UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly period ended October 31, 1998
COMMISSION FILE NUMBER 0-27830
---------------------
LYCOS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 04-3277338
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
400-2 TOTTEN POND ROAD, WALTHAM, MASSACHUSETTS 02451-2000
(Address of principal executive offices, including Zip Code)
(781) 370-2700
(Registrant's telephone number, including area code)
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.
X Yes No
- --- ---
The number of shares outstanding of the registrant's Common Stock as of
November 30, 1998 was 42,942,234.
LYCOS, INC.
TABLE OF CONTENTS
Page
----
PART I. FINANCIAL INFORMATION
ITEM 1 Unaudited Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheets
October 31, 1998 and July 31, 1998.............................. 3
Condensed Consolidated Statements of Operations
Three months ended October 31, 1998 and 1997.................... 4
Condensed Consolidated Statements of Cash Flows
Three months ended October 31, 1998 and 1997.................... 5
Notes to Condensed Consolidated Financial Statements............ 7
ITEM 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................... 12
PART II OTHER INFORMATION
ITEM 1 Legal Proceedings............................................... 16
ITEM 2 Changes in Securities........................................... 16
ITEM 3 Defaults Upon Senior Securities................................. 16
ITEM 4 Submission of Matters to a Vote of Securities Holders........... 16
ITEM 5 Other Information............................................... 16
ITEM 6 Exhibits and Reports on Form 8-K................................ 16
Signature....................................................... 17
2
LYCOS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
OCTOBER 31, JULY 31,
1998 1998
----------------- ------------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents................................................ $ 140,771,169 $ 153,728,200
Accounts receivable, net................................................. 15,906,633 10,958,470
License fees receivable.................................................. 27,099,167 30,223,986
Prepaid expenses......................................................... 18,627,723 5,559,842
Other current assets..................................................... 636,352 326,292
------------- -------------
Total current assets.................................................. 203,041,044 200,796,790
------------- -------------
Property and equipment, less accumulated depreciation...................... 6,155,196 3,960,059
Long-term license fees receivable.......................................... 25,625,000 21,537,371
Investments................................................................ 8,427,416 8,874,568
Intangible assets, net..................................................... 148,436,383 10,310,475
Other assets............................................................... 4,809,929 3,278,994
------------- -------------
Total assets.......................................................... $ 396,494,968 $ 248,758,257
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable......................................................... $ 3,019,042 $ 4,873,302
Accrued expenses......................................................... 15,457,660 17,277,168
Deferred revenues........................................................ 32,879,177 30,730,390
Billings in excess of revenues........................................... 800,041 681,849
Current portion of long-term debt........................................ 1,538,469 171,783
------------- -------------
Total current liabilities............................................. 53,694,389 53,734,492
Deferred revenues.......................................................... 28,395,581 26,159,754
Long-term debt, less current portion....................................... 1,445,323 140,749
Deferred income taxes...................................................... 31,667 36,667
------------- -------------
29,872,571 26,337,170
Commitments and contingencies -- --
Stockholders' equity:
Common stock............................................................. 433,611 389,917
Additional paid-in capital............................................... 436,889,126 278,126,583
Treasury stock, at cost.................................................. (984,596) (984,596)
Deferred compensation.................................................... (104,705) (116,339)
Accumulated deficit...................................................... (123,385,284) (108,728,970)
Accumulated other comprehensive income..................................... 79,856 --
------------- -------------
Total stockholders' equity............................................ 312,928,008 168,686,595
------------- -------------
Total liabilities and stockholders' equity............................ $ 396,494,968 $ 248,758,257
============= =============
See accompanying notes to condensed consolidated financial statements.
3
LYCOS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS THREE MONTHS
ENDED ENDED
OCTOBER 31, OCTOBER 31,
1998 1997
------------------- ------------------
REVENUES:
Advertising....................................................... $ 17,274,840 $ 6,409,033
Electronic commerce, license and other............................ 7,509,279 2,894,119
------------ -----------
Total revenues................................................. 24,784,119 9,303,152
Cost of revenues.................................................... 5,300,325 1,779,382
------------ -----------
Gross profit................................................... 19,483,794 7,523,770
Operating expenses:
Research and development.......................................... 5,303,566 1, 434,535
In process research and development............................... 15,400,000 --
Sales and marketing............................................... 16,170,301 5,476,746
General and administrative........................................ 2,486,226 931,779
Amortization of intangible assets................................. 6,796,266 113,422
------------ -----------
Total operating expenses....................................... 46,156,359 7,956,482
------------ -----------
Operating loss...................................................... (26,672,565) (432,712)
Interest income, net................................................ 1,896,420 540,192
Gain on sale of investments......................................... 10,119,831 --
------------ -----------
Net income (loss)................................................... $(14,656,314) $ 107,480
============ ===========
Basic and diluted net income (loss) per share....................... $ (0.35) $ 0.00
============ ===========
Shares used in computing net income (loss) per share:
Basic.......................................................... 41,909,950 28,185,860
============ ===========
Diluted........................................................ 41,909,950 29,363,952
============ ===========
See accompanying notes to condensed consolidated financial statements.
4
LYCOS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS THREE MONTHS
ENDED ENDED
OCTOBER 31, OCTOBER 31,
1998 1997
----------------- -----------------
OPERATING ACTIVITIES
Net income (loss)................................................... $(14,656,314) $ 107,480
Adjustments to reconcile net income (loss) to net cash used in
operating activities:
Amortization of deferred compensation............................. 11,634 34,196
Depreciation...................................................... 885,683 261,344
Amortization of intangible assets................................. 6,796,266 106,787
Allowance for doubtful accounts................................... (107,018) 105,021
Gain on sale of investments....................................... (10,119,831) --
In-process research and development expense....................... 15,400,000 --
Deferred income taxes............................................. (5,000) (5,000)
Changes in operating assets and liabilities:
Accounts receivable............................................... (2,495,311) (763,452)
License fees receivable........................................... (962,810) (386,340)
Prepaid expenses.................................................. (11,769,432) (548,607)
Other current assets.............................................. (306,019) (695,541)
Other assets...................................................... (1,505,584) --
Accounts payable.................................................. (3,442,969) 1,618,132
Accrued expenses.................................................. (3,480,814) (898,925)
Deferred revenues................................................. 2,438,932 1,527,776
Billings in excess of revenues.................................... 118,192 (760,471)
Due to related parties............................................ -- 5,401
------------ -----------
Net cash used in operating activities............................... (23,200,395) (292,199)
------------ -----------
INVESTING ACTIVITIES
Purchase of property and equipment.................................. (166,423) (103,145)
Acquisition costs paid.............................................. (1,114,101) --
Cash proceeds from sale of investment............................... 12,158,790 --
Cash acquired through acquisitions.................................. 1,906,467 --
Investment in affiliates............................................ (1,511,951) --
------------ -----------
Net cash provided by (used in) investing activities................. 11,272,782 (103,145)
------------ -----------
FINANCING ACTIVITIES
Proceeds from exercise of stock options............................. 778,953 646,453
Proceeds from issuance of common stock under ESPP................... 82,522 --
Proceeds from note receivable....................................... 623,438 --
Payments on notes payable........................................... (2,514,331) --
------------ -----------
Cash provided by (used in) financing activities..................... (1,029,418) 646,453
------------ -----------
Net increase (decrease) in cash and cash equivalents................ (12,957,031) 251,109
------------ -----------
Cash and cash equivalents at beginning of period.................... 153,728,200 40,766,258
------------ -----------
Cash and cash equivalents at end of period.......................... $140,771,169 $41,017,367
============ ===========
See accompanying notes to condensed consolidated financial statements.
5
LYCOS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(UNAUDITED)
THREE MONTHS THREE MONTHS
ENDED ENDED
OCTOBER 31, OCTOBER 31,
1998 1997
------------------- -------------------
Schedule of non-cash financing and investing activities:
Issuance of common stock upon acquisition
of WhoWhere? Inc............................................... $157,994,762 $ --
Assets and liabilities recorded upon acquisition
Of WhoWhere? Inc.;
Accounts receivable............................................ 2,345,834 --
Prepaids....................................................... 1,302,490 --
Property and equipment......................................... 2,914,397 --
Notes receivable............................................... 623,438 --
Other assets................................................... 25,351 --
Notes payable.................................................. 5,185,591 --
Accounts payable............................................... 1,588,709 --
Accrued expenses............................................... 1,661,306 --
Deferred revenues.............................................. 1,945,682 --
See accompanying notes to condensed consolidated financial statements.
6
LYCOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. THE COMPANY AND BASIS OF PRESENTATION
Lycos, Inc., ("Lycos" or the "Company") is a global Internet navigation
and community network that offers globally branded media properties and
aggregated content distributed primarily through the Web. Under the "Lycos
Network" brand, Lycos provides guides to online content, aggregated third-party
content, Web search and directory services and community and personalization
features. Lycos seeks to draw a large number of viewers to its Websites by
providing multiple destinations for identifying, selecting and accessing
resources, services, content and information on the Web. The Company was formed
in June 1995 by CMG@Ventures L.P., a wholly-owned subsidiary of CMG Information
Services. The Company operates in one industry segment, generating revenue from
selling advertising, electronic commerce and licensing its products and
services. The Company's fiscal year end is July 31.
The accompanying unaudited consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiaries and have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions for Form 10-Q and Article 10 of
Regulation S-X. In the opinon of management, these financial statements contain
all adjustments, consisting only of normal recurring adjustments, necessary for
a fair presentation of the results of these interim periods. Certain
information and related footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted, although the Company believes the disclosures in
these financial statements are adequate to make the information presented not
misleading. These financial statements should be read in conjunction with the
Company's audited financial statements for the year ended July 31, 1998,
included in the Company's Annual Report on Form 10-K filed with the Securities
and Exchange Commission. The results of operations for the interim periods shown
are not necessarily indicative of the results for any future interim period or
for the entire fiscal year.
2. REVENUE RECOGNITION
The Company's advertising revenues are derived principally from short-term
advertising contracts in which the Company guarantees a number of impressions
for a fixed fee or on a per impression basis with an established minimum fee.
Revenues from advertising are recognized as the services are performed.
Electronic commerce revenues are derived principally from "slotting fees" paid
for selective positioning and promotion within the Company's suite of products
as well as from royalties from the sale of goods and services from the Company's
Websites. The Company's license and product revenues are derived principally
from product licensing fees and fees from maintanance and support of its
products. Electronic commerce, license and product revenues are generally
recognized upon delivery provided that no significant Company obligations remain
and collection of the receivable is probable. In cases where there are
significant remaining obligations, the Company defers such revenue until those
obligations are satisfied. Fees from maintenance and support of the Company's
products including revenues bundled with the initial licensing fees are deferred
and recognized ratably over the service period.
Deferred revenues are comprised of license and electronic commerce fees to be
earned in the future on noncancelable agreements at the balance sheet date.
7
LYCOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
3. INVESTMENTS
The Company's investments include those in which its ownership is less than
20%, and are not majority-owned or controlled, and are recorded at cost. In
March, 1998, the Company acquired a 9.9% interest in GlobeComm, Inc. (iName), a
leading global provider of free Web-based e-mail products, in exchange for
shares of the Company's Common Stock valued at $4.0 million at the time of the
transaction. Lycos utilizes GlobeComm's e-mail products to provide free Web
based e-mail to Lycos users. Additionally, in April 1998, the Company acquired
an approximate 14% ownership stake in Sage Enterprises, Inc. (PlanetAll) which,
at the time, was owned 29% by CMGI, a related party, in exchange for shares of
the Company's Common Stock valued at $2.5 million at the time of the
transaction. Launched in November 1997, PlanetAll provides through the Internet
free core contact management services.
In August 1998, pursuant to an Agreement and Plan of Merger, Amazon.com
acquired all of the outstanding capital stock of PlanetAll for approximately
800,000 shares of Amazon.com common stock valued at approximately $87 million.
Of the total 800,000 shares issued by Amazon.com, the Company received 107,376
shares valued at approximately $12.8 million at the time of acquisition in
exchange for its shares of PlanetAll, resulting in a gain of $10.1 million in
the quarter ended October 31, 1998. The Company has 10,737 shares of Amazon.com
remaining at October 31, 1998, which are subject to escrow restrictions that
expire in August 1999.
4. COMPREHENSIVE INCOME (LOSS)
The Company adopted Statement of Financial Accounting Standard No. 130 (SFAS
130), "Reporting Comprehensive Income" during the quarter ended October 31,
1998. SFAS 130 establishes standards for the reporting and display of
comprehensive income and its components in the financial statements.
Comprehensive income as defined includes all changes in equity during a period
from non-owner sources. Examples of items to be included in comprehensive
income, which are excluded from net income, include foreign currency translation
adjustment and unrealized gains and losses on available-for-sale securities.
For the quarter ended October 31, 1998, comprehensive loss was $14,576,458. The
difference between net loss and comprehensive loss for the quarter is due to
$79,856 of unrealized gains on marketable securities classified as available-
for-sale. The Company had no "other comprehensive income" items in the quarter
ended October 31, 1997.
5. LONG-TERM DEBT
Upon acquisition of WhoWhere? Corporation on August 13, 1998 (see Note 9), the
Company assumed a $1.5 million note payable to a bank, $1.5 million in capital
lease obligations, and $2.2 million in notes payable to the former stockholders
of Angelfire, a company acquired by WhoWhere? in October 1997. In September
1998, the Company paid off the $1.5 million note payable to a bank in full. As
of October 31, 1998, $1,422,852 of principal remains under the capital lease
obligations, of which $489,493 is classified as a current liability. The
capital lease obligations require principal and interest payments through
December 2001, bear interest at various rates from 9% to 15.7%, and are
collateralized by the certain of the Company's property and equipment. As of
October 31, 1998, $1,290,416 remains outstanding under the notes payable to the
former stockholders of Angelfire, of which $877,193 is classified as a current
liability. The notes mature on October 17, 2000, bear interest at 7%, and are
collateralized by substantially all of the assets of WhoWhere?.
Long-term debt also includes a senior loan assumed upon the acquisition of
WiseWire. As of October 31, 1998, the loan has an outstanding balance of
$270,524, of which $171,783 is classified as a current liability. The senior
loan and security agreement cannot exceed $750,000, bears interest at 18.4%, and
is collateralized by certain of the Company's computer equipment. The existing
promissory note requires 36 monthly principal and interest payments of $16,216
through January 1, 2000, and a final payment equal to the then fair market value
of the collateral at that time as determined by the lender, but not less than
10% of the original loan, or, at the Company's option, 6 additional monthly
payments of $16,216 through July 1, 2000. Prepayments are not permitted under
the terms of the loan agreement.
8
LYCOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
6. COMMITMENTS AND CONTINGENCIES
The Company leases its facilities and certain other equipment under operating
lease agreements expiring through 2004. Future noncancelable minimum payments
under these leases for each fiscal year are as follows:
1999 $ 8,409,663
2000 5,934,501
2001 3,615,590
2002 3,402,195
2003 2,384,660
Thereafter 1,228,522
-----------
$24,975,131
===========
The Company is subject to legal proceedings and claims which arise in the
ordinary course of its business. In the opinion of management, the amount of
ultimate liability with respect to these actions will not materially effect the
financial position, results of operations or cash flows of the Company.
7. STOCK SPLIT
In July 1998, the Company's Board of Directors approved a two-for-one common
stock split. Shareholders of record on August 14, 1998 (the record date) were
entitled to one additional share of the Company's common stock for every share
held on August 25, 1998. All share and per share amounts presented in the
condensed consolidated financial statements have been restated to reflect the
stock split.
8. SIGNIFICANT AGREEMENTS
During the quarter, the Company paid approximately $19 million under contracts
to provide search and navigation services between June 1998 and September 1999
(the "Premier Provider Agreements"). The Company recognizes the cost of the
Premier Provider Agreements ratably over the one year terms, with the cost
included in sales and marketing expense.
9. ACQUISITIONS
Acquisition of WhoWhere? Inc.
On August 7, 1998, the Company entered into an Agreement and Plan of Merger
(the "Agreement") by and among the Company, What Acquisition Corp., a Delaware
corporation and a wholly-owned subsidiary of the Company ("WWAC"), WhoWhere?
Inc., a California corporation ("WhoWhere?"), and certain shareholders of
WhoWhere? providing for the merger of WWAC with and into WhoWhere? (the
"Merger"). On August 13, 1998, the Company completed the closing of the Merger
and WhoWhere? became a wholly-owned subsidiary of the Company.
The acquisition was accounted for under the purchase method of accounting. The
purchase price was allocated to the assets acquired and liabilities assumed
based on their estimated fair values. Results of operations for WhoWhere? were
included with those of the Company beginning on August 13, 1998, the date of
acquisition.
9
LYCOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(continued)
9. ACQUISITIONS (continued)
In the Merger, all outstanding shares of Common Stock and Preferred Stock of
WhoWhere? were converted into an aggregate of 3,770,254 shares of Common Stock ,
par value $.01 per share, of the Company (the "Lycos Common Stock"), and all
outstanding options and warrants to purchase Common Stock or Preferred Stock of
WhoWhere? were assumed by the Company and became options or warrants to purchase
an aggregate of 1,335,244 shares of Lycos Common Stock.
The Company has filed a Registration Statement on Form S-3 with respect to the
resale of the shares of Lycos Common Stock issued in the Merger and the shares
of Lycos Common Stock issuable upon the exercise of warrants assumed in the
Merger and filed a Registration Statement on Form S-8 with respect to the shares
of Lycos Common Stock issuable upon the exercise of options and warrants assumed
in the Merger.
Under the terms of the Agreement and related Escrow Agreement dated August 13,
1998, an aggregate of 377,038 shares of Lycos Common Stock and options and
warrants to purchase an additional 133,540 shares of Lycos Common Stock will be
held in escrow for the purpose of indemnifying the Company against certain
liabilities of WhoWhere? and its stockholders. The escrow will expire on August
13, 1999.
The purchase price was allocated as follows:
In-process research and development $ 15,400,000
Developed technology, goodwill and
other intangibles 144,922,174
Other assets, principally cash and equipment 9,117,977
Liabilities assumed (10,381,288)
------------
Purchase price $159,058,863
============
Pro forma financial information for the three months ended October 31, 1998 is
not materially different than the Company's actual consolidated results as
reported. Unaudited combined pro forma financial information for the three
months ended October 31, 1997, assuming the WhoWhere? acquisition had occurred
on August 1, 1997, would have resulted in net revenues of $10.1 million, net
loss of $11.7 million, and basic and diluted loss per share of $0.35. The pro
forma net loss includes amortization of developed technology, goodwill and other
intangible assets of $7.8 million for the three months ended October 31, 1997.
The unaudited pro forma information is for illustrative purposes only and is not
necessarily indicative of the actual results of operations had the acquisition
occurred on August 1, 1997, nor the results of any future period.
Upon consummation of the WhoWhere? acquisition, the Company's management made
certain assessments with respect to the determination of all identifiable assets
resulting from, or to be used in, research and development activities as of the
acquisition date. Each of these activities were evaluated as of the acquisition
date to determine their stage of development and related fair value. The
Company's review, as of the acquisition date, indicated that $15.4 million of
in-process research and development had not reached a state of technological
feasibility and had no evidence of alternative future use. In the case of in-
process projects, the Company made estimates to quantify the cost-to-complete
for each project, identifying the project date of introduction, the estimated
life of the project, the project's "fit" within the Company's own in-process
research projects, the revenues to be generated in each future period and the
corresponding operating expenses and other charges to apply to this revenue
stream. In order to determine the value of the earnings stream attributable to
the in-process research and development, the excess earnings from the projects
were calculated by deducting the earnings stream attributable to all other
assets including working capital and tangible assets. Based upon these
assumptions, after-tax cash flows attributable to the in-process projects were
determined, appropriately discounted back to its respective net present value,
taking into account the uncertainty surrounding the successful development of
the purchased in-process projects.
10
LYCOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
9. ACQUISITIONS (continued)
In the case of in-process technology, fair values of the corresponding
technologies were determined by the Income Approach which included both a
discounted future earnings methodology and a relief from royalty methodology.
Under these methodologies, the value of the in-process technology is comprised
of the total present value of the future earnings stream attributable to the
technology throughout its anticipated life. An adjustment to the value of
certain in-process research and development projects has been applied based on a
percentage of completion formula.
Acquisition of Wired Ventures, Inc.
On October 5, 1998, the Company entered into a definitive merger agreement to
acquire Wired Ventures Inc. ("Wired") in a stock-for-stock transaction. The
transaction will be accounted for under the purchase method of accounting, and
accordingly, the purchase price will be allocated to assets acquired and
liabilities assumed based on their respective fair values. Intangible assets
will be amortized over a period of five years. The merger is subject to several
conditions, including approval of Wired's shareholders and the Federal Trade
Commission. The Company has filed a Registration Statement on Form S-4, which
is pending the approval of the Securities and Exchange Commission, with respect
to the registration of the shares of Lycos Common Stock to be issued in the
merger.
The following represents the preliminary allocation of the purchase price over
the historical net book values of the acquired assets and liabilities of Wired
at September 30, 1998, and is presented for illustrative purposes only. Actual
fair values will be based on financial information as of the acquisition date.
Based on preliminary estimates, approximately $1 million to $5 million of the
purchase price will be allocated to in-process research and development expense
which will be charged to operations during the quarter in which the merger
agreement is consummated. For the purpose of the following presentation, $5
million was used as the amount of acquired in-process research and development.
The following illustration assumes the Company issues approximately 2.2 million
shares at $42.86 per share, which represents the maximum share price subject to
the collar contained in the merger agreement. The following illustration also
assumes that the Wired cash balance will be paid by the Company in cash.
The estimated purchase price is expected to be allocated as follows:
Developed technology, goodwill and other
intangible assets $101,253,000
In-process research and development 5,000,000
Other assets, principally cash 59,493,000
Liabilities assumed (19,905,000)
------------
$145,841,000
============
10. RECLASSIFICATIONS
Certain amounts in the quarter ended October 31, 1997 have been reclassified
to permit comparison to the current period presentation.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The matters discussed in this report contain forward-looking statements that
involve risks and uncertainties. The Company's actual results could differ
materially from those discussed herein. Factors that could cause or contribute
to such differences include, but are not limited to, those discussed in this
section and elsewhere in this Report, and the risks discussed in the "Factors
Affecting the Company's Business, Operating Results and Financial Condition"
section included in the Company's 1998 Annual Report on Form 10-K filed with the
Securities and Exchange Commission on October 29, 1998.
RESULTS OF OPERATIONS
Total Revenues Total revenues for the three months ended October 31, 1998
increased 166% to $24.8 million from $9.3 million for the three months ended
October 31, 1997, as a result of the growth in the number of advertisers. As of
October 31, 1998, deferred revenues, including billings in excess of revenues,
increased to $62.1 million, compare to $57.6 million at July 31, 1998,
attributable to advertising contracts and guaranteed commitments under license
and electronic commerce agreements for which there are significant obligations
of the Company remaining.
Advertising Revenues Advertising revenues increased 170% to $17.3 million
for the three months ended October 31, 1998, representing 70% of total revenues,
as compared to advertising revenues of $6.4 million for the three months ended
October 31, 1997, which represented 69% of total revenues. The top ten customers
accounted for 21% of advertising revenues in the quarter ended October 31, 1998
as compared to 31% of advertising revenues in the quarter ended October 31,
1997. The increase in advertising revenue was attributable primarily to an
increase in the number of advertisers.
The Company currently derives a substantial portion of its revenues from the
sale of advertisements on its Websites, primarily through banner advertisements
and sponsorships. Advertising contracts are primarily sold as: (1) a "run of
site" contract under which a customer is guaranteed a number of impressions; (2)
a "key word" contract in which a customer purchases the right to advertise in
connection with specified word searches; or (3) a "targeted" contract where the
customer purchases a specified number of impressions in one of the targeted
categories or on a specified page or service.
Electronic Commerce, Licensing and Other Revenues Electronic commerce,
licensing and other revenues increased 159% to $7.5 million for the three months
ended October 31, 1998, representing 30% of total revenues as compared to $2.9
million for the three months ended October 31, 1997, representing 31% of total
revenues. The increase in electronic commerce, licensing and other revenue is
attributable primarily to the addition of several new partners including, among
others, AT&T and Preview Travel.
Electronic commerce revenues are derived principally from "slotting fees" paid
for selective positioning and promotion within the Company's suite of products
as well as from royalties from the sale of goods and services from the Company's
websites. The Company's license and product revenues are derived principally
from product licensing fees and fees from maintenance and support of its
products. Electronic commerce, license and product revenues are generally
recognized upon delivery provided that no significant Company obligations remain
and collection of the receivable is probable. In cases where there are
significant remaining obligations, the Company defers such revenue until those
obligations are satisfied. Fees from maintenance and support of the Company's
products including revenues bundled with the initial licensing fees are deferred
and recognized ratably over the service period.
Cost of Revenues Cost of revenues totaled $5.3 million for the quarter
ended October 31, 1998, representing 21% of total revenues, as compared to $1.8
million in the quarter ended October 31, 1997, which represented 19% of total
revenues. Cost of revenues consist primarily of expenses associated with the
ongoing maintenance and support of the Company's products and services,
including compensation, consulting fees, equipment costs, networking and other
related indirect costs.
12
OPERATING EXPENSES
Research and Development Research and development expenses totaled $5.3
million for the three months ended October 31, 1998, representing 21% of total
revenues as compared to $1.4 million for the three months ended October 31,
1997, or 15% of total revenues. Research and development expenses consist
primarily of equipment and salary costs. The overall increase in research and
development expenses was primarily due to increased engineering staffing to
continue to develop and enhance the Company's expanded product offerings.
With the exception of technology acquired in the Tripod and WiseWire
acquisitions, all research and development costs have been expensed as incurred.
The Company believes that significant investments in research and development
are required to remain competitive. As a consequence, the Company expects to
continue to commit substantial resources to research and development in the
future.
In-process Research and Development Upon consummation of the WhoWhere?
acquisition, the Company's management made certain assessments with respect to
the determination of all identifiable assets resulting from, or to be used in,
research and development activities as of the acquisition date. Each of these
activities were evaluated as of the acquisition date to determine their stage of
development and related fair value. The Company's review, as of the acquisition
date, indicated that $15.4 million of in-process research and development had
not reached a state of technological feasibility and had no evidence of
alternative future use. In the case of in-process projects, the Company made
estimates to quantify the cost-to-complete for each project, identifying the
project date of introduction, the estimated life of the project, the project's
"fit" within the Company's own in-process research projects, the revenues to be
generated in each future period and the corresponding operating expenses and
other charges to apply to this revenue stream. In order to determine the value
of the earnings stream attributable to the in-process research and development,
the excess earnings from the projects were calculated by deducting the earnings
stream attributable to all other assets including working capital and tangible
assets. Based upon these assumptions, after-tax cash flows attributable to the
in-process projects were determined, appropriately discounted back to its
respective net present value, taking into account the uncertainty surrounding
the successful development of the purchased in-process projects.
In the case of in-process technology, fair values of the corresponding
technologies were determined by the Income Approach which included both a
discounted future earnings methodology and a relief from royalty methodology.
Under these methodologies, the value of the in-process technology is comprised
of the total present value of the future earnings stream attributable to the
technology throughout its anticipated life. An adjustment to the value of
certain in-process research and development projects has been applied based on a
percentage of completion formula.
Sales and Marketing Sales and marketing expenses totaled $16.2 million for
the three months ended October 31, 1998, representing 65% of total revenues, as
compared to $5.5 million for the three months ended October 31, 1997,
representing 59% of total revenues. Sales and marketing expenses consist
primarily of compensation, advertising, public relations, trade shows, travel
and costs of marketing literature. The spending increases were due to the
addition of sales and marketing personnel, increased commissions associated with
higher sales, and expenses pertaining to the Company's advertising, marketing
and public relations campaigns. Sales and marketing expenses also includes the
cost of the Company's Premier Provider Agreements, as further described below.
The Company expects continued increases in sales and marketing expenses in
future periods.
During the quarter, the Company paid approximately $19 million under Premier
Provider Agreements to provide search and navigation services between June 1998
and September 1999. The Company recognizes the cost of the Premier Provider
Agreements ratably over the one year terms, with the cost included in sales and
marketing expense.
General and Administrative General and administrative expenses totaled
$2.5 million for the three months ended October 31, 1998, representing 10% of
total revenues, as compared to $932,000 for the three months ended October 31,
1997, representing 10% of total revenues. General and administrative expenses
consist primarily of compensation, rent expenses and fees for professional
services. The increases in spending were primarily due to the expansion of the
Company's corporate infrastructure, including the addition of finance and
administrative personnel, installation of information systems and increased
costs for professional services.
13
Amortization of Intangible Assets Amortization of intangible assets was
approximately $6.8 million for the three months ended October 31, 1998 versus
$113,000 for the three months ended October 31, 1997. The increase is
attributable to increased amortization related to developed technology and
goodwill and other intangible assets recorded upon the acquisitions of
WhoWhere?, Tripod, WiseWire and GuestWorld.
Interest Income, Net Net interest income was approximately $1.9 million
for the three months ended October 31, 1998 versus $540,000 for the three months
ended October 31, 1997. Interest income is generated from investment of the
Company's cash equivalents. The $1.4 million increase in interest income
reflects the investment of the net proceeds of the Company's secondary stock
offering in June 1998. Interest expense was not significant in either period.
Gain on sale of Investments In August 1998, pursuant to an Agreement and
Plan of Merger, Amazon.com acquired all of the outstanding capital stock of
PlanetAll for approximately 800,000 shares of Amazon.com common stock valued at
approximately $87 million. Of the total 800,000 shares issued by Amazon.com,
the Company received 107,376 shares valued at approximately $12.8 million at the
time of acquisition in exchange for its shares of PlanetAll, resulting in a gain
of $10.1 million in the quarter ended October 31, 1998. The Company has 10,737
shares of Amazon.com remaining at October 31, 1998, which are subject to escrow
restrictions that expire in August 1999.
FACTORS WHICH MAY AFFECT FUTURE OPERATIONS
There are a number of business factors which singularly or combined may affect
the Company's future operating results. These factors include dependence on
third party relationships to create traffic on the Company's websites,
dependence on major customers, dependence on advertising revenues, dependence on
the Internet, rapid technological change, competition and variability of
quarterly results, which have been outlined in the Company's 1998 Annual Report
on Form 10-K.
LIQUIDITY AND CAPITAL RESOURCES
At October 31, 1998, the Company had cash and cash equivalents of
approximately $140.8 million. The Company regularly invests excess funds in
short-term money market funds, government securities and commercial paper.
The Company used cash from operations of approximately $23.2 million during
the three months ended October 31, 1998, due primarily to increases in prepaid
expenses pertaining to the Company's Premier Provider Agreements paid during the
quarter. The Company's primary investing activity during the quarter pertains
to the cash proceeds received from the sale of Amazon.com common stock as
discussed above.
As of October 31, 1998 the Company is committed to noncancelable minimum
payments totaling $25 million under operating lease agreements that expire at
various times through 2004.
At October 31, 1998, the Company had deferred revenues of $61.3 million
representing primarily license fees to be earned in the future on noncancelable
license agreements. In addition, the Company had billings in excess of revenues
from advertising contracts of $800,000 at October 31, 1998.
The Company currently believes that available funds and cash flows expected to
be generated by operations, if any, will be sufficient to fund its working
capital and capital expenditures requirements for at least the next twelve
months. Thereafter, the Company may need to raise additional funds. The Company
may need to raise additional funds sooner in order to fund more rapid expansion,
to develop new or enhanced products and services, to respond to competitive
pressures or to acquire complementary businesses or technologies. If additional
funds are raised through the issuance of equity securities, the percentage
ownership of the stockholders of the Company will be reduced, stockholders may
experience additional dilution, and such equity securities may have rights,
preferences or privileges senior to those of the Company's Common Stock. There
can be no assurance that additional financing will be available when needed on
terms favorable to the Company or at all. If adequate funds are not available
or are not available on acceptable terms, the Company may be unable to develop
or enhance products or services, take advantage of future opportunities or
respond to competitive pressures, which could have a material adverse effect on
the Company's business, results of operations or financial condition.
14
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products are coded to
accept only two-digit entries in the date code field and cannot distinguish 21st
century dates from 20th century dates. These date code fields will need to
distinguish 21st century dates from 20th century dates and, as a result, many
companies' software and computer systems may need to be upgraded or replaced in
order to comply with such "Year 2000" requirements.
State of Readiness The Company has evaluated the year 2000 readiness of
the hardware and software products sold by the Company ("Products"), the
information technology systems used in its operations ("IT Systems"), and its
non-IT Systems, such as building security, voice mail and other systems. The
Company's evaluation covered the following phases: (i) identification of all
Products, IT Systems, and non-IT Systems; (ii) assessment of repair or
replacement requirements; (iii) repair or replacement; (iv) testing; (v)
implementation; and (vi) creation of contingency plans in the event of year 2000
failures. The evaluation was completed in 1998. Based on this evaluation, the
Company believes it is year 2000 compliant.
However, the assessment of whether a complete system or device in which a
product is embedded will operate correctly for an end-user depends in large part
on the year 2000 compliance of the product or system's other components, many of
which are supplied by parties other than the Company. The supplier of the
Company's current financial and accounting software has informed the Company
that such software is year 2000 compliant. Further, the Company relies, both
domestically and internationally, upon various vendors, governmental agencies,
utility companies, telecommunications service companies, delivery service
companies and other service providers who are outside of the Company's control.
There is no assurance that such parties will not suffer a year 2000 business
disruption, which could have a material adverse effect on the Company's
financial condition and results of operations.
Costs To date, the Company has not incurred any material expenditures in
connection with identifying or evaluating year 2000 compliance issues. Most of
its expenses have related to the opportunity cost of time spent by employees of
the Company evaluating its software, the current versions of its products, and
year 2000 compliance matters generally.
Contingency Plan The Company has not developed a year 2000-specific
contingency plan. If year 2000 compliance issues are discovered, the Company
then will evaluate the need for contingency plans relating to such issues.
15
PART II
ITEM 1. Legal Proceedings
On November 5, 1998, Labrador Software, Inc. filed a lawsuit in the
United State District Court for the District of Massachusetts against
Lycos alleging Lycos violated several of Labrador's rights under 15
U.S.C. 1125, and Massachusetts statutory and common law. More
specifically, Labrador alleges that Lycos' current advertising campaign
featuring a black labrador retriever retrieving information on the
Internet constitutes: (1) both unfair competition and trademark
infringement under both federal and common law; (2) injury to
Labrador's business reputation and trademark dilution under
Massachusetts statutory and common law; and (3) unfair and deceptive
trade practices under Massachusetts statutory law. Labrador requested
that the court issue a temporary restraining order restraining Lycos
from selling or advertising the Lycos products and services under the
current advertising campaign, which request the court denied. Lycos is
vigorously defending against the lawsuit and does not believe the
outcome would have a material adverse effect on its business, financial
condition, results of operations or cash flows.
The Company is subject to legal proceedings and claims which arise in
the ordinary course of its business. In the opinion of management, the
amount of ultimate liability with respect to these actions will not
materially effect the financial position, results of operations or cash
flows of the Company.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
A special meeting of the stockholders of the Company was held on August
13, 1998. The purpose of the meeting was to consider a proposal to
amend the Company's Restated Certificate of Incorporation to increase
the number of shares of authorized common stock, par value $.01 per
share, from 40,000,000 to 100,000,000 shares. 16,353,506 shares were
cast in favor of the proposal, while 351,313 were cast against the
proposal. There were 22,281 abstentions.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit 11.1: Statement of Computation of Basic and Diluted Net
Income (Loss) Per Share herein included on page 17.
Exhibit 27.1: Financial Data Schedule
(b) The following reports on Form 8-K were filed during the quarter
ended October 31, 1998:
On August 11, 1998 and August 13, 1998 the Company filed current
reports on Form 8-K reporting the Agreement and Plan of Merger with
WhoWhere?. On October 27, 1998 the Company filed a Form 8-K/A which
amended the Company's current reports on Form 8-K originally filed
on August 11, 1998 and August 13, 1998.
On October 20, 1998 the Company filed a current report on Form 8-K
reporting the Agreement and Plan of Merger with Wired Ventures.
16
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LYCOS, INC.
Date: December 14, 1998 By: /s/ Edward M. Philip
------------------------------------
Edward M. Philip
Chief Operating Officer and
Chief Financial Officer
(Principal Financial and Accounting
Officer, Authorized Officer)
17