majority of such laws was adopted before the widespread use and
commercialization of the Internet and, as a result, do not contemplate or
address the unique issues of the Internet and related technologies. Neither the
outcome of new legislative proposals, nor their impact on the online information
and services industry in general, or on us in particular, can be predicted at
this time. Any such new legislation or regulation or governmental enforcement of
existing regulations may limit the growth of the Internet and our other markets,
increase our cost


                                       11
<PAGE>   12

of doing business or increase our legal exposure, which could have a material
adverse effect on our business, financial condition and results of operations.

     The on-line information and services industry is evolving and will be
affected in the future by laws, regulations and policies adopted at the federal,
state and local levels of government. There are many laws, regulations and
policies, both existing and proposed, at all levels of government that may
impact, in varying degrees, the manner in which we market and deliver our
products and services. Neither the outcome of these proposals, nor their impact
on the on-line information and services industry in general, or on us in
particular, can be predicted at this time.

FORWARD LOOKING INFORMATION AND RISK FACTORS

     We or our representatives from time to time may make, or may have made,
certain forward-looking statements, whether orally or in writing, including,
without limitation, any such statements made, or to be made, under Management's
Discussion and Analysis of Financial Condition and Results of Operations, press
releases and other information contained in our various filings with the
Securities and Exchange Commission. We wish to ensure that such statements are
accompanied by meaningful cautionary statements, so as to ensure to the fullest
extent possible the protections of the "safe harbor" established in the Private
Securities Litigation Reform Act of 1995. Accordingly, such statements are
qualified in their entirety by reference to, and are accompanied by, the
following discussion of certain important factors that could cause actual
results to differ materially from those projected in such forward-looking
statements.

     We caution you that this list of factors does not describe all of the risks
of an investment in our common stock. We operate in a rapidly changing business
environment, and new risk factors continually emerge. We cannot predict every
risk factor, nor can we assess the impact of all these risk factors on our
business or the extent to which any factor, or combination of factors, may cause
actual results to differ from those projected in any forward-looking statements.
Accordingly, you should not rely upon forward-looking statements as a prediction
of our actual results.

We May Not Be Able to Generate Enough Cash to Service Our Debt and We May be
Required to Refinance All or a Portion of These Obligations, Sell Some of Our
Assets or Take Other Steps to Recapitalize or Reorganize Our Businesses and
Assets.

     Our ability to meet our payment obligations with respect to our Notes and
our other indebtedness will depend on our ability to generate substantial cash
flow in the future. Accordingly, we cannot assure you that our business will
generate sufficient cash flow to service our debt.

     If we are unable to generate sufficient cash flow from operations, or
otherwise satisfy our obligations on our Notes and other indebtedness, we may be
required to refinance all or a portion of these obligations, sell some of our
assets or take other steps to recapitalize or reorganize our assets. We expect
that any payment of the principal on any of our Notes or other indebtedness may
have to be refinanced, including the possibility that this financing may occur
by selling some of our assets. However, the indenture governing the Notes
restricts our ability to incur additional indebtedness and to sell assets.
Additionally, we may not be able to refinance, sell assets or recapitalize or
reorganize our businesses and assets on acceptable terms or at an appropriate
time. On March 3, 2000, we received 886,000 shares of Liberate common stock with
a fair market value of approximately $87.4 million, based on the closing price
of Liberate common stock on that of $98.6875 per share. As of March 23, 2001,
the value of Liberate common stock held by us was approximately $7.0 million
based on a closing price of Liberate common stock of $7.875 per share.
Accordingly, we cannot assure you that the value received from the sale of the


                                       12
<PAGE>   13
Liberate common stock held by us could enable us to meet interest payments for
the remaining life of the Notes. Due to significant fluctuations in the fair
market value of the Liberate stock, there can be no assurances that we will have
sufficient funds in order to pay our interest payments due on our Notes on May
1, 2001 and November 1, 2001, of approximately $5.3 million each. Any steps
taken to refinance, recapitalize or reorganize our assets and liabilities could
have a material adverse effect on our business and could involve significant
dilution to our existing shareholders.

Our Auditors Have Informed Us That They Believe There is a Substantial Doubt
About Our Ability to Continue as a Going Concern

     Ernst & Young, our independent auditors have included in their opinion a
reference to a substantial doubt about our ability to continue as a going
concern. We have reported both an operating loss and a net loss each year since
our inception, including an operating loss of $12.7 million and a net loss
attributable to common stockholders of $19.8 million for the year ended December
31, 2000. We also may be required to provide additional funding for
SourceSuite's operations in 2001. Additionally, we have interest payments on our
Notes of approximately $5.3 million each due on May 1 and November 1, 2001.

     Our available sources of cash during the next fiscal year will be derived
from operations. In recent months, in an effort to reduce costs, we have taken
necessary steps to restructure our business which include discontinuing
front-of-book advertising services, exiting low margin products and instituting
staff reductions and cost control measures. At December 31, 2000, we had $7.8
million of cash available, along with our Liberate stock valued at $12.1 million
as of that date. Additionally, we have engaged UBS Warburg LLC as our financial
advisor to help us evaluate strategic alternatives, especially related to our
debt requirements. At this time, we cannot state with any degree of certainty
whether additional financing will be available to us and, if available, that the
source of financing would be available on terms and conditions acceptable to us.
Any potential sources of additional financing may be subject to business and
economic conditions outside our control. Our accompanying consolidated financial
statements do not include any adjustments to reflect the possible future effects
on the recoverability and classification of assets or the amount and
classification of liabilities that may result from the outcome of this
uncertainty. While we are currently working with UBS Warburg LLC to evaluate
strategic alternatives, there can be no assurances that we will be able to make
the necessary changes in order to continue as a going concern.

We May Not be Able to Obtain Additional Financing Required to Repay or Otherwise
Retire Our Notes and to Redeem Our Preferred Stock.

     We will require additional financing to repay or otherwise retire our Notes
and to redeem our Preferred Stock. The Notes mature November 1, 2004 and the
Preferred Stock must be redeemed on November 1, 2007. We cannot be certain that
any additional financing required will be available at the time or times needed,
or available on terms acceptable to us. In addition, any additional financing
may involve significant dilution to our existing shareholders.

We Could Have Insufficient Collateral to Repay Our Notes Upon an Event of
Default

     In an event of default under the indenture governing the Notes occurs, the
collateral may not be sufficient to repay our Notes in full. Although the
collateral consists of substantially all of our assets, most of the assets
consist of cash, investments, goodwill, other intangibles and accounts
receivable. As of December 31, 2000, the tangible assets (excluding cash,
investments, receivables and other current assets) included in the collateral
had a net book value of approximately $1.3 million, and consisted primarily of
computer and other equipment.


                                       13
<PAGE>   14

On March 3, 2000, we received 886,000 shares of Liberate common stock with a
fair market value of approximately $87.4 million, based on the closing price of
Liberate common stock on that date of $98.6875 per share. At December 31, 2000,
the fair market value of this stock was approximately $12.1 million. As of March
23, 2001, the value of Liberate common stock was approximately $7.0 million.

Our High Degree of Leverage Could Have Certain Negative Consequences on Our
Operations and Financial Condition

     We are highly leveraged and substantially all of our assets are subject to
security interests securing our Notes. As of December 31, 2000, we had
outstanding approximately $88.5 million principal amount of Notes and shares of
Preferred Stock with a stated value of $8.6 million and a liquidation value of
$13.7 million due in 2007.

     Our high degree of leverage could have certain negative consequences,
including:

     o    A substantial portion of our cash flow will be required for the
          payment of principal and interest on our Notes and will not be
          available for other purposes;

     o    Our ability to obtain additional financing for capital expenditures,
          acquisitions, working capital or other purposes may be impaired;

     o    We may be more leveraged than some of our competitors and this may
          place us at a competitive disadvantage; and

     o    Our high degree of leverage reduces our flexibility in responding to
          changes in economic conditions, including increased competition and
          demand for new products and services.

     In addition, the indenture governing the Notes and the certificate of
designation relating to the Preferred Stock impose significant financial and
operating restrictions on us.

We Have a History of Operating and Net Losses and May Not Achieve Profitability
in the Future

     We have reported both an operating loss and a net loss in each year since
our inception, including an operating loss of $12.7 million and a net loss
attributable to common stockholders of $19.8 million in the year ended December
31, 2000. We expect to incur operating losses at least through 2001, and may
incur operating losses thereafter.

A Change of Control Would Require Us to Offer to Repurchase Our Notes and
Preferred Stock, for Which We May Not Have Sufficient Funds

     If a change of control occurs, we must offer to repurchase our Notes at
101% of their principal amount, plus accrued and unpaid interest to the date of
repurchase, and our Preferred Stock at 101% of the liquidation preference, plus
accumulated and unpaid dividends. We cannot be certain that we will have
sufficient funds to make any required repurchase. If we do not have sufficient
available funds to pay for our Notes tendered for repurchase, an event of
default will occur under the indenture. If an event of default occurs, it will
cause an accelerated maturity of our Notes, unless waived by the holders of our
Notes. If we are required to offer to repurchase our Preferred Stock and we do
not have sufficient available funds, the holders of our Preferred Stock will
have the right to elect two directors.

                                       14
<PAGE>   15


The Loss of Our Largest Customer of Our Interactive TV Applications and Services
Could Adversely Affect Our Revenues and Future Prospects

     In the past, we have derived, and expect in the future to derive, a
significant portion of our revenues from a limited number of customers. In the
event that these customers cease to offer our Interactive TV applications and
services, or if any of these customers does not give a positive reference on our
Interactive TV applications and services, to other prospective customers, our
business, operating results and financial condition could be materially
adversely affected. In 2000, Insight Communications accounted for approximately
91% of SourceSuite's revenues. We cannot assure you that Insight will continue
to offer our Interactive TV applications and services to its cable subscribers.

The Failure of Cable System Operators to Provide Us Access to Channels Would
Result in Our Being Unable to Successfully Market and Sell Our Interactive TV
Applications and Services

     Our ability to offer our Interactive TV applications and services on any
cable television system depends on obtaining a satisfactory programming services
agreement from cable television and other system operators. Intense competition
exists among suppliers of programming for access to channels. We cannot be
certain that we will enter into any additional programming services agreements.
Even if programming service agreements are entered into, there is no assurance
that our programming services will be distributed as a result of such
agreements. Currently, we have programming services agreements with Cablevision
Systems Corporation and several overbuilders and a letter of intent with Insight
Communications. If we are unable to enter into a programming services agreement
with Insight, or other additional system operators, on standard terms, our
business and financial condition will be materially and aversely affected.

Demand for Our Applications and Services Will Decline Significantly if Our
Software Cannot Support and Manage a Substantial Number of Users

     Despite frequent testing of the scalability of our server-based Interactive
TV applications in a laboratory environment, the ability of our software
platform to support and manage a substantial number of users in an actual
deployment is uncertain. If our software platform does not efficiently scale to
support and manage a substantial number of users while maintaining a high level
of performance, demand for our applications and services and our ability to sell
additional applications to our existing customers will be significantly reduced.

We May Have to Cease or Delay Product Shipments if Our Technology Partner is
Unable to Deliver or Delays Shipment of Its Products

     We currently rely on Liberate to provide technological support and the
middleware solution upon which our Interactive TV applications and services
operate. Liberate technological support may not continue to be available to us,
or our customers, on commercially reasonable terms, or at all. Further, Liberate
may cease or delay its product shipments, including its middleware solution, to
our customers. If Liberate does not continue to support our applications and
services, we would be required to find an alternative platform to operate our
applications and services. The process of redesigning our applications and
services to operate on one or more other middleware platforms would be time
consuming and costly. In addition, we may be required to obtain licenses for
other existing or future technologies that we desire to integrate with our
applications and services. Accordingly, any failure or significant delay by
Liberate in supporting our applications or products or shipping its technology
to our customers, could require us to cease or delay product shipments while we
seek to develop alternative technologies.


                                       15
<PAGE>   16

The Market for Interactive Television and Rich Media Content is Uncertain and
Consumers May Not Choose Our Applications Content and Services

     Interactive television is a new and emerging business. There is no
assurance that a significant market for interactive television will develop or
that cable subscribers will use the television as a source of interactive
information and services. In addition, our Interactive TV applications and
services will be competing with other enhanced television services and services
offering access to the Internet through the television. This competition
includes other interactive programming guides and other interactive information
and entertainment sources. There is no assurance that our Interactive TV
applications and services will prove more desirable to customers than any
competing services. If our applications and services do not achieve market
acceptance, we will be unable to execute our business strategy and our business
will be adversely affected.

     In addition, the emphasis of our IT Network business on the production,
sale and delivery of rich media content involves significant competitive risk.
There are several branded content providers that deliver or are capable of
delivering rich media content. Some of these competitors have operations that
are larger and better funded than our IT Network business.

If Independent Information Sources Become Unavailable, We May Have to Develop
More of Our Own Content Which Could Increase Our Costs and Adversely Affect Our
Business

     If we obtain greater distribution for our Interactive TV applications and
services and our rich media content, our success will be dependent, in part, on
the availability on favorable terms of quality programming and local and other
information services such as news, weather and sports information. We use
independent information service providers and local media to create, produce and
update a portion or our programming and content at no, or minimal, cost to us.
We cannot assure you that independent programming sources will continue to be
available to us on favorable terms or at all. If independent information sources
become unavailable, we will have to increase the extent to which we supplement
these independent services with our own content development resources. This
could significantly increase our operating costs.

Failure to Make Necessary Technical Developments will Increase Our Costs of
Providing Programming

     Further technical development of network operating centers is needed to
enable us to economically deploy Interactive TV to multiple cable television
systems. In particular, we require a sophisticated engineering and
communications infrastructure to design, deliver and test our Interactive TV
applications and services. We cannot assure you that the necessary technology
will be completed, or if it is, that it will be completed on schedule or on
budget.

A Delay in the Roll-Out of Digital Set-Top Boxes Could Adversely Affect Our
Ability to Provide Our Programming Services

     Expansion of our Interactive TV business is dependent upon the widespread
distribution of digital set-top boxes and the upgrading of cable infrastructure
to two-way, digital capabilities. If cable companies delay conversion of their
systems to digital set-top boxes, limit the number of digital set-top boxes
distributed or fail to upgrade their cable infrastructures, our ability to
successfully execute our business strategy would be adversely affected.


                                       16
<PAGE>   17


Our Industry is Highly Competitive and We Cannot Give Assurances that We Will be
Able to Compete Effectively

     In industries characterized by extensive capital requirements and rapid
technological change, we face potential competition for the acceptance of our
on-line programming and services from a number of companies, most of which have
significantly greater financial, technical, manufacturing and marketing
resources than us and may be in a better position to compete in the industry. In
both our Interactive TV business and our IT Network business, we face
competition for subscription, advertiser and commerce revenues from other media,
including radio, television, newspapers, magazines and the Internet. Rich media
content is accessible across multiple platforms requiring content providers,
including us, to compete aggressively for revenue opportunities. We believe that
for the foreseeable future, public access to digital television will generally
be through cable and satellite operators. Accordingly, we must compete with
other providers of television programming to establish relationships with cable
and satellite operators to gain channel access and other distribution
privileges.

We May be Subject to Third Party Intellectual Property Infringement Claims that
Could be Expensive to Defend

     We expect that, like other software application developers and service
providers, we will increasingly be subject to infringement claims as the number
of products and competitors developing Interactive TV applications and services
grows and the functionality of products in different industry segments overlaps.
From time to time, we hire or retain employees or external consultants who have
worked for independent software vendors or other companies developing products
similar to those offered by us. These prior employers may claim that our
products are based on their products and that we have misappropriated their
intellectual property. We cannot guarantee that:

     o    An infringement claim will not be asserted against us in the future;

     o    The assertion of such a claim will not result in litigation;

     o    We would prevail in such litigation; or

     o    We would be able to obtain a license for the use of any infringed
          intellectual property from a third party on commercially reasonable
          terms, or at all.

     Any claims relating to our intellectual property, regardless of their
merit, could seriously harm our ability to develop and market our applications
and services and manage our day-to-day operations because they could:

     o    Be time consuming and costly to defend;

     o    Divert management's attention and resources;

     o    Cause product shipment delays;

     o    Require us to redesign our products; or

     o    Require us to enter into royalty or licensing agreements.


                                       17
<PAGE>   18


Rapid Technological Advances Could Render Our Products and Technologies Obsolete
or Non-Competitive

     The on-line information and services industry is experiencing rapid change.
Products or technologies developed by others could render obsolete or otherwise
significantly diminish the value of our products or technologies. Our future
performance depends substantially on our ability to respond to competitive
developments, upgrade our programming, commercialize products and services
incorporating upgraded programming, and adapt our operational and financial
control systems as necessary to respond to continuing changes in our businesses.
We cannot be certain that we will be successful in these efforts.

Our Shareholder Rights Plan Could Discourage a Strategic Transaction Involving
Our Company, which Might Otherwise Benefit Our Shareholders

     In April 1998, we adopted a shareholder rights plan and declared a dividend
distribution of one common share purchase right on each outstanding share of our
common stock. Our shareholder rights plan has certain anti-takeover effects.
Generally, if a person or group acquires 15% or more of our common stock, the
rights will entitle shareholders other than the acquirer to purchase shares of
the common stock (or, in certain circumstances, cash, other property or other
securities) at half price. If, after the acquisition by a person or group of 15%
or more of our common stock, we sell more than 50% of our assets or earning
power or we are acquired in a merger or other business combination transaction,
the acquirer must assume the obligations under the shareholder rights plan and
the rights become exercisable to acquire the shares of stock of the acquirer at
the discounted price. This plan expires no later than May 7, 2008. The
shareholder rights plan could delay or make difficult a merger, tender offer or
proxy contest involving us.

Our Stock Price is Volatile

     Our common stock price can be extremely volatile and has experienced
substantial and sudden fluctuations. The price of our common stock has been and
may continue to be subject to wide fluctuations in response to a number of
events and factors, such as:

     o    variations in our operating results;

     o    differences between our results of operations and analysts' estimates;

     o    announcements by us or our competitors of technological innovations or
          new products and services;

     o    the announcement of the results of existing or new litigation; and

     o    general economic and market conditions.

Future Stock Sales Could Adversely Affect the Price of Our Common Stock

     Sale of a substantial number of shares of our common stock in the public
market could negatively impact the market price for our common stock. All shares
of our common stock currently outstanding are freely tradable without
restriction by persons other than our "affiliates" except for the shares issued
to Insight Interactive in November 1999. In addition, as of March 23, 2001,
there were options, warrants and exchange rights outstanding entitling such
holders to acquire approximately 11.8 million shares of our common stock.


                                       18
<PAGE>   19


Our Common Stock was De-listed from Quotation on the NASDAQ National Market
System and now trades on the Over-the-Counter Bulletin Board

     As of March 7, 2001, our common stock was delisted from the NASDAQ National
Market System for failure to meet specific listing conditions. As a result, our
common stock is currently quoted on the over-the-counter bulletin board under
the symbol SRCM.OB. In addition to reducing the trading liquidity of our common
stock, the delisting from the NASDAQ may significantly impair our ability to
raise additional funds to operate our businesses. We cannot assure you that we
will be able to satisfy the NASDAQ listing requirements in the future or that
our shares will again be listed on the NASDAQ.

The Inability to Retain and Motivate Our Key Management Could Result in an
Adverse Effect on Our Business

     The success of our business depends, to a large extent, on our ability to
retain and motivate our executive officers and other key management personnel.
The loss of any one of our executive officers and other key management
personnel, including our chief executive officer, chief financial officer, chief
legal officer and our senior vice presidents, could be detrimental to our
ability to successfully execute our business strategy. In addition, for us to
implement our strategy and continue our development and growth, it will be
necessary to attract and retain qualified personnel in all areas.

Our Business has been and Continues to be Subject to Extensive Governmental
Legislation and Regulation and Changes in this Legislation and Regulation Could
Adversely Affect Our Business

     Current and future government regulation may have an impact on our
business. The telecommunications and cable television industries are heavily
regulated by federal, state and local governmental agencies. Existing
regulations were substantially affected by the passage of the Telecommunications
Act of 1996, which allows both cable television companies and telephone
companies to enter and participate in new lines of business. This introduced the
possibility of new, non-traditional competition for both cable television and
telephone companies and may result in greater competition for us. The outcome of
federal and state administrative proceedings may also affect the nature and
extent of competition that we will encounter. In addition, future regulations
may prevent us from realizing sales of database information about consumers
obtained by us from our television and telephone businesses. These competitive
developments, as well as other regulatory requirements relating to privacy
issues, may have an adverse effect on our business.

     Although there are currently few laws and regulations directly applicable
to the Internet, it is likely that new laws and regulations will be adopted in
the United States and elsewhere covering issues such as music licensing,
broadcast license fees, copyrights, privacy, pricing, sales taxes and
characteristics and quality of Internet services. There are many laws,
regulations and policies, both existing and proposed, at all levels of
government that may impact, in varying degrees, the manner in which we market
and deliver our applications and services. It is possible that governments will
enact legislation that may be applicable to our operations in areas such as
content, network security, encryption and the use of key escrow, data and
privacy protection, electronic authentication or "digital" signatures, illegal
and harmful content, access charges and retransmission activities. Moreover, the
applicability to the Internet of existing laws governing issues such as property
ownership, content, taxation, defamation and personal privacy is uncertain. The
majority of such laws was adopted before the widespread use and
commercialization of the Internet and, as a result, do not contemplate or
address the unique issues of the Internet and related technologies. Neither the
outcome of new legislative proposals, nor their impact on the on-line
information and services industry in general, or on us in particular, can


                                       19
<PAGE>   20

be predicted at this time. Any such new legislation or regulation or
governmental enforcement of existing regulations may limit the growth of the
Internet and our other markets, increase our cost of doing business or increase
our legal exposure, which could have a material adverse effect on our business,
financial condition and results of operations.

     By distributing content over the Internet, we also face potential liability
for claims based on the nature and content of the materials that we distribute,
including claims for defamation, negligence or copyright, patent or trademark
infringement, which claims have been brought, and sometimes successfully
litigated, against Internet companies. Our general liability insurance may not
cover potential claims of this type or may not be adequate to indemnify us for
any liability that may be imposed. Any liability not covered by insurance or in
excess of insurance coverage could have a material adverse effect on our
business, results of operations and financial condition.

ORGANIZATIONAL HISTORY

     For financial reporting purposes, we operate in two business segments: IT
Network and Interactive TV. For information regarding revenues, operating
results, identifiable assets and certain other information by business segment,
see Note 14 -- Segment Reporting, presented in the Notes to Consolidated
Financial Statements. Our operations are conducted through our operating
subsidiaries, IT Network, Inc. ("IT Network"), Interactive Channel, Inc.
("Interactive Channel") and Interactive Channel Technology, Inc. ("ICTI") and
through SourceSuite, our joint venture with Insight Interactive.

     SMI Holdings, Inc. ("SMI Holdings") was incorporated on July 19, 1988. On
June 23, 1995, SMI Holdings merged with a wholly owned subsidiary of HB
Communications Acquisition Corp. ("HBAC"), a public company formed in Delaware
in 1993 for the purpose of acquiring a company engaged in the communications
industry, with SMI Holdings surviving as a wholly owned subsidiary of HBAC. In
connection with the merger, HBAC changed its name to Source Media, Inc., and the
outstanding common stock and preferred stock of SMI Holdings were converted into
common stock of Source Media. On January 14, 1997, we acquired substantially all
of the outstanding shares of ICTI in exchange for 1,390,000 shares of our common
stock. On October 30, 1997, we purchased certain of the electronic publishing
assets of Brite Voice Systems, Inc. ("Brite") for $35.6 million and certain of
the assets of Voice News Network ("VNN"), a unit of Tribune Company, for $9.0
million. In October 1997, SMI Holdings formed IT Network and Interactive Channel
as wholly owned operating subsidiaries.

     We have experienced significant changes in our Interactive TV business
since the beginning of 1999. In November 1999, we contributed this business,
including the assets and properties related to the VirtualModem software and
associated businesses, to a 50/50 joint venture with Insight Interactive.
Insight Interactive contributed $13 million of equity financing to the joint
venture and purchased 842,105 shares of our common stock, or 6% of our issued
and outstanding stock, for $12 million ($14.25 per share). We also issued to
Insight Interactive warrants to purchase 4,596,786 additional shares of our
common stock at $20 per share and one share of our non-participating preferred
stock, which entitles Insight Interactive to appoint up to three members to our
Board of Directors. On March 3, 2000, we and Insight Interactive sold our
interests in the joint venture to Liberate in exchange for the issuance to each
of us and Insight Interactive of 886,000 shares of Liberate common stock and
other consideration. Prior to the completion of that sale, we formed SourceSuite
and transferred to SourceSuite the assets and properties not related to
VirtualModem. Accordingly, Liberate acquired all patents and technology
underlying the Virtual Modem software and businesses. Liberate granted us an
exclusive perpetual license to use the patents and technology in connection with
SourceGuide. We also retained ownership of the source code for the Interactive
TV applications developed as


                                       20
<PAGE>   21

of the date of the transaction with Liberate. As a result, our Interactive TV
business became a provider of applications and services other than middleware.

     We manage SourceSuite which operates our Interactive TV business. After the
completion of the sale to Liberate, the original joint venture changed its name
from SourceSuite LLC to Liberate Technologies LLC and the new joint venture
changed its name from SourceSuite Acquisition LLC to SourceSuite LLC.

ITEM 2. PROPERTIES

     We lease approximately 13,100 square feet of office space at 5400 LBJ
Freeway in Dallas, Texas for our corporate offices and for our Interactive TV
business. This lease expires in September 2001. We are consolidating our
operations and do not currently intend to renew this lease. We also sublease
from Verizon Corporation approximately 17,800 square feet of office space at
5601 Executive Drive, Irving, Texas where our IT Network business is
headquartered. We are in the process of renewing this sublease and expect to
extend the term through September 2003. We also have leased space in areas where
we maintain the voice response system that supports our voice information
services. We are likely to close these locations as we exit the front-of-book
yellow pages advertising business. We maintain two regional sales offices across
the country. We are in the process of closing these offices as we centralize our
selling activities in our Dallas facility. One office lease expires March 2001,
and the other continues through February 2003. We believe that our existing
facilities are suitable to meet our requirements for the immediate future but we
continue to evaluate our requirements in light of our business plans and
strategy. Substantially all of our assets are subject to a security interest
granted in connection with the issuance of the Notes.

ITEM 3. LEGAL PROCEEDINGS

     Reference is made to Note 3 -- Commitments and Contingencies to our
Consolidated Financial Statements and to Note 6 -- Commitments and Contingencies
to SourceSuite LLC's Financial Statements included herein for a discussion of
certain litigation.

     From time to time we become aware of certain threatened claims against us
that may develop into litigation. We are not aware of any threatened claim that,
if determined adversely to us, would have a material adverse effect on our
business or financial condition. Further, from time to time, we are party to
routine litigation arising out of the ordinary course of business, none of which
is expected to have a material adverse effect on our business or its financial
condition.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

     On December 19, 2000, we held our annual meeting of stockholders to elect
four directors to serve for a term of one year, and to ratify the appointment of
Ernst & Young LLP as our independent auditors to serve until the 2001 annual
meeting of stockholders.

     The following individuals were elected to serve as directors until the next
annual meeting:

<TABLE>
<CAPTION>
                                            VOTE FOR            VOTE WITHHELD
                                            --------            -------------
<S>                                        <C>                     <C>
       James L. Greenwald                  11,953,948              338,444

       Michael J. Marocco                  11,953,847              338,540

       Stephen W. Palley.                  11,947,724              345,654

       Barry Rubenstein                    11,954,888              337,500
</TABLE>


                                       21
<PAGE>   22

     Insight Interactive, as holder of a share of our Non-Participating
Preferred Stock, is entitled to designate three of our directors. Kim Kelly,
Sidney Knafel and Michael Willner, Insight Interactive's designees, continued to
serve on our board after the meeting.

     The stockholders ratified the appointment of Ernst & Young LLP as our
independent auditors to serve until the 2001 annual meeting of stockholders. The
result of the vote was as follows: 12,222,097 votes were for the selection,
59,261 votes were against the selection.

ITEM 4A. EXECUTIVE OFFICERS

     Information regarding our executive officers at March 24, 2001 is set forth
below:

<TABLE>
<CAPTION>
           NAME                AGE        POSITION WITH THE COMPANY
           ----                ---        -------------------------
<S>                            <C>   <C>
    Stephen W. Palley.......   56    President, Chief Executive Officer and Director
    Benjamin J. Douek.......   50    Chief Financial Officer and Treasurer
    Derrick L. Horner.......   31    Vice President and General Counsel
    Phil Howort.............   58    Senior Vice President, Interactive Channel Marketing
    Lawrence Brickman.......   44    Senior Vice President, Interactive Channel Programming
    Tom Peters..............   56    Senior Vice President, Interactive Channel Business Development
    Scott Bennett...........   40    Senior Vice President, IT Network Marketing
    John Gregoire...........   43    Senior Vice President, IT Network New Media
</TABLE>

     STEPHEN W. PALLEY has served as a director since June 1999 and joined us in
April 1999 as our President and Chief Executive Officer. Mr. Palley was Chief
Operating Officer of King World Productions, Inc. from 1986 to 1996. Mr.
Palley's background includes entertainment and securities law. He is a member of
the New York State Bar and the Museum of Radio and Television Council. Mr.
Palley is a graduate of American University and the Columbia University School
of Law.

     BENJAMIN J. DOUEK joined Source Media in February 2001. Prior to joining
Source Media, Mr. Douek served as Senior Vice President, CFO and Member of the
Board of Directors of AdStar.com, a provider of remote advertising entry
solutions for newspapers and advertisers. Prior to Adstar, Mr. Douek was
Executive Vice President and Director of Investment Banking at Ladenburg,
Thalmann & Co. Inc., where he was a member of the Board of Directors and the
Management Committee. Mr. Douek has also served as a Managing Director of
Bankers Trust Company, where he headed a distressed debt acquisition group, and
as a Managing Director and principal of Donaldson, Lufkin & Jenrette Securities
Corporation, where he specialized in principal transactions and acquisitions of
financial institutions. Mr. Douek also has practiced law with Sullivan &
Cromwell. He attended Yeshiva University and is a graduate, with honors, of the
City University of New York and Fordham University School of Law.

     DERRICK L. HORNER joined Source Media in November 2000 as Vice President
and General Counsel. Prior to joining Source Media, Mr. Horner was a senior
associate at Simpson Thacher & Bartlett where he advised clients on U.S.
securities laws, international corporate finance, and mergers and acquisitions.
Most recently, his practice focused on strategic alliance and financing
transactions for software and other technology companies. Mr. Horner also
regularly advised clients on structuring a range of private investment funds,
including private equity and venture capital funds. Mr. Horner graduated magna
cum laude from Harvard College with a degree in economics and received his law
degree with honors from Harvard Law School.

     PHIL HOWORT joined Source Media in October 2000 as Senior Vice President.
Prior to joining Source Media, Mr. Howort served as Senior Vice President of
Media, Programming and Sales for Kaleidoscope Sports & Entertainment, a division
of The Interpublic Group of Companies.


                                       22
<PAGE>   23

Mr. Howort also served as CEO of Nabisco house agency Ohlmeyer Advertising. He
has worked in the digital media space for the past several years as a consultant
to many companies entering the digital media space. Mr. Howort is a graduate of
Brooklyn College, and attended the University of Florida as a Doctoral candidate
in Economics.

     LAWRENCE BRICKMAN was named Senior Vice President of Programming for Source
Media's Interactive Channel in June 2000. He has twenty years experience in
communications and media, most recently as Director of Interactive Products for
Cablevision Systems Corporation. From 1993 to 1997, Mr. Brickman was President
and Co-Founder of i2i Incorporated, a marketing communications company that
provided consulting, creative and production services.

     TOM PETERS joined Source Media in September 1995 as President of Source
Media's International Division and, since January 1997, has served as Senior
Vice President of Business Development for Source Media's Interactive Channel.
Mr. Peters has over twenty-five years of global sales and strategic business
development experience in the consumer soft goods industry, having launched
branded and private label products domestically and internationally for such
firms as Interco, Inc. and Brown Group International. Before joining Source
Media, Mr. Peters served as Managing Partner and President of the international
sales and sourcing company he founded in 1993. Mr. Peters received his Bachelor
of Arts degree from the University of Illinois.

     SCOTT BENNETT joined IT Network, Inc. in August 2000 as Senior Vice
President of Marketing and is responsible for the company's wireless and
wireline content marketing strategy and product development. Mr. Bennett brings
extensive experience in brand building, positioning, marketing research, product
and business development. Prior to joining the company, he served as Executive
Director, Marketing Communications for Verizon Information Services. Previously,
Mr. Bennett handled business development for Yankelovich Partners, and GVO, a
Palo Alto-based company specializing in product development and innovation. Mr.
Bennett, who holds a Bachelor's degree in Advertising from the University of
Texas in Austin, spent 15 years in the advertising industry, providing strategic
guidance to clients in the telecommunications, aerospace, financial, and
packaged-goods industries.

     JOHN GREGOIRE joined Source Media in June 1994 as Director of Business
Development for Interactive Channel. In 1996, he was promoted to Vice President
of Programming and Production for Interactive Channel. He is now the Senior Vice
President of New Media for IT Network. Prior to joining Source Media, Mr.
Gregoire spent 14 years in Sales and Sales Management with Moore Corporation, a
global leader in business communications. Mr. Gregoire received his B.S. degree
from Eastern Illinois University in 1980 majoring in both Marketing and
Management.

     Paul Tigh, who served as our Chief Financial Officer, resigned from that
position in February 2001.

     Howard Gross, who served as President of our wholly owned subsidiary
IT Network, Inc., resigned from that position in February 2001.

     Victoria Hamilton, who served as our interim Chief Operating Officer,
resigned from that position in December 2000.


                                       23
<PAGE>   24


                                     PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

     Our common stock was quoted on The Nasdaq Stock Market under the symbol
"SRCM" from December 8, 1995 through March 7, 2001. Subsequent to that period,
our common stock has been quoted on the OTC Bulletin Board under the symbol
"SRCM.OB".

     The following table sets forth the high and low closing sales prices per
share for our common stock for the periods indicated.

<TABLE>
<CAPTION>
                       1999     2000
                      ------   ------
<S>                   <C>      <C>
First Quarter
  High ............   $23.94   $21.00
  Low .............    14.81    12.50
Second Quarter
  High ............    23.44    13.25
  Low .............    14.50     3.91
Third Quarter
  High ............    16.88     6.87
  Low .............     6.00     4.13
Fourth Quarter
  High ............    19.50     5.31
  Low .............     7.56     0.47
</TABLE>

     On March 23, 2001, the last reported sale price of our common stock was
$0.25 per share. As of March 23, 2001, there were 138 record holders of our
common stock.

     We have never paid cash dividends. Management intends to retain any future
earnings for the operation and expansion of our business and does not anticipate
paying any cash dividends in the foreseeable future. In addition, the indenture
governing the Notes and the certificate of designation relating to the Preferred
Stock restrict our ability to pay cash dividends to the holders of our common
stock.

RECENT SALES OF UNREGISTERED SECURITIES

     During the fourth quarter of 2000, we issued the following options to
various employees and non-employee directors pursuant to our 1999 Stock Option
Plan and our 1995 Nonqualified Stock Option Plan for Non-Employee Directors:

<TABLE>
<CAPTION>
                 NUMBER OF SHARES       EXERCISE
DATE ISSUED     UNDERLYING OPTIONS   PRICE PER SHARE
-----------     ------------------   ---------------
<S>             <C>                  <C>
  10/09/00            150,000            $4.625
  11/08/00            157,500            $3.031
  12/19/00             18,000            $1.103
</TABLE>

    Exemption from registration under the Securities Act of 1933, as amended, is
claimed for each sale of securities referred to above in reliance upon the
exemption afforded by Section 4(2) of the Securities Act. None of these sales
involved the payment of underwriting commissions.


                                       24
<PAGE>   25


ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

     The following table presents selected consolidated financial data for the
five years ended December 31, 2000, which have been derived from our audited
consolidated financial statements. The information in the following table should
be read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and our Consolidated Financial Statements
and the notes thereto included elsewhere in this report.


<TABLE>
<CAPTION>
                                                                         YEAR ENDED DECEMBER 31,
                                                    -------------------------------------------------------------
                                                       1996        1997          1998        1999        2000
                                                    ---------    ---------    ---------    ---------    ---------
                                                                (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                 <C>          <C>          <C>          <C>          <C>
STATEMENTS OF OPERATIONS DATA:
Monetary revenues ...............................   $   8,575    $  12,387    $  24,351    $  19,147    $  17,916
Nonmonetary revenues(1) .........................       9,944        6,044        1,756        1,823          721
                                                    ---------    ---------    ---------    ---------    ---------
          Total revenues ........................      18,519       18,431       26,107       20,970       18,637
Monetary cost of sales ..........................       3,485        8,611       12,673       13,164       11,340
Nonmonetary cost of sales(1) ....................       9,944        6,044        1,756        1,823          721
                                                    ---------    ---------    ---------    ---------    ---------
          Total cost of sales ...................      13,429       14,655       14,429       14,987       12,061
Gross profit ....................................       5,090        3,776       11,678        5,983        6,576
Selling, general and administrative expenses ....      11,747       19,599       24,772       23,714       11,323
Amortization of intangible assets ...............       1,031        4,987        6,320        4,713        2,391
Research and development expenses ...............       6,331        3,680        3,410        2,578           --
Impairment of intangible assets(2) ..............          --           --       25,936           --        5,588
                                                    ---------    ---------    ---------    ---------    ---------
Operating loss ..................................     (14,019)     (24,490)     (48,760)     (25,022)     (12,726)
Interest (income) expense, net ..................        (174)       4,498       10,897       11,991       10,861
Equity interest in losses of joint venture ......          --           --           --        1,013        4,238
Gain on sale of interest in joint venture .......          --           --           --           --      (74,977)
Other (income) expense, net .....................          10          (62)         (27)         155       75,538
                                                    ---------    ---------    ---------    ---------    ---------
Net loss before extraordinary item and
  cumulative effect of change in accounting
  principle .....................................     (13,855)     (28,926)     (59,630)     (38,181)     (28,386)
Extraordinary loss (gain) extinguishment of
  debt ..........................................          --        3,455           --           --       (4,239)
Cumulative effect of change in accounting
  principle (3) .................................          --           --           --           --        1,159
                                                    ---------    ---------    ---------    ---------    ---------
Net loss ........................................     (13,855)     (32,381)     (59,630)     (38,181)     (25,306)
Preferred stock dividends (difference on
  conversion of preferred stock, net of
  dividend) .....................................          --          416        2,996        1,838       (5,498)
                                                    ---------    ---------    ---------    ---------    ---------
Net loss attributable to common
  stockholders ..................................   $ (13,855)   $ (32,797)   $ (62,626)   $ (40,019)   $ (19,808)
                                                    =========    =========    =========    =========    =========
Net loss per common share .......................   $   (1.39)   $   (2.89)   $   (5.21)   $   (2.93)   $   (1.17)
                                                    =========    =========    =========    =========    ========
Weighted average common shares
  outstanding ...................................       9,935       11,354       12,012       13,679       16,892
                                                    =========    =========    =========    =========    ========
</TABLE>

<TABLE>
<CAPTION>
                                                                           AS OF DECEMBER 31,
                                                    -------------------------------------------------------------
                                                       1996        1997          1998        1999        2000
                                                    ---------    ---------    ---------    ---------    ---------
<S>                                                 <C>          <C>          <C>          <C>          <C>
   BALANCE SHEET DATA:
     Cash and cash equivalents ..................   $   4,043    $   8,431    $  11,662    $  13,410    $   7,774
     Working capital (deficit) ..................        (466)      31,288       19,947       14,408       14,024
     Total assets ...............................      15,897      113,502       56,589       58,016       31,056
     Long-term debt and capital lease
        obligations (including current
        portion): ...............................       4,720      100,000      100,000       96,250       88,542
     Senior Redeemable PIK preferred
        stock ...................................          --       13,698       16,628       18,467        8,571
     Total stockholders' equity (capital
        deficiency) .............................          30      (12,408)     (71,509)     (68,872)     (78,405)
</TABLE>

--------

(1)  Prior to 2000, nonmonetary revenues and nonmonetary cost of sales
     associated with barter transactions are included in the consolidated
     statements of operations at the estimated fair values of advertising time
     and information content received. Beginning in 2000, in accordance with
     EITF 99-17, revenues and cost of sales for nonmonetary advertising barter
     transactions are recorded at the fair value of advertising surrendered by
     the Company. See "Management's Discussion and Analysis of Financial



                                       25
<PAGE>   26


     Condition and Results of Operations" and Note 2 -- Significant Accounting
     Policies of Notes to our Consolidated Financial Statements.

(2)  See "Management's Discussion and Analysis of Financial Condition and
     Results of Operations" regarding acquisitions and impairment of
     intangibles.

(3)  Effective January 1, 2000, the Company changed its method of accounting for
     revenue recognition in accordance with Staff Accounting Bulletin (SAB) No.
     101, "Revenue Recognition in Financial Statements," and recorded an
     adjustment for the cumulative effect of the change in accounting principle.
     See Note 12 - Change in Accounting Principle - Adoption of SAB 101,
     included in the Notes to our Consolidated Financial Statements.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

     The following discussion should be read in conjunction with our
Consolidated Financial Statements and related notes that are included elsewhere
in this report.

GENERAL

     During 2000, we made significant decisions regarding the focus of our
business in an effort to generate revenue opportunities. As a result, decisive
actions were taken to focus on content opportunities rather than technology, to
improve our distribution alliances and to position ourselves for future growth
as revenue opportunities in the interactive television industry emerge. We are
in the process of exiting low-margin business activities and centralizing our
selling activities. We have also taken steps to reduce the size of our work
force to contain expenses. Because of these activities and other recent
transactions and activities described below, and for the reasons set forth under
the caption "Forward Looking Information and Risk Factors," we do not believe
our historical financial results of operations are necessarily indicative of
future operating results.

     We have experienced significant changes in our Interactive TV business
since the beginning of 1999. In November 1999 we contributed this business,
including the assets and properties related to the VirtualModem software and
associated businesses, to a 50/50 joint venture with Insight Interactive.
VirtualModem software is a "middleware" platform or the software which permits
the subscriber to interact with advertisements, programs and other content
through a cable set-top box. Insight Interactive contributed $13 million of
equity financing to the joint venture and purchased 842,105 shares of our common
stock, representing approximately 6% of our issued and outstanding stock, for
$12 million and received warrants to purchase 4,596,786 additional shares of our
common stock at $20 per share. On March 3, 2000, we and Insight Interactive sold
our interests in the joint venture to Liberate in exchange for the issuance to
each of us and Insight Interactive of 886,000 shares of Liberate common stock
and other consideration. This transaction resulted in a gain of $75.0 million
recorded in our results in the first quarter of 2000. Prior to the completion of
that sale, we formed SourceSuite and transferred to SourceSuite the assets and
properties not related to VirtualModem. Accordingly, Liberate acquired all
patents and technology underlying the Virtual Modem software and businesses.
Liberate granted us an exclusive perpetual license to use the patents and
technology in connection with SourceGuide. As a result, our Interactive TV
business became a provider of applications and services other than middleware.
We manage SourceSuite which operates our Interactive TV business. In December
2000, we determined that the decline in the value of the Liberate stock was
other than temporary and recorded a charge to other expense of $75.4 million.

     Prior to December 31, 2000, our IT Network business also was engaged in the
provision of interactive advertising services to commercial advertisers through
yellow page telephone books.


                                       26
<PAGE>   27

Generally, our IT Network interactive advertising services were promoted by
print advertisements in yellow page telephone books distributed by our yellow
pages publisher partners. The print advertising directed consumers to
interactive information services that could be accessed over the telephone and
via the Internet. In the agreements with our publisher partners, we typically
purchased advertising inventory and retained the related advertising revenue, or
we sold advertising on behalf of the publisher partner in a revenue sharing
arrangement. In revenue sharing arrangements, our revenue share depended on the
level of advertiser management, system management and information content
services provided to the yellow pages publisher partner and the amount charged
for services. In our effort to exit low margin business activities and to
position our IT Network business to capture emerging revenue opportunities in
the market for rich media content, we discontinued our front-of-book yellow page
advertising services as of December 31, 2000, subject to fulfilling our
obligations to our commercial advertisers with respect to the current
circulation of yellow pages telephone books. As a result, our IT Network
business now focuses on the production, sale and delivery of rich media content.
For the year ended December 31, 2000, front-of-book yellow page advertising
comprised approximately 45% of our consolidated monetary revenues.

     During the fourth quarter of 2000, as part of our evaluation of our various
product lines and our decision to discontinue front-of-book ("FOB") yellow page
advertising services, it was determined that certain intangible assets related
to goodwill and contract rights recorded as part of the 1997 acquisition of
certain assets of Brite Voice Systems, Inc. and Voice News Network, Inc., were
impaired. Based upon an analysis of the expected future cash flows discounted as
of December 31, 2000, we recorded a non-cash write-down of $5.6 million ($0.33
per share) of the related goodwill and contract rights. Our estimates of future
cash flows attributable to the intangibles were based upon forecasted contract
renewals from existing contracts with former Brite and VNN customers for us to
provide audiotex and other services over the next five years.

     In connection with the discontinuation of FOB yellow page advertising
services, we also recognized a charge of $0.2 million included in cost of sales
for the write down of production equipment held for sale and $0.1 million
included in selling, general, and administrative expenses for non-cancelable
lease costs. Additionally, we will incur employee severance costs of
approximately $0.2 million during the first quarter of 2001 relating to our
continuing restructuring efforts. FOB yellow page advertising services generated
monetary revenue of approximately $12.4 million, $9.4 million, and $8.0 million
in 1998, 1999 and 2000, respectively. We will continue to honor FOB product
commitments during a wind down period through March 2002. Cost of sales for FOB
services has historically been higher than for our content business. Our gross
profit in 2001 will continue to reflect the impact of these higher costs
associated with the FOB revenues we will be recording during the wind down
period. Cost savings resulting from the discontinuance of this product line will
not fully be realized until 2002.

     In 2000, we changed our method of accounting for revenue recognition in
accordance with Staff Accounting Bulletin No. 101, "Revenue Recognition in
Financial Statements." Previously, we had recognized all or a portion of
monetary revenues and associated costs relating to certain print ads included in
yellow page books at the time of distribution by the directory publishers. Since
we generally provide interactive advertising services in connection with the
print ads, under the new accounting method adopted retroactive to January 1,
2000, we now recognize monetary revenues and associated costs for these print
ads and related interactive advertising services on a straight-line basis over
the term of the related contracts, which is typically one year commencing at the
time of the annual distribution of the applicable local yellow pages directory.
As a result of this change, we recorded a $1.2 million charge for the cumulative
effect of a change in accounting principle as of January 1, 2000. The effect of
the change in 2000 was to decrease net


                                       27
<PAGE>   28


loss before extraordinary items and the cumulative effect of the accounting
change by $0.2 million ($1.2 million increase in revenue offset by an increase
in operating expense of $1.0 million.)

     There can be no assurance that the actions we have taken to improve our
operating results will be effective and will enable us to achieve profitability.
Additionally, our Interactive TV business requires substantial development which
will require continued investment of capital resources. We also have interest
payments on our Notes due on May 1 and November 1 of 2001 of approximately $5.3
million, each. See - "Liquidity and Capital Resources."

INVESTMENT IN SOURCESUITE

     Our investment in SourceSuite is recorded using the equity method. As a
result, the net loss of SourceSuite is recorded as "Equity interest in losses of
joint venture" and not included in the various component lines on the statement
of operations. The following represents the unaudited pro forma results of
operations of Source Media as if the formation of our prior joint venture with
Insight in November 1999, and subsequent sale thereof to Liberate, and the
formation of SourceSuite in March 2000 had occurred on January 1, 1999 (in
thousands except for per share data).

<TABLE>
<CAPTION>
                                                       YEAR ENDED DECEMBER 31,
                                                        1999          2000
                                                       --------      --------
<S>                                                    <C>           <C>
Pro forma total revenues                               $ 20,928      $ 18,637
Pro forma operating loss                                (12,128)      (12,726)
Pro forma net loss attributed to common stockholders    (29,892)      (18,722)
Pro forma net loss per common share                       (2.06)        (1.27)
</TABLE>

YEARS ENDED DECEMBER 31, 2000 AND 1999

     Monetary revenues decreased 6% to $17.9 million for the year ended December
31, 2000 from $19.1 million for the same period of 1999. This decrease resulted
from decreases of $1.4 million in information services, $1.4 million in
advertising sales and $0.6 million in advertising services and systems
management, offset in part by an increase of $2.2 million in new product
revenues including content and internet advertising. As we complete the process
of exiting the FOB advertising services business, we expect advertising sales
and service revenue to continue to decrease.

     Monetary cost of sales decreased 14% to $11.3 million for the year ended
December 31, 2000 from $13.2 million for the year ended December 31, 1999, as a
result of 1999 costs of $1.6 million of unfulfilled sales guarantees, $0.9
million of costs incurred in 1999 for the Interactive TV business, which was
transferred to our prior joint venture with Insight Interactive in November
1999, and $0.7 million reduction in page costs and revenue share costs related
to decreased advertising sales. These cost reductions were partially offset by
increased operational costs of $1.3 million primarily related to new product
costs.

     Nonmonetary revenues and nonmonetary cost of sales decreased 60% to $0.7
million for the year ended December 31, 2000 from $1.8 million for the same
period in 1999. Nonmonetary sales accounted for 3.9% of revenues for the year
ended December 31, 2000 compared to 8.7% of revenues for the same period in
1999. The decrease is primarily due to the adoption of EITF 99-17 in January
2000. Beginning in January 2000, we record revenues and cost of sales for
nonmonetary advertising barter transactions at the fair value of advertising
surrendered. Revenues and cost of sales were previously recorded at the fair
value of the advertising received. This decrease in value was partially offset
by an increase in volume.


                                       28
<PAGE>   29

     Selling, general and administrative expenses decreased 52% to $11.3 million
for the year ended December 31, 2000 from $23.7 million for the year ended
December 31, 1999. The decrease is primarily due to the following: (a) $4.7
million of cost of the Interactive TV operations transferred to our joint
venture with Insight; (b) decreased legal and professional fees of $3.5 million
which were incurred in 1999 in connection with a proposed joint venture that
were expensed after the termination of the proposed transaction; (c) $0.7
million of professional fees incurred in connection with the 1999 transaction
with Insight to form the original joint venture; (d) reductions of $0.4 million
in severance expense in 2000; and (e) $3.1 million in other administrative cost
reductions.

     Amortization of intangible assets decreased 49% to $2.4 million from $4.7
million for the year ended December 31, 2000, due to the transfer of patents to
our joint venture with Insight in November 1999, which were subsequently sold to
Liberate, and to the completion of amortization of GTE contract rights.

     Impairment of intangible assets in 2000 resulted from the write-down of
$5.6 million of goodwill and contract rights originally recorded as part of the
acquisition of certain assets of Brite Voice Systems, Inc. and Voice News
Network, Inc. determined to be impaired in late 2000.

     Research and development expense decreased $2.6 million due to the transfer
of research and development activities to our prior joint venture with Insight
Interactive in November 1999.

     Interest expense decreased 9.2% to $11.6 million for the year ended
December 31, 2000 from $12.8 million in 1999. This decrease is due to the
retirement of $11.5 million of Notes, $3.75 million of which were exchanged for
cash and an exercise of warrants to purchase shares of common stock in 1999; and
the remaining $7.7 million, which were exchanged for 674,005 shares of common
stock during 2000. The interest is associated with a $100 million debt financing
completed by the Company in October 1997 and described in detail in the Notes to
Consolidated Financial Statements.

     Interest income remained consistent at $0.8 million for the year ended
December 31, 2000 from the prior year.

     Equity interest in losses of joint venture includes our share of the
results of operations of SourceSuite (formed in March 2000) and our prior joint
venture (formed in November 1999) for the year ended December 31, 2000, recorded
using the equity method.

     Gain on sale of interest in joint venture is comprised of $75.0 million of
gain recorded upon the sale of our interest in the prior joint venture with
Insight to Liberate in exchange for 886,000 shares of common stock in Liberate
and $4.4 million cash.

     Other expense (income), net includes $75.4 million of loss recorded on the
write down of the value of the Liberate stock to its fair value at December 31,
2000 to recognize an other-than-temporary decline in value, offset by
miscellaneous other expense.

     An extraordinary gain of $4.2 million was recognized in 2000 on the
exchange of $7.7 million of Notes for 674,005 shares of common stock.

     Effective January 1, 2000, the Company changed its method of accounting for
revenue recognition in accordance with Staff Accounting Bulletin (SAB) No. 101,
"Revenue Recognition in Financial Statements", and recorded a charge of $1.2
million for the cumulative effect of the change in accounting principle. See
Note 12 - Change in Accounting Principle - Adoption of SAB 101, included in the
Notes to our Consolidated Financial Statements.


                                       29
<PAGE>   30


     Preferred Stock dividends in 2000 reflect the benefit of $6.8 million
realized on the issuance of common stock in exchange for Preferred Stock, due to
the excess of the carrying amount of the Preferred Stock over the fair value of
the Company's common stock. This benefit is partially offset by $1.3 million of
dividend expense for the year ended December 31, 2000 as compared to dividend
expense of $1.8 million for the year ended December 31, 1999. The dividend
expense relates to the $20 million of senior redeemable payment-in-kind
preferred stock issued in October 1997 and described in detail in the Notes to
Consolidated Financial Statements. Dividends are recorded at the fair value of
the preferred shares issued as payment-in-kind. Excluding the benefit from the
exchange, the decrease in dividends is related to exchanges of Preferred Stock
for common stock, which took place in the second and third quarters of 2000, as
well as a decrease in the fair value of the Preferred Stock issued as dividends
during the year.

YEARS ENDED DECEMBER 31, 1999 AND 1998

     Monetary revenues decreased 21% to $19.1 million for the year ended
December 31, 1999 from $24.4 million for the year ended December 31, 1998. This
decrease is primarily due to the decreases of $2.2 million in system management
and information services revenues and $3.0 million in advertising sales. In
addition, the 1998 period included $0.1 million of revenues associated with an
Interactive TV test market. There were no such revenues in 1999. The decrease in
system management and information services revenue is attributable to increased
industry competition, customers migrating to their own systems and customers'
Year 2000 hardware issues. Advertising sales decreased primarily due to the
discontinuation of certain products. As a result of delays in rolling out new
products in 1999, such revenues were not immediately replaced.

     Monetary cost of sales increased 4% to $13.2 million for the year ended
December 31, 1999 from $12.7 million for the year ended December 31, 1998
primarily as a result of $1.6 million of expense recognized for payments to
customers for unfulfilled sales guarantees and other increased operational
expenses of $0.1 million partially offset by savings of $1.1 million in page
costs related to decreased advertising sales and savings of $0.1 million related
to the transfer of Interactive TV operations to our prior joint venture with
Insight Interactive.

     Nonmonetary revenues and nonmonetary cost of sales remained relatively flat
at $1.8 million for the years ended December 31, 1999 and 1998. Nonmonetary
sales accounted for 9% of revenues for the year ended December 31, 1999 and 7%
of the revenues for the year ended December 31, 1998.

     Selling, general and administrative expenses decreased 4% for the year
ended December 31, 1999 to $23.7 million from $24.8 million for the year ended
December 31, 1998. Decreased expenses were attributable to: (i) $1.0 million for
non-cash stock compensation expense for certain stock options granted to certain
employees in excess of shares authorized in 1998, (ii) $0.7 million of
transitional costs related to the integration of acquired businesses incurred in
1998, (iii) $0.7 million less of bad debt expense incurred in 1999, (iv)
decreased trade show and trade advertising expenses of $0.7 million, (v) costs
of Interactive TV operations transitioned to our joint venture with Insight
Interactive of $0.9 million, and (vi) other operational savings of $1.7 million.
These decreases were offset by increases of $3.5 million in legal and
professional fees incurred in connection with a proposed joint venture that were
expensed after the termination of the proposed transaction, $0.7 million of
professional fees incurred in connection with the transaction with Insight
Interactive and $0.6 million of severance expense.


                                       30
<PAGE>   31


     Impairment of intangible assets included in the amount for the year ended
December 31, 1998 relates to $25.9 million of write-offs of certain intangible
assets for the year ended December 31, 1998.

     Amortization of intangible assets decreased 26% to $4.7 million for the
year ended December 31, 1999 from $6.3 million in 1998 due to a lower intangible
asset balance related to the write-off of certain intangibles in 1998 and the
contribution of patents to our prior joint venture with Insight Interactive on
November 17, 1999.

     Research and development expenses decreased 24% to $2.6 million for the
year ended December 31, 1999 from $3.4 million in 1998 primarily as a result of
the contribution of the Interactive TV business to our prior joint venture with
Insight Interactive on November 17, 1999.

     Interest expense remained unchanged at $12.8 million for the years ended
December 31, 1999 and 1998. This expense is associated with a $100 million debt
financing we completed in October 1997 and is described in detail in the Notes
to Consolidated Financial Statements.

     Interest income decreased 57% to $0.8 million for the year ended December
31, 1999 from $1.9 million in 1998 due to lower investment and cash balances as
a result of debt interest payments and normal operating expenditures.

     Preferred Stock dividends of $1.8 million and $3.0 million for the years
ended December 31, 1999 and 1998, respectively, relate to the $20 million
Preferred Stock financing we completed in October 1997 and described in detail
in the Notes to Consolidated Financial Statements. Dividends are recorded at the
fair value of the shares issued as payment-in-kind dividends. The fair value of
preferred shares issued in 1999 was lower on the respective dividend dates in
1999 than that of 1998, resulting in a lower dividend expense recognized in the
current year.

LIQUIDITY AND CAPITAL RESOURCES

     Since inception, we have experienced substantial operating losses and net
losses as a result of our efforts to develop, deploy and support our IT Network
business and to develop, conduct trials and commercially launch our Interactive
TV business. As of December 31, 2000, we had an accumulated deficit of $213.1
million and had used cumulative net cash in operations of $115.4 million; $12.7
million of cash was used in operating activities in 2000. The difference at
December 31, 2000 between the accumulated deficit and cumulative net cash used
in operations since inception is attributable primarily to nonmonetary charges
related to financing incentives and the extinguishment of debt, stock
compensation expense, write-downs of analog set-top boxes and intangible assets,
depreciation and amortization and other non-cash expenses.

     In 2000, we generated $8.3 million of cash from investing activities,
primarily through the redemption of short-term investments and funds previously
placed in escrow from the proceeds received in our November 1999 transaction
with Insight in order to pay our May 2000 interest payment on our Notes. We also
generated $1.3 million of cash through financing activities, primarily proceeds
from issuance of common stock.

     We will continue to incur operating losses at least through 2001. Our
agreement to manage SourceSuite could require us to make additional capital
contributions to the joint venture that may require us to raise additional
capital. We own 886,000 shares of Liberate common stock. Our anticipated capital
obligations may require us to sell some or all of the Liberate common stock held
by us. On December 31, 2000, the Liberate shares had an aggregate value of
approximately $12.1 million, based on the closing price of Liberate stock of
$13.625 per share. Liberate


                                       31
<PAGE>   32

common stock is traded on the Nasdaq Stock Market under the symbol "LBRT". As of
March 23, 2001, these shares had a value of $7.875.

     Since inception, we have financed our operations primarily through an
aggregate $156.6 million raised from various financing activities, including the
incurrence of debt and the issuance of our common stock and preferred stock. In
October 1997, we issued $100.0 million principal amount of Notes and $20.0
million of Preferred Stock. The interest escrow account created pursuant to the
indenture governing the Notes was used to fund the first four interest payments
on the Notes in 1998 and 1999. As of December 31, 2000, $88.5 million of Notes
were outstanding, and the dealer quoted value of a Note was $0.20 per dollar
face value, resulting in an aggregate fair market value of the outstanding Notes
of approximately $17.7 million. Interest payments of approximately $5.3 million
each are due on May 1 and November 1, 2001. In addition to the Liberate common
stock held by us, our primary source of liquidity is our cash and cash
equivalents, which totaled $7.8 million at December 31, 2000.

     Our future capital requirements will depend on many factors, including, but
not limited to the following factors, some of which are outside our control: (i)
the operating results of our IT Network business, including the ability to grow
our rich media content business; (ii) the success and timing of the development,
introduction and deployment of our Interactive TV applications and services;
(iii) the extent of market acceptance of our applications, content and services;
(iv) potential acquisitions or asset purchases; (v) the deployment of digital
set-top boxes incorporating technology that is interoperable with our
applications and services; (vi) competitive factors; and (vii) changes in the
regulatory environment.

     We have reported both an operating loss and a net loss each year since our
inception, including an operating loss of $12.7 million and a net loss
attributable to common stockholders of $19.8 million for the year ended December
31, 2000. We also may be required to provide additional funding for
SourceSuite's operations in 2001. Additionally, we have interest payments on our
Notes of approximately $5.3 million each due on May 1 and November 1, 2001 (see
Note 5). These factors raise substantial doubt about our ability to continue as
a going concern.

     In an effort to reduce costs, we have begun restructuring efforts which
include discontinuing FOB advertising services, exiting low margin products and
reducing the number of employees. At December 31, 2000, we had $7.8 million of
cash available, along with our Liberate stock valued at $12.1 million as of that
date. Additionally, we have engaged UBS Warburg LLC as our financial advisor to
help us evaluate strategic alternatives, especially related to our debt
requirements. There can be no assurances that we will be able to refinance, sell
assets or recapitalize or reorganize our business and assets on acceptable terms
or at an appropriate time.

EFFECT OF INFLATION

     We believe that the effect of inflation has not been material during each
of the years ended December 31, 2000, 1999, and 1998.

NET OPERATING LOSS CARRYFORWARDS

     At December 31, 2000, we had net operating loss carryforwards of
approximately $137.4 million for U.S. Federal income tax purposes, which begin
to expire in 2003. See Note 10 -- Income Taxes of Notes to Consolidated
Financial Statements included elsewhere herein. The Internal Revenue Code of
1986, as amended, imposes limitations on the use of net operating loss
carryforwards if certain stock ownership changes occur. An ownership change
occurred in 1995 that caused utilization of $23.1 million of our net operating
losses incurred prior to the ownership change to be limited to approximately
$9.0 million in a given year.


                                       32
<PAGE>   33

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     We are exposed to changes in interest rates related primarily to our Notes
and Preferred Stock. Under our current policies, we do not use interest rate
derivative instruments to manage exposure to interest rate changes. At December
31, 2000, we had Notes outstanding having an aggregate principal amount of
approximately $88.5 million, due November 1, 2004, which bear interest at a
fixed rate of 12% and Preferred Stock outstanding having a liquidation
preference of $13.7 million, due November 1, 2007, which has a dividend rate of
13 1/2% of the liquidation preference per share. The fair value of the Notes and
Preferred Stock at December 31, 2000 was approximately $17.7 million and $0.5
million, respectively, based upon dealer quoted market prices.

     We invest our cash balance in money market funds and commercial paper rated
A1, P1. These securities are in U.S. dollars with maturities of three months or
less, and are not owned for trading purposes. Using this strategy, we have not
experienced any material losses due to interest rate risk, market risk or
foreign exchange risk on our commercial paper investments, and we do not
anticipate any such losses.

     On March 3, 2000, we received 886,000 shares of Liberate common stock as
consideration for our sale of the VirtualModem patents and related businesses to
Liberate. The closing price per share of the Liberate common stock on March 3,
2000 was $98.6875, giving us a total initial investment in Liberate common stock
of approximately $87.4 million. In December 2000, the decline in the value of
the Liberate stock was determined to be other than temporary and a charge to
other expense of $75.4 million was recorded, resulting in an investment in
Liberate common stock valued at $12.1 million at December 31, 2000. We continue
to face the market risk associated with price fluctuations of the Liberate
common stock until such time as we sell or hedge the stock. The closing price
per share of the Liberate common stock on March 23, 2001 was $7.875.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     The Report of Independent Auditors, and our consolidated financial
statements and the notes thereto appear on pages 36 through 70 of this Report.

     The Report of Independent Auditors, and the financial statements of
SourceSuite LLC and the notes thereto appear on pages 71 through 80 of this
Report.

     The Report of Independent Auditors, and the financial statements of
SourceSuite LLC (formed November 17, 1999 and subsequently sold on March 3,
2000) and the notes thereto appear on pages 81 through 90 of this Report.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE

     None.

                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS

     Information called for by Item 10 is set forth under the caption "Executive
Officers" in Part I of this Report and in "Election of Directors" and "Section
16(a) Beneficial Ownership Reporting


                                       33
<PAGE>   34

Compliance" in our proxy statement for the 2001 annual meeting of stockholders
(the "Proxy Statement"), which are incorporated herein by this reference.

ITEM 11. EXECUTIVE COMPENSATION

     Information called for by Item 11 is set forth under the caption "Executive
Compensation" in the Proxy Statement, which is incorporated herein by this
reference.

ITEM 12. SECURITY OWNERSHIP OF BENEFICIAL OWNERS AND MANAGEMENT

     Information called for by Item 12 is set forth under the caption "Security
Ownership of Certain Beneficial Owners and Management" in the Proxy Statement,
which is incorporated herein by this reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     Information called for by Item 13 is set forth under the caption "Certain
Transactions" in the Proxy Statement, which is incorporated herein by this
reference.

                                     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, 1999 and 2000

              Consolidated Statements of Operations for the years ended
              December 31, 1998, 1999, 2000

              Consolidated Statements of Stockholders' Equity (Capital
              deficiency) for the years ended December 31, 1998, 1999, 2000

              Consolidated Statements of Cash Flows for the years ended
              December 31, 1998, 1999, 2000

              Notes to Consolidated Financial Statements

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

              Covered by Report of Independent Auditors:

              Balance Sheet at December 31, 2000

              Statement of Operations for the period from Inception (March 3,
              2000) through December 31, 2000


                                       34
<PAGE>   35

              Statement of Members' Equity for the period from Inception (March
              3, 2000) through December 31, 2000

              Statement of Cash Flows for the period from Inception (March 3,
              2000) through December 31, 2000

              Notes to Financial Statements

          (C) Report of Independent Auditors with respect to SourceSuite LLC
              (formed November 17, 1999 and subsequently sold on March 3, 2000)

              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.

     (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, 2000:

         None.


                                       35
<PAGE>   36

                         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, 1999 and 2000, 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, 2000. 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, 1999 and 2000, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2000, in conformity with accounting principles generally accepted
in the United States.

     The accompanying consolidated financial statements have been prepared
assuming that Source Media, Inc. will continue as a going concern. As more fully
described in Note 1, the Company has incurred recurring operating losses, has a
net capital deficiency, and will be required to make significant interest
payments on long-term debt during 2001. These conditions raise substantial doubt
about the Company's ability to continue as a going concern. The consolidated
financial statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets or the amounts
and classifications of liabilities that may result from the outcome of this
uncertainty.

     As discussed in Note 12 to the financial statements, in 2000 the Company
changed its method of accounting for certain revenues.


                                                       /s/ ERNST & YOUNG LLP

Dallas, Texas
March 14, 2001


                                       36
<PAGE>   37

                               SOURCE MEDIA, INC.

                           CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                                                    DECEMBER 31,
                                                                                                   1999        2000
                                                                                                ---------    ---------
                                                                                                     (IN THOUSANDS,
                                                                                                EXCEPT PER SHARE DATA)
<S>                                                                                             <C>          <C>
                                                ASSETS
      Current Assets:
        Cash and cash equivalents ...........................................................   $  10,910    $   7,774
        Short-term investments ..............................................................       2,500           --
        Restricted investments ..............................................................       5,997           --
        Trade accounts receivable, less allowance for doubtful
          accounts of $605 and $716 in 1999 and 2000, respectively ..........................       1,643        1,402
        Related party receivables ...........................................................       1,458          390
        Prepaid expenses and other current assets ...........................................       1,068        1,759
        Investment in securities available for sale .........................................          --       12,072
                                                                                                ---------    ---------
              Total current assets ..........................................................      23,576       23,397
      Property and equipment:
        Production equipment ................................................................       4,511        3,232
        Computer equipment ..................................................................       3,612        3,702
        Other equipment .....................................................................       1,612        2,431
        Furniture and fixtures ..............................................................         656          606
                                                                                                ---------    ---------
                                                                                                   10,391        9,971
      Accumulated depreciation ..............................................................       7,957        8,694
                                                                                                ---------    ---------
      Net property and equipment ............................................................       2,434        1,277
      Intangible assets:
        Goodwill ............................................................................       3,688           --
        Contract rights .....................................................................      11,933        1,578
                                                                                                ---------    ---------
                                                                                                   15,621        1,578
      Accumulated amortization ..............................................................       6,119           --
                                                                                                ---------    ---------
      Net intangible assets .................................................................       9,502        1,578
      Investment in joint venture ...........................................................      18,669        2,008
      Other non-current assets ..............................................................       3,835        2,796
                                                                                                ---------    ---------
              Total assets ..................................................................   $  58,016    $  31,056
                                                                                                =========    =========

                     LIABILITIES AND STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY)

      Current Liabilities:
        Trade accounts payable ..............................................................   $     955    $   1,315
        Accrued interest ....................................................................       1,991        1,771
        Accrued payroll .....................................................................         591          150
        Other accrued liabilities ...........................................................       3,706        1,870
        Unearned income .....................................................................       1,925        4,267
                                                                                                ---------    ---------
              Total current liabilities .....................................................       9,168        9,373
      Long-term debt ........................................................................      96,250       88,542
      Minority interests in consolidated subsidiaries .......................................       3,840        3,840
      Note receivable and accrued interest from minority
        stockholder, net of discount of $12 and $0 in 1999 and 2000, respectively ...........        (837)        (865)
                                                                                                ---------    ---------
                                                                                                    3,003        2,975
      Senior redeemable payment-in-kind (PIK) preferred stock, $25
        per share liquidation preference, $.001 par value,
        net of discount; Authorized shares -- 1,712; Issued and
        outstanding shares 1,043 and 547 in 1999 and 2000, respectively .....................      18,467        8,571
      Non-participating preferred stock, $25 per share
        liquidation preference,  $.001 par value; Authorized and issued -- 1 single share ...          --           --

      Stockholders' equity (capital deficiency):
        Common stock, $.001 par value:
          Authorized shares -- 50,000; 16,278 and 17,869 issued
           and outstanding in 1999 and 2000, respectively ...................................          16           18
        Less treasury stock, at cost -- 268 and 187 shares in
          1999 and 2000, respectively .......................................................      (2,647)      (1,861)
        Capital in excess of par value ......................................................     120,883      136,576
        Accumulated deficit .................................................................    (187,124)    (213,138)
                                                                                                ---------    ---------
              Total stockholders' equity (capital deficiency) ...............................     (68,872)     (78,405)
                                                                                                ---------    ---------
              Total liabilities and stockholders' equity (capital deficiency) ...............   $  58,016    $  31,056
                                                                                                =========    =========
</TABLE>


          See accompanying Notes to Consolidated Financial Statements.


                                       37
<PAGE>   38



                               SOURCE MEDIA, INC.

                      CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
                                                                   YEAR ENDED DECEMBER 31,
                                                               -------------------------------
                                                                 1998        1999       2000
                                                               --------    --------    --------
                                                             (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                            <C>         <C>         <C>
Monetary revenues ..........................................   $ 24,352    $ 19,147    $ 17,916
Nonmonetary revenues .......................................      1,756       1,823         721
                                                               --------    --------    --------
          Total revenues ...................................     26,108      20,970      18,637
Monetary cost of sales .....................................     12,674      13,164      11,340
Nonmonetary cost of sales ..................................      1,756       1,823         721
                                                               --------    --------    --------
          Total cost of sales ..............................     14,430      14,987      12,061
                                                               --------    --------    --------
Gross profit ...............................................     11,678       5,983       6,576
Selling, general and administrative expenses ...............     24,772      23,714      11,323
Impairment of intangible assets ............................     25,936          --       5,588
Amortization of intangible assets ..........................      6,320       4,713       2,391
Research and development expenses ..........................      3,410       2,578          --
                                                               --------    --------    --------
                                                                 60,438      31,005      19,302
                                                               --------    --------    --------
Operating loss .............................................    (48,760)    (25,022)    (12,726)
Interest expense ...........................................     12,830      12,819      11,638
Interest income ............................................     (1,933)       (828)       (777)
Equity interest in losses of joint venture .................         --       1,013       4,238
Gain on sale of interest in joint venture ..................         --          --     (74,977)
Other expense (income), net ................................        (27)        155      75,538
                                                               --------    --------    --------
Net loss before extraordinary item and cumulative effect
  of change in accounting principle ........................    (59,630)    (38,181)    (28,386)
Extraordinary gain -- early extinguishment of debt .........         --          --      (4,239)
Cumulative effect of change in  accounting principle .......         --          --       1,159
                                                               --------    --------    --------
Net loss ...................................................    (59,630)    (38,181)    (25,306)
Preferred stock dividends (difference on conversion of
  preferred stock, net of dividend) ........................      2,996       1,838      (5,498)
                                                               --------    --------    --------
Net loss attributable to common stockholders ...............   $(62,626)   $(40,019)   $(19,808)
                                                               ========    ========    ========

Basic and diluted net loss per common share:
Net loss attributable to common stockholders before
  extraordinary item and cumulative effect of change in
  accounting principle .....................................   $  (5.21)   $  (2.93)   $  (1.35)
Extraordinary gain -- early extinguishment of debt .........         --          --        0.25
Cumulative effect of change in accounting principle ........         --          --       (0.07)
                                                               --------    --------    --------
Net loss attributable to common stockholders ...............   $  (5.21)   $  (2.93)   $  (1.17)
                                                               ========    ========    ========
Weighted average common shares outstanding .................     12,012      13,679      16,892
                                                               ========    ========    ========
</TABLE>

           See accompanying Notes to Consolidated Financial Statements


                                       38
<PAGE>   39


                               SOURCE MEDIA, INC.

                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                              (CAPITAL DEFICIENCY)

<TABLE>
<CAPTION>
                                                                                                                      TOTAL
                                                                                                        NOTES      STOCKHOLDERS'
                                          COMMON STOCK                   CAPITAL IN                   RECEIVABLE      EQUITY
                                        -----------------   TREASURY      EXCESS OF    ACCUMULATED      FROM         (CAPITAL
                                        SHARES     AMOUNT    STOCK        PAR VALUE      DEFICIT     STOCKHOLDERS   DEFICIENCY)
                                        ------     ------   --------    -------------  -----------   ------------  -------------
                                                                        (IN THOUSANDS)
<S>                                     <C>        <C>      <C>         <C>            <C>           <C>           <C>
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)
                                        ======     ======   =========      =========    =========      =========      =========
Issuance of common stock
  upon exercise of stock
  options .........................        109         --          --            955           --             --            955
Issuance of common stock for
  employee stock plan .............         --         --         786             --         (708)            --             78
Stock compensation ................         --         --          --          1,131           --             --          1,131
Issuance of common stock in
  exchange for Preferred stock ....        725          1          --          4,397           --             --          4,398
Issuance of warrants ..............         83         --          --            244           --             --            244
Issuance of common stock in
  exchange for long-term debt .....        674          1          --          3,468           --             --          3,469
Net loss ..........................         --         --          --             --      (25,306)            --        (25,306)
Difference on conversion of
  preferred stock, net of
  dividend ........................         --         --          --          5,498           --             --          5,498
                                        ------     ------   ---------      ---------    ---------      ---------      ---------
BALANCE AT DECEMBER 31,
  2000 ............................     17,869     $   18   $  (1,861)     $ 136,576    $(213,138)     $      --      $ (78,405)
                                        ======     ======   =========      =========    =========      =========      =========
</TABLE>

           See accompanying Notes to Consolidated Financial Statements


                                       39
<PAGE>   40


                               SOURCE MEDIA, INC.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                              YEAR ENDED DECEMBER 31,
                                                                        ------------------------------------
                                                                          1998          1999         2000
                                                                        --------      --------      --------
                                                                                    (IN THOUSANDS)
<S>                                                                     <C>           <C>           <C>
OPERATING ACTIVITIES
Net Loss ..........................................................     $(59,630)     $(38,181)     $(25,306)
Adjustments to reconcile net loss to net cash used in
  operating activities:
  Impairment of intangible assets .................................       25,936            --         5,588
  Depreciation ....................................................        2,540         2,599         1,489
  Amortization of intangible assets ...............................        6,320         4,713         2,391
  Stock compensation ..............................................        2,054         1,057         1,131
  Non-cash interest expense .......................................          833           829         1,039
  Non-cash interest income ........................................         (982)         (281)         (123)
  Provision for losses on accounts receivable .....................        1,077           250           560
  Extraordinary gain on issuance of common stock in exchange
    for long-term debt ............................................           --            --        (4,239)
  Issuance of common stock in litigation settlement ...............          623            --            --
  Gain on sale of interest in joint venture .......................           --            --       (74,977)
  Write down of investment in Liberate ............................           --            --        75,365
  Equity investment in losses of joint venture ....................           --         1,013         4,238
  Other, net ......................................................          (62)          (57)         (119)
Changes in operating assets and liabilities:
  Trade accounts receivable .......................................       (1,876)        1,703          (319)
  Related party receivables .......................................           --        (1,458)        1,067
  Prepaid expenses and other current assets .......................          450           317          (691)
  Trade accounts payable and accrued liabilities ..................        1,586           583        (2,137)
  Unearned income .................................................       (2,274)          175         2,342
                                                                        --------      --------      --------
Net cash used in operating activities .............................      (23,405)      (26,737)      (12,701)
INVESTING ACTIVITIES
  Capital expenditures ............................................       (1,510)       (1,235)         (331)
  Redemption of restricted investments ............................       12,000         6,000         6,119
  Redemption of short-term investments ............................       15,682            --         2,500
  Purchase of short-term investments ..............................           --        (2,500)           --
  Capitalized acquisition costs ...................................           --          (478)           --
  Proceeds from sale of interest in joint venture .................           --            --         4,392
  Investment in SourceSuite LLC ...................................           --            --        (4,392)
                                                                        --------      --------      --------
Net cash provided by investing activities .........................       26,172         1,787         8,288
FINANCING ACTIVITIES
  Proceeds from issuance of common stock upon exercise of
    stock options and warrants ....................................          641        11,971           244
  Proceeds from issuance of common stock ..........................           --        12,000         1,033
  Other ...........................................................         (177)          227            --
                                                                        --------      --------      --------
Net cash provided by financing activities .........................          464        24,198         1,277
                                                                        --------      --------      --------
Net increase (decrease) in cash and cash equivalents ..............        3,231          (752)       (3,136)
Cash and cash equivalents at beginning of period ..................        8,431        11,662        10,910
                                                                        --------      --------      --------
Cash and cash equivalents at end of period ........................     $ 11,662      $ 10,910      $  7,774
                                                                        ========      ========      ========
Supplemental disclosures of cash flow information
  Cash paid during the period for interest on long-term debt ......     $ 12,066      $ 12,000      $ 11,087
                                                                        ========      ========      ========
  Long-term debt cancelled as part of exercise of warrants ........     $     --      $  3,750      $     --
                                                                        ========      ========      ========
  Long-term debt extinguished in exchange for shares
    of common stock ...............................................     $     --      $     --      $  7,708
                                                                        ========      ========      ========
  Warrants issued to Insight Interactive ..........................     $     --      $ 13,800      $     --
                                                                        ========      ========      ========
</TABLE>

           See accompanying Notes to Consolidated Financial Statements


                                       40
<PAGE>   41

                               SOURCE MEDIA, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 2000

1. COMPANY DESCRIPTION AND HISTORY

     Unless the context otherwise requires, all references to the "Company" or
"Source Media" include Source Media, Inc. and its wholly owned operating
subsidiaries ("Subsidiaries"), including IT Network, Inc. ("IT Network"),
Interactive Channel, Inc. ("Interactive Channel"), and SMI Holdings, Inc.
("Holdings"), its other operating subsidiary, Interactive Channel Technologies
Inc. ("ICTI"), as well as its wholly owned non-operating subsidiary, Source
Investments, Inc. and SourceSuite LLC ("SourceSuite"), a 50/50 joint venture
with Insight Interactive, LLC, a subsidiary of Insight Communications Company,
Inc. ("Insight").

     Holdings 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.

     Source Media aggregates, produces and delivers rich media content across a
range of communication platforms including the Internet, digital television,
telephone-based voice portal systems, wireless and wireline telephone networks
and automobile telematic systems. The Company also operates SourceSuite LLC, a
50/50 joint venture between the Company and Insight Interactive, which provides
interactive television programming applications and services, including its
SourceGuide(TM) interactive program guide and its LocalSource(TM) interactive
programming service. The Company categorizes these operations as its IT Network
business and its Interactive TV business, respectively.

     The Company has experienced significant changes in its Interactive TV
business since the beginning of 1999. In November 1999, Source Media contributed
this business, including the assets and properties related to the VirtualModem
software and associated businesses, to a 50/50 joint venture with Insight
Interactive. VirtualModem software is a "middleware" platform or the software
which permits the subscriber to interact with advertisements, programs and other
content through a cable set-top box. Insight Interactive contributed $13 million
of equity financing to the joint venture and purchased 842,105 shares of the
Company's common stock for $12 million ($14.25 per share) and warrants to
purchase 4,596,786 additional shares of its common stock at $20 per share. On
March 3, 2000, the Company and Insight Interactive sold their interests in the
joint venture to Liberate Technologies ("Liberate") in exchange for the
issuance to each of Source Media and Insight Interactive of 886,000 shares of
Liberate common stock and other consideration. Prior to the completion of that
sale, Source Media and Insight formed SourceSuite and transferred from the joint
venture to SourceSuite the net assets and properties not related to VirtualModem
which were valued at $1.1 million. Accordingly, Liberate acquired all patents
and technology underlying the Virtual Modem software and businesses. Liberate
granted SourceSuite an exclusive perpetual license to use the patents and
technology in connection with SourceGuide. As a result, SourceSuite's
Interactive TV business became a provider of applications and services other
than middleware.


                                       41
<PAGE>   42


Financial Condition

     The Company has reported both an operating loss and a net loss each year
since its inception, including an operating loss of $12.7 million and a net loss
attributable to common stockholders of $19.8 million for the year ended December
31, 2000. The Company also may be required to provide additional funding for
SourceSuite's operations in 2001. Additionally, the Company has interest
payments on its Notes of approximately $5.3 million each due on May 1 and
November 1, 2001 (see Note 5). These factors raise substantial doubt about our
ability to continue as a going concern.

     In an effort to reduce costs, the Company has begun restructuring efforts
which include discontinuing FOB advertising services, exiting low margin
products and reducing the number of employees. At December 31, 2000, the Company
had $7.8 million of cash available, along with its Liberate stock valued at
$12.1 million as of that date. Additionally, the Company has engaged UBS Warburg
LLC as our financial advisor to help us evaluate strategic alternatives,
especially related to its debt requirements. There can be no assurances that the
Company will be able to refinance, sell assets or recapitalize or reorganize our
business and assets on acceptable terms or at an appropriate time.

2. SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

     The consolidated financial statements include the accounts of the Company,
its wholly owned operating subsidiaries: Holdings, IT Network, Interactive
Channel; its other operating Canadian subsidiaries, ICTI and 997758 Ontario Inc.
("997758"), as well as its wholly owned non-operating subsidiary, Source
Investments, Inc. 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 Statements 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. For the year ended December 31, 2000, the Company received $3.2
million in reimbursements from SourceSuite. These costs are included in the
receivable from related parties and are reimbursed to the Company by SourceSuite
on a regular basis.

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.


                                       42
<PAGE>   43

Minority Interests in Consolidated Subsidiaries

     Minority interests in consolidated subsidiaries represent the minority
stockholder's proportionate share of the equity of 997758. At December 31, 1999
and 2000, 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 7 -- 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.

Available for Sale Securities

     Investment in securities available for sale, which consists of the
Company's investment in Liberate's common stock, is recorded at fair value.
Unrealized gains and losses on the investment are included in other
comprehensive loss. Declines deemed other than temporary declines in fair value
are charged to earnings.

Monetary Revenue Recognition

     IT Network earns monetary revenues from sales of audio and text
programming, audio text to newspapers, advertiser management services and system
management services. Monetary revenues relating to these sales are recognized
over the contract period as the services are performed, typically one year. IT
Network has historically also earned monetary revenue 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. In accordance with the
requirements of Staff Accounting Bulletin No. 101 (see Note 12) effective
January 1, 2000, monetary revenues and associated costs relating to print ads
appearing in yellow page telephone books and related interactive advertising
services are recognized over the life of the contract, which is generally one
year.

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. Prior to 2000, 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. Beginning in 2000, in accordance with EITF 99-17, revenues and cost of
sales for nonmonetary advertising barter transactions are recorded at the fair
value of advertising surrendered by the Company. The decline in nonmonetary
revenues from 1999 to 2000 is largely attributable to this change. Nonmonetary
revenues and cost of sales are recognized on a straight-line basis over the
terms of the respective contracts.

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

                                       43
<PAGE>   44

three-year period. Production and other equipment are depreciated over a
five-year period. Furniture and fixtures are depreciated over a seven-year
period.

Intangible Assets

     Intangible assets are amortized using the straight-line method over an
estimated useful life of five to seven years for contract rights and five years
for goodwill. 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.

     During the fourth quarter of 2000, as part of the Company's evaluation of
its various product lines, and, as a result of its decision to discontinue its
front of book ("FOB") yellow page advertising services, it was determined that
certain intangible assets related to goodwill and contract rights recorded as
part of the 1997 acquisition of certain assets of Brite Voice Systems, Inc.
("Brite") and Voice News Network, Inc. ("VNN"), were impaired. Based upon an
analysis of the expected future cash flows, discounted as of December 31, 2000,
the Company recorded a non-cash write-down of $5.6 million ($0.33 per share) of
the related goodwill and contract rights.

     In the second quarter of 1998, 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. This impairment charge was recognized based upon an
analysis of estimated discounted future cash flows after the Company learned
that former Brite and IT Network employees had formed a company to service many
of the former Brite clients, and, as a result, several former Brite customers
cancelled or did not renew their contracts with IT Network.

Advertising Costs

     The Company expenses the costs of advertising as incurred. Excluding costs
associated with non-monetary advertising barter transactions described above,
advertising expenses were $0.4 million and $0.2 million for the years ended
December 31, 1998 and 1999, respectively. There were no such advertising
expenses for the year ended December 31, 2000.

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
material 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". All
potentially dilutive common stock equivalents, which include stock options and
warrants (see Note 7), are anti-dilutive and have been excluded from net loss
per common share calculations.


                                       44
<PAGE>   45

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 for a grant is at or above the fair market value
of the underlying stock on the date of grant.

New Accounting Pronouncements

     FAS 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 believes the adoption
of this statement during the first quarter of 2001 will not have a material
effect on the Company's results of operations.

3. COMMITMENTS AND CONTINGENCIES

     On August 21, 1998, the first of fourteen class action complaints were
filed against the Company and certain of its present and former officers and
directors in the United States District Court for the Northern District of Texas
asserting violations of sections 10(b) and 20(a) of the Securities Exchange Act
of 1934 and Rule 10-b5 promulgated thereunder. The fourteen complaints were
consolidated into the first filed case. Plaintiffs filed an amended complaint on
March 3, 1999. The plaintiffs sought damages in an unspecified amount. On May 1,
2000, the Court set a series of deadlines for the disposition of the case with
the trial set for April 16, 2001. The Company believes it is adequately insured
against losses from this litigation and that this case is totally without merit.
The Company intends to defend itself, and its officers and directors,
vigorously.

     As part of the sale of the VirtualModem technology to Liberate, Liberate
acquired certain patents that were the subject of a patent infringement lawsuit.
This lawsuit was initially brought by the Company's subsidiaries, Interactive
Channel Technologies and SMI Holdings, against WorldGate Communications in May
1998 in the United States District Court for the District of Delaware. The
patent infringement claims have been assigned to Liberate as a result of its
acquisition of the VirtualModem technology from the Company. In June 1998,
WorldGate filed a counterclaim against the Company, alleging, among others,
violations of the Lanham Act and Delaware's Uniform Deceptive Trade Practices
Act, common law unfair competition, tortious interference with existing and
prospective business relationships and misappropriation of confidential
information and trade secrets. SourceSuite joined the litigation after its
formation. Following discovery and briefing of the patent claim construction
issues, the parties have entered into settlement negotiations covering both
WorldGate's cross-complaint against the Company and Liberate's patent
infringement claims against WorldGate. Further, as part of the acquisition of
VirtualModem, Liberate agreed to defend the Company against WorldGate's
cross-complaint and to undertake to settle the litigation and acquire a
dismissal with prejudice of WorldGate's cross-complaint against the Company. On
March 20, 2001, the court issued a ruling enforcing a proposed settlement
agreement among the parties which included a dismissal with prejudice of
WorldGate's cross-complaint against the Company and an agreement by the Company
and Liberate not to sue with respect to certain WorldGate technology. The
Company continues to evaluate its position in this litigation to take
appropriate steps to protect its intellectual property rights.

     From time to time, the Company becomes aware of certain threatened claims
against it that may develop into litigation. The Company is not aware of any
threatened claim that, if determined adversely to it, would have a material and
adverse effect on its business or financial condition. Further, from time to
time, the Company is a party to routine litigation arising out of


                                       45
<PAGE>   46

the ordinary course of business, none of which is expected to have a material
and adverse effect on its business or financial condition.

     In 1999, 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 expired in 2000.

     At December 31, 2000, the Company has employment agreements with six
executives that expire in 2001 and 2002. The agreements generally provide that
the Company will pay a base salary amount and grant stock options to the
employees, which vest over a fixed period, typically four years. In the event of
a termination without cause, the Company remains obligated to make certain
payments as defined in the agreements.

     In 1999 and 2000, the Company entered into severance agreements totaling
$0.6 million and $0.3 million, respectively, with certain executives that
provide for salary continuation for up to six months and Company payment of
health insurance premiums.

4. INVESTMENTS

     The Company held certain short-term investments in 1999 and 2000, which
consisted of highly liquid investments with maturities of three months or less,
which were classified as cash equivalents. In 1999, the Company also had
securities that were held to maturity.

     As of December 31, 1999, the Company had funds in an escrow account,
established to pay interest on its long-term indebtedness (see Note 5), which
totaled $6.0 million and consisted of securities to be held to maturity. The
restricted investments included in the Escrow were carried at amortized cost,
which approximated fair value. Substantially all of the investments represented
U.S. corporate obligations. During 2000, all funds in the Escrow Account were
disbursed.

     At December 31, 2000, our investment in securities available for sale
consisted solely of Liberate common stock. The fair value and cost of this
investment at December 31, 2000 were $12.1 million and $87.5 million,
respectively. During December 2000, we judged the decline in value of our
investment in Liberate to be other than temporary. Accordingly, we recognized a
charge to other expense of $75.4 million based upon the closing price per share
of Liberate common stock of $13.625 as of December 31, 2000. This investment is
held by our wholly owned subsidiary, Source Investments, Inc. and is pledged as
collateral on our long-term debt.

5. LONG-TERM DEBT

     On October 30, 1997, the Company issued Senior Secured Notes ("Senior
Secured Notes" or "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 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 an escrow account. Additionally, the Company placed in escrow $6.0
million in November 1999 from proceeds received in the transaction with Insight
(see Note 1). All proceeds in escrow as of December 31, 1999 were subsequently
disbursed to pay the May 2000 interest payment. The November 2000 interest
payment was made from available cash funds.


                                       46
<PAGE>   47

     The Notes are fully and unconditionally guaranteed, jointly and severally,
by each of the Company's subsidiaries (the "Subsidiary Guarantors"), other than
Source Investments, Inc. Source Investment, Inc. has pledged the Liberate shares
as collateral to secure payment on its Notes. The guarantees are senior
obligations of the Subsidiary Guarantors and are secured by substantially all of
the assets of the Subsidiary Guarantors. The guarantees rank pari passu in right
of payment with all existing and future senior indebtedness of the Subsidiary
Guarantors and rank senior in right of payment to all existing and future
subordinated obligations of the Subsidiary Guarantors. The guarantees may be
released upon the occurrence of certain events. The guarantee executed by IT
Network contains a covenant that restricts payment of dividends on its capital
stock to an amount sufficient to cover debt service on the Notes, redemptions or
repurchases of the Notes or the Company's Senior PIK Preferred Stock (see Note
6), dividends on the Preferred Stock and corporate overhead. The assets of the
Company consist solely of the capital stock of its subsidiaries, investments in
Liberate and SourceSuite, and the remaining invested proceeds from Insight's
equity investment and the issuance of 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 SourceSuite, the Company pledged its
membership units in SourceSuite as collateral to secure payments on the Notes.

     On December 13, 1999, $3.75 million of Notes were tendered to the Company
and additional cash was received in exchange for an exercise of warrants to
purchase shares of common stock. In 2000, the Company issued 674,005 shares of
common stock in exchange for Notes with a carrying value of $7.7 million. These
transactions resulted in extraordinary gains of $4.2 million. Interest payments
of $12.1 million, $12.0 million and $11.1 million were made in 1998, 1999 and
2000, respectively.

     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. The Notes are not subject to any sinking fund
requirement. All Notes are due November 1, 2004. Upon the occurrence of a change
in control, the Company will be required to make an offer to repurchase the
Notes at a price equal to 101% of the principal amount thereof, together with
accrued and unpaid interest, if any, to the date of the repurchase. The
indenture contains certain covenants including, but not limited to, limitations
on indebtedness, restricted payments, liens, restrictions on distributions from
restricted subsidiaries, sales of assets and subsidiary stock, affiliate
transactions, issuances of capital stock of restricted subsidiaries and
sale/leaseback transactions. As of December 31, 2000, $88.5 million of Notes
were outstanding and the dealer quoted value of a Note was $0.20 per dollar face
value, resulting in an aggregate fair market value of the outstanding Notes of
approximately $17.7 million.

6. PREFERRED STOCK

     SENIOR PIK PREFERRED STOCK

     On October 30, 1997, the Company issued 800 units (the "Units") of the
Preferred Stock and warrants for an aggregate purchase price of $20 million,
Each Unit consisted 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


                                       47
<PAGE>   48


purchase 447,000 shares of common stock. The Units were sold in connection with
the Company's acquisitions of certain assets.

     Dividends on the Preferred Stock are payable quarterly on each February 1,
May 1, August 1 and November 1, commencing February 1, 1998, at 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 establishing the
Preferred Stock limits the amount of cash dividends that may be paid on the
Preferred Stock. Prior to November 1, 2002, the Preferred Stock is not
redeemable. On or after November 1, 2002, the Company may redeem the Preferred
Stock, in whole or in part, at any time, at various redemption prices, plus
accumulated and unpaid dividends, to the date of redemption. Upon the occurrence
of a change in control, the Company will be required to make an offer to
purchase the outstanding shares of the Preferred Stock at a price equal to 101%
of the liquidation preference thereof, plus accumulated and unpaid dividends, to
the date of purchase. The Preferred Stock will be subject to mandatory
redemption in whole on November 1, 2007, at a price equal to 100% of the then
effective liquidation preference thereof, plus, without duplication, all accrued
and unpaid dividends to the date of redemption. The certificate of designation
contains certain covenants including, but not limited to, limitations on
indebtedness, restricted payments, affiliate transactions, issuances of capital
stock of restricted subsidiaries and sale/leaseback transactions.

     The Preferred Stock ranks senior to all classes of common stock and to each
other class of capital stock or series of preferred stock with respect to
dividend rights and rights on liquidation, winding-up and dissolution of the
Company. The Preferred Stock is non-voting except in certain circumstances. The
Company may not authorize any new class of preferred stock that ranks senior or
pari passu to the Preferred Stock without the approval of the holders of at
least a majority of the shares of Preferred Stock then outstanding, voting or
consenting, as the case may be, as one class, provided, however, that the
Company 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 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. The fair value of the Preferred Stock at December 31,
2000 was $0.5 million based on dealer quoted market prices.

     During 1999 and 2000, 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 and $2.7 million, respectively, 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 in 1999 and $1.3 million in 2000, which were recorded as
preferred stock dividends.

     During the second and third quarters of 2000, the Company entered into a
number of agreements whereby it exchanged shares of its common stock for shares
of Preferred Stock. In each instance, the exchange ratio was 1.2 common shares
for each share of Preferred Stock. The Company issued 725,064 shares of common
stock with a market value of $4.4 million, in


                                       48
<PAGE>   49

exchange for Preferred Stock with a carrying value of $11.2 million. Dividends
on preferred shares were deducted from the difference between the carrying value
of preferred shares and the market value of the common shares issued to
determine the amount to be added back in arriving at net loss available to
common shareholders for 2000.

     NON-PARTICIPATING PREFERRED STOCK

     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.

7. 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
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.


                                       49
<PAGE>   50


    The following table is a summary of stock option activity under the employee
stock option plans during the years ended December 31, 1998, 1999, and 2000:


<TABLE>
<CAPTION>
                                                                                                    WEIGHTED
                                                                                                    AVERAGE
                                       OPTIONS         SHARES                      OPTIONS OR       EXERCISE
                                      AVAILABLE         UNDER       AGGREGATE       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, 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
  Options Authorized............              --             --             --                --         --
  Options Granted...............        (825,500)       825,500      6,124,460     3.03 -  11.94       7.42
  Options Exercised.............                       (106,280)      (938,575)    6.41 -  16.63       8.83
  Options Cancelled -- 1995
    Plan........................         338,815       (338,815)    (4,106,493)    6.41 -  16.63      12.12
  Options Cancelled -- Other
    Plans.......................         103,000       (103,000)    (1,010,838)    7.56 -  11.94       9.81
                                      ----------      ---------    -----------    --------------     ------
BALANCE AT DECEMBER 31, 2000....       1,189,000      2,670,009    $28,819,240    $3.03 - $16.63     $10.79
                                      ==========      =========    ===========    ==============     ======
</TABLE>

     On January 2, 1998, the Company granted stock options to its employees,
which fully vest on January 2, 2004. If certain target stock prices are met, the
vesting accelerates. As a portion of the underlying shares for these options had
not been authorized by the common stockholders at the date of grant, the portion
of unauthorized options were treated as a variable compensation plan through
July 28, 1998, when the stockholders authorized the shares. Separately, in 2000,
the Company accelerated vesting and modified the terms of stock options
associated with the severance of an employee, which resulted in $0.6 million of
compensation expense on the new measurement date. Total stock compensation
expense amounted to $2.1 million, $1.1 million, and $1.1 million in selling,
general and administrative expense during 1998, 1999, and 2000, respectively.

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

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




                                       50
<PAGE>   51

summary of stock option activity under the Directors' Plan during the years
ended December 31, 1998, 1999, and 2000:

<TABLE>
<CAPTION>
       DIRECTORS' PLAN              OPTIONS      SHARES                      OPTION OR      WEIGHTED AVERAGE
        STOCK OPTION               AVAILABLE      UNDER      AGGREGATE       EXERCISE           EXERCISE
          ACTIVITY                 FOR GRANT     OPTION        PRICE      PRICE PER SHARE   PRICE PER SHARE
  ------------------------         ---------    ---------    ----------   ---------------   ----------------
<S>                                <C>          <C>          <C>          <C>               <C>
  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
  Options Granted................   (18,000)      18,000         19,856              1.10         1.10
  Options Exercised..............        --       (3,000)       (17,730)             5.91         5.91
  Options Cancelled..............    15,000      (15,000)      (118,355)    1.10 -  13.19         7.89
                                    -------      -------     ----------   ---------------       ------
  BALANCE AT DECEMBER 31, 2000...    41,000       78,000     $  953,962   $ 1.10 - $22.84       $12.23
                                    =======      =======     ==========   ===============       ======
</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 2000, no Replacement
Options were exercised. As of December 31, 2000, the remaining options represent
the right to purchase 23,927 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, 2000, is being presented based on a range of exercise prices as follows:

<TABLE>
<CAPTION>
                                                                            EXERCISE PRICES
                                                           $1.10 - $4.15    $4.62 - $16.63    $17.54 - 22.84
                                                           -------------    --------------    --------------
<S>                                                        <C>              <C>               <C>
        Number of outstanding options...................       193,427          2,515,582            39,000
        Weighted average exercise price of outstanding
          Options.......................................    $     3.04        $     10.46       $     18.78
        Weighted average remaining contractual life.....     9.3 years         7.53 years        7.36 years
        Number of options exercisable...................        35,837          1,390,544            25,890
        Weighted average exercise price of options
          Exercisable...................................    $     3.10        $     10.94       $     19.40
</TABLE>

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


<TABLE>
<CAPTION>
                                                  1998            1999             2000
                                                  ----            ----             ----
<S>                                             <C>             <C>              <C>
       Risk-free interest rate...........         5.31%           4.83%            6.11%
       Expected dividend yield...........         0.00%           0.00%            0.00%
       Expected volatility...............           76%            104%             119%
       Expected lives....................        2.7 years       2.6 years       4.0 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.


                                       51
<PAGE>   52

     The weighted-average fair value of stock options granted during the years
ended December 31, 1998, 1999 and 2000 was $4.50, $9.35, and $5.67,
respectively. For purposes of the pro forma disclosures, the estimated fair
value of stock options granted from January 1, 1995 through December 31, 2000
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>
                                                                                     1998       1999       2000
                                                                                   --------   --------   --------
<S>                                                                                <C>        <C>        <C>
           Net loss attributable to common stockholders.............  As reported  $ 62,626   $ 40,019   $ 19,808
                                                                      Pro forma      64,271     44,548     22,411
           Net loss per common share................................  As reported      5.21       2.93       1.17
                                                                      Pro forma        5.35       3.26       1.33
</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, 2000,
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>
                       1,015,338                 $ 6.00                  November 2001
                         100,000                   6.41                  May 2001
                       2,226,763(1)               11.00                  December 2001
                          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
                         150,864                   0.01                  November 2007
                      ----------
                       8,856,283
                      ==========

</TABLE>

(1) In the event the sales price of the Company's common stock equals or exceeds
    $13.00 per share for 10 consecutive trading days, the Company will have the
    right to call warrants representing 2,226,813 common shares upon 20 days
    written notice at a price of $11.00 per share.

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.

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, 2001, 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.

                                       52
<PAGE>   53


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 187,605 shares of common stock held in treasury. On June
30, 2000 and December 31, 2000, 17,445 shares and 62,854 shares of common stock
were purchased by employees at prices of $3.0281 per share and $0.39843 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.

Shares Reserved for Future Issuance

     As of December 31, 2000, common shares reserved for future issuance were as
follows:

<TABLE>
<CAPTION>
                                                         NUMBER OF
                   SECURITY                            RESERVED SHARES
                   --------                            ---------------
           <S>                                         <C>
           Warrants ................................      8,856,283
           Stock options ...........................      2,771,936
           Employee stock purchase plan ............        187,605
           997758 Class Y Stock exchange rights ....        206,376
                                                         ----------
                                                         12,022,200
                                                         ==========
</TABLE>

8. NOTES RECEIVABLE FROM STOCKHOLDERS

     On May 20, 1993, the Company lent $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, 2001. The Company recorded a
discount to reflect the difference between the actual interest rate and a
reasonable market rate (10%). The note and accrued interest, net of unamortized
discount, are reflected as a reduction of minority interests in the accompanying
consolidated balance sheet.

9. LEASES

     The Company leases office space and various office equipment under
operating leases. Rent expense was $1.1 million, $1.1 million and $.8 million
for the years ended December 31, 1998, 1999, and 2000, respectively.

     At December 31, 2000, aggregate amounts of future minimum payments under
lease commitments are as follows:

<TABLE>
<CAPTION>
                                                             OPERATING LEASES
                                                             ----------------
                                                               (IN THOUSANDS)
<S>                                                          <C>
       2001....................................                    $   841
       2002....................................                         44
       2003....................................                         10
                                                                   -------
                 Total future minimum lease payments               $   895
                                                                   =======
</TABLE>



                                       53
<PAGE>   54

10. INCOME TAXES

     For the years ended December 31, 1998, 1999 and 2000, the Company had no
provision or benefit for income taxes because the deferred benefit from
operating losses was offset by an increase in the valuation allowance of $18.3
million, $9.9 million and $9.6 million, respectively. Significant components of
the Company's deferred tax assets and liabilities are as follows:

<TABLE>
<CAPTION>
                                                                1998             1999              2000
                                                            ------------     ------------     ------------
<S>                                                         <C>               <C>              <C>
Deferred tax liabilities:
Tax over book depreciation .............................    $   (523,243)    $   (353,932)    $   (293,487)
Book over tax basis in investment in joint venture .....              --       (3,909,790)              --
Book over tax basis in stock investment ................              --               --       (1,486,660)
Other ..................................................          (7,706)         (19,707)         (58,275)
                                                            ------------     ------------     ------------
          Total deferred tax liabilities ...............        (530,949)      (4,283,429)      (1,838,422)
Deferred tax assets:
  Net operating loss carryforwards .....................      32,431,574       46,376,006       51,155,392
  Investment tax credits ...............................         488,025          459,279          332,916
  Unearned income ......................................         787,065          712,132        1,328,969
  Book over tax basis of intangibles ...................      10,420,726       10,290,481       10,124,887
  Reserve for intangible asset impairment ..............         739,763               --        2,067,560
  Accrued expenses .....................................         927,397        1,527,482        1,488,294
  Other ................................................         143,312          227,303          270,464
                                                            ------------     ------------     ------------
          Total deferred tax assets ....................      45,937,862       59,592,683       66,768,482
Valuation allowance for deferred tax assets ............     (45,406,913)     (55,309,254)     (64,930,060)
                                                            ------------     ------------     ------------
Net of valuation allowance .............................         530,949        4,283,429        1,838,422
                                                            ------------     ------------     ------------
Net deferred tax asset                                                --               --               --
                                                            ============     ============     ============
</TABLE>

     At December 31, 2000, the Company had net operating loss carryforwards of
approximately $137.4 million for United States income tax purposes that expire
in 2003 through 2020, which may be used to reduce future United States taxable
income. The Internal Revenue Code, as amended, imposes limitations on the use of
net operating loss carryforwards if certain stock ownership changes occur. An
ownership change occurred in 1995 that caused utilization of $23.1 million of
the Company's net operating losses to be limited to approximately $9.0 million
in a given year.

     At December 31, 2000, ICTI had net operating loss carryforwards for
Canadian income tax purposes of approximately Cdn $0.7 million, expiring in 2002
through 2003, which may be used to reduce future Canadian taxable income of
ICTI. ICTI also has available at December 31, 2000 investment tax credits
totaling Cdn $0.5 million, expiring in 2001 through 2002.

     Certain transactions between ICTI and its subsidiaries in 1998 resulted in
utilization of approximately Cdn $4.0 million of Canadian net operating loss
carryforwards.

11. 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 balance of the allowance for
doubtful accounts at December 31, 1998, 1999 and 2000 is $0.4 million, $0.6
million and $0.7 million, respectively. Bad debt expense of $1.1 million, $0.3
million and $0.6 million was recorded in the years ended December 31, 1998, 1999
and 2000, respectively. Write-offs against the allowance totaled $0.8 million,
$0.1 million and $0.5 million in 1998, 1999 and 2000, respectively.



                                       54
<PAGE>   55

     As of December 31, 1999 and 2000, balances due from BellSouth Advertising
and Publishing represented 16% and 18%, 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 2000.

     For the years ended December 31, 1998, 1999, and 2000, a major customer
accounted for 12%, 18%, and 19% of monetary revenue, respectively. No other
customer accounted for greater than 10% of monetary revenues for any of the
three years ended December 31, 2000.

12. CHANGE IN ACCOUNTING PRINCIPLE - ADOPTION OF SAB 101

     Effective January 1, 2000, the Company changed its method of accounting for
revenue recognition in accordance with Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements" ("SAB 101"). Previously, the
Company had recognized all or a portion of monetary revenues and associated
costs relating to certain print ads included in yellow page telephone books at
the time of distribution by the directory publishers. Since the Company
generally provides interactive advertising services in connection with the print
ads, under the new accounting method adopted retroactive to January 1, 2000, the
Company now recognizes monetary revenues and associated costs for on the print
ads and related interactive advertising services on a straight-line basis over
the term of the related contracts, which is typically one year commencing at the
time of the annual distribution of the applicable local yellow pages directory.

     The cumulative effect of the change on prior years resulted in a charge to
operations of $1.2 million and an increase in revenues of $3.8 million, which
are included in results of operations for the year ended December 31, 2000. The
effect of the change on the year ended December 31, 2000 was to decrease net
loss before extraordinary items and the cumulative effect of the accounting
change by $0.2 million ($0.01 per share). Assuming the accounting change was
made retroactively to prior periods, pro forma net loss attributable to common
stockholders (unaudited) and net loss per common share attributable to common
stockholders (unaudited) would have been $63.6 million and $5.30 for the year
ended December 31, 1998 and $40.2 million and $2.94 for the year ended December
31, 1999.

13. EQUITY IN SOURCESUITE JOINT VENTURE

     On November 17, 1999 the Company completed the creation of a joint venture
with Insight to conduct the business of its former VirtualModem and Interactive
TV lines of business. The investment in the joint venture was accounted for by
the equity method. The Company contributed certain assets of the "VirtualModem"
and "Interactive Channel" products and businesses in exchange for a 50%
ownership in the joint venture. Insight contributed $13 million in cash to the
joint venture in exchange for a 50% interest. In connection with the formation
of this venture, the Company issued warrants to Insight to purchase 4,596,786
shares of its common stock at $20 share and sold 842,105 shares of its common
stock to Insight for $12 million ($14.25 per share). On March 3, 2000, the joint
venture conveyed its Interactive TV line of business to SourceSuite, and Source
Media and Insight each sold their interests in the joint venture to Liberate in
exchange for the issuance to each of Source Media and Insight of 886,000 shares
of Liberate common stock and $4.4 million of cash. The Company and Insight each
contributed $4.4 million of cash to SourceSuite in return for a 50% ownership
interest in the joint venture.

     This transaction resulted in a gain for the Company of $75.0 million in the
first quarter. The gain was calculated based on the cash received and the
closing price of Liberate common stock on March 3, 2000 (the closing date) of
$98.6875 per share, net of the Company's adjusted book basis in the joint
venture investment of $16.9 million. The Company has net operating loss carry
forwards in excess of the tax effect of this gain and, consequently, has
reported no current or deferred income tax expense.


                                       55
<PAGE>   56

     The following represents the unaudited pro forma results of operations of
Source Media as if the Company's prior joint venture with Insight and subsequent
sale to Liberate and the formation of SourceSuite had occurred on January 1,
1999 (in thousands except for per share data).

<TABLE>
<CAPTION>
                                                             YEAR ENDED DECEMBER 31,
                                                              1999            2000
                                                            --------        --------
<S>                                                         <C>             <C>
Pro forma total revenues                                    $ 20,928        $ 18,637
Pro forma operating loss                                     (12,128)        (12,726)
Pro forma net loss attributed to common stockholders         (12,892)        (18,722)
Pro forma net loss per common share                           (2.06)          (1.27)
</TABLE>

     SourceSuite is managed by the Company within the terms of the operating
agreement and the annual operating plan approved by the Management Committee.
Special actions by SourceSuite require approval of a four-member management
committee with equal representation, by both Source Media and Insight, on the
Management Committee. The Operating Agreement of SourceSuite restricts any
distribution of equity to members for a period of three years.

     The Company has recorded its share of SourceSuite's results of operations
using the equity method in the Consolidated Statement of Operations. Assets
contributed to SourceSuite have been valued based on an independent appraisal of
fair value and allocated to assets, liabilities and goodwill.

     The Company records amortization of the assets contributed to the joint
venture on its historical basis.

     Summary financial data of SourceSuite at December 31, 2000 is as follows
(in thousands):

<TABLE>
<S>                                                                  <C>
                  ASSETS:
                    Current assets............................       $  3,670
                    Software development costs................            188
                    Property and equipment, net...............            600
                    Intangible assets, net....................            762
                                                                     --------
                                                                     $  5,220
                                                                     ========

                  LIABILITIES AND MEMBERS' EQUITY:
                    Current liabilities.......................       $  1,204
                    Members' equity...........................          4,016
                                                                     --------
                                                                     $  5,220
                                                                     ========

                    Revenues..................................       $    128
                    Net loss..................................       $ (5,951)
</TABLE>


                                       56
<PAGE>   57


Summary financial data of the joint venture (formed on November 17, 1999 and
subsequently sold on March 3, 2000) 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>


14. SEGMENT REPORTING

     In accordance with FAS 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 provides rich media content that can be accessed via the
Internet, telephone, wireless and personal devices and 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 is operated through SourceSuite LLC, a 50/50
joint venture we manage, which provides interactive programming services,
including a fully interactive program known as SourceGuide, and an information
entertainment service known as LocalSource. The Company accounts for its
investment in SourceSuite using the equity method. Prior to November 17, 1999,
the Interactive TV business included the results of the Interactive Channel and
ICTI subsidiaries.

     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.


                                       57
<PAGE>   58

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

<TABLE>
<CAPTION>
                                                                       YEAR ENDED DECEMBER 31,
                                                           ---------------------------------------------
                                                             1998               1999             2000
                                                           ---------          ---------        ---------
                                                                            (IN THOUSANDS)
<S>                                                        <C>                <C>              <C>
     Monetary revenues:
       IT Network..........................                $  24,244          $  19,105        $  17,916
       Interactive TV......................                      108                 42               --
                                                           ---------          ---------        ---------
               Total monetary revenues.....                $  24,352          $  19,147        $  17,916
                                                           =========          =========        =========
     Nonmonetary revenues:
       IT Network..........................                $   1,756          $   1,823        $     721
       Interactive TV......................                       --                 --               --
                                                           ---------          ---------        ---------
               Total nonmonetary revenues..                $   1,756          $   1,823        $     721
                                                           =========          =========        =========
     Net revenues:
       IT Network..........................                $  26,000          $  20,928        $  18,637
       Interactive TV......................                      108                 42               --
                                                           ---------          ---------        ---------
               Total net revenues..........                $  26,108          $  20,970        $  18,637
                                                           =========          =========        =========
     Operating loss:
       IT Network (1)......................                $ (29,475)         $  (6,145)       $ (10,090)
       Interactive TV......................                  (11,325)            (9,017)              --
       Corporate...........................                   (7,960)            (9,860)          (2,636)
                                                           ---------          ---------        ---------
               Total operating loss........                $ (48,760)         $ (25,022)       $ (12,726)
                                                           =========          =========        =========
     Equity interest in loss of joint venture:
       Interactive TV......................                $      --          $  (1,013)       $  (4,238)
                                                           =========          =========        =========
     Identifiable assets:
       IT Network..........................                $  19,408          $  15,474        $   6,907
       Interactive TV......................                    8,401             20,675               --
       Corporate...........................                   28,780             21,867           24,149
                                                           ---------          ---------        ---------
               Total identifiable assets...                $  56,589          $  58,016        $  31,056
                                                           =========          =========        =========
     Depreciation and amortization:
       IT Network..........................                $   5,684          $   4,329        $   3,780
       Interactive TV......................                    2,925              2,765               --
       Corporate...........................                      251                218              100
                                                           ---------          ---------        ---------
               Total depreciation and
                 amortization .............                $   8,860          $   7,312        $   3,880
                                                           =========          =========        =========
     Equity investment in joint venture:
       Interactive TV......................                $      --          $  18,669        $   2,008
                                                           =========          =========        =========
     Capital expenditures:
       IT Network..........................                $     993          $     643        $     104
       Interactive TV......................                      432                570               --
       Corporate...........................                       85                 22              227
                                                           ---------          ---------        ---------
               Total capital expenditures..                $   1,510          $   1,235        $     331
                                                           =========          =========        =========
</TABLE>

----------

(1) In 1998 and 2000, the operating loss included write-downs of $25.9 million
and $5.6 million, respectively, for impairment of intangibles.

15. RESTRUCTURING CHARGES

     In the fourth quarter, as part of the Company's continuing evaluation of
its product lines, the Company decided to discontinue its FOB advertising
services. The Company will continue to honor commitments on contracts in books
that have already published, resulting in a wind-down period through March 2002.
As a result of this decision, the Company recognized a charge of $0.2 million
included in cost of sales for the write-down of production equipment held for
sale and $0.1 million included in selling, general and administrative expenses
for non-cancelable lease costs. Additionally, the Company will incur employee
severance costs of approximately $0.2 million during the first quarter of 2001
relating to continued restructuring efforts. FOB


                                       58
<PAGE>   59
advertising services generated revenue of approximately $12.4 million, $9.4
million and $8.0 million in 1998, 1999 and 2000 respectively.

16.  FINANCIAL INFORMATION FOR RELATED ISSUERS AND GUARANTORS

     Source Media, Inc. and its wholly owned subsidiaries have operations
organized as separate corporate subsidiaries. The Notes discussed in Note 5
result in debt securities that are fully and unconditionally guaranteed, jointly
and severally by each of the Company's subsidiaries (the "Subsidiary
Guarantors") other than Source Investments, Inc. ("Other Non-Guarantor
Subsidiary"). However, Source Investments, Inc. has pledged the Liberate shares
as collateral to secure payment on the Notes. The guarantees are senior
obligations of the Subsidiary Guarantors and are secured by substantially all of
the assets of the Subsidiary Guarantors. The following tables present the
financial positions, results of operations, and cash flows for each of the three
years ended December 31, 2000 combined into three categories: 1) the operations
of Source Media, Inc., 2) Subsidiary Guarantors, and 3) Other Non-Guarantor
Subsidiary (in thousands):


                                      59
<PAGE>   60
                               SOURCE MEDIA, INC.

                     CONDENSED CONSOLIDATING BALANCE SHEETS
                               DECEMBER 31, 2000
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                                          NON-
                                                             SOURCE MEDIA, SUBSIDIARY  GUARANTOR
                                                                 INC.      GUARANTORS  SUBSIDIARY   ELIMINATIONS CONSOLIDATED
                                                             ------------- ----------  ----------   ------------ ------------

<S>                                                          <C>           <C>           <C>          <C>            <C>
                                     ASSETS

Cash and cash equivalents ...............................    $      --     $   7,771     $       3    $       --     $   7,774
Trade accounts receivable, less allowance
  for doubtful accounts .................................           --         1,402            --            --         1,402
Related party receivables ...............................           --           390            --            --           390
Prepaid expenses and other current assets ...............           --         1,759            --            --         1,759
Investment in securities available for sale .............           --            --        12,072            --        12,072
                                                             ---------     ---------     ---------    ----------     ---------
Total current assets ....................................           --        11,322        12,075            --        23,397
Net property and equipment ..............................           --         1,277            --            --         1,277
Net intangible assets ...................................           --         1,578            --            --         1,578
Investment in SourceSuite LLC............................        2,008            --            --            --         2,008
Investment in SMI Holdings ..............................     (114,342)      165,387            --       (51,045)           --
Investment in Source Investments, Inc....................       12,075        75,373            --       (87,448)           --
Other non-current assets ................................        2,796            --            --            --         2,796
Intercompany ............................................      117,942      (117,942)           --            --            --
                                                             ---------     ---------     ---------    ----------     ---------
Total assets ............................................    $  20,479     $ 136,995     $  12,075    $ (138,493)    $  31,056
                                                             =========     =========     =========    ==========     =========

           LIABILITIES AND STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY)

Trade accounts payable ..................................    $      --     $   1,315     $      --    $       --     $   1,315
Accrued interest ........................................        1,771            --            --            --         1,771
Other accrued interest ..................................           --         2,020            --            --         2,020
Unearned income .........................................           --         4,267            --            --         4,267
                                                             ---------     ---------     ---------    ----------     ---------
Total current liabilities ...............................        1,771         7,602            --            --         9,373

Long-term debt ..........................................       88,542            --            --            --        88,542
Minority interests in consolidated subsidiaries .........                      3,840            --            --         3,840
Note receivable and accrued interest from
  minority stockholder ..................................           --          (865)           --            --          (865)
Senior redeemable payment-in-kind (PIK)
  preferred stock .......................................        8,571            --            --            --         8,571
Non-participating preferred stock .......................           --            --            --            --            --
Stockholders' equity ....................................      (78,405)      126,418        12,075      (138,493)      (78,405)
                                                             ---------     ---------     ---------    ----------     ---------
Total liabilities and stockholders' equity
  (capital deficiency) ..................................    $  20,479     $ 136,995     $  12,075    $ (138,493)    $  31,056
                                                             =========     =========     =========    ==========     =========
</TABLE>


                                       60
<PAGE>   61
                               SOURCE MEDIA, INC.
                CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

                                DECEMBER 31, 2000
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                                    NON-
                                                       SOURCE      SUBSIDIARY    GUARANTOR
                                                     MEDIA, INC.   GUARANTORS    SUBSIDIARY    ELIMINATIONS  CONSOLIDATED
                                                     -----------   ----------    ----------    ------------  ------------

<S>                                                <C>             <C>           <C>           <C>            <C>
Revenues .........................................    $      --     $  17,916     $      --     $      --     $  17,916
Cost of sales ....................................           --        11,340            --            --        11,340
                                                      ---------     ---------     ---------     ---------     ---------
Gross profit .....................................           --         6,576            --            --         6,576

Selling, general and administrative
  expenses .......................................           --        11,315             8            --        11,323
Impairment of intangible assets ..................           --         5,588            --            --         5,588
Amortization of intangible assets ................           --         2,391            --            --         2,391
                                                      ---------     ---------     ---------     ---------     ---------
                                                             --        19,294             8            --        19,302

Operating loss ...................................           --       (12,718)           (8)           --       (12,726)

Interest (income) expense, net ...................       11,638          (777)           --            --        10,861
Equity interest in losses of joint venture .......        4,238            --            --            --         4,238
Gain on sale of interest in joint venture ........      (74,977)           --            --            --       (74,977)
Equity interest in losses of subsidiary ..........       88,646          (182)           --       (88,464)           --
Other expense (income), net ......................           --           173        75,365            --        75,538
                                                      ---------     ---------     ---------     ---------     ---------
Net loss before extraordinary item ...............      (29,545)      (11,932)      (75,373)      (88,464)      (28,386)

Extraordinary loss - early extinguishment
  of debt ........................................       (4,239)           --            --            --        (4,239)
Cumulative effect of change in accounting
  principle ......................................           --         1,159            --            --         1,159
                                                      ---------     ---------     ---------     ---------     ---------
Net loss .........................................      (25,306)      (13,091)      (75,373)      (88,464)      (25,306)

Preferred stock dividends ........................       (5,498)           --            --            --        (5,498)
                                                      ---------     ---------     ---------     ---------     ---------

Net loss attributable to common
  stockholders ...................................     $(19,808)     $(13,091)     $(75,373)     $(88,464)     $(19,808)
                                                      =========     =========     =========     =========     =========
</TABLE>


                                       61
<PAGE>   62

                               SOURCE MEDIA, INC.
                CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

                                DECEMBER 31, 2000
                                 (IN THOUSANDS)


<TABLE>
<CAPTION>
                                                                                          NON-
                                                         SOURCE        SUBSIDIARY      GUARANTOR
                                                      MEDIA, INC.      GUARANTORS      SUBSIDIARY      ELIMINATIONS    CONSOLIDATED
                                                      -----------      ----------      ----------      ------------    ------------

<S>                                                  <C>               <C>             <C>             <C>             <C>
   OPERATING ACTIVITIES
   Net cash used in operating activities ............  $ (11,001)        $ (1,692)        $     (8)        $   --        $ (12,701)

   INVESTING ACTIVITIES
       Capital expenditures .........................         --             (331)              --             --             (331)
       Redemption of short-term investments .........         --            2,500               --             --            2,500
       Redemption of restricted investments .........      5,997              122               --             --            6,119
       Proceeds from sale of joint venture ..........         --            4,392               --             --            4,392
       Investment in  Source Investment .............         (8)          (4,384)              --             --           (4,392)
       Intercompany .................................      3,775           (3,775)              --             --               --
                                                       ---------         --------         --------         ------        ---------
   Net cash provided by (used in) investing
     activities .....................................      9,764           (1,476)              --             --            8,288

   FINANCING ACTIVITIES
       Proceeds from issuance of common
         stock ......................................      1,033               --               --             --            1,033
       Other ........................................        204               29               11             --              244
                                                       ---------         --------         --------         ------        ---------
   Net cash provided by financing activities ........      1,237               29               11             --            1,277

   Net increase (decrease) in cash and cash
     equivalents ....................................         --           (3,139)               3             --           (3,136)
   Cash and cash equivalents at beginning of
     period .........................................         --           10,910               --             --           10,910
                                                       ---------         --------         --------         ------        ---------

   Cash and cash equivalents at end of period .......  $      --         $  7,771         $      3         $   --        $   7,774
                                                       =========         ========         ========         ======        =========
</TABLE>



                                      62
<PAGE>   63
                               SOURCE MEDIA, INC.
                     CONDENSED CONSOLIDATING BALANCE SHEETS

                                DECEMBER 31, 1999
                                 (IN THOUSANDS)


<TABLE>
<CAPTION>
                                                                                                NON-
                                                                  SOURCE        SUBSIDIARY   GUARANTOR
                                                                MEDIA, INC.     GUARANTORS   SUBSIDIARY  ELIMINATIONS  CONSOLIDATED
                                                                -----------    ------------  ----------  ------------  ------------
<S>                                                             <C>            <C>            <C>         <C>           <C>
                ASSETS

Cash and cash equivalents ....................................  $        --    $     10,910   $     --    $       --    $   10,910
Short-term investments .......................................           --           2,500         --            --         2,500
Restricted investments .......................................        5,997              --         --            --         5,997
Trade accounts receivable, less allowance
  for doubtful accounts ......................................           --           1,643         --            --         1,643
Related party receivables ....................................           --           1,458         --            --         1,458
Prepaid expenses and other current assets ....................           --           1,068         --            --         1,068
Investment in securities available for sale ..................           --              --         --            --            --
                                                                -----------    ------------   --------    ----------    ----------
Total current assets .........................................        5,997          17,579         --            --        23,576
Net property and equipment ...................................           --           2,434         --            --         2,434
Net intangible assets ........................................           --           9,502         --            --         9,502
Investment in SourceSuite LLC ................................       18,669              --         --            --        18,669
Investment in SMI Holdings ...................................      (94,865)        145,910         --       (51,045)           --
Other non-current assets .....................................        3,835              --         --            --         3,835
Intercompany .................................................      114,200        (114,200)        --            --            --
                                                                -----------    ------------   --------    ----------    ----------
Total assets .................................................  $    47,836    $     61,225   $     --    $  (51,045)   $   58,016
                                                                ===========    ============   ========    ==========    ==========

LIABILITIES AND STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY)

Trade accounts payable .......................................  $        --    $        955   $     --    $       --    $      955
Accrued interest .............................................        1,991              --         --            --         1,991
Other accrued interest .......................................           --           4,297         --            --         4,297
Unearned income ..............................................           --           1,925         --            --         1,925
                                                                -----------    ------------   --------    ----------    ----------
Total current liabilities ....................................        1,991           7,177         --            --         9,168

Long-term debt ...............................................       96,250              --         --            --        96,250
Minority interests in consolidated
  subsidiaries ...............................................           --           3,840         --            --         3,840
Note receivable and accrued interest from
  minority stockholder .......................................           --            (837)        --            --          (837)
Senior redeemable payment-in-kind (PIK)
  preferred stock ............................................       18,467              --         --            --        18,467
Non-participating preferred stock ............................           --              --         --            --            --
Stockholders' equity .........................................      (68,872)         51,045         --       (51,045)      (68,872)
                                                                -----------    ------------   --------    ----------    ----------
Total liabilities and stockholders' equity
  (capital deficiency) .......................................  $    47,836    $     61,225   $     --    $  (51,045)   $   58,016
                                                                ===========    ============   ========    ==========    ==========
</TABLE>



                                       63
<PAGE>   64



                               SOURCE MEDIA, INC.
                CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

                               DECEMBER 31, 1999
                                 (IN THOUSANDS)


<TABLE>
<CAPTION>
                                                                                        NON-
                                                     SOURCE         SUBSIDIARY       GUARANTOR
                                                   MEDIA, INC.      GUARANTORS       SUBSIDIARY      ELIMINATIONS     CONSOLIDATED
                                                  -------------    -------------    -------------   -------------    -------------
<S>                                               <C>              <C>              <C>             <C>              <C>
Revenues ......................................   $          --    $      19,147    $          --   $          --    $      19,147
Cost of sales .................................              --           13,164               --              --           13,164
                                                  -------------    -------------    -------------   -------------    -------------
Gross profit ..................................              --            5,983               --              --            5,983

Selling, general and administrative
  expenses ....................................              --           23,714               --              --           23,714
Amortization of intangible assets .............              --            4,713               --              --            4,713
Research and development expenses .............              --            2,578               --              --            2,578
                                                  -------------    -------------    -------------   -------------    -------------
                                                             --           31,005               --              --           31,005

Operating loss ................................              --          (25,022)              --              --          (25,022)

Interest (income) expense, net ................          12,819             (828)              --              --           11,991
Equity interest in losses of joint venture ....           1,013               --               --              --            1,013
Equity interest in losses of subsidiaries .....          24,349               --               --         (24,349)              --
Other expense (income), net ...................              --              155               --              --              155
                                                  -------------    -------------    -------------   -------------    -------------
Net loss ......................................         (38,181)         (24,349)              --         (24,349)         (38,181)

Preferred stock dividends .....................           1,838               --               --              --            1,838
                                                  -------------    -------------    -------------   -------------    -------------
Net loss attributable to common
  stockholders ................................   $     (40,019)   $     (24,349)   $          --   $     (24,349)   $     (40,019)
                                                  =============    =============    =============   =============    =============
</TABLE>



                                       64
<PAGE>   65

                               SOURCE MEDIA, INC.
                CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

                                DECEMBER 31, 1999
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                                  NON-
                                                     SOURCE       SUBSIDIARY    GUARANTOR
                                                   MEDIA, INC.    GUARANTORS    SUBSIDIARY   ELIMINATIONS   CONSOLIDATED
                                                   -----------    ----------    ----------   ------------   ------------
<S>                                                <C>            <C>           <C>          <C>            <C>
OPERATING ACTIVITIES
Net cash used in operating activities ..........   $   (12,281)   $  (14,456)   $       --   $         --   $    (26,737)

INVESTING ACTIVITIES
    Capital expenditures .......................            --        (1,235)           --             --         (1,235)
    Redemption of restricted
      investments ..............................         6,000            --            --             --          6,000
    Purchase of short-term investments .........            --        (2,500)           --             --         (2,500)
    Capitalized acquisition costs ..............            --          (478)           --             --           (478)
    Investment in SourceSuite LLC ..............          (477)          477            --             --             --
    Intercompany ...............................       (17,441)       17,441            --             --             --
                                                   -----------    ----------    ----------   ------------   ------------
Net cash provided by (used in)
  investing activities .........................       (11,918)       13,705            --             --          1,787

FINANCING ACTIVITIES
    Proceeds from issuance of common
      stock upon exercise of stock
      options and warrants .....................        11,971            --            --             --         11,971
    Proceeds from issuance of common
      stock ....................................        12,000            --            --             --         12,000
    Other ......................................           228            (1)           --             --            227
                                                   -----------    ----------    ----------   ------------   ------------
Net cash provided by financing activities ......        24,199            (1)           --             --         24,198

Net increase (decrease) in cash and
  cash equivalents .............................            --          (752)           --             --           (752)
Cash and cash equivalents at beginning
  of period ....................................            --        11,662            --             --         11,662
                                                   -----------    ----------    ----------   ------------   ------------

Cash and cash equivalents at end of
  period .......................................   $        --    $   10,910    $       --   $         --   $     10,910
                                                   ===========    ==========    ==========   ============   ============
</TABLE>


                                       65
<PAGE>   66



                               SOURCE MEDIA, INC.
                     CONDENSED CONSOLIDATING BALANCE SHEETS

                                DECEMBER 31, 1998
                                 (IN THOUSANDS)


<TABLE>
<CAPTION>
                                                                                              NON-
                                                                    SOURCE     SUBSIDIARY  GUARANTOR
                                                                  MEDIA, INC.  GUARANTORS  SUBSIDIARY  ELIMINATIONS  CONSOLIDATED
                                                                  -----------  ----------  ----------  ------------  ------------
<S>                                                               <C>          <C>         <C>         <C>           <C>
                                     ASSETS

   Cash and cash equivalents ..................................   $        --  $   11,662  $       --  $         --  $     11,662
   Restricted investments .....................................        11,716          --          --            --        11,716
   Trade accounts receivable, less
      allowance for doubtful accounts .........................            --       3,596          --            --         3,596
   Prepaid expenses and other current assets ..................            --       1,384          --            --         1,384
                                                                  -----------  ----------  ----------  ------------  ------------
   Total current assets .......................................        11,716      16,642          --            --        28,358
   Net property and equipment .................................            --       4,400          --            --         4,400
   Net intangible assets ......................................            --      19,019          --            --        19,019
   Investment in SMI Holdings .................................       (67,029)    123,479          --       (56,450)           --
   Other non-current assets ...................................         4,812          --          --            --         4,812
   Intercompany ...............................................        97,620     (97,620)         --            --            --
                                                                  -----------  ----------  ----------  ------------  ------------
   Total assets ...............................................   $    47,119  $   65,920  $       --  $    (56,450) $     56,589
                                                                  ===========  ==========  ==========  ============  ============

   LIABILITIES AND STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY)

   Trade accounts payable .....................................   $        --  $    2,501  $       --  $         --  $      2,501
   Accrued interest ...........................................         2,000          --          --            --         2,000
   Other accrued interest .....................................            --       2,159          --            --         2,159
   Unearned income ............................................            --       1,750          --            --         1,750
                                                                  -----------  ----------  ----------  ------------  ------------
   Total current liabilities ..................................         2,000       6,410          --            --         8,410

   Long-term debt .............................................       100,000          --          --            --       100,000
   Minority interests in consolidated
     subsidiaries .............................................            --       3,840          --            --         3,840
   Note receivable and accrued interest
     from minority stockholder ................................            --        (780)         --            --          (780)
   Senior redeemable payment-in-kind (PIK)
     preferred stock ..........................................        16,628          --          --            --        16,628
   Stockholders' equity .......................................       (71,509)     56,450          --       (56,450)      (71,509)
                                                                  -----------  ----------  ----------  ------------  ------------
   Total liabilities and stockholders'
     equity (capital deficiency) ..............................   $    47,119  $   65,920  $       --  $    (56,450) $     56,589
                                                                  ===========  ==========  ==========  ============  ============
</TABLE>



                                       66
<PAGE>   67
                               SOURCE MEDIA, INC.
                CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

                                DECEMBER 31, 1998
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                                         NON-
                                                      SOURCE        SUBSIDIARY        GUARANTOR
                                                    MEDIA, INC.     GUARANTORS        SUBSIDIARY    ELIMINATIONS       CONSOLIDATED
                                                  -------------     ----------        ----------    ------------      ------------
<S>                                               <C>               <C>                <C>           <C>                <C>

Revenues ....................................        $     --         $ 24,352         $     --        $     --         $ 24,352
Cost of sales ...............................              --           12,674               --              --           12,674
                                                     --------         --------         --------        --------         --------
Gross profit ................................              --           11,678               --              --           11,678

Selling, general and administrative
  expenses ..................................              --           24,772               --              --           24,772
Impairment of intangible assets .............              --           25,936               --              --           25,936
Amortization of intangible assets ...........              --            6,320               --              --            6,320
Research and development expenses ...........              --            3,410               --              --            3,410
                                                     --------         --------         --------        --------         --------
                                                           --           60,438               --              --           60,438

Operating loss ..............................              --          (48,760)              --              --          (48,760)

Interest (income) expense, net ..............          12,830           (1,933)              --              --           10,897
Equity interest in losses of subsidiaries ...          46,800               --               --         (46,800)              --
Other expense (income), net .................              --              (27)              --              --              (27)
                                                     --------         --------         --------        --------         --------
Net loss ....................................         (59,630)         (46,800)              --         (46,800)         (59,630)

Preferred stock dividends ...................           2,996               --               --              --            2,996
                                                     --------         --------         --------        --------         --------

Net loss attributable to common
  stockholders ..............................        $(62,626)        $(46,800)        $     --        $(46,800)        $(62,626)
                                                     ========         ========         ========        ========         ========
</TABLE>



                                       67
<PAGE>   68
                               SOURCE MEDIA, INC.
                CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

                                DECEMBER 31, 1998
                                 (IN THOUSANDS)


<TABLE>
<CAPTION>
                                                                                          NON-
                                                       SOURCE         SUBSIDIARY       GUARANTOR
                                                     MEDIA, INC.      GUARANTORS       SUBSIDIARY    ELIMINATIONS    CONSOLIDATED
                                                   -------------      ----------       ----------    ------------    ------------
<S>                                                <C>                <C>              <C>           <C>             <C>

OPERATING ACTIVITIES
Net cash used in operating activities .......        $ (12,979)        $ (10,426)        $   --        $   --        $ (23,405)

INVESTING ACTIVITIES
    Capital expenditures ....................               --            (1,510)            --            --           (1,510)
    Redemption of short-term
      investments ...........................               --            15,682             --            --           15,682
    Redemption of restricted
      investments ...........................           12,000                --             --            --           12,000
    Intercompany ............................              495              (495)            --            --               --
                                                     ---------         ---------         ------        ------        ---------
Net cash provided by (used in)
  investing activities ......................           12,495            13,677             --            --           26,172

FINANCING ACTIVITIES
    Proceeds from issuance of
      common stock upon exercise of
      stock options and warrants ............              641                --             --            --              641
    Other ...................................             (157)              (20)            --            --             (177)
                                                     ---------         ---------         ------        ------        ---------
Net cash provided by financing
  activities ................................              484               (20)            --            --              464

Net increase (decrease) in cash and
  cash equivalents ..........................               --             3,231             --            --            3,231
Cash and cash equivalents at
  beginning of period .......................               --             8,431             --            --            8,431
                                                     ---------         ---------         ------        ------        ---------

Cash and cash equivalents at end of
  period ....................................        $      --         $  11,662         $   --        $   --        $  11,662
                                                     =========         =========         ======        ======        =========
</TABLE>

17. SUBSEQUENT EVENTS

     In March 2001, the Company hired UBS Warburg LLC as its financial advisor
to help the Company evaluate strategic alternatives for the Company.

     Since January 2001, the Company has taken steps to reduce its workforce to
contain expenses. The Company continues to evaluate its workforce requirements
in light of its business strategy and goals.



                                       68
<PAGE>   69


UNAUDITED QUARTERLY FINANCIAL DATA

     The following table includes selected unaudited quarterly financial data
for the years ended December 31, 2000 and 1999, including selected data
previously reported by the Company on Form 10-Q during 2000 and restated data to
include the effects, effective January 1, 2000, of the Company's adoption of
EITF 99-17 and Staff Accounting Bulletin No. 101. See Notes 1 and 12 included in
the Notes to our Consolidated Financial Statements. All amounts presented are in
thousands of dollars, except share and per share data.

<TABLE>
<CAPTION>
                                                                 FIRST QUARTER              SECOND QUARTER
                                                                     ENDED                       ENDED
                                                                 MARCH 31, 2000             JUNE 30, 2000
                                                            ----------------------     -----------------------
                                                                AS                         AS
                                                            PREVIOUSLY      AS         PREVIOUSLY        AS
                                                             REPORTED     RESTATED      REPORTED      RESTATED
                                                             --------     --------      --------      --------
<S>                                                         <C>          <C>           <C>           <C>
Monetary revenues(1)                                         $  3,976     $  4,468      $  4,587      $  4,639
Nonmonetary revenues(1)                                           660          224           666           215
                                                             --------     --------      --------      --------
   Total revenues                                               4,636        4,692         5,253         4,854

Gross profit                                                    1,636        1,621         1,870         1,680
Income (loss) before extraordinary item and cumulative
   effect of change in accounting principle(2)                 67,888       67,984        (5,425)       (5,585)
Extraordinary item - gain on extinguishment of debt                --           --         2,530         2,530
Cumulative effect of change in accounting principle                --       (1,159)           --            --
                                                             --------     --------      --------      --------
Net income (loss)                                              67,888       66,825        (2,895)       (3,055)

Preferred stock dividends (difference on conversion of
   preferred stock, net of dividend)                              822          822        (4,702)       (4,702)
                                                             --------     --------      --------      --------
Net income (loss) attributable to common stockholders        $ 67,066     $ 66,003      $  1,807      $  1,647
                                                             ========     ========      ========      ========
Amounts per diluted common share:
   Income (loss) before extraordinary item and
     cumulative effect of change in accounting principle     $   3.72     $   3.73      $  (0.04)     $  (0.05)
   Extraordinary item                                              --           --          0.15          0.15
   Cumulative effect of change in accounting principle             --        (0.06)           --            --
                                                             --------     --------      --------      --------
   Net income (loss) attributable to common stockholders     $   3.72     $   3.67      $   0.11      $   0.10
                                                             ========     ========      ========      ========

   Weighted average common shares outstanding                  18,028       18,028        16,417        16,417
                                                             ========     ========      ========      ========
<CAPTION>
                                                                THIRD QUARTER         FOURTH QUARTER
                                                                    ENDED                 ENDED
                                                              SEPTEMBER 30, 2000     DECEMBER 31, 2000
                                                            -----------------------  -----------------
                                                                AS
                                                            PREVIOUSLY       AS
                                                             REPORTED      RESTATED
                                                             --------      --------
<S>                                                         <C>           <C>           <C>
Monetary revenues(1)                                         $  4,063      $  4,588      $  4,221
Nonmonetary revenues(1)                                           397           178           104
                                                             --------      --------      --------
   Total revenues                                               4,460         4,766         4,325

Gross profit                                                    1,641         1,951         1,324
Income (loss) before extraordinary item and cumulative
   effect of change in accounting principle(2)                 (5,095)       (4,828)      (85,957)
Extraordinary item - gain on extinguishment of debt             1,709         1,709            --
Cumulative effect of change in accounting principle                --            --            --
                                                             --------      --------      --------
Net income (loss)                                              (3,386)       (3,119)      (85,957)

Preferred stock dividends (difference on conversion of
   preferred stock, net of dividend)                           (1,763)       (1,763)          145
                                                             --------      --------      --------
Net income (loss) attributable to common stockholders        $ (1,623)     $ (1,356)     $(86,102)
                                                             ========      ========      ========
Amounts per diluted common share:
   Income (loss) before extraordinary item and
     cumulative effect of change in accounting principle     $  (0.19)     $  (0.18)     $  (4.89)
   Extraordinary item                                            0.10          0.10            --
   Cumulative effect of change in accounting principle             --            --            --
                                                             --------      --------      --------
   Net income (loss) attributable to common stockholders     $  (0.09)     $  (0.08)     $  (4.89)
                                                             ========      ========      ========

   Weighted average common shares outstanding                  17,451        17,451        17,619
                                                             ========      ========      ========
</TABLE>

--------

(1)    For the year ended December 31, 2000, the Company recognized $3.8 million
       in revenue that was included in the SAB 101 cumulative effect adjustment
       as of January 1, 2000 for a change in accounting principle. The revenue
       was included in the following quarters during 2000: first quarter, $1.5
       million; second quarter, $1.2 million; third quarter, $0.8 million; and
       fourth quarter, $0.3 million.

(2)    First quarter 2000 results include a gain of $75.0 million recognized on
       March 3, 2000 for the Company's sale of its joint venture interest to
       Liberate Technologies. Fourth quarter 2000 results include a charge
       of $75.4 million recognized for the other than temporary decline of the
       Company's investment in Liberate common stock and a charge of $5.6
       million for the impairment of intangible assets.


                                       69
<PAGE>   70

UNAUDITED QUARTERLY FINANCIAL DATA (CONTINUED)

<TABLE>
<CAPTION>
                                                       FIRST QUARTER      SECOND QUARTER     THIRD QUARTER      FOURTH QUARTER
                                                           ENDED              ENDED              ENDED               ENDED
                                                       MARCH 31, 1999     JUNE 30, 1999    SEPTEMBER 30, 1999  DECEMBER 31, 1999
                                                       --------------     -------------    ------------------  -----------------
<S>                                                    <C>                <C>              <C>                 <C>
Monetary revenues                                        $  4,943           $  4,406           $  4,275           $  5,523
Nonmonetary revenues                                          409                473                555                386
                                                         --------           --------           --------           --------
   Total revenues                                           5,352              4,879              4,830              5,909

Gross profit                                                2,246                362              1,190              2,185
                                                         --------           --------           --------           --------
Net loss                                                   (8,295)           (13,065)            (8,055)            (8,766)

Preferred stock dividends                                     716                713                  4                405
                                                         --------           --------           --------           --------

Net loss attributable to common stockholders             $ (9,011)          $(13,778)          $ (8,059)          $ (9,171)
                                                         ========           ========           ========           ========

Amounts per diluted common share:

   Net loss                                              $  (0.65)          $  (0.98)          $  (0.60)          $  (0.61)
   Preferred stock dividends                             $  (0.05)          $  (0.05)          $  (0.00)          $  (0.03)
                                                         --------           --------           --------           --------
   Net loss attributable to common stockholders          $  (0.70)          $  (1.03)          $  (0.60)          $  (0.64)
                                                         ========           ========           ========           ========
   Weighted average common shares outstanding              12,830             13,353             13,499             14,221
                                                         ========           ========           ========           ========
</TABLE>


                                       70
<PAGE>   71

                         REPORT OF INDEPENDENT AUDITORS

Members and Management Committee
SourceSuite LLC

     We have audited the accompanying balance sheet of SourceSuite LLC (the
Company) at December 31, 2000, and the related statements of operations,
members' equity and cash flows for the period from inception (March 3, 2000)
through December 31, 2000. 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 financial position of SourceSuite LLC at December
31, 2000, and the results of its operations and its cash flows for the period
from inception (March 3, 2000) through December 31, 2000 in conformity with
accounting principles generally accepted in the United States.

     The accompanying financial statements have been prepared assuming that
SourceSuite LLC will continue as a going concern. As more fully described in
Note 1, the Company has incurred operating losses and is dependent upon its
Members for additional capital. These conditions raise substantial doubt about
the Company's ability to continue as a going concern. Management's plans in
regard to these matters are also described in Note 1. The financial statements
do not include any adjustments to reflect the possible future effects on the
recoverability and classification of assets or the amounts and classification of
liabilities that may result from the outcome of this uncertainty.

                                                       /s/ ERNST & YOUNG LLP

Dallas, Texas
March 14, 2001


                                       71
<PAGE>   72

                                 SOURCESUITE LLC

                                  BALANCE SHEET
                               DECEMBER 31, 2000
                             (DOLLARS IN THOUSANDS)

<TABLE>
<S>                                                                  <C>
                                ASSETS
Current assets:
  Cash and cash equivalents ......................................   $ 3,252
  Related party receivable .......................................       124
  Prepaid expenses and other current assets ......................       294
                                                                     -------
          Total current assets ...................................     3,670
Software development costs .......................................       188
Property and equipment:
  Computer and production equipment ..............................       825
  Accumulated depreciation .......................................      (225)
                                                                     -------
Net property and equipment .......................................       600
Intangible assets:
  Goodwill .......................................................       915
  Accumulated amortization .......................................      (153)
                                                                     -------
Net intangible assets ............................................       762
                                                                     -------
          Total assets ...........................................   $ 5,220
                                                                     =======

                   LIABILITIES AND MEMBERS' EQUITY

Current liabilities:
  Accounts payable ...............................................   $   199
  Accrued liabilities ............................................       615
  Payable to Source Media, Inc. ..................................       390
                                                                     -------
          Total current liabilities ..............................     1,204
Members' equity:
  Contributed capital, 1,000,000 units authorized, issued and
    outstanding ..................................................     9,967
  Accumulated deficit ............................................    (5,951)
                                                                     -------
          Total members' equity ..................................     4,016
                                                                     -------
          Total liabilities and members' equity ..................   $ 5,220
                                                                     =======
</TABLE>


                 See accompanying Notes to Financial Statements.


                                       72
<PAGE>   73

                                 SOURCESUITE LLC

                             STATEMENT OF OPERATIONS
         PERIOD FROM INCEPTION (MARCH 3, 2000) THROUGH DECEMBER 31, 2000
                                 (IN THOUSANDS)

<TABLE>
<S>                                                 <C>
Revenues ........................................   $   128
Cost of sales ...................................     1,682
                                                    -------
Gross profit (loss) .............................    (1,554)
Selling, general and administrative expenses ....     4,713
                                                    -------

Operating loss ..................................    (6,267)
Interest income .................................       316
                                                    -------
Net loss ........................................   $(5,951)
                                                    =======
</TABLE>

                 See accompanying Notes to Financial Statements.


                                       73
<PAGE>   74

                                 SOURCESUITE LLC

                          STATEMENT OF MEMBERS' EQUITY
         PERIOD FROM INCEPTION (MARCH 3, 2000) THROUGH DECEMBER 31, 2000


<TABLE>
<CAPTION>
                                                 MEMBERSHIP  MEMBERS'
                                                   UNITS      EQUITY
                                                 ---------   ---------
                                                (DOLLARS IN THOUSANDS)
<S>                                              <C>         <C>
Opening balance at inception .................          --          --
Sale of membership units on March 3, 2000 ....   1,000,000   $   9,967
Net loss .....................................          --      (5,951)
                                                 ---------   ---------
Balance at December 31, 2000 .................   1,000,000   $   4,016
                                                 =========   =========
</TABLE>


                 See accompanying Notes to Financial Statements.


                                       74
<PAGE>   75

                                 SOURCESUITE LLC

                             STATEMENT OF CASH FLOWS
         PERIOD FROM INCEPTION (MARCH 3, 2000) THROUGH DECEMBER 31, 2000
                                 (IN THOUSANDS)

<TABLE>
<S>                                                          <C>
OPERATING ACTIVITIES
Net loss .................................................   $(5,951)
Adjustments to reconcile net loss to net cash used in
  operating activities:
  Depreciation ...........................................       225
  Amortization of intangible assets ......................       153
  Changes in operating assets and liabilities:
     Related party receivable ............................       957
     Prepaid expenses and other current assets ...........      (247)
     Trade accounts payable and accrued liabilities ......       256
     Payable to Source Media, Inc. .......................      (149)
                                                             -------
Net cash used in operating activities ....................    (4,756)

INVESTING ACTIVITIES
Purchase of net assets on March 3, 2000 ..................    (1,135)
Software development .....................................      (188)
Capital expenditures .....................................      (636)
                                                             -------
Net cash used in investing activities ....................    (1,959)

FINANCING ACTIVITY
Sale of membership units on March 3, 2000 ................     9,967
                                                             -------
Net cash provided from financing activity ................     9,967
                                                             -------

Opening cash and cash equivalents at inception ...........        --
Net increase in cash and cash equivalents ................     3,252
                                                             -------
Cash and cash equivalents at end of period ...............   $ 3,252
                                                             =======
</TABLE>

                 See accompanying Notes to Financial Statements.


                                       75
<PAGE>   76

                                 SOURCESUITE LLC

                          NOTES TO FINANCIAL STATEMENTS
         PERIOD FROM INCEPTION (MARCH 3, 2000) THROUGH DECEMBER 31, 2000

1. DESCRIPTION OF BUSINESS

     SourceSuite LLC ("SourceSuite" or "the Company"), a Delaware limited
liability company, was formed on March 3, 2000 as a 50/50 joint venture between
Source Media, Inc. ("Source Media") and Insight Interactive, LLC ("Insight")
(collectively, "the Members"). Source Media manages SourceSuite which provides
interactive television programming applications and services, including our
SourceGuide(TM) interactive program guide and our LocalSource(TM) interactive
programming service. We categorize these operations as our Interactive TV
business.

     On November 17, 1999 Source Media contributed specific assets related to
its VirtualModem(TM)" products and businesses, and Insight contributed $13
million in cash to a joint venture, each in exchange for a 50% interest in that
joint venture. VirtualModem software is a "middleware" platform, or the software
which permits a subscriber to interact with advertisements, programming and
other services through a cable set-top box. On March 3, 2000, Source Media and
Insight Interactive sold their interests in the joint venture to Liberate
Technologies ("Liberate"). Liberate issued to each of Source Media and Insight
Interactive 886,000 shares of Liberate common stock and $4.4 million of cash.
This cash was contributed by Source Media and Insight to SourceSuite, which was
formed prior to the completion of the transaction with Liberate. SourceSuite
purchased from the joint venture the net assets and properties not related to
the VirtualModem software and businesses, which were valued at $1.1 million.
Accordingly, Liberate acquired all patents and technology underlying the
VirtualModem software and business. Liberate granted the Company an exclusive
perpetual license to use the patents and technology in connection with
SourceGuide. As a result, SourceSuite became a provider of applications and
services other than middleware.

     Upon completion of the transactions on March 3, 2000, the net assets of
SourceSuite consisted of $8.8 million in cash and $1.1 million in purchased net
assets from the joint venture, allocated as follows (in thousands):

<TABLE>
<S>                                              <C>
Related party receivable .....................   $ 1,081
Prepaid expenses and other current assets ....        47
Property and equipment .......................       189
Goodwill .....................................       915
Accrued liabilities ..........................      (558)
Related party payable ........................      (539)
                                                 -------
    Net assets acquired ......................   $ 1,135
                                                 =======
</TABLE>


     Liberate provides SourceSuite, without charge, specific software
development services for the Interactive TV applications and services under a
programming services agreement. The fair value of these software development
services cannot be reasonably estimated. Liberate is expected to deliver
specific software components and technology pursuant to the agreement in the
first half of 2001. In order to increase the distribution of SourceSuite's
applications and services, SourceSuite entered into a preferred content provider
agreement with Liberate on March 3, 2000



                                       76
<PAGE>   77


with an initial term of four years. Pursuant to this agreement, Liberate offers
specified pricing discounts to its customers that agree to use SourceSuite's
applications and services with the VirtualModem products. The agreement requires
SourceSuite to reimburse Liberate for the pricing discounts offered as the
revenue is received from the customer.

     Since inception on March 3, 2000, SourceSuite has incurred a net loss of
$6.0 million and its operating activities have used approximately $4.8 million
in cash. SourceSuite is expected to continue to incur operating losses at least
through 2001. SourceSuite's ability to continue operations through and beyond
2001 is dependent upon the availability of sufficient cash to meet its working
capital, development, and other operational needs. As of December 31, 2000,
SourceSuite's primary source of liquidity is its cash and cash equivalents of
approximately $3.3 million; however, SourceSuite's cash requirements for fiscal
2001 are expected to exceed this amount. As a result, SourceSuite will be
dependent upon capital contributions from Source Media and Insight to meet its
additional cash requirements. In addition, a significant portion of
SourceSuite's projected revenues for fiscal 2001 is likely to be derived from
its service relationship with Insight.

     Source Media anticipates continuing losses, has a capital deficiency and
will be required to make significant interest payments during fiscal 2001.
These issues create substantial doubt as to the ability of Source Media to
continue as a going concern through 2001. The dependence of SourceSuite upon
capital contributions from Source Media, combined with SourceSuite's anticipated
losses, creates substantial doubt about the ability of SourceSuite to continue
as a going concern through 2001.

     In evaluating the funding requirements of SourceSuite, the Management
Committee may explore the availability of outside debt or equity financing. If
such financing is not available on appropriate terms, the Management Committee
may inform the Members of a need for additional capital contributions to fund
operations (each a "Capital Call"). Both Source Media and Insight have expressed
their intent to provide additional capital contributions to SourceSuite in
response to a Capital Call. In the event of a Capital Call, Source Media and
Insight will share in the additional capital contributions according to their
respective ownership interests in SourceSuite (50/50 as of December 31, 2000).
We believe SourceSuite's financial resources, including existing cash and cash
equivalents and available cash from Capital Calls, will be sufficient to meet
SourceSuite's anticipated working capital, development and other operational
needs through 2001.

2. ACCOUNTING POLICIES

     Basis of Presentation

     As described in Note 1, SourceSuite purchased certain assets for $1.1
million on March 3, 2000 (date of inception). The purchase price was allocated
to tangible net assets based upon their fair values, with the excess of the
purchase price over the fair value of net assets acquired recorded as goodwill.

     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.


                                       77
<PAGE>   78

     Software Development Costs

     Software development costs are capitalized in accordance with Statement of
Financial Accounting Standards No. 86 "Accounting for the Costs of Computer
Software to be Sold, Leased or Otherwise Marketed" ("SFAS 86"). Under SFAS 86,
capitalization of software development costs begin upon the establishment of
technological feasibility and ends when a product is available for general
release to customers. All software development costs incurred through December
31, 2000 have been capitalized.

     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

     Intangible assets consist of goodwill. 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 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.

     Revenue Recognition

     SourceSuite earns revenues principally from fees charged to cable operators
based on the numbers of subscribers receiving SourceSuite products. Revenues are
recognized when services are provided. Advance payments are deferred until the
services are provided.

3. INCOME TAXES

     SourceSuite is considered a partnership for federal income tax purposes;
therefore, it is not subject to federal income tax.

4. RESTRICTION ON MEMBER EQUITY DISTRIBUTIONS

     Under SourceSuite's joint venture agreement, except as unless otherwise
determined by the Management Committee of SourceSuite, there will be no
distribution of equity to Members during the first two years of operation.

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 agreement. As part of this arrangement, SourceSuite
pays Source Media a management fee equal to 5% of gross operating revenues, as
defined, on an annual basis. SourceSuite reimburses Source Media for the direct
costs of the Interactive TV business and certain overhead costs. Since inception
(March 3, 2000) through December 31, 2000, SourceSuite reimbursed Source Media
for $3.2 million of such costs. These costs have been included in the payable to
related parties and are reimbursed to Source Media on a regular basis.
Additionally, SourceSuite


                                       78
<PAGE>   79

purchases certain hardware on behalf of Insight. These amounts are billed to
Insight, at cost, and are included in related party receivables.

     SourceSuite provides Interactive TV applications and services to Insight
pursuant to a letter of intent. Approximately 91% of our SourceSuite's revenues
to date have been derived from its service relationship with Insight.

6. COMMITMENTS AND CONTINGENCIES

     Upon formation, SourceSuite assumed the responsibility for the following
litigation:

ADVANCED INTERACTIVE, INC.

     On October 6, 1998, Advanced Interactive, Inc. filed a complaint in U.S.
District Court for the Northern District of Illinois, Eastern Division, against
Interactive Channel Technologies, Inc. ("ICTI"), a subsidiary of Source Media,
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.
alleged that the Defendants infringed its patents by manufacturing, using and/or
selling or offering to sell each Defendants particular product or service. The
plaintiff seeks monetary damages. ICTI and each of the Defendants have filed an
answer and have collectively joined the Motion for Partial Summary Judgment
submitted by Matsushita Electric Corporation of America, Sharp Electronics
Corp., Sharp Corp. and the Toshiba Defendants. On June 26, 2000, the court
entered a judgment that, among other things, ICTI's products do not infringe on
Advanced Interactive's patents. The plaintiff filed a Notice of Appeal of this
judgment in the U.S. Court of Appeals of the Federal Circuit dated August 3,
2000. This case was transferred from the joint venture between Source Media and
Insight in November 1999 and was assumed by SourceSuite on March 3, 2000. The
Company is vigorously defending the appeal.

WORLDGATE

     As part of the sale of the VirtualModem technology to Liberate, Liberate
acquired certain patents that were the subject of a patent infringement lawsuit.
This lawsuit was initially brought by Source Media's subsidiaries, Interactive
Channel Technologies and SMI Holdings, against WorldGate Communications in May
1998 in U.S. District Court for the District of Delaware. The patent
infringement claims have been assigned to Liberate as a result of its
acquisition of the VirtualModem technology from Source Media. In June 1998,
WorldGate filed a counterclaim against Source Media, alleging, among others,
violations of the Lanham Act and Delaware's Uniform Deceptive Trade Practices
Act, common law unfair competition, tortious interference with existing and
prospective business relationships and misappropriation of confidential
information and trade secrets. SourceSuite joined the litigation as a defendant
after its formation. Following discovery and briefing of the patent claim
construction issues, the parties have entered into settlement negotiations
covering both WorldGate's cross-complaint against Source Media and Liberate's
patent infringement claims against WorldGate. Further, as part of the
acquisition of VirtualModem, Liberate agreed to defend Source Media against
WorldGate's cross-complaint and to undertake to settle the litigation and
acquire our full release against any liability for the WorldGate cross-complaint
without any payment of damages or other legal or equitable relief against Source
Media. On


                                       79
<PAGE>   80

March 20, 2001, the court issued a ruling enforcing a proposed settlement
agreement among the parties, which included a dismissal of WorldGate's
cross-complaint against Source Media, and an agreement by Source Media and
Liberate not to sue with respect to certain WorldGate technology. Source Media
continues to evaluate its position in this litigation to take appropriate steps
to protect our intellectual property rights.


                                       80
<PAGE>   81

                         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


                                       81
<PAGE>   82


                                SOURCESUITE, LLC
                          (FORMED NOVEMBER 17, 1999 AND
                       SUBSEQUENTLY SOLD ON MARCH 3, 2000)

                           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.


                                       82
<PAGE>   83

                                SOURCESUITE, LLC
                          (FORMED NOVEMBER 17, 1999 AND
                       SUBSEQUENTLY SOLD ON MARCH 3, 2000)

                      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.


                                       83
<PAGE>   84


                                SOURCESUITE, LLC
                          (FORMED NOVEMBER 17, 1999 AND
                       SUBSEQUENTLY SOLD ON MARCH 3, 2000)

                          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.


                                       84
<PAGE>   85

                                SOURCESUITE, LLC
                          (FORMED NOVEMBER 17, 1999 AND
                       SUBSEQUENTLY SOLD ON MARCH 3, 2000)

                             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.


                                       85
<PAGE>   86

                                SOURCESUITE, LLC
                          (FORMED NOVEMBER 17, 1999 AND
                       SUBSEQUENTLY SOLD ON MARCH 3, 2000)

                   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 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.


                                       86
<PAGE>   87

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 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.


                                       87
<PAGE>   88

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>

     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:


                                       88
<PAGE>   89

     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 Motion for summary Judgment 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.


                                       89
<PAGE>   90

     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.


                                       90
<PAGE>   91


                                   SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Annual Report 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: March 30, 2001

     Pursuant to the requirements of the Securities Exchange Act of 1934, this
Annual Report has been signed by the following persons in the capacities and on
the dates indicated.

<TABLE>
<S>                                        <C>                                                <C>
      /s/ STEPHEN W. PALLEY                President, Chief Executive Officer and Director    March 30, 2001
      ------------------------             (Principal Executive Officer)
      Stephen W.  Palley

      /s/ BENJAMIN J. DOUEK                Chief Financial Officer and Treasurer              March 30, 2001
      ------------------------             (Principal Financial and Accounting Officer)
      Benjamin J. Douek

      /s/ MICHAEL S. WILLNER
      ------------------------             Director                                           March 30, 2001
      Michael S. Willner

      /s/ JAMES L. GREENWALD
      ------------------------             Director                                           March 30, 2001
      James L. Greenwald

      /s/ MICHAEL J. MAROCCO
      ------------------------             Director                                           March 30, 2001
      Michael J. Marocco

      /s/ BARRY RUBENSTEIN
      ------------------------             Director                                           March 30, 2001
      Barry Rubenstein

      /s/ KIM D. KELLY
      ------------------------             Director                                           March 30, 2001
      Kim D. Kelly

      /s/ SIDNEY KNAFEL
      ------------------------             Director                                           March 30, 2001
      Sidney Knafel
</TABLE>


                                       91
<PAGE>   92
                                INDEX TO EXHIBITS

<TABLE>
<CAPTION>
EXHIBIT
NUMBER                              DESCRIPTION
-------                             -----------
<S>               <C>
2.1               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, SourceSuite Acquisition LLC and Liberate
                  Acquisition Co. LLC (filed as Exhibit 10.10 to the Company's
                  Registration Statement on Form S-4 (no. 333-95023), and
                  incorporated herein by reference)

3.1               Restated Certificate of Incorporation, as amended, of the
                  Company (filed as Exhibit 3.1 to the Company's Report on Form
                  10-K for the Year Ended December 31, 1999, and incorporated
                  herein by reference)

3.2               Bylaws, as amended, of the Company (filed as Exhibit 3.2 to
                  the Company's Report on Form 10-K for the Year Ended December
                  31, 1999, and incorporated herein by reference)

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

4.2               Certificate of Designation for Senior PIK Preferred Stock, as
                  amended (filed as Exhibit 4.2 to the Company's Report on Form
                  10-K for the Year Ended December 31, 1999, and incorporated
                  herein by reference)

4.3               Certificate of Designations for Non-Participating Preferred
                  Stock of the Company (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 between Source Media,
                  Inc. and U.S. Trust Company of Texas, N.A. (filed as Exhibit
                  4.1 to the Company's Current Report on Form 8-K dated October
                  30, 1997, and incorporated herein by reference)

4.5               First Supplemental Indenture dated as of November 1, 1999
                  among Source Media, Inc., its subsidiaries parties thereto and
                  U.S. Trust Company of Texas, N.A. (filed as Exhibit 4.5 to the
                  Company's Annual Report on Form 10-K for the year ended
                  December 31, 1999, and incorporated herein by reference)

4.6               Second Supplemental Indenture dated as of January 1, 2000
                  among Source Media, Inc., its subsidiaries parties thereto and
                  U.S. Trust Company of Texas, N.A. (filed as Exhibit 4.6 to the
                  Company's Annual Report on Form 10-K for the year ended
                  December 31, 1999, and incorporated herein by reference)
</TABLE>


<PAGE>   93


<TABLE>
<S>               <C>
4.7               Warrant Agreement dated as of October 30, 1997 between Source
                  Media, Inc. and ChaseMellon Shareholder Services (filed as
                  Exhibit 4.3 to the Company's Current Report on Form 8-K dated
                  October 30, 1997, and incorporated herein by reference)

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

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

10.3              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**            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 by reference herein)

10.6**            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)

10.7**            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)

10.8**            Employment Agreement 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 by
                  reference herein)

10.9**            Employment Agreement 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)

10.10**           Employment Agreement between the Company and Howard Gross
                  (filed as Exhibit 10.15 to the Company's Report on Form 10-K
                  for the Year Ended December 31, 1999, and incorporated herein
                  by reference)
</TABLE>



<PAGE>   94

<TABLE>
<S>               <C>
10.11**           Employment Agreement between the Company and Paul Tigh (filed
                  as Exhibit 10.1 to the Company's Report on Form 10-Q for the
                  Quarter Ended September 30, 1999, and incorporated herein by
                  reference)

10.12**           Employment Agreement between the Company and Philip Howort
                  (filed as Exhibit 10.2 to the Company's Report on Form 10-Q
                  for the Quarter Ended September 30, 1999, and incorporated
                  herein by reference)

10.13**           Employment Agreement between the Company and Derrick Horner
                  (filed as Exhibit 10.3 to the Company's Report on Form 10-Q
                  for the Quarter Ended September 30, 1999, and incorporated
                  herein by reference)

10.14**           Employment Agreement between the Company and Benjamin J.
                  Douek*

10.15**           Employment Agreement between Interactive Channel, Inc. and
                  Lawrence Brickman*

21                Subsidiaries*

23.1              Consent of Ernst & Young LLP*
</TABLE>
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*  Filed herewith

** Compensatory Agreement