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UNITED STATES 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 YEAR ENDED JULY 31, 1999
COMMISSION FILE NUMBER 0-27830
LYCOS, INC.
(Exact Name of Registrant as Specified in its Charter)
Delaware 04-3277338
(State or other jurisdiction (IRS Employer
of Incorporation or Organization) Identification No.)
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)
Securities Registered Pursuant to Section 12(b) of the Act:
None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock $.01 Par Value
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
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. [_] Yes [X] No
The aggregate market value of voting stock held by non-affiliates of the
registrant as of October 27, 1999 was $3,699,588,746 (based on the last
reported sale price on the NASDAQ National Market on that date). The number of
shares outstanding of the registrant's Common Stock as of October 27, 1999 was
96,386,855.
DOCUMENTS INCORPORATED BY REFERENCE
Specifically identified information in the definitive Proxy Statement for
the 1999 Annual Meeting of Shareholders to be held on December 21, 1999, is
incorporated by reference into Part III herein.
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LYCOS, INC.
1999 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page
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PART I
Item 1. Business............................................................................... 1
Item 2. Properties............................................................................. 8
Item 3. Legal Proceedings...................................................................... 8
Item 4. Submissions of Matters to a Vote of Security Holders................................... 9
Item 4a. Executive Officers of the Registrant................................................... 9
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.................. 11
Item 6. Selected Financial Data................................................................ 12
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.. 13
Item 8. Financial Statements and Supplementary Data............................................ 34
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure... 63
PART III
Item 10. Executive Officers of the Registrant................................................... 63
Item 11. Executive Compensation................................................................. 63
Item 12. Security Ownership of Certain Beneficial Owners and Management......................... 63
Item 13. Certain Relationships and Related Transactions......................................... 63
PART IV
Item 14. Exhibits, Financial Statements Schedules and Reports on Form 8-K....................... 63
Signatures............................................................................. 66
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THIS ANNUAL REPORT ON FORM 10-K ("REPORT") CONTAINS FORWARD-LOOKING
STATEMENTS WHICH INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS
COULD DIFFER MATERIALLY FROM THOSE SET FORTH IN THE FORWARD-LOOKING STATEMENTS
AS A RESULT OF A NUMBER OF FACTORS, INCLUDING THOSE SET FORTH IN THIS ANNUAL
REPORT UNDER THE HEADINGS "FACTORS AFFECTING THE COMPANY'S BUSINESS, OPERATING
RESULTS AND FINANCIAL CONDITION".
PART I
ITEM 1. BUSINESS
Company Overview
Lycos, "Your Personal Internet Guide," is a network of globally branded
media properties and aggregated content distributed primarily through the
World Wide Web. Under the "Lycos Network" brand, the Company provides
aggregated third party content, Web search and directory services, community
and personalization features, personal Web publishing, and online shopping.
The Company seeks to draw a large number of viewers to its web sites by
providing a one-stop destination for information, communication and shopping
services on the Web.
Since its inception in June 1995, the Company has rapidly expanded into a
global Internet Network. According to Media Metrix, the Company's web sites
attracted approximately 28 million unique users, which constitutes
approximately 44% of all Web users, to the Company's web sites during
September 1999. The Company generates revenues primarily through selling
advertising and sponsorships, electronic commerce and by licensing its
products and technology. The Company's web sites have become a widely accepted
advertising medium for several prominent companies, including Coca-Cola,
Disney, Dell, The Gap, Intel, Sony, and Visa among others. The Company has
established electronic commerce and sponsorship relationships with several
companies, including Barnes & Noble, First USA Bank, Fleet Bank and WebMD. In
addition, Lycos has established strategic licensing and technological
alliances with some of the world's leading corporations, including such
companies as Fidelity Investments, IBM, Microsoft, Packard Bell/NEC, RCN, and
Viacom.
The Company's ability to easily adapt its technology in a variety of
languages has made its service a popular global Internet destination, widely
accessible to users throughout the world. In order to expand the international
distribution of the Company's services, the Company has entered into joint
ventures in Europe (with Bertelsmann AG, in May 1997), Japan (with Sumitomo
Corporation and Internet Initiative Japan ("IIJ"), in March 1998), Korea (with
Mirae Corporation, in March 1999), and, after the close of the 1999 fiscal
year, Asia (with Singapore Telecom, in September 1999). Most recently, the
Company announced that it has launched localized, Company-owned and -operated
sites in six South and Central American countries. The Company currently
offers localized versions of the Lycos service in Argentina, Belgium, Brazil,
Chile, Denmark, France, Germany, Italy, Japan, Korea, Luxembourg, the
Netherlands, Norway, Mexico, Peru, Spain, Sweden, Switzerland, the United
Kingdom and Venezuela.
STRATEGY
The Company's objective is to continue to draw a large number of viewers to
the Lycos Network by striving to provide the most comprehensive array of the
most popular Web content, products and services, and by presenting those
offerings to as many Internet users as possible.
Key elements of the Company's strategy include:
Aggressively Extend Brand Name Recognition. The Company believes that
continuing to enhance its brand name recognition is crucially important to
attract consumers who are just beginning to use the Internet as a key source
of information, entertainment and commercial activity. The Company seeks to
continue its brand awareness through advertising campaigns, personalization of
its product line, international partnerships and distribution relationships
with Internet service providers ("ISPs") and hardware and software
manufacturers. The Company is also extending the Lycos brand name by licensing
its products for use in other media, such as books, videos and CD-ROMs.
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Enhance, Expand and Personalize the Company's Content and Services. Lycos
intends to enhance its products and services with additional content, features
and functionality to maintain its position as a leading online service. The
Company's strategy is to differentiate its products and services from
competing companies and increase user loyalty and retention through the
availability of personalized offerings and by expanding the breadth and depth
of its services such that it maintains its position as one of the most popular
destinations on the Web. In order to expand the Company's product offerings,
the Company has completed acquisitions of businesses, technologies, content
and services that are complementary or related to the Company's operations and
may pursue other acquisitions in the future. The Company also incorporates
into its products and services new technologies developed internally or
licensed from other companies which it believes will further differentiate its
offerings and provide viewers with a richer, more satisfying Internet
experience.
Expand Online Community. The Company seeks to make the Lycos service the
first and most frequent stop for Internet users. The Company believes one of
the most effective ways to achieve this is through the creation of a sense of
online community which, in turn, results in increased user affinity to the
site. Products and services such as free personal homepages, personalized e-
mail, topic-based chat services, and online clubs are designed to create a
sense of community among users. By establishing a sense of community, the
Company believes that users will both visit the site more frequently and
remain at the site for a longer period of time.
Create Innovative Advertising Solutions. The Company believes that the
traffic flow generated from its products and services provides an attractive
platform for measurable, targeted, cost-effective and interactive advertising
on the Internet. The Company combines technical skills with advertising
industry expertise to provide differentiated solutions to advertisers, helping
them exploit the capabilities of the Internet as an advertising medium. The
Company actively seeks to develop innovative ways for advertisers to reach
their target audiences through the Internet. The Company designs and offers
customized packages which include the ability to change advertisements quickly
and frequently, to link a specific search advertisement to a term or topic, to
target advertisements based on demographics, to conduct advertising test
campaigns with rapid result delivery and to track daily usage statistics.
Pursue Value-Added Electronic Commerce Solutions. The Company believes that
Web-based electronic commerce will continue to grow as an increasing number of
businesses and consumers embrace the Internet as a viable method of purchasing
goods and services. The Company's strategy is to integrate its commerce
offerings into the Lycos service based on the user's information needs. By
integrating the commerce transaction into the online community and
navigational process, the Company believes it will be able to better target
products to potential customers. For example, through the Company's
arrangement with Barnes & Noble, a user who types a search query on a
particular topic is presented with a link to the Barnes & Noble web site which
contains a list of books on the related topic.
Expand Distribution Through Strategic Alliances. In order to increase
traffic to the Company's web sites and to extend the Lycos brand
internationally, the Company seeks to enter into strategic relationships with
business partners who offer content, technology and distribution capabilities
as well as marketing and cross-promotional opportunities. In addition, the
Company seeks to partner with key aggregators of users such as ISPs and
hardware and software manufacturers in order to drive additional traffic to
its sites. Whenever feasible, the Company also seeks to broaden its offering
of localized versions of its products and services to users outside the United
States by partnering with large local companies in order to leverage the
promotion, marketing and sales strengths of its partners and reduce the costs
associated with global expansion. In addition, the local partners provide
local expertise and infrastructure. By creating sites in native languages with
local content, the Company believes that it can improve the experience for the
international user.
Recent Acquisitions
In June 1999, Lycos completed the acquisition of Wired Ventures, Inc. Based
in San Francisco, California, Wired Ventures operates several online news and
content sites, including Wired News, HotWired and Webmonkey, and the award-
winning Web search site, HotBot. Similar to the Lycos site, the HotBot site
offers
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advertising and sponsorship opportunities, as well as aggregated and
integrated content and shopping. On the results page of each Lycos Web search,
users are presented with the opportunity to conduct the same search on HotBot,
and vice versa. This arrangement has proven to be a significant source of
traffic growth for the Lycos Network.
In July 1999, Lycos completed the acquisition of Internet Music
Distribution, Inc. ("IMDI"). Based in San Francisco, California, IMDI is a
provider of digital content delivery systems, including Sonique, an audio
player that downloads various music and audio formats (such as "MP3") from the
Internet and formats them to be played from the user's computer. Sonique has
been integrated within Lycos' online music search and content offerings.
On September 2, 1999, the Company entered into an Agreement and Plan of
Merger (the Agreement) with Quote.com, Inc. ("Quote.com"). The acquisition
will be accounted for as a purchase. The purchase price will be allocated to
the assets acquired and liabilities assumed based on their estimated fair
values. Results of operations for Quote.com will be included with those of the
Company for periods subsequent to the date of acquisition. The acquisition,
which is subject to Quote.com shareholder approval, is expected to close in
the second quarter of fiscal year 2000.
Products
The Company offers a comprehensive suite of online products and services.
These products and services are developed internally by the Company or
licensed by the Company from third parties.
Premier Navigation Functionality
Lycos offers its users the ability to quickly and easily find information on
the Web by searching through indexes of Web documents. Lycos' primary search
and navigation products include:
Search. Using the Lycos Search, a user may enter a search term or terms and
review a list of the best matches from all indexed Web pages. The search
results also provide a direct hypertext link to the actual pages matching the
search. The HotBot search, although licensed from a third party, operates in a
manner similar to the Lycos Search. Lycos also licenses content-specific
search products, such as an MP3 search, an FTP search, and yellow pages, from
other third parties.
Guides and Directories. In order to give users an easy-to-use framework in
which to efficiently explore and utilize the wealth of content on the
Internet, Lycos maintains a series of Guides and directories, including
WebGuides, CityGuide, and a version of the Open Directory developed by
Netscape. Lycos' topic-based WebGuides provide categorized areas of interest
that enable users to browse through groupings of related information.
CityGuide is a collection of guides to more than 800 cities throughout the
world. The Open Directory, developed initially by Netscape, is a collection of
web sites organized into a navigable taxonomy by volunteer editors. The Open
Directory was designed to rapidly compile highly relevant links by employing a
large number of volunteers who, through self-selection, have significant
interest and expertise in the topics to which they contribute.
Reference Services. Lycos provides a vast array of products for its users to
locate other individuals, businesses, products and places. WhoWhere?, a home
address, e-mail address and phone number directory, assists users in locating
individuals worldwide. Lycos also licenses several references from third
parties, including a yellow pages, which allows users to locate businesses
throughout the United States by searching according to category, business
name, business address or keyword; Lycos Classifieds, which offers a
convenient way for users to find where to both buy and sell goods and services
online; and Lycos' RoadMaps, which allows users to search for and obtain
driving directions and map to any street address in the United States.
3
Personalized Content and Information Resources
By providing the ability for users to personalize their Lycos experience and
access personally important information, the Company believes it provides a
value-added service to users that increases their overall utilization of the
Company's web sites. Lycos' personalized information resource products include
the following:
MyLycos. MyLycos automatically delivers a personalized view of the Lycos
service, including news, weather, stock quotes, sports scores, horoscopes,
lottery results, local television listings and web site reviews, all
tailored by each individual to his or her preferences.
Personal Investing and Business News. Through a Lycos-branded version of
the Quote.com service, Lycos provides customizable financial information on
publicly held companies, mutual funds, money market funds and the major
financial indices and allows users to chart stock prices, track their
personal investment portfolios and receive the latest business and company-
specific news. Similarly, Lycos' Companies Online, built in cooperation
with Dun & Bradstreet, provides searchable access to a vast amount of
information on more than 100,000 public and private companies, organized
into 14 different industry groups. This service offers a way for users to
gather highly relevant information, including management, annual sales,
ownership structure, DUNS number, and provides a direct link to the
Company's web site.
Online Community Products
Communities are groupings of Internet users organized around topics or areas
of interest in such a way that the user actively contributes to both the
dialogue and content within the community. Lycos believes that users who
become involved with the various Lycos online community products and services
are more likely to return to the site in the future. Consequently, Lycos seeks
to develop an active, loyal user base by building significant community
features into the Lycos Network through the following online products:
E-mail. Through its MailCity product, Lycos offers its users a free
personalized Web-based e-mail account which can be accessed using an easy-
to-use interface from any computer with an Internet connection. As MailCity
users do not need to change their e-mail addresses when they move or change
Internet service providers, the same e-mail address can be used
indefinitely.
Chat and Bulletin Boards. Lycos offers its users the opportunity to
participate in free online chat sessions, in which users can interact, in
real time, with multiple users from all over the world. Lycos Chat
regularly features hosted chats with celebrities and experts on topics of
interest to Lycos' users. Lycos also offers free online bulletin boards, to
which users can post messages to existing message threads or create a new
thread by posting a message on a topic or topics of the user's choice.
Personal Homepages. Through its Angelfire and award-winning Tripod
products, Lycos offers users free disk space and all of the online
publishing tools necessary to create and publish their own personal
homepages. The simplest pages can be created and published in minutes, yet
the space and tools provided allow a user, without any programming skills,
to create a "professional-looking" site that incorporates photos, images,
graphics, audio and video files, and a guestbook. Through what are commonly
known as "affiliate programs", users also can create links to major
electronic commerce sites and earn credit towards purchases by referring
visitors to those electronic commerce sites.
Clubs. The Company licenses from a third party the technology necessary
to permit users to create their own topic-based clubs that incorporate the
other personlization features described above.
Advertising
Advertising revenue is generated by placing banner advertisements and
sponsorship links on the Web pages that are displayed on the Company's web
sites. From each advertisement, a viewer can link directly to the advertiser's
web site, thus affording the advertiser the opportunity to interact directly
with a potential customer. The Company's advertising contracts generally have
a term of one to twelve months. Advertising contracts are sold primarily as:
(1) a "run of site" or "run of network" contract under which a customer is
guaranteed a number of impressions (an impression is a one-on-one view of an
advertisement by the end user), the exact
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placement of which is at Lycos' discretion; (2) a "key word" contract in which
a customer purchases the right to advertise in connection with specified word
searches (for example, when "automobile" is searched, an automotive or car
manufacturer advertisement appears); or (3) a "targeted" contract where the
customer purchases a specified number of impressions in one of the topical
WebGuides or on a specified page or service.
The Company advises customers on advertisement placement and design,
enabling them to develop advertisements and monitor the advertisements for
effectiveness. To facilitate these services, the Company provides advertisers
with online reports showing advertising impressions and the number of times
users "click on" an advertisement to visit the advertiser's site. The
Company's standard rates for advertising range from $16 to $100 per one
thousand impressions depending on such factors as the contract length,
advertisement placement within the site and the targeted nature of the
advertisements.
The Company employs a direct sales force to address the new and evolving
requirements of the Internet advertising market. The Company has hired the
majority of its sales force from the advertising industry because it believes
that an experienced sales force is critical to initiate and maintain
relationships with advertisers and advertising agencies. The Company employs
advertising sales personnel in New York, San Francisco, Boston, Miami,
Chicago, Dallas, Philadelphia, Atlanta and Los Angeles. International
advertising territories are handled primarily by the Company in South and
Central America and by the Company's joint venture partners in Europe and
Asia. See "--Strategic Alliances."
Electronic Commerce
Lycos believes electronic commerce is a natural extension of the Company's
search and navigation services. The Company contracts with merchants to
integrate their products into the Lycos service, making them available for
sale to the Company's users. In its electronic commerce arrangements, the
Company generally receives a fixed fee and a share of the proceeds from online
sales. In addition, the Company benefits from promotional and branding
opportunities available from its merchant relationships which are intended to
create greater demand for the Company's online services.
These electronic commerce agreements typically have one to three year terms.
In some instances, the Company has entered into exclusive sponsorship
arrangements for certain commercial categories. The Company's electronic
commerce relationships include, among others, agreements with the following
entities:
AT&T--providing Internet access for Lycos Online as well as the ability
for Lycos users to purchase telecommunication services over the
Internet;
autobytel.com, Inc.--providing Lycos users with the opportunity to
solicit dealer offers to sell new cars;
Barnes & Noble, Inc.--providing Lycos users with the opportunity to
purchase books throughout the Company's web site;
First USA Bank, N.A.--providing Lycos users with a host of online banking
products through its Wingspanbank.com online bank;
Fleet Credit Card Services--providing Lycos users with a Lycos Network
branded credit card; and
WebMD, Inc.--providing a wide variety of health related products and
services.
After the end of the 1999 fiscal year, Lycos launched LycoShop, an online
marketplace offering thousands of products and services from the brand name
retailers mentioned above and others, small specialty stores, auctions and
classifieds. Designed to satisfy consumer needs at every point in the shopping
cycle, LycoShop integrates the search and community capabilities of the Lycos
Network so that shoppers can research their options, talk to like-minded
consumers, compare product prices and features, search for the best way to
purchase the product and then make the purchase--all on one site. LycoShop
also features a sophisticated store-building product that permits large and
small retailers to create and maintain online stores, accept credit card
purchases and track sales, all for a single monthly fee.
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Licensing
The Company licenses its products and technology to leading corporations to
establish and promote its products and services as a ubiquitous, branded media
service. The Company's strategy is to license its products and technology to a
wide-range of companies seeking to enhance the value of their Internet
products and services. These companies include media companies,
telecommunications companies, online service providers, Internet service
providers, hardware and software providers and publishers. In most of these
arrangements, the Company receives a license fee, maintenance fees for product
updates and, where applicable, a share of the advertising revenues,
subscription fees or product sales received by licensees. The agreements
generally have terms of one to three years. The Company generally co-brands
its products with the products offered by the licensee in order to preserve
and enhance Lycos brand recognition. The Company's product offerings enable
its licensees to provide a comprehensive set of Internet navigational services
and to maintain the up-to-date information required by their viewers to keep
up with the rapid growth of the Internet without incurring the extensive costs
associated with the internal development of such products. In addition, the
Company's licensing arrangements enable the Company to create multiple points
of entry and alternative distribution channels for the Company's products and
services, build brand awareness, and expand without the associated
infrastructure costs. Lycos has licensed its technology and brand to numerous
partners, including IBM, Fidelity Investments, PackardBell/NEC, RCN and
Viacom. See "--Strategic Alliances."
Branding
The Company's strategy is to build brand awareness through an integrated
plan utilizing online and traditional media, public relations and promotions.
The Company's media campaign has included traditional media such as broadcast
and cable television, local radio and print advertising in consumer and trade
magazines. The Company also significantly cross-promotes through advertising
in online media. In addition, the Company utilizes non-traditional marketing
channels, such as professional sports sponsorships, to increase its brand
awareness. The Company plans to continue to promote its brand in order to
increase brand awareness and increase usage of the Lycos Network.
Strategic Alliances
In order to increase traffic to the Company's web sites and to extend the
Lycos brand internationally, the Company seeks to expand upon its strategic
relationships with business partners who offer content, technology and
distribution capabilities as well as marketing and cross-promotional
opportunities. In furtherance of this strategy, the Company has established
the following strategic relationships:
Lycos Europe. In May 1997, the Company entered into a joint venture
agreement with Bertelsmann Internet Services to create localized versions
of the Lycos search and navigation service and the Tripod community site
throughout Europe. The joint venture, named Lycos Bertelsmann GmbH & Co. KG
("Lycos Bertelsmann"), is owned 50% by Lycos and 50% by Bertelsmann.
Lycos Japan. In March 1998, Lycos established Lycos Japan KK as the basis
for a joint venture to promote and operate a Japanese version of the Lycos
web site and MailCity. Lycos' joint venture partners are Sumitomo
Corporation, one of the largest conglomerates in Japan, Internet Initiative
Japan ("IIJ"), Japan's largest Internet service provider. Lycos owns 40% of
the joint venture.
Lycos Korea. In March 1999, Lycos established Lycos Korea, Inc., a Korean
company, to promote localized versions of the Lycos web site, Tripod and
MailCity. Lycos' joint venture partner is Mirae Corporation, a prominent
high-technology company in Korea. Lycos and Mirae each own 50% of the joint
venture.
IBM, Packard Bell/NEC, and RCN Distribution Agreements. Pursuant to these
agreements and ones like them, Lycos' products and services are the default
offerings on software such as IBM's Lotus Notes, hardware such as Packard
Bell/NEC desktop computers and ISP homepages, such as those created for
RCN.
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Strategic Investments. Lycos has made strategic investments in Internet
service companies whose products are integrated into the Lycos services. In
April 1998, Lycos acquired a 9.9% ownership stake in Mail.com, a leading
global provider of free Web-based e-mail products, in exchange for shares
of the Company's Common Stock valued at $4.6 million at the time of the
transaction. Additionally, in April 1998, Lycos acquired a 14.8% ownership
stake in Sage Enterprises, Inc. (PlanetAll) in exchange for shares of the
Company's Common Stock valued at $3.3 million at the time of the
transaction. In August 1998, Amazon.com acquired all of the outstanding
stock of PlanetAll. Lycos received 322,128 shares of Amazon.com common
stock valued at approximately $12.8 million in exchange for its shares of
PlanetAll. In September 1998, Lycos acquired a 19.9% ownership in Bidder's
Edge, a leading provider of tools and services that enable on-line auction
users to easily and automatically find similar items from multiple on-line
auctions. In December 1998, Lycos acquired a 16.7% ownership stake in
Valent Software, a developer of software that powers online clubs, where
access is limited to those whom the user chooses. In April 1999, the
Company acquired a 16.7% ownership stake in Frictionless Commerce, a
developer of comparison shopping technologies that takes into account such
options as price, product features, brand reputation and delivery time.
In addition, in July 1999, Lycos formed Lycos Ventures to make early-stage
investments in companies that are involved with electronic commerce, online
media, or the development or utilization of Internet technology, content or
services. Joining Lycos in the approximately $75 million fund are Bear
Stearns, Mellon Ventures, Inc., Sumitomo Corporation, Vulcan Ventures and
others.
Technology
The Company uses a combination of proprietary technology, both developed in-
house and purchased through the acquisition of the developing companies, and
licensed technology and services to deliver its Lycos-branded products and
services. Technology developed in-house includes the MyLycos personal page,
the LycosPro advanced search and the Search Guard online filter. Technology
acquired through strategic acquisitions include the Tripod and Angelfire
personal publishing tools, the Guestworld personal homepage guestbook, the
MailCity e-mail product, and the Sonique music player. The Company licenses
technology and services that power its chat, clubs and bulletin board product
offerings as well as much of the LycoShop features and functionality.
The Lycos search and indexing technology was developed at Carnegie Mellon
University ("CMU"). In June 1995, the Company entered into a license agreement
with CMU pursuant to which CMU granted to the Company a perpetual, worldwide
right to use and sub-license the Lycos search and indexing technology and
other intellectual property rights associated therewith, including the "Lycos"
trademark and the domain name lycos.com. CMU has been issued a patent in the
United States relating to Lycos' search and indexing technology.
Competition
The market for Internet products and services, and for Internet advertising
served in connection with those products and services, is highly competitive.
The Company believes the principal competitive factors in this market are name
recognition, performance, ease of use, variety of value-added services,
features and quality of support.
A number of companies currently offer competitive products in the Company's
target markets. The primary competitors of the Company's products and services
are other companies providing online services and include About.com, Inc.
(formerly The Mining Company), America Online (including Netscape's Netcenter
and CompuServe), CMGi's Alta Vista, Excite@Home (including WebCrawler),
theGlobe.com, Inc., Disney's Infoseek Corporation, Looksmart Ltd., Microsoft's
MSN, NBC's Snap, Xoom, Inc., and Yahoo! Inc. (including GeoCities). In
addition, a number of companies offering Internet products and services,
including direct competitors of the Company, recently have begun to integrate
multiple features within the products and services they offer to consumers.
Integration of Internet products and services is occurring through development
of
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competing products and through acquisitions of, or entering into joint
ventures and/or licensing arrangements involving, competitors of the Company.
Also, many other large media companies have announced that they are
contemplating developing or acquiring Internet navigation services and are
attempting to become "gateway" sites for Web users.
Employees
As of October 27, 1999, Lycos employed 785 persons, including 363 in sales
and marketing, 336 in research and development, product development and
service operations and 86 in finance and administrative functions. The Company
also employs 35 independent contractors for software development,
documentation, artistic design and editorial reviews. None of the Company's
employees is represented by a labor union and Lycos considers its employee
relations to be good.
ITEM 2. PROPERTIES
The Company's corporate headquarters is located in an approximately 77,000
square foot office facility in Waltham, Massachusetts, under a lease which
expires in June 2003. The Company also maintains a sales office in New York,
New York under a lease which expires in April 2002 and a corporate office and
a sales office in San Francisco, California under leases which expire in March
2002 and August 2006. Lycos also maintains corporate offices in Mountain View,
California under a lease which expires in December 2002. The Company believes
that its current facilities are adequate for its current needs.
The Company maintains substantially all of its computer systems in the
California, New Jersey and Massachusetts sites of Exodus Communications, Inc.
The Company's operations are dependent in part upon its ability to protect its
operating systems against physical damage from fire, floods, earthquakes,
power loss, telecommunications failures, break-ins or other similar events.
Furthermore, despite the implementation of network security measures by the
Company, its servers are also vulnerable to computer viruses, break-ins and
similar disruptive problems. The occurrence of any of these events could
result in interruptions, delays or cessations in service to users of the
Company's products and services which could have a material adverse effect on
the Company's business, results of operations and financial condition. See
"Factors affecting the Company's Business, Operating Results and Financial
Condition".
ITEM 3. LEGAL PROCEEDINGS
In February 1999, the Company announced its intention to enter into a
transaction with USA Networks, Inc. and certain affiliated companies pursuant
to which, among other things, Lycos would have been merged into a subsidiary
of USA Networks. In May 1999, the parties to the proposed transaction
terminated the merger by mutual agreement.
Prior to such termination, eight purported class action lawsuits were filed
in the Court of Chancery for the State of Delaware in and for New Castle
County, by shareholders of the Company allegedly on behalf of all common
stockholders of the Company. The complaints request, among other things, that
the proposed transaction be enjoined or that rescissionary damages be awarded
to the purported class and that plaintiffs be awarded all costs and fees,
including attorneys' fees. Although the proposed merger has since been
terminated, the suits have not been dismissed. The Company believes that the
allegations in the complaints are without merit and intends to contest them
vigorously.
Also prior to the termination of the proposed merger, a series of purported
securities class action lawsuits were filed in the United States District
Court for the District of Massachusetts. The suits, which have since been
consolidated, allege, among other claims, violations of United States Federal
securities laws through alleged misrepresentations and omissions relating to
the announced transaction with USA Networks. The consolidated complaint seeks
an unspecified award of damages. The Company believes that the allegations in
the consolidated complaint are without merit and intends to contest them
vigorously.
8
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
A special meeting of the stockholders of the Company was held on July 15,
1999. 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 100,000,000
shares to 300,000,000. 32,915,063 shares were cast in favor of the proposal,
while 3,373,045 were cast against the proposal. There were 64,030 abstentions.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by Item 10 of Form 10-K with respect to executive
officers of the Company is set forth below. Executive officers of the Company
are elected by the Board of Directors on an annual basis and serve until their
successors have been duly elected and qualified. There are no family
relationships among any of the executive officers or directors of the Company.
The executive officers of the Company are:
Name Age Position
---- --- --------
Robert J. Davis......... 43 President, Chief Executive Officer and Director
Edward M. Philip........ 34 Chief Operating Officer, Chief Financial Officer and Secretary
Ron A. Sege............. 42 Executive Vice President
David G. Peterson....... 42 Vice President of Advertising Sales
Thomas E. Guilfoile..... 35 Vice President of Finance and Administration
Jeffrey J. Crown........ 40 Vice President of Business Development
John P. McMahon......... 47 Chief Human Resources Officer
Robert J. Davis has served as President, Chief Executive Officer and
Director of the Company since its inception in June 1995. From January 1993 to
June 1995, Mr. Davis served as Vice President of Sales at Cambex Corporation,
a manufacturer of computer-related products. From January 1982 to January
1993, Mr. Davis was employed by Wang Laboratories, a computer manufacturer, in
various sales and marketing positions, including Director of United States
Commercial Sales and Marketing and Director of Worldwide Marketing. Mr. Davis
holds a Bachelor of Science degree, with highest honors, from Northeastern
University and a Master in Business Administration from Babson College.
Edward M. Philip has served as Chief Financial Officer and Secretary of the
Company since December 1995 and Chief Operating Officer since December 1996.
From July 1991 to December 1995, Mr. Philip was employed by The Walt Disney
Company where he served in various finance positions, most recently as Vice
President and Assistant Treasurer. From September 1989 to May 1991, Mr. Philip
attended Harvard Business School. From August 1987 to June 1989, Mr. Philip
was an investment banker at Salomon Brothers Inc. Mr. Philip received a
Bachelor of Science degree in Economics and Mathematics from Vanderbilt
University and a Master in Business Administration from Harvard Business
School.
Ron A. Sege has served as Executive Vice President Officer since January
1999. Mr. Sege is responsible for steering the development of the rapidly
growing Lycos Network. Prior to joining Lycos, Mr. Sege worked for 3Com
Corporation, most recently as senior vice president of one of three business
units at 3Com, a company with approximately $6 billion in annual revenue and
13,000 employees. Before joining 3Com, Mr. Sege worked for Rolm Corporation
through its acquisition by IBM. Mr. Sege serves on various corporate and non-
profit boards, including Artel Video Systems, the Massachusetts
Telecommunications Council and Junior Achievement of New England. He holds a
Bachelor of Arts degree from Pomona College and a Master in Business
Administration from Harvard Business School.
9
David G. Peterson has served as Vice President of Advertising Sales of the
Company since December 1996. From 1985 to 1996, Mr. Peterson served in various
sales positions at International Data Group ("IDG"), most recently as
Associate Publisher of Computerworld, where he was responsible for all U.S.
advertising sales operations and managed seven regional offices. Previously,
Mr. Peterson also held such positions within IDG as Vice President of Eastern
Advertising Sales, Regional Vice President of New England Advertising Sales
and District Manager. Mr. Peterson holds a Bachelor of Arts degree in
Economics from the University of New Hampshire and a Master of Business
Administration from Northeastern University.
Thomas E. Guilfoile has served as Vice President of Finance and
Administration since December 1996 and previously served as Controller since
February 1996. From July 1986 to January 1996, Mr. Guilfoile was employed by
Ernst & Young LLP, most recently as Senior Manager in the Entrepreneurial
Services Group. While at Ernst and Young, Mr. Guilfoile provided both audit
and consulting services to both privately held and publicly traded
organizations, primarily in the high-tech area with a focus on companies in
the Information, Communications and Entertainment industries. Mr. Guilfoile is
a member of the Board of Directors of AdOne LLC and holds a Bachelor of
Business Administration degree in Accounting from the University of Notre
Dame.
Jeffrey J. Crown has served as Vice President of Business Development since
July 1997 and previously served as Director of Business Development since
January 1996. Mr. Crown was formerly the Director of Sales and Marketing for
Xyvision, Inc. and has 15 years of technical sales and marketing experience at
McDonnell Douglas and Auto-trol Technology Corporation. Mr. Crown holds a
Bachelor of Science in Marketing/Industrial Sales from Penn State University.
John P. McMahon has served as Chief Human Resources Officer since August
1999. Prior to joining Lycos, McMahon served as Vice President of Human
Resources at Wang Global. Before joining Wang Global, McMahon served as Senior
Vice President of Human Resources at Stream International and Stride Rite.
McMahon has a Master of Science degree in Human Resource Management from
Upsala College and a Bachelor of Science degree in Criminal Justice from Mercy
College.
10
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Common Stock of the Company has traded on the NASDAQ Stock Market under
the symbol LCOS since the Company's initial public offering on April 2, 1996.
Prior to that time, there was no public market for the Company's Common Stock.
The following table sets forth the high and low reported sale prices for the
Company's Common Stock for the period indicated as reported by the NASDAQ
Stock Market.
Year Fiscal Quarter Ended High Low
---- -------------------- ----- -----
2000 October 31, 1999 (through October 27, 1999).............. 67.25 28.56
1999 October 31, 1998......................................... 22.25 10.03
January 31, 1999......................................... 72.69 20.63
April 30, 1999........................................... 72.50 34.50
July 31, 1999............................................ 61.31 35.00
1998 October 31, 1997......................................... 10.50 4.07
January 31, 1998......................................... 10.50 6.32
April 30, 1998........................................... 19.79 8.80
July 31, 1998............................................ 26.82 12.08
1997 October 31, 1996......................................... 3.19 1.44
January 31, 1997......................................... 4.69 2.38
April 30, 1997........................................... 5.69 3.00
July 31, 1997............................................ 4.82 2.80
1996 April 30, 1996 (commencing April 2, 1996)................ 7.32 3.50
July 31, 1996............................................ 4.82 1.47
As of October 27, 1999, the Company had 96,386,855 shares of Common Stock
held by approximately 1,248 shareholders of record. This does not reflect
persons or entities who hold their stock in nominee or "street" name through
various brokerage firms.
The Company has not paid any cash dividends on its Common Stock. The Company
anticipates it will reinvest earnings to finance future growth, and therefore
does not intend to pay dividends in the foreseeable future.
11
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data presented below under the caption Consolidated
Statements of Operations Data with respect to the years ended July 31, 1999,
1998, 1997, 1996 and for the period from Inception (June 1, 1995) to July 31,
1995 and under the caption Consolidated Balance Sheet Data at July 31, 1999,
1998, 1997, 1996 and 1995 are derived from the consolidated financial
statements of the Company and its subsidiary, which financial statements have
been audited by KPMG LLP, independent certified public accountants. The
following selected consolidated financial data should be read in conjunction
with the "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and the Consolidated Financial Statements and Notes
thereto included elsewhere in this Report.
Inception
Year Ended Year Ended Year Ended Year Ended (June 1, 1995)
July 31, 1999 July 31, 1998 July 31, 1997 July 31, 1996 July 31, 1995
------------- ------------- ------------- ------------- --------------
Consolidated Statement
of Operations Data:
Revenues:
Advertising............ $ 93,440,262 $ 41,768,607 $17,417,388 $ 4,478,474 $ --
Electronic commerce,
license and other..... 42,080,564 14,291,698 4,855,654 778,753 5,000
------------ ------------ ----------- ----------- ----------
Total revenues....... 135,520,826 56,060,305 22,273,042 5,257,227 5,000
Cost of revenues (1).... 28,726,949 12,513,259 4,335,941 2,900,808 27,576
------------ ------------ ----------- ----------- ----------
Gross profit........... 106,793,877 43,547,046 17,937,101 2,356,419 (22,576)
Operating expenses:
Research and
development........... 26,279,267 9,477,708 4,301,267 906,591 15,940
In process research and
development (2)....... -- 17,280,000 -- 452,000 --
Sales and
marketing (1)......... 78,807,148 35,035,754 19,126,317 4,747,805 29,530
General and
administrative........ 16,249,670 5,631,104 2,718,763 1,692,362 37,335
Amortization of
intangible assets..... 52,427,704 7,613,711 540,416 359,868 --
------------ ------------ ----------- ----------- ----------
Total operating
expenses............ 173,763,789 75,038,277 26,686,763 8,158,626 82,805
------------ ------------ ----------- ----------- ----------
Operating loss.......... (66,969,912) (31,491,231) (8,749,662) (5,802,207) (105,381)
Interest income......... 6,166,942 3,051,747 2,130,472 714,369 --
Other income, net....... 8,759,406 -- -- -- --
------------ ------------ ----------- ----------- ----------
Net loss................ $(52,043,564) $(28,439,484) $(6,619,190) $(5,087,838) $ (105,381)
============ ============ =========== =========== ==========
Basic and diluted net
loss per share (3)..... $ (0.60) $ (0.46) $ (0.12) $ (0.11) $ (0.00)
============ ============ =========== =========== ==========
Shares used in computing
net loss per
share (4).............. 86,428,459 61,865,964 55,178,972 47,969,660 44,051,056
============ ============ =========== =========== ==========
July 31, July 31, July 31, July 31, July 31,
1999 1998 1997 1996 1995
------------- ------------- ------------- ------------- --------------
Consolidated Balance
Sheet Data:
Working capital......... $167,708,224 $147,062,298 $38,129,429 $39,973,810 $ 329,411
Total assets............ $874,642,068 $317,235,336 $65,419,009 $53,660,575 $1,316,655
Long-term portion of
deferred revenues, net
of current portion..... $ 55,934,152 $ 26,159,754 $ 5,100,000 $ -- $ --
Total Stockholders'
equity................. $725,682,620 $237,163,674 $37,647,027 $44,106,157 $1,144,619
12
- --------
(1) Certain amounts in 1997 and 1996, which were previously included in the
consolidated income statement under the caption "Cost of revenues", have
been reclassified as "Sales and marketing" expense for all periods
presented. This reclassification conforms the Company's presentation to
industry practice. This change in classification has no effect on
previously reported net loss or net loss per share.
(2) Reflects "In process research & development" expense recorded in
connection with the Company's acquisitions.
(3) Net loss per share is calculated using the weighted average number of
common stock and common stock equivalent shares outstanding during the
respective periods. See Note 1 of Notes to Consolidated Financial
Statements.
(4) Reflects the Company's two for one stock splits effective July 26, 1999
and August 25, 1998. All prior periods have been adjusted to reflect
these stock splits.
ITEM 7. 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
"Factors Affecting the Company's Business, Operating Results and Financial
Condition" as well as those discussed in this section and elsewhere in this
Report.
Fiscal 1999 Compared To Fiscal 1998
Results Of Operations
Revenues. Total revenues for the year ended July 31, 1999 increased $79.5
million or 142%, to $135.5 million from $56.1 million for the previous year
ended July 31, 1998 primarily as a result of the growth in the number and size
of advertising contracts as well as an increase in the number and value of
electronic commerce agreements.
Advertising Revenues. Advertising revenues increased $51.7 million or 124%,
to $93.4 million for the year ended July 31, 1999 representing 69% of total
revenues. For the previous year ended July 31, 1998, advertising revenues were
$41.8 million representing 75% of total revenues. The increase in advertising
revenue was attributable primarily to an increase in the number of advertisers
as well as growth in the average contract size and value.
The Company currently derives a substantial portion of its revenues from the
sale of advertisements on its web sites, 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 Web Guides or on a specified page or service.
Electronic Commerce, License and Other Revenues. Electronic commerce,
license and other revenues increased $27.8 million or 194%, to $42.1 million
for the year ended July 31, 1999, representing 31% of total revenues. For the
previous year ended July 31, 1998, electronic commerce, license and other
revenues were $14.3 million, representing 25% of total revenues. For the year
ended July 31, 1999, the increase in electronic commerce, license and other
revenues is attributable primarily to the addition of several new partners
during the year, including, among others, Microsoft, Fleet Bank, WebMD and
First USA Bank.
13
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 web sites. 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 increased $16.2 million or 130%, to $28.7
million for the year ended July 31, 1999, representing 21% of total revenues.
Cost of revenues for the previous year ended July 31, 1998 were $12.5 million,
representing 22% 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, bandwidth, networking and other related indirect costs. The overall
increase in the cost of revenues was primarily due to increased usage of the
company's services. The Company expects increases in the cost of revenues as
demand for the Company's product offerings increase.
Operating Expenses
Research and Development. Research and development expenses increased $16.8
million or 177%, to $26.3 million for the year ended July 31, 1999,
representing 19% of total revenues. For the year ended July 31, 1998, research
and development expenses were $9.5 million, or 17% 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 growing product offerings. The Company believes that significant
investment in research and development is required to remain competitive. As a
consequence, the Company expects to continue to commit substantial resources
to research and development in the future.
Sales and Marketing. Sales and marketing expenses increased $43.8 million or
125%, to $78.8 million for the year ended July 31, 1999, representing 58% of
total revenues for the year. For the year ended July 31, 1998, sales and
marketing expenses were $35.0 million, representing 62% 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, and expenses associated with the Company's expanded
advertising, marketing and public relations campaign. The Company expects
continued increases in sales and marketing expenses in future periods. Sales
and marketing expenses also includes the cost of the Company's "Premier
Provider" Agreements with Netscape and Microsoft, which totaled $17.6, $4.3
million, and $4.5 million in the fiscal years ended July 31, 1999, 1998 and
1997, respectively.
General and Administrative. General and administrative expenses increased
$10.6 million or 189%, to $16.2 million for the year ended July 31, 1999,
representing 12% of total revenues. For the year ended July 31, 1998, general
and administrative expenses were $5.6 million, representing 10% of total
revenues. Included in general and administrative expenses for the year ended
July 31, 1999 are non-recurring expenses of $4.2 million related to the USA
Networks acquisition, as well as expenses associated with the consolidation of
Lycos' Pittsburgh offices. Excluding these costs, general and administrative
costs increased $6.4 million or 114%, to $12.0 million for the year ended July
31, 1999, representing 8.9% of total revenues. General and administrative
expenses consist primarily of compensation, fees for professional services and
other general corporate overhead costs. Net of these non-recurring charges,
the increases in spending were primarily due to the expansion of the Company's
corporate infrastructure, including the addition of finance and administrative
personnel and increased costs for professional services.
Amortization of Intangible Assets. Amortization of intangible assets
increased $44.8 million or 589%, to $52.4 million for the year ended July 31,
1999, representing 39% of revenues. For the year ended July 31, 1998,
14
amortization of intangible assets was $7.6 million, representing 14% of total
revenues. The increase is attributable to increased amortization related to
intangible assets recorded upon the acquisitions of WhoWhere?, Wired Ventures,
and Internet Music Distribution. The Company amortizes intangible assets
recorded upon the acquisitions over a five year period. The Company believes
that its use of a five year amortization period is appropriate based on the
following factors:
(a) Independently, none of these companies held leadership positions in the
Web search, navigation, or e-commerce markets.
(b) The internet industry has very low barriers of entry for companies
offering competing services to these companies.
(c) Each company acquired was less than five years old and had a history of
operating losses.
(d) Industry practice has demonstrated certain technology companies
utilizing amortization periods of three to five years.
(e) The determination of the useful life of goodwill and other intangible
assets requires a significant amount of judgment on the part of
management.
Interest Income. Interest income increased $3.1 million or 102%, to $6.2
million for the year ended July 31, 1999, representing 5% of total revenues.
Interest income was approximately $3.1 million for the year ended July 31,
1998, representing 5% of total revenues. Interest income is derived primarily
from the investment of net proceeds received upon the closing of the Company's
public offerings of common stock in April 1996 and June 1998, as well as
acquired cash.
Other income, net. Other income, net for the year ended July 31, 1999,
consists of a $10.1 million gain on sale of equity securities, net of a $1.4
million loss in the Company's equity share of losses in affiliates.
Income Taxes. As of July 31, 1999, the Company had approximately $151
million in Federal and State net operating loss carryforwards. The Federal net
operating losses will expire beginning in 2004 if not utilized. The State net
operating losses will expire beginning in 2004 if not utilized. A portion or
all of net operating loss carryforwards which can be utilized in any year may
be limited by changes in ownership of the Company, pursuant to Section 382 of
the Internal Revenue Code and similar statutes.
Acquisitions
WhoWhere?, Inc.
On August 13, 1998, the Company acquired WhoWhere?, Inc. in a stock-for-
stock transaction valued at approximately $159.1 million, resulting in
intangible assets of $161.3 million. The transaction was accounted for as a
purchase, and accordingly, the purchase price was allocated to the assets
acquired and liabilities assumed based on their respective fair values.
Wired Ventures, Inc.
On June 30, 1999, the Company acquired Wired Ventures, Inc. in a stock-for-
stock transaction valued at approximately $290.9 million, resulting in
intangible assets of $268.0 million. The transaction was accounted for as a
purchase, and accordingly, the purchase price was allocated to the assets
acquired and liabilities assumed based on their respective fair values.
Internet Music Distribution, Inc.
On July 27, 1999, the Company acquired Internet Music Distribution, Inc. in
a stock-for-stock transaction valued at approximately $49 million, resulting
in intangible assets of $50.0 million. Terms of the merger also provide for
future purchase payments, not to exceed $15,000,000, contingent upon unique
user downloads of the Sonique Player. The Company has retained security
interests in certain common stock that was issued in this
15
transaction. The transaction was accounted for as a purchase, and accordingly,
the purchase price was allocated to the assets acquired and liabilities
assumed based on their respective fair values.
Fiscal 1998 Compared To Fiscal 1997
Results of Operations
Revenues. Total revenues for the year ended July 31, 1998 increased $33.8
million or 152%, to $56.1 million from $22.3 million for the previous year
ended July 31, 1997 primarily as a result of the growth in the number and size
of advertising contracts as well as an increase in the number and value of
electronic commerce agreements.
Advertising Revenues. Advertising revenues increased $24.4 million or 140%,
to $41.8 million for the year ended July 31, 1998 representing 75% of total
revenues. For the previous year ended July 31, 1997, advertising revenues were
$17.4 million representing 78% of total revenues. The increase in advertising
revenue was attributable primarily to an increase in the number of advertisers
as well as growth in the average contract size and value.
Electronic Commerce, License and Other Revenues. Electronic commerce,
license and other revenues increased $9.4 million or 194%, to $14.3 million
for the year ended July 31, 1998, representing 25% of total revenues. For the
previous year ended July 31, 1997, electronic commerce, license and other
revenues were $4.9 million, representing 22% of total revenues. For the year
ended July 31, 1998, the increase in electronic commerce, license and other
revenues is attributable primarily to the addition of several new partners
during the year, including, among others, AT&T, Barnes and Noble, Microsoft
and CDnow.
Cost of Revenues. Cost of revenues increased $8.2 million or 189%, to $12.5
million for the year ended July 31, 1998, representing 22% of total revenues.
Cost of revenues for the previous year ended July 31, 1997 were $4.3 million,
representing 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, bandwidth, networking and other related indirect costs. The overall
increase in the cost of revenues was primarily due to increased usage of the
Company's services.
Operating Expenses
Research and Development. Research and development expenses increased $5.2
million or 120%, to $9.5 million for the year ended July 31, 1998,
representing 17% of total revenues for the year, but declined 2% as a
percentage of total revenues. For the year ended July 31, 1997, research and
development expenses were $4.3 million, or 19% 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 growing product offerings. The Company believes that significant
investment in research and development is required to remain competitive.
In-process research and development. During 1998, the Company initiated a
strategy of purchasing selected technologies as opposed to developing the
products in-house, in an effort to enhance the speed with which the Company
could bring new product offerings to market. From February 1998 through July
1998, the Company purchased two such technologies of significance: (1)
homepage building tools from Tripod, Inc. in February 1998; and (2) automated
directory services from WiseWire, Inc. in April 1998. Each of these companies
were in early stages of development, had yet to develop any significant
revenue streams and had devoted most of its efforts to date in the development
of new technologies for the Internet. As a result of acquisitions during 1998,
the Company recorded an in-process research and development charge of $17.3
million, representing the purchased in-process research and development that
has not yet reached technological feasibility and has no alternative future
use.
16
Subsequent to the end of its fiscal year end, the Company continued its
acquisition strategy. However, whereas the previous acquisitions had focused
on purchasing technologies, the addition of WhoWhere?, Inc. in August 1998 and
Wired Ventures, Inc. in October 1998 centered around adding new users as well
as a suite of more established products and services to the Company's product
offerings. This change in focus was part of the Company's strategic initiative
to change the Company from a technology focus to a mass market media company.
The following is a description of each of the Company's acquisitions,
including a summary of all major in-process research and development projects
at the time of acquisition. The technologies described below for each
acquisition have been determined to be in-process research and development
assets. These technologies have not reached a state of technological
feasibility as of the acquisition date, nor do they exhibit any alternative
future use or uses as determined by management.
Tripod, Inc.
Lycos acquired Tripod, Inc., on February 12, 1998 for total purchase
consideration of $61.4 million. The portion of the purchase price allocated to
in-process research and development was $7.2 million or approximately 12% of
the total purchase price. At the acquisition date, Tripod's major in-process
project was the development of an advanced Home Page Building (HPB) technology
and related web site management infrastructure to integrate and support this
new HPB technology. The objective of the project was to develop and package a
community building technology product that could be licensed to other
companies to build and manage their own community-oriented sites. The new HPB
technology was designed to build everything from simple web pages to complex
web sites. Beyond the basic technology, the in-process HPB technology would
offer two important features: plug-ins and templates. Plug-ins provide new
interactive software tools to homepage builders without altering the basic HPB
technology. For instance, plug-ins can enable users to easily add games,
quizzes, electronic commerce capabilities and other interactive elements to
their homepages. The HPB technology will also provide multiple template types,
allowing a user to fill in a web form and build an electronic brochure without
learning the HTML programming language.
At the date of acquisition, management estimated that completion of the HPB
technology product would be accomplished by May 31, 1998. The initial
development effort to create a licensable HPB technology product had commenced
in June, 1997. The major obstacle to launching the product was completing
software development, integrating the various components into a functional
online system, completing the Application Programming Interface (API) and the
development of a user interface. At the acquisition date, the new HPB
technology product had not reached a completed prototype stage and beta
testing had not yet commenced. The project was delayed due to unexpected
technical difficulty in completing software development, integrating and
packaging the technology and creating a new user interface that performed in a
live production environment. At the acquisition date, approximately 24 man-
months of effort had been invested in the HPB project and related development.
An additional 12 man months of effort was necessary to complete the project in
September 1998. At the time of the Lycos purchase, the project was
approximately 67% complete.
WiseWire, Inc.
Lycos acquired WiseWire, Inc., on April 30, 1998, for a total purchase price
of $39.4 million. The portion of the purchase price allocated to in-process
research and development was $9.08 million or approximately 23% of the total
purchase price. The theoretical concepts underlying WiseWire's technology were
conceived at Carnegie Mellon's Artificial Intelligence Labs. The WiseWire
technology is generally described by management as "super personalization
through adaptive machine learning techniques". Despite four years of
development at Carnegie Mellon University and another three years at WiseWire
Corporation, the primary components of the technology still had not yet
reached a state of technological feasibility as of the acquisition date.
At the acquisition date, WiseWire was developing two primary product lines:
WiseWire Community Directory, aimed at the consumer user and those web sites
that seek to attract high volumes of consumers; and WiseWire for Web
Sites/WiseWire Professional for the corporate intranet market segment.
17
The Community Directory was intended to enable clients to utilize WiseWire's
machine learning and collaborative filtering technology to rapidly deploy a
full-featured directory of Web, Net News, product descriptions, and
proprietary content. WiseWire Community Directory product automatically
creates and manages the entire directory structure eliminating the need for
large editorial support. The directory is intended to be dynamic in that it is
constantly changing and being updated with new material independent of actions
by an editorial staff. Over time, the content will change and reflect the
needs and interests of the community of users. At the acquisition date, a
prototype of this product was being used to power the Web Guides on Lycos,
however, it is estimated that only about one-third of the technology's long-
term intended performance capability and functionality was being utilized.
Although a subset of the Community Directory technology was developed and was
functioning at the Lycos site in a limited capacity, approximately two thirds
of its intended performance capability and feature set was still in
development at the acquisition date.
At the acquisition date, approximately 36 man-months of effort had been
invested in the project and it was estimated that the Community Directory R&D
project would be completed within three to four months. Thus, at the time of
the Lycos purchase, the project was estimated to be approximately 90%
complete.
In addition to the Community Directory, WiseWire was developing two other
components of its product line as part of an expanded offering to the
corporate, rather than consumer user:
WiseWire for Web Sites: The WiseWire for Web Sites product will allow
companies to easily integrate the WiseWire technology into their existing
web site, offering direct links to continuously updated, real-time
information specific to their business objectives. WiseWire uses artificial
intelligence to search the broadest variety of online content tailored to
the topics that their users have defined. Sources include hundreds of
online newspapers and periodicals, Web pages, online discussion groups,
news wire feeds, and even the company's own proprietary content. Since the
WiseWire technology is interactive, users of the site contribute to the
evolution and quality of the information.
WiseWire Professional: The WiseWire Professional product provides a low-
cost, high-value tool for personalizing a company's view of the Internet.
WiseWire technology easily integrates with the Company's existing online
network to give their employees high-quality information while blocking
content that is not applicable or is recreational in nature.
At the acquisition date, working prototypes of these products were in the
testing and debugging phase. Significant technological advancements regarding
portability of the technology to a client's site and scalability for high
volume environments had yet to be resolved. In addition, many of the usability
enhancements described below needed to be integrated with the products so that
customers could actually use the product as designed without continuous
intervention and support by the Company.
At the acquisition date, it was estimated that the WiseWire for Web Sites
and WiseWire Professional technology projects would be completed within three
to six months, depending on resource availability, at a tax adjusted cost of
$600,000.
The Wisewire in-process technology projects were completed by December 1998.
In projecting the net earnings attributable to the in-process research and
development projects, management estimated revenues, revenue growth rates,
operating expenses, income taxes, and the costs associated with the
utilization of working capital and other complementary assets. These estimates
are based on the following assumptions:
. Projections of revenue growth over a five year forecast period are based
on management's estimates of market potential that are supported by
independent industry data regarding the Internet. Tripod generated
revenues of approximately $350,000 in 1996 and $900,000 in 1997.
WiseWire generated revenues of $4,346 in fiscal year 1996 and $8,647 in
fiscal year 1997. Both Tripod and WiseWire were development stage
enterprises when acquired by Lycos. Because of the absence of meaningful
historical revenues for Tripod and WiseWire, management projected
revenues for the initial year of the forecast period based on
18
its assessment of future market potential and each company's ability to
successfully launch its new product offerings. After the initial year of
the five year forecast period, revenues were predicted to grow at rates
comparable to the growth of Internet users and online activity and the
impact such growth would have on Internet advertising and electronic
commerce. For Tripod, forecasted annual growth rates range from 133% in
1999 to 39% in the fifth year of the projection period. For WiseWire,
forecasted annual growth rates range from a high of 200% in 2001 and then
decline to an annual rate of 97% in the fifth year of the forecast.
. Forecasted operating expenses were estimated at 70% of revenues for both
Tripod and WiseWire. Income taxes were estimated at a provisional rate
of 40%. The estimated after tax margin as a percentage of revenue of 18%
is consistent with future industry expectations for businesses operating
in this segment of the Internet marketplace. The 70% rate is consistent
with a convergence of the industry averages evident in the computer,
software and telecommunications industries. We believe that the 70% rate
takes into account on-going maintenance and research and development
costs typically associated with software technologies, as well as the
costs to integrate the products into the Lycos Network. As a result of a
70% operating expense ratio, pre-tax income is 30% and after tax income
is 18%, assuming a 40% tax rate. We believe that an 18% profit margin is
reasonable and consistent with industry expectations.
. The return on working capital and other assets necessary to support the
growth of each company has been estimated so as to derive an income
stream specifically attributable to the in-process technology. Net
working capital requirements have been estimated at 15% of revenues. The
8% rate applied to working capital reflects the long term expectation
for interest rates for working capital loans. The projected return on
working capital is based upon a market rate of return of 8%, or 4.8% on
an after-tax basis. Tangible assets have been estimated based upon the
level of tangible assets currently deployed in each business and upon
anticipated capital expenditures for normal asset replacement. The
tangible asset base required to support Tripod's R&D activities is
estimated at approximately $1,000,000 over the 5 year forecast period.
The tangible asset base required to support WiseWire's R&D activities is
estimated at approximately $920,000 over the 5 year forecast period. The
12% interest rate applied to fixed assets reflects the long term lending
rate expectation for financing the purchase of equipment. The projected
return on tangible assets is based upon a market rate of return estimate
of 12%, or 7.2% on an after-tax basis.
. The calculated weighted average cost of capital (WACC) is approximately
16%. The 16% rate was based upon an analysis of the WACC for publicly
traded companies within the same industry. The WACC calculation produces
the average required rate of return of an investment in an operating
enterprise. The required rate of return for working capital and tangible
assets would generally be lower than the WACC given the fact that less
risk is associated with such assets. As stated above, management
estimates an 8% return on working capital and a 12% return on tangible
assets. For intangible assets that reflect a considerably higher degree
of risk, such as in-process technology, a rate range of 25.2% to 28.8%
has been utilized depending on the relevant risk of the earning stream
associated with the technology. The risk rates used to present value the
earnings streams relating to in-process research and development are
approximately 20% higher than the rates used for valuing the developed
technology. We believe that this additional increment in the discount
rate accounts for the additional risks involved in completing the
project and gaining customer acceptance.
If actual results differ significantly from the above assumptions, the
Company may be adversely affected in future periods. In addition, the value of
other assets acquired may become impaired.
Sales and Marketing. Sales and marketing expenses increased $15.9 million or
83%, to $35.0 million for the year ended July 31, 1998, representing 62% of
total revenues for the year. For the year ended July 31, 1997, sales and
marketing expenses were $19.1 million, representing 86% of total revenues, but
declined 4% as a percentage 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, and
expenses associated with the Company's expanded
19
advertising, marketing and public relations campaign. Sales and marketing
expenses also includes the cost of the Company's "Premier Provider" Agreements
with Microsoft and Netscape, which totaled $17.6 million, $4.3 million and
$4.5 million in the fiscal years ended July 31, 1999, 1998 and 1997,
respectively.
General and Administrative. General and administrative expenses increased
$2.9 million or 107%, to $5.6 million for the year ended July 31, 1998,
representing 10% of total revenues. For the year ended July 31, 1997, general
and administrative expenses were $2.7 million, representing 12% of total
revenues. General and administrative expenses consist primarily of
compensation, fees for professional services and other general corporate
overhead costs. The increases in spending were primarily due to the expansion
of the Company's corporate infrastructure, including the addition of finance
and administrative personnel and increased costs for professional services.
Amortization of Intangible Assets. Amortization of intangible assets
increased $7.1 million to $7.6 million for the year ended July 31, 1998,
representing 13.6% of revenues. The increase is attributable to increased
amortization related to developed technology and goodwill and other intangible
assets recorded upon the acquisitions of Tripod, WiseWire and GuestWorld.
At July 31, 1998, the Company had total net assets of $237.2 million, of
which $78.8 million pertained to goodwill and other intangible assets. The
Company continually evaluates the existence of long-lived assets impairment in
accordance with the provisions of SFAS 121, "Accounting for the Impairment of
Long-Lived Assets and Long-Lived Assets to be disposed of." The Company wrote-
off $98,000 of goodwill related to Point Communications and $830,000 related
to its license agreement with Carnegie Mellon University. See Note 9 to the
Consolidated Financial Statements.
Interest Income. Interest income increased $921,000 or 43%, to $3.1 million
for the year ended July 31, 1998, representing 5% of total revenues. Interest
income was approximately $2.1 million for the year ended July 31, 1997,
representing 10% of total revenues. Interest income is derived primarily from
the investment of net proceeds received upon the closing of the Company's
public offerings of common stock in April 1996 and June 1998.
Income Taxes. The Company has not recorded an income tax expense or benefit
because it has incurred net operating losses since Inception. As of July 31,
1998, the Company had approximately $38 million in Federal and State net
operating loss carryforwards. Of this amount, approximately $13 million
relates to the acquisitions of Point Communications, Tripod, Inc., WiseWire
Corporation, and GuestWorld, Inc. and will reduce goodwill when utilized. The
Federal net operating losses will expire beginning in 2007 if not utilized.
The State net operating losses will expire beginning in 1998 if not utilized.
A portion or all of net operating loss carryforwards which can be utilized in
any year may be limited by changes in ownership of the Company, pursuant to
Section 382 of the Internal Revenue Code and similar statutes.
Acquisitions
Tripod, Inc.
On February 12, 1998, the Company acquired Tripod, Inc. in a stock-for-stock
transaction valued at approximately $61.4 million. The transaction was
accounted for as a purchase, and accordingly, the purchase price was allocated
to the assets acquired and liabilities assumed based on their respective fair
values. In connection with the acquisition, the Company recorded a one-time
charge related to in-process research and development of $7.2 million.
WiseWire Corporation
On April 30, 1998, the Company acquired WiseWire Corporation in a stock-for-
stock transaction valued at approximately $39.4 million. The transaction was
accounted for as a purchase, and accordingly, the purchase
20
price was allocated to the assets acquired and liabilities assumed based on
their respective fair values. In connection with the acquisition, the Company
recorded a one-time charge related to in-process research and development of
$9.1 million.
GuestWorld, Inc.
On June 16, 1998, the Company acquired GuestWorld, Inc. in a stock-for-stock
transaction valued at approximately $3.6 million. The transaction was
accounted for as a purchase, and accordingly, the purchase price was allocated
to the assets acquired and liabilities assumed based on their respective fair
values. In connection with the acquisition, the Company recorded a one-time
charge related to in-process research and development of $1.0 million.
Liquidity and Capital Resources
Prior to its initial public offering, the Company financed its operations
primarily from proceeds of the private sale of equity securities and, to
lesser extent, operating leases. On April 2, 1996, the Company completed an
initial public offering of its common stock in which 12,000,000 shares of
common stock were issued at a price of $4.00 per share. On April 12, 1996,
pursuant to the exercise of an over-allotment option granted to the
underwriters of the Company's initial public offering, the Company issued an
additional 540,000 shares of its common stock at $4.00 per share. Proceeds
from the offering were approximately $46.0 million, net of offering costs.
On June 4, 1998, 9,000,000 of the Company's shares were sold at a price of
$25.00 per share under a registration statement filed with the SEC, filed on
May 15, 1998. Of the 9,000,000 shares sold, 8,000,000 shares were sold by the
Company and 1,000,000 were sold by CMG Information Services, Inc ("CMGI"). The
Company did not receive any proceeds from the sale of shares by CMGI. Proceeds
to the Company were approximately $95 million. The Underwriters exercised an
option to purchase 1,350,000 additional shares of Common Stock, resulting in
additional proceeds to the Company of approximately $16 million.
At July 31, 1999, the Company had cash and cash equivalents of approximately
$153 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 $37.9 million in the
year ended July 31, 1999, due primarily to the net loss, as well as increases
in accounts receivable and electronic commerce and license fees receivable.
The Company's primary investing activity during the year has been, and further
expenditures are anticipated to be, for the purchase of computers and office
equipment to support the Company's continued growth. During the year ended
July 31, 1999, the Company also used approximately $18.8 million for payments
under the 1998 and 1999 Premier Provider Agreements with Netscape and
Microsoft.
At July 31, 1999, the Company had deferred revenues of approximately $120
million representing primarily license and electronic commerce fees to be
earned in the future on noncancelable license and electronic commerce
agreements.
In August 1998, all of the outstanding capital stock of PlanetAll was
acquired by Amazon.com in a stock-for-stock transaction valued at
approximately $87 million. Of the total of 800,000 shares issued by
Amazon.com, the Company received 322,128 shares valued at approximately $12.2
million, as of the acquisition date, in exchange for its shares of PlanetAll.
See Note 2 to the Consolidated Financial Statements.
The Company is obligated to make payments totaling approximately $14 million
under contracts to provide search and navigation services between June 1999
and September 2000. No payments had been made under these agreements as of
July 31, 1999.
From time to time, the Company expects to evaluate the acquisition of
products, businesses and technologies that complement the Company's business.
As of the date of this Report other than those noted herein, the Company does
not have any understandings, commitments or agreements with respect to any
such material acquisitions.
21
The Company currently believes that available funds and cash flows 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.
Year 2000 Compliance
LYCOS' SYSTEM MAY EXPERIENCE DIFFICULTIES RELATED TO YEAR 2000 COMPUTER
PROBLEMS.
The codes of many currently installed computer systems and software products
accept only two-digit entries in the date code field and cannot distinguish
21st century dates from 20th century dates. Many companies' software and
computer systems, including those of Lycos and the companies on which Lycos
depends, may need to be upgraded or replaced so that they will be able to
distinguish 21st century dates from 20th century dates in order to comply with
year 2000 requirements and therefore be year 2000 compliant.
Lycos' State Of Year 2000 Readiness. Lycos is currently evaluating the Year
2000 readiness of the hardware and software products it sells, the information
technology systems it uses and its non-information technology systems, like
building security, voice mail and other systems. This evaluation includes the
following phases: identification of all hardware and software products it
sells and information technology systems and non-information technology
systems it uses; assessment of repair or replacement requirements; repair or
replacement; testing; implementation; and creation of contingency plans in the
event of Year 2000 failures. Lycos has completed its assessment of all current
versions of these hardware and software products and believes that they are
Year 2000 compliant. Lycos is currently completing its testing of these
systems which it expects to complete by December 11, 1999. There can be no
assurance that these tests will be successful. Whether a complete system or
device that uses hardware or software used by Lycos will process 21st century
dates depends on other components that are supplied by parties other than
Lycos. Lycos is in the process of contacting vendors regarding whether their
software is Year 2000 compliant. Lycos relies, both domestically and
internationally, upon various service providers that are outside of its
control including: various vendors; governmental agencies; utility companies;
telecommunications service companies; delivery service companies; and other
service providers. These third parties may suffer a Year 2000 business
disruption caused by the inability of various systems to process 21st century
dates that could hinder Lycos' ability to conduct its business. To the extent
that Lycos fails to identify and remedy any non-compliant internal or external
Year 2000 problems, or the Year 2000 phenomenon creates a systemic failure
beyond Lycos' control, like a prolonged telecommunications or electrical
failure or a prolonged failure of third-party software on which Lycos relies,
Lycos could be prevented from operating its business and permitting users
access to its web sites.
Costs Of Year 2000 Compliance To Lycos. To date, Lycos has not incurred any
material expenditures in connection with identifying or evaluating Year 2000
compliance issues. Most of its expenses thus far relate to retaining third
party consultants to assist Lycos in its compliance efforts and to the
opportunity cost of time spent by Lycos employees evaluating its software, the
current versions of the hardware and software sold by Lycos and Year 2000
compliance matters generally.
22
Status Of Lycos' Contingency Plan. Lycos has not yet developed a Year 2000-
specific contingency plan. If Lycos discovers Year 2000 compliance issues, it
will evaluate the need for contingency plans relating to these issues.
Subsequent Events
Acquisition of Quote.com, Inc.
On September 2, 1999, the Company entered into an Agreement and Plan of
Merger (the Agreement) with Quote.com, Inc., a California corporation
("Quote.com") in a stock-for-stock transaction valued at approximately $88
million. The acquisition will be accounted for as a purchase. The purchase
price will be allocated to the assets acquired and liabilities assumed based
on their estimated fair values. Results of operations for Quote.com will be
included with those of the Company for periods subsequent to the date of
acquisition. The acquisition, which is subject to shareholder approval, is
expected to close in the second quarter of fiscal year 2000.
Lycos Asia Joint Venture
In September 1999, the Company established Lycos Asia as the basis for a
joint venture agreement with Singapore Telecommunications Limited (SingTel) to
create a localized version of the Lycos Network services to be offered in
Singapore, Hong Kong, China, Taiwan, India and certain other countries in
Southeast Asia. The joint venture is owned 50% by Lycos and 50% by SingTel, a
telecommunications provider in Singapore. The investment will be accounted for
under the equity method and accordingly, the Company will recognize 50% of the
net losses and profits of Lycos Asia when realized.
New Accounting Pronouncements
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-1 ("SOP 98-1"), "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use", which establishes guidelines
for the accounting for the costs of all computer software developed or
obtained for internal use. The Company is required to adopt SOP 98-1 effective
August 1, 1999. The adoption of SOP 98-1 is not expected to have a material
impact on the Company's consolidated financial statements.
In April, 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-5 ("SOP 98-5"), "Reporting on the Costs of
Start-Up Activities." The statement is effective for fiscal years beginning
after December 15, 1998. The statement requires costs of start-up activities
and organization costs to be expensed as incurred. The Company is required to
adopt SOP 98-5 effective August 1, 1999. The adoption of SOP 98-5 is not
expected to have a material impact on the Company's consolidated financial
statements.
In June 1998, the Financial Accounting Standards Board issued Statement No.
133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging
Activities", which requires that all derivative instruments be recorded on the
balance sheet at their fair value. The Company currently expects to adopt SFAS
133, as amended by SFAS 137, for the year ending July 31, 2001. Management has
determined there will be no impact on its results of operations or financial
position resulting from the adoption of SFAS 133 because the Company currently
does not hold derivative instruments.
Factors Affecting the Company's Business, Operating Results and Financial
Condition
The following risk factors should be considered in conjunction with the
other information included in this Report. This Report (including the
documents incorporated by reference herein) may include forward-looking
statements that involve risks and uncertainties. In addition to those risk
factors discussed elsewhere in this Report, the Company identifies the
following risk factors which could affect the Company's actual results and
cause actual results to differ materially from those in the forward-looking
statements.
Limited Operating History; Anticipation of Continued Losses. The Company was
founded in June 1995 and for the years ended July 31, 1999 and 1998 generated
revenues of $135.5 million and $56.1 million, respectively. Accordingly, the
Company has a limited operating history upon which an evaluation of the
23
Company and its prospects can be based. The Company and its prospects must be
considered in light of the risks, expenses and difficulties frequently
encountered by companies in their early stages of development, particularly
companies in new and rapidly evolving markets. These risks include the
Company's ability to continue to develop and extend the "Lycos" brand; the
Company's ability to maintain premier positions on high traffic Web access
points such as its arrangements with Netscape Communications Corp.
("Netscape") or to enter into additional distribution relationships and
strategic alliances; the ability of the Company to maintain and increase
levels of traffic on its web sites; the ability of the Company to continue to
develop or acquire content, features and functionality for its services; the
development of equal or superior services or products by competitors; the
failure of the market to adopt the Web as an advertising or commercial medium;
the reduction in market prices for Web-based advertising as a result of
competition or otherwise; the Company's ability to effectively generate
commerce-related revenues through sponsored services and placements in Lycos
services; the Company's success in attracting, retaining and motivating
qualified personnel and changes in the law governing activities in which the
Company participates. There can be no assurance that the Company will be
successful in addressing such risks.
The limited operating history of the Company makes the prediction of future
results of operations difficult or impossible, and therefore, the recent
revenue growth experienced by the Company should not be taken as indicative of
the rate of growth, if any, that can be expected in the future. The Company
has incurred significant losses since inception. The Company reported a loss
of $(0.60) per share (a $(0.05) loss per share before amortization and one-
time acquisition related charges) for the year ended July 31, 1999 and there
can be no assurance that the Company will sustain revenue growth or maintain
profitability in the future. As of July 31, 1999, the Company had an
accumulated deficit of $92.3 million. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and Consolidated
Financial Statements.
Potential Fluctuations in Quarterly Results. As a result of the Company's
limited operating history, the Company does not have historical financial data
for any significant period of time on which to base planned operating
expenses. The Company's expense levels are based in part on its expectations
as to future revenues and to a certain extent are fixed. Quarterly sales and
operating results generally depend on the advertising, electronic commerce,
license fees and other revenues received within the quarter, which are
difficult to forecast. Because the Company's expense levels are based upon
anticipated advertising, electronic commerce and licensing revenue, the
Company may not be able to adjust spending in a timely manner to compensate
for any unexpected revenue shortfall. Accordingly, any significant shortfall
in relation to the Company's expectations would have an immediate adverse
impact on the Company's business, results of operations and financial
condition.
In addition, the Company plans to significantly increase its operating
expenses to fund greater levels of research and development, increase its
sales and marketing operations, develop new distribution channels, broaden its
customer support capabilities, maintain brand identity and pursue strategic
alliances. In the future, leading web sites, browser providers and other
distribution channels may require payments or other consideration in exchange
for providing access to the Company's products and services. Additionally, the
Company may incur costs pertaining to the introduction or enhancement of
services offered by the Company or the acquisition of businesses or
technologies. To the extent that such expenses precede or are not subsequently
followed by increased revenues, the Company's business, results of operations
and financial condition could be materially adversely affected.
The Company's operating results may fluctuate significantly in the future as
a result of a variety of factors, some of which are outside of the Company's
control. These factors include general economic conditions, specific economic
conditions in the Internet industry, usage of the Internet, the level of
traffic to the Company's web sites, demand for Internet advertising and
electronic commerce, the addition or loss of advertisers or electronic
commerce sponsors, seasonal trends in advertising sales, the advertising
budgeting cycles of individual advertisers, capital expenditures and other
costs relating to the expansion of operations, incurrence of costs relating to
acquisitions, the introduction of new products or services by the Company or
its competitors, the mix
24
of the services sold, the channels through which those services are sold, and
pricing changes. As a strategic response to a changing competitive
environment, the Company may elect from time to time to make certain pricing,
service or marketing decisions or acquisitions that could have a material
adverse effect on the Company's business, results of operations and financial
condition. Due to the nascent nature of the Internet industry, the Company
believes that period to period comparisons of its operating results are not
meaningful and should not be relied upon for an indication of future
performance. The Company also has experienced, and expects to continue to
experience, seasonality in its business, with user traffic on the Company's
web sites and the web sites of its partners being lower during the summer and
year-end vacation and holiday periods, when usage of the Web and the Company's
services has typically declined. Due to all of the foregoing factors and
others that the Company cannot predict, it is possible that in some future
quarter, the Company's operating results may be below the expectations of
analysts and investors. In such event, the price of the Company's Common Stock
would likely be materially adversely affected. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
Reliance on Advertising Revenues; Risks Related to Sponsorships. The Company
derives a significant portion of its revenues from the sale of advertisements
on its Web pages. For the fiscal year ended July 31, 1999, advertising
revenues represented approximately 69% of the Company's total revenues. The
Company's strategy is to continue to develop advertising and other methods of
generating revenues through the use of its products and services.
The Company's ability to increase its advertising revenues will depend,
among other things, on advertisers' acceptance of the Internet as an
attractive and sustainable medium, the development of a large base of users of
the Company's products and services possessing demographic characteristics
attractive to advertisers, the expansion of the Company's advertising sales
force and the development of the Internet as an attractive platform for
electronic commerce. In addition, there is fluid and intense competition in
the sale of advertising on the Internet, resulting in a wide range of rates
quoted and a variety of pricing models offered by different vendors for a
variety of advertising services, which makes it difficult to project future
levels of advertising revenues that will be realized generally or by any
specific company. It is also difficult to predict which pricing models will be
adopted by the industry or advertisers. For example, advertising rates based
on the number of "click throughs" from the Company's network to advertisers'
pages, instead of rates based solely on the number of impressions, could
materially adversely affect the Company's revenues. In addition, "filter"
software programs that limit or remove advertising from the Web user's desktop
are available. The widespread adoption of such software by users could have a
material adverse effect on the viability of advertising on the Web.
Accordingly, there can be no assurance that the Company will be successful in
generating significant future advertising revenues, and the failure to do so
would have a material adverse effect on the Company's business, results of
operations and financial condition. Further, significant and consistent
investment on the Internet by many advertisers is dependent upon validation
that the Internet is an effective advertising medium, which validation has not
yet occurred and which is essential to the achievement of steady and
predictable advertising revenues. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and "Business--Advertising."
The Company has entered into sponsorship arrangements with third parties to
provide sponsored services and placements on the Company's web sites in
addition to traditional banner advertising. In connection with these
arrangements, the Company may receive sponsorship fees as well as a portion of
transaction revenues received by such third party sponsors from users
originated through the Company's web sites, in return for minimum levels of
user impressions or click throughs to be provided by the Company. To the
extent implemented, these arrangements expose the Company to potentially
significant financial risks, including the risk that the Company fails to
deliver required minimum levels of user impressions or click throughs (in
which case, these agreements typically provide for adjustments to the fees
payable thereunder or "make good" periods) and that third party sponsors do
not renew the agreements at the end of their terms. Certain of these
arrangements also require the Company to integrate sponsors' content with the
Company's services, which requires the dedication of resources and significant
programming and design efforts to accomplish. There can be no assurance that
the Company will
25
be able to attract additional sponsors or that it will be able to renew
existing sponsorship arrangements when they expire. In addition, the Company
has granted exclusivity provisions to certain of its sponsors, and may in the
future grant additional exclusivity provisions. Such exclusivity provisions
may have the effect of preventing the Company, for the duration of such
exclusivity arrangements, from accepting advertising or sponsorship
arrangements within a particular subject matter in the Company's web sites or
across the Company's entire service. The inability of the Company to enter
into further sponsorship or advertising arrangements as a result of its
exclusivity arrangements could have a material adverse effect on the Company's
business, results of operations and financial condition. See "Business--
Advertising" and "--Electronic Commerce."
The Internet as a commercial endeavor has been in existence for a short
period of time. The costs of establishing a web site are low, and new online
service providers, content providers and advertisers are being launched
regularly. Many of these companies are funded with venture capital and other
forms of financing before they have proven both that their particular industry
segment and their business strategy will be successful. Those companies that
are unable to prove themselves successful before their initial funding is
depleted may find it difficult or impossible to secure additional funding. The
failure of any of the Company's advertisers or electronic commerce sponsors to
pay amounts due to the Company on a timely basis could have a material adverse
effect on the Company's business, results of operations and financial
condition.
Risks Associated With Electronic Commerce. The Company believes that the
portion of its business dedicated to electronic commerce will play a
significant role in the Company's future financial growth and development. In
order to support its electronic commerce initiative, the Company must rely on
the efficiencies and proper business practices of its third party suppliers.
The failure of such third parties to provide quality service to users of the
Company's web sites, timely deliver to such users the products purchased by
users on the Company's web sites, or deliver superior products may result in
user dissatisfaction, which may, in turn, cause users to stop visiting the
Company's web sites or using the Company's services. In addition, to the
extent that the Company is an intermediary in such electronic commerce
transactions, there is the potential that users may involve the Company in
claims associated with the sale of goods, including, without limitation,
claims relating to product liability and consumer protection.
Dependence on Third Party Relationships. The Company is dependent on a
number of third party relationships, including its relationship with Netscape,
to create traffic on the Company's web sites and consequently generate
revenues. These relationships include arrangements relating to the positioning
of the Company's products and services on Web browsers such as those offered
by Netscape and Microsoft, and on other sites through license agreements in
which Internet sites are linked to or otherwise utilize the Company's
services. For the fiscal year ended July 31, 1999, a significant portion of
the traffic to the Company's web sites was derived through the Netscape and
Microsoft browsers. In May 1999, the Company's agreement with Microsoft
expired and was not renewed. However, on June 7, 1999, the Company renewed its
one-year "Premier Provider" Agreement with Netscape (the "Netscape Agreement")
pursuant to which the Company is designated as a "Premier Provider" of search
and navigation services accessible from the "Net Search" button on the
Netscape browser through June 30, 2000. Under the terms of the Netscape
Agreement, as subsequently amended, Netscape will commit search exposures
during the one-year term of the Netscape Agreement to the Company's search
services in exchange for a per-impression payment by the Company based on the
actual number of exposures delivered to the Company by Netscape. Because
Netscape provides only exposures from its Net Search page (as compared to a
number of users who "click through" to the Company's web sites), there can be
no assurance that the Netscape Agreement will provide the Company's web sites
with material amounts of traffic. Although the Netscape Agreement may only be
terminated under certain limited circumstances, if the Company were unable to
continue as a "Premier Provider," the Company's web sites could lose a
material portion of their traffic, traffic on competing services could
substantially increase, and the Company's web sites could otherwise become
less attractive to advertisers, which would have a material adverse effect on
the Company's business, results of operations and financial condition. A
traffic reduction could, in turn, result in advertisers on the Company's web
sites, including sponsors and partners, terminating their contracts with the
Company, as such contracts are typically of short duration and terminable on
relatively short notice, or reducing the number of
26
impressions purchased. Furthermore, the Company's contracts with advertisers
and sponsors generally guarantee a minimum number of page views, and a failure
to achieve the minimum page views could result in a reduction in payments to
the Company or compel the Company to provide "make good" impressions if such
minimums are not met. If the Company is unable to maintain its relationships
with third parties to create traffic on the Company's web sites or is
otherwise unable to offset a reduction in traffic, advertising revenues would
be materially adversely affected, resulting in a material adverse affect on
the Company's business, results of operations and financial condition. See
"Business--Strategic Alliances."
The Company is also dependent on web site operators that provide links to
the Company's web sites and, for certain elements of the Company's properties,
the Company licenses technology and related databases from third parties,
including directories, chat, street mapping and other similar services. The
Company believes that certain of its third party relationships are important
to its ability to attract traffic and advertisers. Any errors, failures or
delays experienced in connection with these third party technologies and
information services could alienate the Company's users and adversely affect
the Company's brand and its business. Although the Company views these
relationships as important direct and indirect factors in the generation of
revenues, many of the Company's arrangements do not include minimum
commitments to use the Company's services or to provide access or links to the
Company's products or services in the future, are not exclusive and generally
have a term of only one to three years. In addition, there can be no assurance
that the Company's partners regard their relationship with the Company as
important to their own respective businesses and operations, that they will
not reassess their commitment to the Company's products or services at any
time in the future, or that they will not develop their own competitive
products or services. There can be no assurance that the Company's existing
relationships will result in sustained business partnerships, successful
product or service offerings or the generation of significant revenues for the
Company. Failure of one or more of the Company's partnering relationships to
achieve or maintain market acceptance or commercial success, or the
termination of one or more successful partnering relationships, could have a
material adverse effect on the Company's business, results of operations and
financial condition. In addition, the termination of the Company's position on
a Web browser, or the grant to a competitor of an exclusive arrangement with
respect to positioning on a Web browser, would significantly reduce traffic on
the Company's web sites, which would have a material adverse effect on the
Company's business, results of operations and financial condition.
Intense Competition. The market for Internet products and services is highly
competitive. In addition, the market for Internet advertising and electronic
commerce arrangements is intensely competitive and the Company expects that
competition will continue to intensify. Although the Company believes that the
diverse segments of the Internet market will provide opportunities for more
than one supplier of products and services similar to those of the Company, it
is possible that a single supplier may dominate one or more market segments.
The Company believes that the principal competitive factors in this market are
name recognition, distribution arrangements, performance, ease of use, a
variety of value-added services, functionality and features, and quality of
support.
A number of companies offer competitive products addressing certain of the
Company's target markets. The primary competitors of the Company's products
and services are other companies providing online services, including
About.com, Inc. (formerly The Mining Company), America Online (including
Netscape's Netcenter and CompuServe), CMGi's Alta Vista, Excite@Home
(including WebCrawler), theGlobe.com, Inc., Disney's Infoseek Corporation,
Looksmart Ltd., Microsoft's MSN, NBC's Snap, Xoom, Inc., and Yahoo! Inc.
(including GeoCities). In addition, a number of companies offering Internet
products and services, including direct competitors of the Company, recently
have begun to integrate multiple features within the products and services
they offer to consumers. Integration of Internet products and services is
occurring through development of competing products and through acquisitions
of, or entering into joint ventures and/or licensing arrangements involving,
competitors of the Company. For example, the Web browsers offered by Netscape
and Microsoft, which are the two most widely-used browsers and substantial
sources of traffic for the Company, may incorporate and promote information
search and retrieval capabilities in future releases or upgrades that could
make it more difficult for Internet viewers to find and use the Company's
products and services. In addition, many large media companies have announced
that they are contemplating developing or acquiring Internet navigation
services and
27
are attempting to become "gateway" sites for Web users. In the event these
companies develop such "portal" sites, the Company could lose a substantial
portion of its user traffic, which would have a material adverse effect on the
Company's business, results of operations and financial condition. Further,
entities that sponsor or maintain high-traffic web sites or that provide an
initial point of entry for Internet viewers, such as the Regional Bell
Operating Companies or ISPs such as Prodigy, Inc. and America Online, Inc.,
currently offer and can be expected to consider further development,
acquisition or licensing of Internet search and navigation functions
competitive with those offered by the Company, or could take actions that make
it more difficult for viewers to find and use the Company's products and
services. Consolidations, integration and strategic relationships involving
competitors of the Company could have a material adverse effect on the
Company's business, results of operations and financial condition.
The Company also competes with metasearch services that allow a user to
search the databases of several catalogs and directories simultaneously. The
Company also competes indirectly with database vendors that offer information
search and retrieval capabilities with their core database products. Tripod
and Angelfire compete with other community-based web sites, including Yahoo
Inc.'s GeoCities, Inc. Many of the Company's existing competitors, as well as
a number of potential new competitors, have significantly greater financial,
technical and marketing resources than the Company. There can be no assurance
that the Company's competitors will not offer Internet products and services
that are superior to those of the Company or that achieve greater market
acceptance than the Company's offerings. Moreover, a number of the Company's
current advertising customers and partners have established relationships with
certain of the Company's competitors, and future advertising customers and
partners may establish similar relationships. The Company competes with online
services and other web site operators as well as traditional off-line media,
such as print and television, for a share of advertisers' total advertising
budgets. There can be no assurance that the Company will be able to compete
successfully against its current or future competitors or that competition
will not have a material adverse effect on the Company's business, results of
operations and financial condition. See "Business--Competition."
Risks Associated with Brand Development. The Company believes that
establishing and maintaining the "Lycos Network" brand is a crucial aspect of
its efforts to continue to expand and attract its Internet audience and that
the importance of brand recognition will increase in the future due to the
growing number of Internet sites and the relatively low barriers to entry.
Promotion and enhancement of the "Lycos Network" brand will depend largely on
the Company's ability to provide consistently high-quality products and
services, which cannot be assured. If consumers do not perceive the Company's
existing products and services to be of high quality, or if the Company
introduces new products and services or enters into new business ventures that
are not favorably received by consumers, the Company will be unsuccessful in
promoting and maintaining its brand, and will risk diluting its brand and
decreasing the attractiveness of its audiences to advertisers.
Developing Market; Unproven Acceptance of the Company's Products and
Services; Uncertain Adoption of the Internet as an Advertising Medium. The
market for the Company's products and services has only recently begun to
develop, is rapidly evolving and is characterized by an increasing number of
market entrants who have introduced or developed products and services for use
on the Internet. The Company's market is highly dependent upon the increased
use of the Internet for information publication and distribution, commerce,
and on the development of the Internet as an advertising medium. The Company's
future operating results will depend upon the growth of the Internet
advertising and commerce markets, the successful implementation of the
Company's advertising program and the Company's ability to establish
electronic commerce and licensing relationships and other strategic alliances.
There can be no assurance, however, that the Internet advertising or commerce
market will develop as an attractive and sustainable medium, that the Company
will achieve or sustain market acceptance of its products and services or that
the Company will be able to execute its business plan successfully. As is
typical in the case of a new and rapidly evolving industry, demand and market
acceptance for recently introduced products and services are subject to a high
level of uncertainty. The industry is young and has few proven products.
Moreover, critical issues concerning the commercial use of the Internet
(including security, reliability, cost, ease of use and access, quality of
service and acceptance of advertising and electronic commerce) remain
unresolved and may impact the growth of the Internet, or the placement of
advertisements on
28
the Internet or the growth of the Internet as a means of electronic commerce.
If commercial use of the Internet does not grow, if the Internet does not
develop as an attractive medium for advertising or electronic commerce, or if
the Internet infrastructure does not effectively support growth that may
occur, the Company's business, results of operations and financial condition
would likely be materially adversely affected.
Risks Associated with Potential Acquisitions and Investments. The Company
has completed, and may in the future pursue, acquisitions of companies,
technologies or assets that complement the Company's business, such as the
recent Wired Ventures and Sonique acquisitions. There can be no assurance that
the Company will be able to identify additional suitable acquisition
candidates available for sale at reasonable prices, consummate any acquisition
or successfully integrate any acquired business into the Company's operations.
Acquisitions may result in the potentially dilutive issuance of equity
securities, the incurrence of additional debt, the write-off of in-process
research and development or software acquisition and development costs, and
the amortization of expenses related to goodwill and other intangible assets,
any of which could have a material adverse effect on the Company's business,
results of operations and financial condition. Acquisitions would involve
numerous additional risks, including difficulties in the assimilation of the
operations, services, products and personnel of the acquired company, the
diversion of management's attention from other business concerns along with
the risks involved in entering markets in which the Company has little or no
experience. Problems with an acquired business could have a material adverse
effect on the performance of the Company. The Company has made, and may in the
future make, investments in companies involved in the development of
technologies or services that are complementary or related to the Company's
operations. The Company has recently made investments in Bidder's Edge, Valent
Software, and Frictionless Commerce. These companies are in early stages of
development and may be expected to incur substantial losses. There can be no
assurance that any investments in such companies will result in any return,
nor can there be any assurance as to the timing of any such return, or that
the Company will not suffer the loss of its entire investment. See "Business--
Recent Acquisitions" and "--Strategic Alliances."
Management of Growth; Need to Establish Infrastructure; Additional
Personnel. The rapid execution necessary for the Company to successfully offer
its products and services and implement its business plan in a rapidly
evolving market requires an effective planning and management process. The
Company's rapid growth has placed, and is expected to continue to place, a
significant strain on the Company's managerial and operational resources. To
manage its growth, the Company must continue to implement and improve its
operational and financial systems and to expand, train and manage its employee
base. Further, the Company will be required to manage multiple relationships
with various customers and other third parties. There can be no assurance that
the Company has made adequate allowances for the costs and risks associated
with this expansion and transition, that the Company's systems, procedures or
controls will be adequate to support the Company's operations, or that the
Company's management will be able to achieve the rapid execution necessary to
offer successfully the Company's products and services and implement its
business plan. The Company's future operating results will also depend on many
factors, including its ability to expand its advertising sales and business
development organizations and expand its support organization commensurate
with the growth of its business. If the Company is unable to manage growth
effectively, the Company's business, results of operations and financial
condition could be materially adversely affected. See Item 4A--"Executive
Officers of the Registrant."
Risks Associated with International Expansion. International sales,
primarily from licensing the Company's products and services, accounted for
less than 10% of the Company's revenues for the fiscal year ended July 31,
1999. As part of its business strategy, the Company has entered into joint
ventures in Europe (with Bertelsmann AG, in May 1997), Japan (with Sumitomo
Corporation and Internet Initiative Japan ("IIJ"), in March 1998), Korea (with
Mirae Corporation, in March 1999), and, after the close of the 1999 fiscal
year, Asia (with Singapore Telecom, in September 1999). Most recently, the
Company announced that it has launched localized, Company-owned and -operated
sites in six South and Central American countries. The Company currently
offers localized versions of the Lycos service in Argentina, Belgium, Brazil,
Chile, Denmark, France, Germany, Italy, Japan, Korea, Luxembourg, the
Netherlands, Norway, Mexico, Peru, Spain, Sweden, Switzerland, the United
Kingdom and Venezuela. The Company believes that this expansion is important
to the
29
Company's ability to continue to grow and to market its products and services.
In marketing its products and services internationally, however, the Company
will face new competitors. In addition, the ability of the Company to enter
international markets will be dependent upon the Company's ability to create
localized versions of its products and services. There can be no assurance
that the Company will be successful in creating localized versions of its
products and services, marketing or distributing its products abroad or that,
if the Company is successful, its international revenues will be adequate to
offset the expense of establishing and maintaining international operations.
To date, the Company has limited experience in marketing and distributing its
products internationally. In addition to the uncertainty as to the Company's
ability to establish an international presence, there are certain difficulties
and risks inherent in doing business on an international level, such as
compliance with regulatory requirements and changes in those requirements,
export restrictions, export controls relating to technology, tariffs and other
trade barriers, protection of intellectual property rights, difficulties in
staffing and managing international operations, longer payment cycles,
problems in collecting accounts receivable, political instability,
fluctuations in currency exchange rates and potentially adverse tax
consequences. There can be no assurance that one or more of such factors will
not have a material adverse effect on any international operations established
by the Company and, consequently, on the Company's business, results of
operations and financial condition. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and Consolidated Financial
Statements.
Dependence on the Internet. The use of the Company's products and services
will depend in large part upon the development by others of an infrastructure
for providing Internet access and services. Because global commerce and online
exchange of information on the Internet and other similar open wide area
networks are relatively new and evolving, it is difficult to predict with any
certainty whether the Internet will prove to be a viable commercial
marketplace. The Internet may not prove to be a viable commercial marketplace
for a number of reasons, including lack of acceptable security technologies,
potentially inadequate development of the necessary infrastructure, such as a
reliable network backbone, or timely development and commercialization of
performance improvements, including high speed modems or an alternative to
them. In addition, to the extent that the Internet continues to experience
significant growth in the number of users and level of use, there can be no
assurance that the Internet infrastructure will continue to be able to support
the demands placed upon it by such potential growth or that the performance or
reliability of the Web will not be adversely affected by this continued
growth. In addition, the Internet could lose its commercial viability due to
delays in the development or adoption of new standards and protocols (for
example, the next generation Internet Protocol) to handle increased levels of
Internet activity. There can be no assurance that the infrastructure or
complementary services necessary to make the Internet a viable commercial
marketplace will be developed or, if developed, that the Internet will become
a viable commercial marketplace for products and services such as those
offered by the Company. If the necessary infrastructure or complementary
services or facilities are not developed, or if the Internet does not become a
viable commercial marketplace or platform for advertising and electronic
commerce, the Company's business, results of operations and financial
condition will be materially adversely affected.
Risk of Capacity Constraints and System Failure. A key element of the
Company's strategy is to generate a high volume of traffic to its products and
services, which the Company makes available free of charge to users of the
Internet. Accordingly, the performance of the Company's products and services
is critical to the Company's reputation, its ability to attract advertisers to
the Company's web sites and the market acceptance of these products and
services. Any system failure that causes interruptions in the availability, or
increases response time, of the Company's products and services could result
in less traffic to the Company's web sites and, if sustained or repeated,
could reduce the attractiveness of the Company's products and services to
advertisers and partners. An increase in the volume of searches conducted
through the Company's products and services could strain the capacity of the
software or hardware deployed by the Company or the capacity of the Company's
network infrastructure, which could lead to slower response time or system
failures. In addition, as the number of Web pages and users increases, there
can be no assurance that the Company's products and services will be able to
scale proportionately. Any failure to expand the capacity of the Company's
hardware or network infrastructure on a timely basis or on commercially
reasonable terms could have a material adverse effect on the Company's
business, results of operations and financial condition.
30
The Company is dependent upon Web browsers and Internet and online service
providers for access to its products and services, and users have experienced
difficulties due to browser and provider system failures unrelated to the
Company's systems, products and services. The Company is also dependent on
hardware suppliers for prompt delivery, installation and service of servers
and other equipment and services used to provide its products and services.
The Company outsources substantially all of its hardware operations to third
parties. There can be no assurance that a system failure at any of these
locations would not adversely affect the performance of the Company's products
and services. This system is vulnerable to damage from fire, floods,
earthquakes, power loss, telecommunications failures, break-ins and similar
events. The Company does not presently have a comprehensive disaster recovery
plan, and relies, instead, on maintaining most of its core services on two
"mirror" sites; if one server fails, all of the traffic can be redirected and
served from the other server. Despite the implementation of network security
measures by the Company, its servers are also vulnerable to computer viruses,
break-ins and similar disruptive problems. Computer viruses, break-ins or
other problems caused by third parties could lead to interruptions, delays or
cessation in service to users of the Company's products and services. The
occurrence of any of these risks could have a material adverse effect on the
Company's business, results of operations and financial condition. See
"Business--Properties."
Advertising Management System. The process of managing advertising within
large, high traffic web sites such as the Company's is an increasingly
important and complex task. The Company licenses from a third party an
advertising management system. To the extent that the Company encounters
system failures or material difficulties in the operation of this system, the
Company could be unable to deliver banner advertisements and sponsorships
through its web sites. Any extended failure of, or material difficulties
encountered in connection with, the Company's advertising management system
may expose the Company to "make good" obligations with its advertising
customers, which, by displacing advertising inventory, among other
consequences, would reduce revenue and would have a material adverse effect on
the Company's business, results of operations and financial condition. See
"Business--Advertising."
Technological Change and New Products. The market for Internet products and
services is characterized by rapidly changing technology, evolving industry
standards and customer demands, and frequent new product introductions and
enhancements. These market characteristics are exacerbated by the emerging
nature of this market and the fact that many companies are expected to
introduce new Internet products in the near future. The Company's future
success will depend in significant part on its ability to continually improve
the performance, features and reliability of the Lycos search and navigation
services in response to both evolving demands of the marketplace and
competitive product offerings, and there can be no assurance that the Company
will be successful. In addition, a key element of the Company's business
strategy is the development, introduction and integration of new products that
capitalize on the increasing use of the Internet. There can be no assurance
that the Company will be successful in developing or integrating such products
or services or that such products and services will meet with market
acceptance. In addition, new product releases by the Company may contain
undetected errors that require significant design modifications, resulting in
a loss of customer confidence and viewer support, which will adversely affect
the use of the Company's products and services and, consequently, the
Company's business, results of operations and financial condition. See
"Business--Strategy" and "--Technology; Intellectual Property and Proprietary
Rights."
Intellectual Property and Proprietary Rights. The Company's success depends
significantly upon its proprietary technology. The Company currently relies on
a combination of copyright and trademark laws, trade secrets, confidentiality
procedures and contractual provisions to protect its proprietary rights. The
Company generally enters into confidentiality agreements with its employees
and with its consultants and partners. The Company has registered and applied
for registration of certain service marks and trademarks, and will continue to
evaluate the registration of additional service marks and trademarks, as
appropriate. In addition, Carnegie Mellon University ("CMU") has been issued a
patent in the United States relating to Lycos' search and indexing technology,
which has been licensed to the Company on a perpetual basis. There can be no
assurance that such patent will not be challenged, and if such challenges are
brought, that the patent will not be invalidated. There also can be no
assurance that the Company will develop proprietary products or technologies
that are patentable,
31
that any issued patent will provide the Company with any competitive
advantages or will not be challenged by third parties, or that the patents of
others will not have a material adverse effect on the Company's ability to do
business. Despite the Company's efforts to protect its proprietary rights,
unauthorized parties may attempt to copy aspects of the Company's products or
services or to obtain and use information that the Company regards as
proprietary. The laws of some foreign countries do not protect proprietary
rights to as great an extent as do the laws of the United States and the
Company does not currently have any patents or patent applications pending in
any foreign country. There can be no assurance that the Company's means of
protecting its proprietary rights will be adequate or that the Company's
competitors will not independently develop similar technology or duplicate the
Company's products or design around patents issued to the Company or other
intellectual property rights of the Company. There have been substantial
amounts of litigation in the computer industry regarding intellectual property
rights. There can be no assurance that third parties will not in the future
claim infringement by the Company with respect to current or future products,
trademarks or other proprietary rights. Any such claims or counterclaims could
be time-consuming, result in costly litigation, diversion of management's
attention, cause product release delays, require the Company to redesign its
products or require the Company to enter into royalty or licensing agreements,
any of which could have a material adverse effect upon the Company's business,
results of operations and financial condition. Such royalty or licensing
agreements, if required, may not be available on terms acceptable to the
Company, or at all. See "Business--Technology."
Government Regulation and Legal Uncertainties. The Company currently is
subject only to limited direct regulation by government agencies, other than
regulations applicable to businesses generally. However, due to the increasing
popularity and use of the Web, it is likely that a number of laws and
regulations will be adopted with respect to the Web, covering issues such as
user privacy, consumer protection, content and database use, and others. The
adoption of any additional laws or regulations may decrease the growth of the
Web, which could in turn decrease the demand for the Company's services and
products or increase the Company's cost of doing business or otherwise have a
material adverse effect on the Company's business, results of operations or
financial condition. Due to the global nature of the Web, it is possible that,
although transmission of the Company's services originate from its operations
centers in Massachusetts, California and New Jersey, the governments of other
states and foreign countries might attempt to regulate the Company's
transmissions or prosecute the Company for violations of their laws. There can
be no assurance that violations of local laws will not be alleged or charged
by state or foreign governments, that the Company might not unintentionally
violate such law or that such laws will not be modified, or new laws enacted,
in the future. It is also possible that states or foreign countries may seek
to impose sales taxes on out of state companies that engage in commerce over
the Internet. In the event that states or foreign countries succeed in
imposing sales or other taxes on Internet commerce, the growth of the use of
the Internet for commerce could slow substantially. Any of the foregoing
developments could have a material adverse effect on the Company's business,
results of operations or financial condition.
Dependence on Key Personnel. The Company's performance is substantially
dependent on the performance of its executive officers and key employees, all
of whom have worked together for only a short period of time. The Company does
not have in place key person life insurance policies on any of its employees.
The loss of the services of any of its executive officers or other key
employees could have a material adverse effect on the business, results of
operations or financial condition of the Company. The Company is heavily
dependent upon its ability to attract, retain and motivate skilled technical
and managerial personnel. The Company's future success also depends on its
continuing ability to identify, hire, train and retain other highly qualified
technical and managerial personnel. Competition for such personnel is intense,
and there can be no assurance that the Company will be able to attract, hire,
assimilate or retain other highly qualified technical and managerial personnel
in the future. The inability to attract, hire, assimilate or retain the
necessary technical and managerial personnel could have a material adverse
effect upon the Company's business, results of operations or financial
condition. See Item 4A--"Executive Officers of the Registrant."
Liability for Information Retrieved from the Internet. Because material may
be downloaded by the online or Internet services operated or facilitated by
the Company or the Internet access providers with which the Company has
relationships, and be subsequently distributed to others, it is possible that
claims will be made
32
against the Company on the basis of defamation, negligence, copyright or
trademark infringement or other theories based on the nature and content of
such materials, including claims based on the Company providing access to
obscene or hateful information. Although the Company has broad liability
insurance, the Company's insurance may not cover potential claims of this
type, or may not be adequate to indemnify the Company for all liability that
may be imposed. Any imposition of liability that is not covered by insurance
or is in excess of insurance coverage could have a material adverse effect on
the Company's business, results of operations or financial condition.
Volatility of Stock Price. The price of the Company's Common Stock has been
and may continue to be subject to wide fluctuations in response to a number of
events and factors, such as quarterly variations in results of operations,
announcements of new technological innovations or new products and media
properties by the Company or its competitors, changes in financial estimates
and recommendations by securities analysts, the operating and stock price
performance of other companies that investors may deem comparable to the
Company, and news relating to trends in the Company's markets. In addition,
the stock market in general, and the market prices for Internet-related
companies in particular, have experienced extreme volatility that often has
been unrelated to the operating performance of such companies. These broad
market and industry fluctuations may adversely affect the price of the
Company's Common Stock, regardless of the Company's operating performance. See
Item 5--"Market for Registrants Common Equity and Related Stockholder
Matters."
33
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PART I. FINANCIAL INFORMATION
Page
----
Consolidated Financial Statements:
Independent Auditors' Report.............................................. 35
Consolidated Balance Sheets at July 31, 1999 and 1998..................... 36
Consolidated Statements of Operations for the years ended July 31, 1999,
1998, and 1997........................................................... 37
Consolidated Statements of Stockholders' Equity and Comprehensive Income
(Loss) for the years ended July 31, 1999, 1998, and 1997................. 38
Consolidated Statements of Cash Flows for the years ended July 31, 1999,
1998 and 1997............................................................ 39
Notes to Consolidated Financial Statements................................ 41
34
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Lycos, Inc.:
We have audited the accompanying consolidated balance sheets of Lycos, Inc.
as of July 31, 1999 and 1998 and the related consolidated statements of
operations, stockholders' equity and comprehensive income, and cash flows for
each of the years in the three year period ended July 31, 1999. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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 consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Lycos, Inc. at July 31, 1999 and 1998, and the results of its operations
and cash flows for each of the years in the three year period ended July 31,
1999, in conformity with generally accepted accounting principles.
/s/ KPMG LLP
Boston, Massachusetts
August 17, 1999
35
LYCOS, INC.
CONSOLIDATED BALANCE SHEETS
July 31, July 31,
1999 1998
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents........................ $152,970,244 $153,728,200
Accounts receivable, less allowance for doubtful
accounts of $2,377,000 and $1,208,000 at July
31, 1999 and 1998, respectively................. 24,639,514 10,958,470
Electronic commerce and license fees receivable.. 71,843,202 30,223,986
Prepaid expenses................................. 8,537,383 5,559,842
Other current assets............................. 143,448 326,292
------------ ------------
Total current assets........................... 258,133,791 200,796,790
------------ ------------
Property and equipment, less accumulated
depreciation and amortization..................... 7,471,230 3,960,059
Electronic commerce and license fees receivable.... 48,029,100 21,537,371
Investments........................................ 48,000,570 8,874,568
Intangible assets, less accumulated amortization... 505,682,024 78,787,554
Other assets....................................... 7,325,353 3,278,994
------------ ------------
Total assets................................... $874,642,068 $317,235,336
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable--current........................... $ 2,589,271 $ 171,783
Accounts payable................................. 1,381,721 4,873,302
Accrued expenses................................. 22,438,326 17,277,168
Deferred revenues................................ 64,016,249 31,412,239
------------ ------------
Total current liabilities...................... 90,425,567 53,734,492
Notes payable...................................... 2,599,729 140,749
Deferred revenues.................................. 55,934,152 26,159,754
Other liabilities.................................. -- 36,667
------------ ------------
58,533,881 26,337,170
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.01 par value; 5,000,000 shares
authorized, none issued or outstanding.......... -- --
Common stock, $.01 par value; 300,000,000 shares
authorized, 96,706,803 shares at July 31, 1999
and 77,982,872 at July 31, 1998 issued and
outstanding..................................... 967,071 779,832
Additional paid-in capital....................... 801,494,011 277,736,666
Deferred compensation............................ (69,802) (116,338)
Accumulated deficit.............................. (92,295,457) (40,251,893)
Treasury stock, at cost, 1,814,893 shares at July
31, 1999 and 1,417,348 shares at July 31, 1998.. (3,286,293) (984,593)
Accumulated other comprehensive income........... 18,873,090 --
------------ ------------
Total stockholders' equity..................... 725,682,620 237,163,674
------------ ------------
Total liabilities and stockholders' equity..... $874,642,068 $317,235,336
============ ============
See accompanying notes to consolidated financial statements.
36
LYCOS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended
-------------------------------------------
July 31, 1999 July 31, 1998 July 31, 1997
------------- ------------- -------------
Revenues:
Advertising......................... $ 93,440,262 $ 41,768,607 $17,417,388
Electronic commerce, license and
other.............................. 42,080,564 14,291,698 4,855,654
------------ ------------ -----------
Total revenues.................... 135,520,826 56,060,305 22,273,042
Cost of revenues...................... 28,726,949 12,513,259 4,335,941
------------ ------------ -----------
Gross profit...................... 106,793,877 43,547,046 17,937,101
Operating expenses:
Research and development............ 26,279,267 9,477,708 4,301,267
In process research and
development........................ -- 17,280,000 --
Sales and marketing................. 78,807,148 35,035,754 19,126,317
General and administrative.......... 16,249,670 5,631,104 2,718,763
Amortization of intangible assets... 52,427,704 7,613,711 540,416
------------ ------------ -----------
Total operating expenses.......... 173,763,789 75,038,277 26,686,763
------------ ------------ -----------
Operating loss........................ (66,969,912) (31,491,231) (8,749,662)
Interest income....................... 6,166,942 3,051,747 2,130,472
Equity share of losses in affiliates.. (1,360,425) -- --
Gain on sale of investments........... 10,119,831 -- --
------------ ------------ -----------
Net loss.............................. $(52,043,564) $(28,439,484) $(6,619,190)
============ ============ ===========
Basic and diluted net loss per share.. $ (0.60) $ (0.46) $ (0.12)
============ ============ ===========
Shares used in computing basic and
diluted net loss per share........... 86,428,459 61,865,964 55,178,972
============ ============ ===========
See accompanying notes to consolidated financial statements.
37
LYCOS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
(LOSS)
Accumulated
Common Stock Additional Treasury Stock Other
------------------- Paid-in Deferred Accumulated --------------------- Comprehensive
Shares Amount Capital Compensation Deficit Shares Amount Income (Loss)
---------- -------- ------------ ------------ ------------ --------- ----------- -------------
Balances at July 31,
1996.................. 55,171,584 $551,716 $ 49,123,821 $(376,161) $ (5,193,219) -- -- --
Comprehensive income
(loss):
Net loss............ -- -- -- -- (6,619,190) -- -- --
Other comprehensive
income (loss):
Unrealized gains
on available-for-
sale securities...
Comprehensive
income (loss)...
Issuance of common
stock in connection
with Employee Stock
Purchase Plan......... 14,896 148 18,254 -- -- -- -- --
Cancellation of
options............... -- -- (49,067) 49,067 -- -- -- --
Amortization of
deferred
compensation.......... -- -- -- 141,658 -- -- -- --
---------- -------- ------------ --------- ------------ --------- ----------- -----------
Balances at July 31,
1997.................. 55,186,480 551,864 49,093,008 (185,436) (11,812,409) -- -- --
Comprehensive income
(loss):
Net loss............ -- -- -- -- (28,439,484) -- -- --
Other comprehensive
income (loss):
Unrealized gains
on available-for-
sale securities...
Comprehensive
income (loss)...
Issuance of common
stock in connection
with Employee Stock
Purchase Plan......... 17,176 172 65,870 -- -- -- -- --
Cancellation of
options............... -- -- (22,562) 22,562 -- -- -- --
Issuance of common
stock in connection
with exercise of stock
options............... 4,094,040 40,940 3,201,254 -- -- 123,112 $ (307) --
Purchase of treasury
stock in connection
with exercise of stock
options............... -- -- -- -- -- 1,216,368 (467,589) --
Issuance of common
stock in connection
with exercise of
warrants.............. 414,456 4,144 1,359,444 -- -- 37,672 (113,581) --
Issuance of common
stock in connection
with strategic
investments, net of
offering costs........ 602,056 6,024 7,876,419 -- -- -- -- --
Issuance of common
stock and warrants in
connection with
acquisitions.......... 8,298,284 82,984 104,766,071 -- -- 40,196 (403,116) --
Issuance of common
stock in connection
with Secondary Public
Offering, net of
offering costs........ 9,350,000 93,500 111,097,366 -- -- -- -- --
Issuance of common
stock in connection
with services
rendered.............. 20,380 204 299,796 -- -- -- -- --
Amortization of
deferred
compensation.......... -- -- -- 46,536 -- -- -- --
---------- -------- ------------ --------- ------------ --------- ----------- -----------
Balances at July 31,
1998.................. 77,982,872 779,832 277,736,666 (116,338) (40,251,893) 1,417,348 (984,593)
Comprehensive income
(loss):
Net loss............ -- -- -- -- (52,043,564) -- -- --
Other comprehensive
income (loss):
Unrealized gains
on available-for-
sale securities,
net of tax........ $18,873,090
Comprehensive
income (loss)...
Issuance of common
stock in connection
with Employee Stock
Purchase Plan......... 19,112 191 247,300 -- -- -- -- --
Issuance of common
stock in connection
with exercise of stock
options............... 3,120,163 31,201 15,512,243 -- -- 397,545 (2,301,700) --
Tax benefit of stock
option exercises...... -- -- 12,582,000 -- -- -- -- --
Issuance of common
stock in connection
with acquisitions..... 15,584,656 155,847 495,415,802 -- -- -- -- --
Amortization of
deferred
compensation.......... -- -- -- 46,536 -- -- -- --
---------- -------- ------------ --------- ------------ --------- ----------- -----------
Balances at July 31,
1999.................. 96,706,803 $967,071 $801,494,011 $ (69,802) $(92,295,457) 1,814,893 $(3,286,293) $18,873,090
========== ======== ============ ========= ============ ========= =========== ===========
Comprehensive
Total Income (Loss)
------------- --------------
Balances at July 31,
1996.................. $ 44,106,157
Comprehensive income
(loss):
Net loss............ (6,619,190) $ (6,619,190)
Other comprehensive
income (loss):
Unrealized gains
on available-for-
sale securities... --
--------------
Comprehensive
income (loss)... $ (6,619,190)
==============
Issuance of common
stock in connection
with Employee Stock
Purchase Plan......... 18,402
Cancellation of
options............... --
Amortization of
deferred
compensation.......... 141,658
-------------
Balances at July 31,
1997.................. 37,647,027
Comprehensive income
(loss):
Net loss............ (28,439,484) $(28,439,484)
Other comprehensive
income (loss):
Unrealized gains
on available-for-
sale securities... --
--------------
Comprehensive
income (loss)... $(28,439,484)
==============
Issuance of common
stock in connection
with Employee Stock
Purchase Plan......... 66,042
Cancellation of
options............... --
Issuance of common
stock in connection
with exercise of stock
options............... 3,241,887
Purchase of treasury
stock in connection
with exercise of stock
options............... (467,589)
Issuance of common
stock in connection
with exercise of
warrants.............. 1,250,007
Issuance of common
stock in connection
with strategic
investments, net of
offering costs........ 7,882,443
Issuance of common
stock and warrants in
connection with
acquisitions.......... 104,445,939
Issuance of common
stock in connection
with Secondary Public
Offering, net of
offering costs........ 111,190,866
Issuance of common
stock in connection
with services
rendered.............. 300,000
Amortization of
deferred
compensation.......... 46,536
-------------
Balances at July 31,
1998.................. 237,163,674
Comprehensive income
(loss):
Net loss............ (52,043,564) $(52,043,564)
Other comprehensive
income (loss):
Unrealized gains
on available-for-
sale securities,
net of tax........ $ 18,873,090 $ 18,873,090
--------------
Comprehensive
income (loss)... $(33,170,474)
==============
Issuance of common
stock in connection
with Employee Stock
Purchase Plan......... 247,491
Issuance of common
stock in connection
with exercise of stock
options............... 13,241,744
Tax benefit of stock
option exercises...... 12,582,000
Issuance of common
stock in connection
with acquisitions..... 495,571,649
Amortization of
deferred
compensation.......... 46,536
-------------
Balances at July 31,
1999.................. $725,682,620
=============
See accompanying notes to consolidated financial statements.
38
LYCOS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended
---------------------------------------
July 31, July 31, July 31,
1999 1998 1997
------------ ------------ -----------
Operating activities
Net loss............................. $(52,043,564) $(28,439,484) $(6,619,190)
Adjustments to reconcile net loss to
net cash used in operating
activities:
Amortization of deferred
compensation...................... 46,536 46,536 141,658
Amortization of intangible assets.. 52,427,704 7,613,711 540,416
Depreciation....................... 3,554,128 1,525,132 728,648
Allowance for doubtful accounts.... 1,169,000 654,000 405,000
Gain on sale of investments........ (10,119,831) -- --
Equity share of losses in
affiliates........................ 1,360,425 -- --
In process research and development
expense........................... -- 17,280,000 --
Issuance of common stock for
services rendered................. -- 300,000 --
Changes in operating assets and
liabilities:
Accounts receivable................ (6,206,871) (4,768,973) (3,745,337)
Electronic commerce and license
fees receivable................... (68,110,945) (42,045,551) (7,731,585)
Prepaid expenses................... (1,675,051) (1,258,140) (3,296,707)
Other current assets............... 182,844 (326,292) --
Other assets....................... (3,272,683) (2,895,379) (216,000)
Accounts payable................... (6,321,113) 774,033 547,634
Accrued expenses................... (9,333,937) 8,343,512 5,641,289
Deferred revenues.................. 60,432,726 40,450,223 12,478,136
Other liabilities.................. (36,667) (29,105) (449,495)
------------ ------------ -----------
Net cash used in operating
activities.......................... (37,947,299) (2,775,777) (1,575,533)
------------ ------------ -----------
Investing activities
Purchase of property and equipment... (1,746,930) (1,091,988) (1,818,798)
Sale of investment................... 12,158,790 -- --
Cash acquired through acquisitions,
net................................. 21,750,667 2,540,619 --
Investment in affiliates............. (5,120,296) (992,125) --
------------ ------------ -----------
Net cash provided by (used in)
investing activities................ 27,042,231 456,506 (1,818,798)
------------ ------------ -----------
Financing activities
Proceeds from issuance of common
stock, net of offering costs........ -- 111,190,866 18,402
Proceeds from exercise of stock
options............................. 15,543,444 3,241,887 --
Proceeds from issuance of common
stock under Employee Stock Purchase
Plan................................ 247,491 66,042 --
Proceeds from exercise of warrants... -- 1,250,007 --
Repayments of notes payable.......... (3,342,123) -- --
Cash used to repurchase treasury
stock............................... (2,301,700) (467,589) --
------------ ------------ -----------
Net cash provided by financing
activities.......................... 10,147,112 115,281,213 18,402
------------ ------------ -----------
Net increase (decrease) in cash and
cash equivalents.................... (757,956) 112,961,942 (3,375,929)
Cash and cash equivalents at
beginning of year................... 153,728,200 40,766,258 44,142,187
------------ ------------ -----------
Cash and cash equivalents at end of
year................................ $152,970,244 $153,728,200 $40,766,258
============ ============ ===========
39
LYCOS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS--(Continued)
Year Ended
---------------------------------------
July 31, July 31, July 31,
1999 1998 1997
------------ ------------ -------------
Schedule of non-cash financing and
investing activities:
Issuance of common stock upon
acquisition of WhoWhere?, Wired
Ventures, and Internet Music
Distribution, Inc.................... $495,571,649 -- --
Assets and liabilities recognized upon
acquisition of WhoWhere?, Wired
Ventures, and Internet Music
Distribution, Inc.
Accounts receivable................ 8,643,173 -- --
Prepaid expenses................... 1,302,490 -- --
Property and equipment............. 5,318,369 -- --
Goodwill and other intangible
assets............................ 479,322,174 -- --
Marketable securities.............. 5,950,000 -- --
Other assets....................... 773,676 -- --
Accounts payable................... 2,829,532 -- --
Accrued expenses................... 17,868,511 -- --
Notes payable...................... 8,218,591 -- --
Deferred revenues.................. 1,945,682 -- --
Issuance of common stock upon
acquisition of Tripod, Inc.,
WiseWire, Corp., and GuestWorld,
Inc................................. -- $104,445,939 --
Assets and liabilities recognized
upon acquisition of Tripod, Inc.,
WiseWire Corp., and GuestWorld, Inc.
Accounts receivable................ -- 209,235 --
Prepaid expenses................... -- 23,284 --
Property and equipment............. -- 1,995,601 --
Developed technology............... -- 12,331,195 --
Goodwill and other intangible
assets............................ -- 72,827,020 --
Accounts payable................... -- 809,756 --
Accrued expenses................... -- 1,858,481 --
Deferred revenues.................. -- 92,780 --
Issuance of common stock in
connection with strategic
investments......................... -- 7,882,443 --
See accompanying notes to consolidated financial statements.
40
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
The Company
Lycos, Inc., ("Lycos" or the "Company") is a network of globally branded
media properties and aggregated content distributed primarily through the
World Wide Web. Under the "Lycos Network" brand, Lycos provides aggregated
third-party content, Web search and directory services, community and
personalization features, personal Web publishing and online shopping. Lycos
seeks to draw a large number of viewers to its Websites by providing a one-
stop destination for information, communication and shopping services on the
Web. The Company was formed in June 1995 by CMG@Ventures L.P., a wholly-owned
subsidiary of CMGI, Inc. The Company conducts its business in one segment,
generating revenue from selling advertising, electronic commerce and licensing
its products and services. The Company's fiscal year end is July 31.
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries, from their respective dates of acquisition.
All significant intercompany balances and transactions have been eliminated.
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 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 specifically attributable to advertising and electronic
commerce, license and product revenues are not separately identifiable and
therefore are not separately disclosed in the consolidated statements of
operations.
Deferred Revenues
Deferred revenues are comprised of license and electronic commerce fees to
be earned in the future on non-cancelable agreements existing at the balance
sheet date.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with original
or remaining maturities of three months or less to be cash equivalents. At
July 31, 1999 and 1998, the Company had no investments with maturities greater
than three months.
41
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Investments
The Company accounts for marketable securities under Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities"(SFAS 115). SFAS 115 establishes the accounting and
reporting requirements for all debt securities and for investments in equity
securities that have readily determinable fair value. All marketable
securities must be classified as one of the following: held-to-maturity,
available-for-sale, or trading. All of the Company's investments are
classified as available-for-sale and, as such, are carried at fair value, with
unrealized holding gains and losses, net of deferred taxes reported as a
separate component of stockholders' equity.
Property and Equipment
Property and equipment are stated at cost, net of accumulated amortization
and depreciation. Property and equipment are depreciated on a straight-line
basis over the estimated useful lives of the assets (three to five years).
Leasehold improvements are amortized on a straight-line basis over the lesser
of the estimated useful life of the asset or the lease term.
Intangible Assets
Intangible assets primarily relate to the Company's acquisitions and include
developed technology, licensed technology, trademarks, trade names, content
copyrights, customer base and goodwill. In connection with acquisitions
accounted for under the purchase method of accounting (see Note 4), the
Company recorded these intangible assets based on the excess of the purchase
price over the identifiable tangible net assets of the acquiree on the date of
purchase. Intangible assets are reported at cost, net of accumulated
amortization, and are being amortized over their estimated useful life of five
years. At July 31, 1999 and 1998, the balance of developed technology, trade
names and other intangible assets, net of accumulated amortization was
$17,796,214 and $3,384,981, respectively.
Goodwill
Goodwill, which represents the excess of purchase price over fair value of
net assets acquired, is amortized on a straight-line basis over the expected
periods to be benefited of 5 years. The Company evaluates whether changes have
occurred that would require revision of the remaining estimated useful life or
impact the recoverability of the goodwill. If such changes occur, the Company
would use an estimate of the undiscounted future operating cash flows to
determine the recoverability of the goodwill. At July 31, 1999 and 1998 the
balance of goodwill, net of accumulated amortization was $487,885,810 and
$75,402,573, respectively.
Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of
The Company accounts for long-lived assets in accordance with the provisions
of SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of. This statement requires that long-lived
assets and certain identifiable intangibles be reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount
of an asset may not be recoverable. Recoverability of assets to be held and
used is measured by a comparison of the carrying amount of an asset to future
net cash flows expected to be generated by the asset. If such assets are
considered to be impaired, the impairment to be recognized is measured by the
amount by which the carrying amount of the assets exceed the fair value of the
assets. Assets to be disposed of are reported at the lower of the carrying
amount or fair value less costs to sell.
Income Taxes
The Company records income taxes using the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying
42
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
amounts of existing assets and liabilities and their respective tax bases and
the tax effect of net operating loss carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
Research and Development Costs
Research and development expenditures are expensed as incurred. Software
development costs are required to be capitalized when a product's
technological feasibility has been established either by completion of a
detail program design or a working model of the product and ending when a
product is available for general release to consumers. To date, attainment of
technological feasibility of the Company's products and general release to
customers have substantially coincided. As a result, the Company has not
capitalized any software development costs since such costs have not been
significant.
Advertising Costs
The Company expenses advertising production costs as incurred. Advertising
expense was approximately $11,755,635, $5,675,000 and $4,427,000 for the years
ended July 31, 1999, 1998 and 1997, respectively.
Stock-Based Compensation
Statement of Financial Accounting Standards No. 123 ("SFAS 123") requires
that companies either recognize compensation expense for grants of stock,
stock options, and other equity instruments based on fair value, or provide
pro forma disclosure of net income (loss) and earnings (loss) per share in the
notes to the financial statements. The Company applies APB Opinion 25 and
related interpretations in accounting for its plans. Accordingly, no
compensation cost has been recognized under SFAS 123 for the Company's stock
option plans, and footnote disclosure is provided in Note 7.
Employee Benefit Plan
The Company maintains a 401(K) Profit Sharing Plan (the "Plan") for its
employees. Each participant in the Plan may elect to contribute from 1% to 15%
of their annual compensation to the Plan. The Company matches employee
contributions at a rate of one-third of the first six percent of compensation
deferred. During 1999, 1998 and 1997, the Company's contributions amounted to
approximately $230,000, $87,000 and $27,000, respectively.
Concentration of Credit Risk
The Company performs ongoing credit evaluations of its customers' financial
conditions and generally does not require collateral on accounts receivable.
The Company maintains allowances for credit losses and such losses have been
within management's expectations. Bad debt expense was $1,169,000, $654,000
and $405,000 in 1999, 1998 and 1997, respectively. No single customer
accounted for greater than 10% of total revenues during the years ended July
31, 1999, 1998 and 1997.
The Company's services are provided to customers in several industries
primarily in North America. Sales to foreign customers for the years ended
July 31, 1999, 1998 and 1997 were approximately $1,990,000, $2,640,000 and
$1,700,000, respectively.
Financial Instruments
The recorded amounts of financial instruments, including cash equivalents,
receivables, accounts payable, accrued expenses and deferred revenues,
approximate their fair market values as of July 31, 1999 and 1998. The Company
has no investments in derivative financial instruments.
43
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Treasury Stock
In connection with a license agreement with Carnegie Mellon University,
CMG@Ventures, Inc. has agreed to sell to the Company the number of shares of
common stock equal to the shares issuable upon exercise of certain options
granted, as defined, at a price equal to the exercise price of the underlying
options exercised (see Note 7). Under this agreement, the Company issues
shares of Company stock to employees upon exercise of options and subsequently
buys an equivalent number of Company shares at the respective exercise price
from CMG@Ventures, resulting in treasury stock.
Reclassifications
Certain prior years' balances have been reclassified to conform with the
current year's presentation.
Comprehensive Income
The Company adopted Statement of Financial Accounting Standard No. 130 (SFAS
130), "Reporting Comprehensive Income" during the year ended July 31, 1999.
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. Comprehensive
loss was $33,170,474 for the year ended July 31, 1999. The difference between
net loss and comprehensive loss for the year ended July 31, 1999 is due to
$18,873,090 of net unrealized gains on the Company's remaining investments,
which are classified as available-for-sale investments under SFAS 115. The
Company had no "other comprehensive income" items in the years ended July 31,
1998 or 1997.
New Accounting Pronouncements
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-1("SOP 98-1"), "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use", which establishes guidelines
for the accounting for the costs of all computer software developed or
obtained for internal use. The Company is required to adopt SOP 98-1 effective
August 1, 1999. The adoption of SOP 98-1 is not expected to have a material
impact on the Company's consolidated financial statements.
In April, 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-5 ("SOP 98-5"), "Reporting on the Costs of
Start-Up Activities." The statement is effective for fiscal years beginning
after December 15, 1998. The statement requires costs of start-up activities
and organization costs to be expensed as incurred. The Company is required to
adopt SOP 98-5 effective August 1, 1999. The adoption of SOP 98-5 is not
expected to have a material impact on the Company's consolidated financial
statements.
In June 1998, the Financial Accounting Standards Board issued Statement No.
133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging
Activities", which requires that all derivative instruments be recorded on the
balance sheet at their fair value. The Company currently expects to adopt SFAS
133, as amended by SFAS 137, for the year ending July 31, 2001. Management has
determined there will be no impact
44
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
on its results of operations or financial position resulting from the adoption
of SFAS 133 because the Company currently does not hold derivative
instruments.
2. Investments
The Company invests in equity instruments of privately held Internet related
companies. These investments are accounted for under the cost method as the
Company's ownership represents less than 20% of each investee. The Company's
carrying value of these investments approximates fair value at July 31, 1999.
For non-quoted investments, the Company regularly reviews the assumptions
underlying the operating performance and cash flow forecasts in assessing the
carrying values.
Marketable Securities
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 free core contact management services through the Internet.
In August 1998, pursuant to an Agreement and Plan of Merger, Amazon.com
acquired all of the outstanding capital stock of PlanetAll. The Company
received 322,128 shares of Amazon.com 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 year ended July 31, 1999. The Company sold
289,917 shares of Amazon.com in October 1998, resulting in $12.2 million of
cash proceeds. The Company has 32,211 shares of Amazon.com remaining at July
31, 1999.
In April 1998, the Company acquired an ownership stake in Mail.com in
exchange for 400,248 shares of the Company's common stock valued at
approximately $4,600,000 at the time of the transaction. Mail.com is a leading
provider of satellite ground segment systems, networks and satellite services.
On June 14, 1999, Mail.com completed an initial public offering of its common
stock. The Company's investment in Mail.com has been adjusted to reflect its
fair value of $35,750,000, based on its traded market price on July 31, 1999.
The cost of marketable securities carried at fair value was $11,805,646 at
July 31, 1999. There was no investments held as available-for-sale at July 31,
1998. Gross unrealized gains and losses relating to securities held as
available-for-sale for the year ended July 31, 1999 are as follows:
Gross Unrealized Gains....................................... $33,117,590
Gross Unrealized Losses...................................... $(1,662,500)
-----------
Net Unrealized Gains....................................... $31,455,090
===========
Joint Ventures
In May 1997, the Company established Lycos Bertelsmann as the basis for a
joint venture agreement with Bertelsmann Internet Services to create localized
versions of the Lycos search and navigation service throughout Europe. The
joint venture is owned 50% by Lycos and 50% by Bertelsmann. Bertelsmann
Internet Services, a subsidiary of Bertelsmann AG, has committed to provide
capital, infrastructure and employees for the venture while Lycos will provide
the core technology and brand name. The carrying value of the Company's
investment in Lycos Bertelsmann was not material at July 31, 1999 or 1998. The
investment is accounted for under the equity method and accordingly, the
Company will recognize 50% of the net profits of Lycos Bertelsmann when
realized.
In April 1998, the Company established Lycos Japan KK as the basis for a
joint venture with Sumitomo Corporation, one of Japan's largest trading
companies, and Internet Initiative Japan (IIJ), the country's largest Internet
Service Provider. The joint venture is owned 40% by Lycos, 50% by Sumitomo
Corporation and 10%
45
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
by IIJ. The investment is accounted for under the equity method. For the year
ending July 31, 1999, Lycos' share of the net loss was approximately
$1,000,000. For the year ending July 31, 1998, Lycos' share of net loss was
not material.
In March 1999, the Company established Lycos Korea as the basis for a joint
venture agreement with Mirae Corporation to create a localized version of the
Lycos Network services to be offered in Korea. The joint venture is owned 50%
by Lycos and 50% by Mirae, a Korean high technology company. The investment is
accounted for under the equity method. For the year ending July 31, 1999,
Lycos' share of net loss was approximately $360,000.
Lycos Ventures Limited Partnership
In July 1999 the Company formed a venture capital fund to make strategic
early-stage investments in companies that are involved with electronic
commerce, online media or the development of Internet technology, content or
services. The Company, as a limited partner, is committed to providing $10
million to Lycos Ventures, L.P. (the "Fund"). The other limited partners,
which include Bear Stearns, Mellon Ventures, Inc., Mirae Corporation, Sumitomo
Corporation, Vulcan Ventures, and others, will provide approximately $60
million to the Fund. The general partner of the fund is Lycos Triangle
Partners, LLC, a Delaware limited liability company formed by Lycos and
Triangle Capital Corporation. As of July 31, 1999 the Company has not provided
any of its $10 million commitment to the Fund.
3. Property and Equipment
Property and equipment, at cost, consisted of the following:
July 31,
-------------------------
1999 1998
------------ -----------
Computers and equipment.......................... $ 14,138,390 $ 3,623,686
Furniture and fixtures........................... 1,626,425 1,091,726
Leasehold improvements........................... 2,980,431 1,356,222
Purchased software............................... 1,188,241 525,197
------------ -----------
19,933,487 6,596,831
Less accumulated depreciation and amortization... (12,462,257) (2,636,772)
------------ -----------
$ 7,471,230 $ 3,960,059
============ ===========
4. Acquisitions
Tripod, Inc.
On February 11, 1998, the Company entered into an Agreement and Plan of
Merger (the "Agreement") by and among the Company, Pod Acquisition Corp., a
Delaware corporation and a wholly-owned subsidiary of the Company ("PAC"),
Tripod, Inc., a Delaware corporation ("Tripod"), William Peabody and Richard
Sabot, providing for the merger of PAC with and into Tripod (the "Merger"). On
February 12, 1998, the Company completed the closing of the Merger and Tripod
became a wholly-owned subsidiary of the Company. In accordance with the terms
of the Agreement, Richard Sabot was elected, effective May 1, 1998, to the
Company's Board of Directors for a term expiring at the first Annual Meeting
of the Company's stockholders held after the Company's fiscal year ending July
31, 2000.
The acquisition was accounted for as a purchase. The purchase price was
allocated to the assets acquired and liabilities assumed based on their
estimated fair values. Results of operations for Tripod have been included
with those of the Company for periods subsequent to the date of acquisition.
46
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In the Merger, all outstanding shares of Common Stock and Preferred Stock of
Tripod and options and warrants to purchase Common Stock and Preferred Stock
of Tripod were converted into 6,241,652 shares and options and warrants to
purchase Common Stock of the Company. All outstanding options to purchase
Common Stock of Tripod have been assumed by the Company and converted into
options to purchase Common Stock of the Company, and all outstanding warrants
to purchase Preferred Stock of Tripod have been assumed by the Company and
converted into warrants to purchase Common Stock of the Company.
The purchase price of Tripod was allocated as follows:
In process research and development............................. $ 7,200,000
Developed technology, goodwill and other intangible assets...... 52,219,935
Other assets, principally cash and equipment.................... 3,633,449
Liabilities assumed............................................. (1,603,731)
-----------
$61,449,653
===========
Accumulated amortization on intangible assets was $15,230,814 and $4,786,827
at July 31, 1999 and 1998, respectively.
WiseWire Corporation
On April 30, 1998, the Company entered into an Agreement and Plan of Merger
(the "Agreement") by and among the Company, Wise Acquisition Corp., a
Pennsylvania corporation and a wholly-owned subsidiary of the Company ("WAC"),
and WiseWire Corporation, a Pennsylvania corporation ("WiseWire"), pursuant to
which WAC was merged with and into WiseWire (the "Merger"). As a result of the
Merger, WiseWire became a wholly-owned subsidiary of the Company.
The acquisition was accounted for as a purchase. The purchase price was
allocated to the assets acquired and liabilities assumed based on their
estimated fair values. Results of operations for WiseWire are included with
those of the Company for periods subsequent to the date of acquisition.
In the Merger, all outstanding shares of Common Stock and Preferred Stock of
WiseWire and options to purchase Common Stock of WiseWire were converted into
3,297,020 shares and options to purchase Common Stock of the Company. All
outstanding options to purchase Common Stock of WiseWire have been assumed by
the Company.
The purchase price of WiseWire was allocated as follows:
In process research and development............................. $ 9,080,000
Developed technology, goodwill and other intangible assets...... 30,107,698
Other assets, principally cash and equipment.................... 1,085,290
Liabilities assumed............................................. (857,286)
-----------
$39,415,702
===========
Accumulated amortization on intangible assets was $7,526,925 and $1,505,385
at July 31, 1999 and 1998, respectively.
GuestWorld, Inc.
On June 16, 1998, the Company entered into an Agreement and Plan of Merger
(the "Agreement") by and among the Company, VW Acquisition Corp., a Delaware
corporation and a wholly-owned subsidiary of the
47
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Company ("VW"), GuestWorld, Inc., a California corporation ("GuestWorld"), and
all of the stockholders of GuestWorld, acquired all of the outstanding capital
stock of GuestWorld through the merger of VW with and into GuestWorld (the
"Merger"). As a result of the Merger, GuestWorld became a wholly-owned
subsidiary of the Company.
In the Merger, all outstanding shares of Common Stock of GuestWorld were
converted into an aggregate of 252,368 shares of Common Stock of the Company.
The acquisition was accounted for as a purchase. Results of operations for
GuestWorld are included with those of the Company for periods subsequent to
the date of acquisition.
The purchase price of GuestWorld was allocated as follows:
In process research and development.............................. $1,000,000
Goodwill and other intangible assets............................. 2,830,584
Property and equipment........................................... 50,000
Liabilities assumed.............................................. (300,000)
----------
$3,580,584
==========
Accumulated amortization on intangible assets was $636,881 and $70,765 at
July 31, 1999 and 1998.
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 as a purchase. The purchase price was
allocated to the assets acquired and liabilities assumed based on their
estimated fair values. Results of operations for WhoWhere? have been included
with those of the Company for periods subsequent to the date of acquisition.
In the Merger, all outstanding shares of Common Stock and Preferred Stock of
WhoWhere? were converted into an aggregate of 8,285,714 shares of Common Stock
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, as the case may be, to purchase
an aggregate of 2,670,488 shares of Lycos Common Stock.
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 expires on August
13, 1999.
The purchase price of WhoWhere? was allocated as follows:
Goodwill and other intangible assets........................... $161,322,174
Other assets, principally cash and equipment................... 8,117,977
Liabilities assumed............................................ (10,381,288)
------------
$159,058,863
============
Accumulated amortization on intangible assets was $30,937,080 at July 31,
1999.
48
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Acquisition of Wired Ventures, Inc.
On October 5, 1998, the Company entered into an Agreement and Plan of Merger
(the "Agreement") by and among the Company and Wired Ventures, Inc., a
California corporation ("Wired"). On June 30, 1999, the Company completed the
closing of the Merger and Wired became a wholly-owned subsidiary of the
Company.
The acquisition was accounted for as a purchase. The purchase price was
allocated to the assets acquired and liabilities assumed based on their
estimated fair values. Results of operations for Wired have been included with
those of the Company for periods subsequent to the date of acquisition.
In the Merger, all outstanding shares of Common Stock and Preferred Stock of
Wired were converted into an aggregate of 6,192,848 shares of Common Stock of
the Company (the "Lycos Common Stock"). All outstanding options to purchase
Common Stock of Wired have been assumed by the Company and converted into
options to purchase Common Stock of the Company.
Under the terms of the Agreement and related Escrow Agreement dated June 30,
1999, an aggregate of 203,103 shares of Lycos Common Stock will be held in
escrow for the purpose of indemnifying the Company against certain liabilities
of Wired and its stockholders. The escrow expires on June 30, 2000.
The purchase price of Wired was allocated as follows:
Goodwill and other intangible assets........................... $268,000,000
Other assets, principally cash and equipment................... 38,915,414
Liabilities assumed............................................ (16,017,346)
------------
$290,898,068
============
Accumulated amortization on intangible assets was $4,466,667 at July 31,
1999.
Acquisition of Internet Music Distribution, Inc.
On July 17, 1999, the Company entered into an Agreement and Plan of Merger
(the "Agreement") by and among the Company and Internet Music Distribution,
Inc., a California corporation ("IMDI"). On July 27, 1999 the Company
completed the closing of the Merger and IMDI became a wholly-owned subsidiary
of the Company.
The acquisition was accounted for as a purchase. The purchase price was
allocated to the assets acquired and liabilities assumed based on their
estimated fair values. Results of operations for IMDI have been included with
those of the Company for periods subsequent to the date of acquisition.
All outstanding shares of Common Stock of IMDI were converted into an
aggregate of 1,106,094 shares of Common Stock of the Company. Terms of the
merger also provide for future purchase payments, not to exceed $15,000,000,
contingent upon unique user downloads of the Sonique Player. The Company has
retained security interests in certain Common Stock that was issued in this
transaction.
The purchase price of IMDI was allocated as follows:
Goodwill and other intangible assets............................ $50,000,000
Other assets, principally cash and equipment.................... 78,400
Liabilities assumed............................................. (1,090,266)
-----------
$48,988,134
===========
Accumulated amortization on intangible assets was not significant at July
31, 1999.
49
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In-Process Research and Development
In connection with the acquisitions of Tripod, WiseWire and GuestWorld, the
Company recorded an in process research and development charge of $17.3
million representing purchased in-process research and development that has
not yet reached technological feasibility and has no alternative future use.
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 respective acquisition dates.
Each of these activities was evaluated as of the respective acquisition dates
so as to determine their stage of development and related fair value. The
Company's review, as of the acquisition date, indicated that the in-process
research and development had not reached a state of technological feasibility
and evidenced no 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 project(s)
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 technology.
In the Tripod and WiseWire acquisitions, the in-process research and
development projects were valued using an Income Approach, which included the
application of a discounted future earnings (excess earnings) methodology. In
both 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. As a basis for the valuation
process, the Company made estimates of the revenue stream 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 that was specifically attributable to the in-process
technology, the excess earnings of the projects were calculated by deducting
the earnings streams attributable to all other assets, including working
capital and tangible assets. Based upon these assumptions, the future after-
tax income streams relating to the in-process technologies were discounted to
present value using a risk adjusted discount rate that reflected the
uncertainty involved in successfully completing and commercializing the in-
process technologies.
The significant assumptions used as a basis for the in-process research and
development valuations include: future revenues and expenses forecasted for
each project; future working capital needs; estimated costs to complete; date
of project completion and product launch; and the probability and risk of
project completion as reflected in the discount rate selected to compute net
present values.
The period in which material net cash inflows from significant projects was
expected to commence was within three to six months or less after the
respective acquisition dates of Tripod and WiseWire. In the case of the Tripod
acquisition, the projects required an additional four months beyond the
initial time estimate to complete the in-process technology. In the case of
the WiseWire acquisition, the in-process technology was completed in December
1998.
50
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In the case of Tripod, management does believe that other intangible assets
had been created at the acquisition date. As a result, in addition to valuing
in-process research and development, management has also allocated a
proportion of the purchase price, based on their respective fair values, to
existing technology employed in the creation and management of pods as well as
to other intangible assets associated with the existing community members.
WhoWhere? offers an array of products that allow users to locate home
addresses, e-mail addresses and phone numbers. In addition, through its
MailCity product, WhoWhere? also offers its users free, personalized, web-
based e-mail. Identifiable assets at the acquisition date consisted primarily
of developed technology, and projects under development at that time were
determined to be enhancements or refinements to existing developed
technologies. As a result, management determined that there was no technology
which would qualify for in-process research and development.
Wired offers search capabilities through HotBot, a popular search and
navigation site. Wired licenses the HotBot principal technology and subsequent
enhancements from a third party. Other Wired properties, which include Wired
News, HotWired and Suck.com provide online content. Wired either produces,
licenses or purchases this content. Based upon the nature of Wired businesses,
management determined the Company does not possess any significant technology
assets nor was there any technology which would qualify for in-process
research and development.
Management assessed the fair market value in continued use of Internet Music
Distributors, Inc. assets to serve as a basis for allocation of purchase
price. It was determined that intangible assets consisted of developed
technology and the Company's trade name, Sonique. Each identifiable asset was
analyzed and valued based upon an Income Approach. In performing its
assessment, management determined there was no in-process research and
development.
The following unaudited pro forma financial information presents the
combined results of operations of Lycos, Wired, WhoWhere? and IMDI as if the
acquisitions had occurred as of the beginning of fiscal 1999 and 1998, after
giving effect to certain adjustments, including amortization of goodwill and
other intangible assets. The pro forma financial information does not
necessarily reflect the results of operations that would have occurred had
Lycos, Wired, WhoWhere? and IMDI constituted a single entity during such
period.
Pro forma year ended
July 31,
----------------------------
1999 1998
------------- -------------
(Unaudited)
Revenues....................................... $ 159,331,854 $ 77,222,305
Net loss....................................... $(133,884,494) $(103,291,484)
Loss per share................................. $ (1.55) $ (1.33)
5. Accrued Expenses
Accrued expenses consist of the following:
July 31, July 31,
1999 1998
----------- -----------
Compensation and benefits........................... $ 7,384,653 $ 2,262,015
Advertising and royalties........................... 3,691,320 9,021,716
Professional fees................................... 3,662,644 1,262,351
Other............................................... 7,699,709 4,731,086
----------- -----------
$22,438,326 $17,277,168
=========== ===========
51
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
6. Commitments and Contingencies
The Company leases its facilities and certain other equipment under
operating lease agreements expiring through 2007. Future noncancelable minimum
payments as of July 31, 1999 under these leases for each fiscal year end are
as follows:
2000............................................................. $14,552,382
2001............................................................. 9,480,535
2002............................................................. 4,764,682
2003............................................................. 2,249,081
2004 and thereafter.............................................. 3,520,695
-----------
$34,567,375
===========
Rent expense under non-cancellable operating leases was $12,039,727,
$5,057,907, and $2,094,774 for the years ended July 31, 1999, 1998 and 1997,
respectively.
7. Stockholders' Equity
Stock Splits
In July 1998, the Company's Board of Directors approved a two-for-one common
stock split. On August 25, 1998, shareholders received one additional share
for every share held on August 14, 1998 (the record date).
In May 1999, the Company's Board of Directors approved a two-for-one common
stock split. On July 26, 1999, shareholders received one additional share for
every share held on July 16, 1999 (the record date). All share and per share
numbers in these consolidated financial statements and notes thereto have been
adjusted for all periods presented to reflect the two-for-one common stock
splits.
Secondary Offering
On June 4, 1998, the Company completed a secondary offering of its common
stock in which 9,000,000 of the Company's shares were sold under a
registration statement filed with the SEC. Of the 9,000,000 shares sold,
8,000,000 shares were sold by the Company and 1,000,000 were sold by CMG
Information Services, Inc ("CMGI"). The Company did not receive any proceeds
from the sale of shares by CMGI. Proceeds to the Company were approximately
$95 million, before deduction of expenses payable by the Company of $350,000.
The Underwriters exercised an option to purchase 1,350,000 additional shares
of Common Stock, resulting in additional proceeds to the Company of
approximately $16 million.
1995 Stock Option Plan
During 1995, the Company adopted the 1995 Stock Option Plan (the "1995
Plan") under which nonqualified stock options to purchase common stock may be
granted to officers and other key employees. Under the Plan, options to
purchase 4,000,000 shares of common stock may be granted at an exercise price
determined by the Board of Directors. Options granted under the 1995 Plan vest
over a five year period from date of grant, except that the vesting of certain
options are subject to acceleration upon the occurrence of certain events.
Options under the 1995 Plan expire six years from date of grant. The total
weighted average contractual life of options outstanding at July 31, 1999 was
2.3 years.
52
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A summary of option activity under the 1995 Plan is as follows:
Weighted-
Average
Number of Exercise
Options Price
---------- ---------
Outstanding at July 31, 1996.............................. 3,905,104 $1.48
Granted................................................. 320,000 3.60
Exercised............................................... (203,200) 0.02
Terminated.............................................. (382,688) 0.86
----------
Outstanding at July 31, 1997.............................. 3,639,216 1.37
----------
Granted................................................. -- --
Exercised............................................... (1,260,368) 0.17
Terminated.............................................. (424,160) 0.63
----------
Outstanding at July 31, 1998.............................. 1,954,688 1.56
----------
Granted................................................. -- --
Exercised............................................... (274,880) 0.67
Terminated.............................................. (7,200) 0.58
----------
Outstanding at July 31, 1999.............................. 1,672,608 $1.71
----------
Exercisable at July 31, 1999.............................. 1,061,440 $1.68
==========
The following table summarizes information about the Company's stock options
outstanding at July 31, 1999.
Options Outstanding Options Exercisable
------------------------------------ ------------------------
Weighted-
1995 Stock Average
Option Remaining Weighted- Weighted-
Plan Range of Number Contractual Average Number Average
Exercise Outstanding at Life Exercise Exercisable at Exercise
Prices July 31, 1999 (years) Price July 31, 1999 Price
------------- -------------- ----------- --------- -------------- ---------
$0.01--$0.58 584,272 2.0 $0.01 329,744 $0.0039
$2.40--$2.40 882,336 2.5 $2.40 705,696 $2.4000
$2.84--$3.97 206,000 2.2 $3.56 26,000 $3.3702
--------- ---------
1,672,608 1,061,440
========= =========
Pursuant to the License Agreement, CMG@Ventures has agreed to sell to the
Company a number of shares of common stock equal to the shares issuable upon
exercise of options granted under the 1995 Plan prior to the initial public
offering at a price equal to the exercise price of the options as such options
are exercised.
The Company has recorded deferred compensation expense of approximately
$610,000 for the difference between the grant price and the estimated fair
value (determined by independent valuations or by reference to third party
transactions) of certain of the Company's stock options granted. This amount
is being amortized over the vesting period of the individual options on a
straight-line basis, determined separately for each portion of the options
that vest in each year. Deferred compensation expense recognized for the year
ended July 31, 1999, 1998 and 1997 was approximately $47,000, $47,000 and
$142,000, respectively.
53
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
1996 Stock Option Plan
On February 2, 1996, the 1996 Stock Option Plan (the "1996 Plan") was
adopted by the Board of Directors. Pursuant to the 1996 Plan, 4,000,000 shares
of common stock may be issued upon exercise of options. On June 27, 1997, the
Company's Board of Directors voted to authorize an additional 8,800,000 shares
for grant under the 1996 Plan. On September 9, 1998 the Company's Board of
Directors voted to authorize an additional 12,000,000 shares for grant under
the 1996 Plan. Additionally, the Board of Directors approved an amendment to
the 1996 Plan, which provides that the shares authorized under the 1996 Plan
will increase annually, beginning on August 1, 1999, in an amount equal to 5%
of the Company's issued and outstanding shares as of each fiscal year end.
Under the 1996 Plan, incentive stock options may be granted to employees and
officers of the Company and non-qualified stock options may be granted to
consultants, employees and officers of the Company. The exercise price of such
incentive stock options cannot be less than the fair market value of the
common stock on the date of grant, or less than 110% of fair market value in
the case of employees or officers holding 10% or more of the voting stock of
the Company. The Compensation Committee of the Board of Directors has the
authority to select optionees and to determine the terms of the options
granted. Options granted under the 1996 Plan on June 30, 1999 or prior
generally vest over a five year period from date of grant. Options granted
under the 1996 Plan on July 1, 1999 or later generally vest over a four year
period from date of grant. Options under the 1996 Plan expire ten years from
the date of grant and certain options are subject to acceleration of vesting
upon the occurrence of certain events. The total weighted average contractual
life of options outstanding at July 31, 1999, was 8.2 years.
A summary of option activity under the 1996 Plan is as follows:
Weighted-
Number of Average
Options Exercise Price
---------- --------------
Outstanding at July 31, 1996......................... 212,000 $ 3.92
Granted............................................ 4,999,688 2.99
Exercised.......................................... -- --
Terminated......................................... (457,600) 3.29
----------
Outstanding at July 31, 1997......................... 4,754,088 2.97
----------
Granted............................................ 6,895,800 11.30
Exercised.......................................... (709,192) 2.90
Terminated......................................... (716,400) 4.07
----------
Outstanding at July 31, 1998......................... 10,224,296 7.68
----------
Granted............................................ 13,429,588 38.51
Exercised.......................................... (1,491,960) 6.89
Terminated......................................... (1,071,300) 13.70
----------
Outstanding at July 31, 1999......................... 21,090,624 $27.06
==========
Exercisable at July 31, 1999......................... 845,843 $ 8.02
==========
54
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table summarizes information about the Company's stock options
outstanding at July 31, 1999.
Options
Outstanding Options Exercisable
------------------------------------- ------------------------
Weighted-
Average Weighted- Weighted-
1996 Stock Option Number Remaining Average Number Average
Plan Range of Outstanding at Contractual Exercise Exercisable at Exercise
Exercise Prices July 31, 1999 Life (years) Price July 31, 1999 Price
- ----------------- -------------- ------------ --------- -------------- ---------
$0.01 - $1.45 100,000 7.0 $ 1.45 40,000 $ 1.45
$1.46 - $2.59 786,814 7.1 $ 2.24 79,601 $ 2.26
$2.59 - $2.79 539,950 6.7 $ 2.77 67,750 $ 2.77
$2.79 - $3.94 668,300 7.4 $ 3.11 89,900 $ 3.04
$3.94 - $5.38 2,054,932 7.8 $ 4.32 245,892 $ 4.28
$5.38 - $12.50 2,350,900 8.0 $ 9.83 75,500 $ 9.74
$12.51 - $25.00 5,735,166 7.9 $14.43 207,200 $15.35
$25.01 - $40.00 818,000 9.0 $29.62 40,000 $28.03
$40.01 - $55.00 5,258,686 8.9 $46.57 -- --
$55.01 - $65.50 2,777,876 9.4 $65.27 -- --
---------- -------
21,090,624 845,843
========== =======
In September 1996, the Company canceled 338,928 options previously granted
to employees under the 1995 Plan and 1996 Plan at various exercise prices and
granted an equivalent number of additional options to those same employees
pursuant to the 1996 Plan at an exercise price of $2.40 per share. No
compensation expense was recognized by the Company as the exercise price of
these options on the date of grant was at or above fair market value.
1995 Tripod Stock Option Plan
In connection with the acquisition of Tripod, the Company assumed the 1995
Stock Option Plan under which incentive stock options and nonqualified stock
options to purchase common stock may be granted to officers, key employees and
advisors. Under the Plan, options to purchase 735,852 shares of common stock
were reserved for grants. Options under the 1995 Tripod Stock Option Plan vest
over a four year period from date of grant. Options under the 1995 Tripod
Stock Option Plan expire ten years from the date of grant. The total weighted-
average contractual life of options outstanding at July 31, 1999 was
approximately 8.3 years.
A summary of option activity under the 1995 Tripod Stock Option Plan is as
follows:
Weighted-
Number of Average
Options Exercise Price
--------- --------------
Outstanding at February 12, 1998...................... 735,852 $0.33
Granted............................................. -- --
Exercised........................................... (268,984) 0.32
Terminated.......................................... (49,640) 0.41
--------
Outstanding at July 31, 1998.......................... 417,228 0.32
--------
Granted............................................. -- --
Exercised........................................... (220,766) 0.31
Terminated.......................................... (76,264) 0.37
--------
Outstanding at July 31, 1999.......................... 120,198 $0.31
--------
Exercisable at July 31, 1999.......................... 38,628 $0.31
========
55
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table summarizes information about stock options outstanding
under the 1995 Tripod Stock Option Plan at July 31, 1999:
Options Outstanding Options Exercisable
------------------------------------- --------------------------
Weighted-
Tripod 1995 Stock Option Average Weighted- Weighted-
Plan Range of Exercise Number Remaining Average Number Average
Prices Outstanding at Contractual Exercise Exercisable Exercise
- ------------------------ July 31, 1999 Life (years) Price at July 31, 1999 Price
-------------- ------------ --------- ---------------- ---------
$0.25 - $0.38 119,592 8.2 $0.31 38,628 $0.31
$0.38 - $1.00 606 10.4 $0.77 -- $0.77
------- ------
120,198 38,628
======= ======
1995 and 1996 WiseWire Stock Option Plans
In connection with the acquisition of WiseWire, the Company assumed the 1995
and 1996 Stock Option Plan under which incentive stock options and
nonqualified stock options to purchase common stock may be granted to
officers, key employees and advisors. Under these plans, the Company may grant
either incentive stock options or non-qualified stock options. The employee
plan was adopted in 1995 and is restricted to Company employees. These options
generally have a term of ten years from the date of grant with 20% vesting
after a brief probationary period and the remainder vesting over a four-year
period. The non-employee plan was adopted in 1996 and is intended primarily
for directors or other non-employees. Options granted under the non-employee
plan typically vest immediately. The total weighted average contractual life
of options outstanding under the 1995 and 1996 WiseWire Stock Option Plans at
July 31, 1999 was approximately 6.9 and 7.4 years, respectively.
A summary of option activity under the 1995 WiseWire Stock Option Plan is as
follows:
Weighted-
Number of Average
Options Exercise Price
--------- --------------
Outstanding at April 30, 1998......................... 420,548 $1.34
Granted............................................. -- --
Exercised........................................... (126,048) 1.01
Terminated.......................................... (54,192) 3.19
---------
Outstanding at July 31, 1998.......................... 240,308 1.35
---------
Granted............................................. -- --
Exercised........................................... (139,016) 0.98
Terminated.......................................... (33,678) 1.92
---------
Outstanding at July 31, 1999.......................... 67,614 $1.82
=========
Exercisable at July 31, 1999.......................... 8,579 $2.91
56
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
===
The following table summarizes information about stock options outstanding
under the 1995 WiseWire Stock Option Plan at July 31, 1999:
Options
Outstanding Options Exercisable
------------------------------------- --------------------------
Weighted-
WiseWire Average Weighted- Weighted-
1995 Stock Option Number Remaining Average Number Average
Plan Range of Exercise Outstanding at Contractual Exercise Exercisable Exercise
Prices July 31, 1999 Life (years) Price at July 31, 1999 Price
- ---------------------- -------------- ------------ --------- ---------------- ---------
$0.50 - $ 1.00 38,414 7.0 $0.67 5,401 $0.67
$2.50 - $26.88 29,200 6.9 $3.33 3,178 $6.72
------ -----
67,614 8,579
====== =====
A summary of option activity under the 1996 WiseWire Stock Option Plan is as
follows:
Weighted-
Number of Average
Options Exercise Price
--------- --------------
Outstanding at April 30, 1998.......................... 42,068 $6.60
Granted.............................................. -- --
Exercised............................................ -- --
Terminated........................................... (26,932) 6.55
-------
Outstanding at July 31, 1998........................... 15,136 6.68
-------
Granted.............................................. -- --
Exercised............................................ (4,964) 6.68
Terminated........................................... -- --
-------
Outstanding at July 31, 1999........................... 10,172 $6.68
=======
Exercisable at July 31, 1999........................... 10,172 $6.68
=======
The following table summarizes information about stock options outstanding
under the 1996 WiseWire Stock Option Plan at July 31, 1999:
Options Outstanding Options Exercisable
------------------------------------- --------------------------
Weighted-
WiseWire Average Weighted- Weighted-
1996 Stock Option Number Remaining Average Number Average
Plan Range of Exercise Outstanding at Contractual Exercise Exercisable Exercise
Prices July 31, 1999 Life (years) Price at July 31, 1999 Price
- ---------------------- -------------- ------------ --------- ---------------- ---------
$5.35 - $8.02 10,172 7.4 $6.68 10,172 $6.68
====== ======
1995 WhoWhere? Stock Option Plan
In connection with the acquisition of WhoWhere?, the Company assumed the
1995 Stock Option Plan under which incentive stock options and nonqualified
stock options to purchase common stock may be granted to officers, key
employees and advisors. Under this plan, the Company may grant either
incentive stock options or non-qualified stock options. These options vest
over a four year period from date of grant. These options generally have a
term of ten years from the date of grant. Upon consummation of the acquisition
of WhoWhere? by the Company, vesting of all outstanding options accelerated by
six months. The total weighted average contractual life of options outstanding
under the 1995 WhoWhere? Stock Option Plans at July 31, 1999 was approximately
6.4 years.
57
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A summary of option activity under the 1995 WhoWhere? Stock Option Plan is
as follows:
Weighted-
Number of Average
Options Exercise Price
--------- --------------
Outstanding at August 13, 1998........................ 1,922,784 $4.01
Granted............................................. -- --
Exercised........................................... (869,126) 2.95
Terminated.......................................... (439,764) 3.40
---------
Outstanding at July 31, 1999.......................... 613,894 $5.94
=========
Exercisable at July 31, 1999.......................... 211,729 $6.47
=========
The following table summarizes information about stock options outstanding
under the 1995 WhoWhere? Stock Option Plan at July 31, 1999:
Options
Outstanding Options Exercisable
------------------------------------ --------------------------
WhoWhere Weighted-
1995 Stock Average
Option Remaining Weighted- Weighted-
Plan Range of Number Contractual Average Number Average
Exercise Outstanding at Life Exercise Exercisable Exercise
Prices July 31, 1999 (years) Price at July 31, 1999 Price
- ---------------- -------------- ----------- --------- ---------------- ---------
$0.01 - $0.50 59,988 7.6 $ 0.46 26,984 $ 0.46
$0.51 - $6.55 242,562 7.8 $ 1.96 59,486 $ 1.68
$6.56 - $13.10 311,344 5.1 $10.10 125,259 $10.04
------- -------
613,894 211,729
======= =======
1996 Non-Employee Director Stock Option Plan
On February 2, 1996, the 1996 Non-Employee Director Stock Option Plan (the
"Director Plan") was approved by the Board of Directors. The Director Plan
authorizes the issuance of a maximum of 400,000 shares of common stock. The
Director Plan is administered by the Board of Directors. Under the Director
Plan each non-employee director first elected to the Board of Directors after
the completion of the initial public offering will receive an option for
10,000 shares on the date of his or her election. The exercise price per share
for all options granted under the Director Plan will be equal to the fair
market value of the common stock as of the date of grant. All options vest in
three equal installments beginning on the first anniversary of the date of
grant. Options under the Director Plan will expire ten years from the date of
grant and are exercisable only while the optionee is serving as a director of
the Company. As of July 31, 1999, 120,000 options had been granted at an
exercise price of $2.88 and $4.50 per share and remained outstanding under the
Director Plan, of which 93,334 were exercisable.
1996 Employee Stock Purchase Plan
On February 2, 1996, the 1996 Employee Stock Purchase Plan ("1996 Purchase
Plan") was adopted by the Company's Board of Directors. The 1996 Purchase Plan
authorizes the issuance of a maximum of 1,000,000 shares of common stock and
is administered by the Compensation Committee of the Board of Directors. All
employees of the Company who have completed six months of service with the
Company are eligible to participate in the 1996 Purchase Plan with the
exception of those employees who own 5% or more of the Company's stock and
directors who are not employees of the Company may not participate in this
plan. Employees elect to have deducted from 1%-10% of their base compensation.
The exercise price for the option is
58
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
the lesser of 85% of the fair market value of the common stock on the first or
last business day of the purchase period (6 months). An employee's rights
under the 1996 Purchase Plan terminate upon his or her voluntary withdrawal
from the Plan at any time or upon termination of employment.
Stock-Based Compensation
The Company has adopted the disclosure provisions of SFAS No. 123 with
respect to its stock-based compensation. The effects of applying SFAS No. 123
in this pro forma disclosure may not be representative of the effects on
reported income or loss for future years. SFAS 123 does not apply to awards
prior to 1995. The Company anticipates additional awards in future years. Had
compensation cost for the Company's stock-based compensation plans been
determined based on the grant date fair value in accordance with SFAS 123, the
Company's net loss and net loss per share for the years ended July 31, 1999,
1998 and 1997 would have been increased to the pro forma amounts indicated
below:
As Reported Pro Forma
---------------------------- -----------------------------
Net Loss Loss Per Share Net Loss Loss Per Share
------------ -------------- ------------- --------------
Year ended July 31,
1999................... $(52,043,564) $(0.60) $(132,022,235) $(1.53)
Year ended July 31,
1998................... $(28,439,484) $(0.46) $ (35,442,185) $(0.57)
Year ended July 31,
1997................... $ (6,619,190) $(0.12) $ (9,588,118) $(0.17)
The grant date fair value of each stock option was estimated using the
Black-Scholes option-pricing model with the following assumptions: expected
life of four years for 1999, 1998 and 1997; volatility of 115% for 1999, 100%
for 1998 and 70% for 1997; dividend yield of 0% for 1999, 1998 and 1997;
weighted average risk-free interest rate of 6.00% in 1999, 5.48% in 1998 and
6.25% in 1997. The weighted average grant date fair values of options granted
in 1999, 1998 and 1997 were $8.24, $2.44 and $0.81, respectively.
8. Income Taxes
The company did not record any provision for federal and state income taxes
through July 31, 1999. The actual tax expense for 1999, 1998 and 1997 differs
from "expected" tax expense (computed by applying the statutory U.S. federal
corporate tax rate of 34% to earnings before income taxes) as follows:
Year Ended July 31,
--------------------------
1999 1998 1997
-------- ------- -------
(In thousands)
Computed "expected" tax benefit................ $(17,695) $(9,669) $(2,251)
Nondeductible amounts and other differences:
In Process Research and Development.......... -- 5,875 --
Goodwill amortization........................ 16,881 2,301 --
Other........................................ 126 85 (326)
Change in valuation allowance for deferred
taxes allocated to income tax expense......... 688 1,408 2,577
-------- ------- -------
$ -- $ -- $ --
======== ======= =======
59
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
At July 31, 1999 and 1998 deferred income tax assets and liabilities result
from temporary differences in the recognition of income and expense for tax
and financial reporting purposes. The sources and tax effects of these
temporary differences are presented below:
July 31,
------------------
1999 1998
-------- --------
(In thousands)
Deferred tax liabilities:
Book over tax basis of developed technology.............. $ 5,259 $ 2,806
Financial basis in excess of income tax basis of avail-
able-for-sale securities................................ 12,582 --
-------- --------
Total deferred liabilities................................. 17,841 2,806
-------- --------
Deferred tax assets:
Deferred Revenue......................................... 2,086 2,169
Reserves................................................. 4,977 2,307
Tax in excess of book basis for differences in equity
investments............................................. (2,410) 2,164
Net operating losses and credit carryforwards............ 57,050 15,979
Other.................................................... 2,639 594
-------- --------
Total gross deferred tax assets............................ 64,342 23,213
Less valuation allowance................................... (46,501) (20,407)
-------- --------
Net deferred tax asset..................................... 17,841 2,806
-------- --------
Net deferred income taxes.................................. $ -- $ --
======== ========
In assessing the realizability of deferred tax assets, the Company considers
whether it is more likely than not that some or all of the deferred tax asset
will not be realized. The Company believes that sufficient uncertainty exists
regarding the realizability of the deferred tax assets such that valuation
allowances of $46,501,000 and $20,407,000 for July 31, 1999 and 1998
respectively, have been established for deferred tax assets.
At July 31, 1999, the Company had approximately $151,418,000 of federal and
state net operating loss carryforwards which will begin to expire in 2007 for
federal purposes and 2004 for state purposes. Utilization of the net operating
losses may be subject to an annual limitation imposed by change in ownership
provisions of Section 382 of the Internal Revenue Code and similar state
provisions.
In accordance with FAS 109, the accounting for the tax benefits of acquired
deductible temporary differences, which are not recognized at the acquisition
date because a valuation allowance is established, and recognized subsequent
to the acquisitions will be applied first to reduce to zero, any goodwill and
other noncurrent intangible assets related to the acquisitions. Any remaining
benefits would be recognized as reduction of income tax expense. As of July
31, 1999, $21,098,000 of the Company's deferred asset pertains to acquired
companies, the future benefits of which will be applied first to reduce to
zero any goodwill and other noncurrent intangible related to the acquisitions
prior to reducing the Company's income tax expense. Deferred tax assets and
related valuation allowance of approximately $23,370,000 relate to certain
operating loss carryforwards resulting from the exercise of employee stock
options, the tax benefit of which, when recognized, will be accounted for as a
credit to additional paid-in capital rather than a reduction of income tax.
The Company's deferred tax liability relates solely to the difference in
bases of acquired assets as well as the tax effects of unrealized gains of
available-for-sale securities. A portion or all of net operating loss
carryforwards which can be utilized in any year may be limited by changes in
ownership of the Company, pursuant to Section 382 of the Internal Revenue Code
and similar statutes.
60
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
9. Related Party Transactions
In connection with the formation of the Company, the Company, CMU,
CMG@Ventures and CMG Information Services, Inc. ("CMGI") entered into a
license agreement ("License Agreement") pursuant to which CMU granted the
Company a perpetual, exclusive (with certain limited exceptions), worldwide
license to use the Lycos Internet search and indexing technology and the Lycos
Catalog. The Company paid licensing fees and additional payments equal to 50%
of certain cash receipts, as defined, totaling approximately $1,250,000. All
amounts due under the License Agreement were paid as of July 31, 1996. The
Company also issued 4,000,000 shares of common stock in connection with this
Agreement. The License Agreement was fully amortized as of July 31, 1998.
On February 9, 1996, the Company sold 366,320 shares and 160,000 shares of
common stock and options to acquire 238,904 shares and 104,344 shares of
Common Stock to CMU and Dr. Michael Mauldin, respectively, for an aggregate
purchase price of $328,950, pursuant to the exercise of preemptive rights
granted to these parties in the License Agreement. These preemptive rights
were exercised in connection with the issuance of shares of common stock
pertaining to the Company's acquisition of Point Communications on October 12,
1995. The options granted to Dr. Mauldin and CMU have an exercise price of
$0.50 per share and became fully vested upon completion of the Company's
initial public offering in April 1996.
In addition to amounts paid to CMU in connection with the License Agreement,
the Company was also required to pay to CMU an additional $525,000 pursuant to
two licenses granted by CMU which were assigned to the Company.
In April 1998 the remaining carrying value of the License Agreement of
approximately $831,000 was written off as it was not considered to have any
remaining future economic benefit.
10. Litigation
In February 1999, the Company announced its intention to enter into a
transaction with USA Networks, Inc. and certain affiliated companies pursuant
to which, among other things, Lycos would have been merged into a subsidiary
of USA Networks. In May 1999, the parties to the proposed transaction
terminated the merger by mutual agreement.
Prior to such termination, eight purported class action lawsuits were filed
in the Court of Chancery for the State of Delaware in and for New Castle
County, by shareholders of the Company allegedly on behalf of all common
stockholders of the Company. The complaints request, among other things, that
the proposed transaction be enjoined or that rescissionary damages be awarded
to the purported class and that plaintiffs be awarded all costs and fees,
including attorneys' fees. Although the proposed merger has since been
terminated, the suits have not been dismissed. The Company believes that the
allegations in the complaints are without merit and intends to contest them
vigorously.
Also prior to the termination of the proposed merger, a series of purported
securities class action lawsuits were filed in the United States District
Court for the District of Massachusetts. The suits, which have since been
consolidated, allege, among other claims, violations of United States Federal
securities laws through alleged misrepresentations and omissions relating to
the announced transaction with USA Networks. The consolidated complaint seeks
an unspecified award of damages. The Company believes that the allegations in
the consolidated complaint are without merit and intends to contest them
vigorously.
61
The Company is also 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 all of the above actions will not materially affect the financial position,
results of operations or cash flows of the Company.
11. Subsequent Events (unaudited)
Acquisition of Quote.com, Inc.
On September 2, 1999, the Company entered into an Agreement and Plan of
Merger (the Agreement) with Quote.com, Inc., a California corporation
("Quote.com") in a stock-for-stock transaction valued at approximately $88
million. The acquisition will be accounted for as a purchase. The purchase
price will be allocated to the assets acquired and liabilities assumed based
on their estimated fair values. Results of operations for Quote.com will be
included with those of the Company for periods subsequent to the date of
acquisition. The acquisition, which is subject to shareholder approval, is
expected to close in the second quarter of fiscal year 2000.
Lycos Asia Joint Venture
In September 1999, the Company established Lycos Asia as the basis for a
joint venture agreement with Singapore Telecommunications Limited (SingTel) to
create a localized version of the Lycos Network services to be offered in
Singapore, Hong Kong, China, Taiwan, India and certain other countries in
Southeast Asia. The joint venture is owned 50% by Lycos and 50% by SingTel, a
telecommunications provider in Singapore. The investment will be accounted for
under the equity method and accordingly, the Company will recognize 50% of the
net losses and profits of Lycos Asia when realized.
12. Selected Quarterly Financial Information (unaudited)
The following table sets forth selected quarterly financial and stock price
information for the years ended July 31, 1999 and 1998. The operating results
for any given quarter are not necessarily indicative of results for any future
period.
Fiscal 1999 Quarter ended Fiscal 1998 Quarter ended
------------------------------------- ---------------------------------
Oct. 31 Jan. 31 Apr. 30 Jul. 31 Oct. 31 Jan. 31 Apr. 30 Jul. 31
------- -------- -------- -------- ------- ------- -------- -------
(In thousands, except per share data)
Total revenues.......... $21,784 $ 30,552 $ 35,082 $ 45,103 $9,303 $12,603 $ 15,129 $19,025
Gross profit............ 19,484 24,112 27,939 35,259 7,524 9,884 10,382 15,757
Net income (loss)....... (3,596) (13,753) (13,302) (21,393) 107 301 (22,052) (6,796)
Basic and diluted net
income (loss) per
share.................. $ (0.04) $ (0.16) $ (0.15) $ (0.24) $ 0.00 $ 0.00 $ (0.71) $ (0.19)
62
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
In accordance with General Instruction G(3) to Form 10-K, except as
indicated in the following sentence, the information called for by Items 10,
11, 12 and 13 is incorporated by reference from the registrant's definitive
proxy statement pursuant to Regulation 14A for the Annual Meeting of
Shareholders to be held on December 21, 1999. As permitted by General
Instruction G(3) to Form 10-K and Instruction 3 to Item 401 (b)
ofRegulation S-K, the information on executive officers called for by Item 10
is included in Part I of this Annual Report on Form 10-K.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statements and Schedules
The Financial Statements and Schedules filed as part of this Annual Report
on Form 10-K are listed in the index under Item 8.
(b) Reports on Form 8-K
The following reports on Form 8-K were filed during the quarter ended July
31, 1999:
On May 14, 1999, the Company filed a Form 8-K with the Securities and
Exchange Commission with respect to the termination of the proposed
transaction with USA Networks, Inc. and Ticketmaster Online-City Search, Inc.
On July 15, 1999, the Company filed a Form 8-K with the Securities and
Exchange Commission with respect to the consummation of the Company's
acquisition of Wired Ventures, Inc.
63
ITEM 21. EXHIBITS
Exhibit
Number Description Of Exhibit
------- ----------------------
3.1* Restated Certificate of Incorporation of the Registrant dated as of
April 4, 1996.
3.2* Certificate of Amendment of Restated Certificate of Incorporation
dated as of July 16, 1999.
3.3* Amended and Restated By-Laws of Registrant.
3.3s* Certificate of Amendment of Restated Certificate of Incorporation
of the Registrant dated August 13, 1998.
4.1* Specimen Certificate of Registrant's Common Stock (incorporated by
reference to Exhibit 4.1 to the Registration Statement on Form S-1
(Reg. No. 333-1354)).
8.1* Opinion of Brobeck, Phleger & Harrison LLP as to United States
federal income tax consequences.
10.1* Subscription Agreement between Registrant and CMG@Ventures, dated
June 16, 1995.
10.2* Subscription Agreement between Registrant and CMU, dated June 16,
1995.
10.3* Subscription Agreement between Registrant and Dr. Mauldin, dated
June 16, 1995.
10.4* Subscription Agreement between Registrant and Dr. Mauldin, dated
February 9, 1996.
10.5* Subscription Agreement between Registrant and CMU, dated February
9, 1996.
10.6* License Agreement among CMU, CMGI, CMG@Ventures, and Registrant,
dated June 16, 1995, as amended.
10.7* Amendment and Waiver to License Agreement among CMU, CMGI,
CMG@Ventures, Registrant and Dr. Mauldin, dated February 9, 1996.
10.8* Stockholders, Agreement between Registrant and Christopher Kitze,
dated October 12, 1995.
10.10* Registration Rights Agreement among Registrant, CMU, CMG@Ventures
and Dr. Mauldin, dated February 9, 1996.
10.11* Consulting, Non-Compete, Invention and Non-Disclosure Agreement
between Registrant and Dr. Mauldin, dated June 16, 1995.
10.12* Non-Competition, Non-Disclosure and Developments Agreement between
Point Communications Corporation and Christopher Kitze, dated
October 12, 1995.
10.13* Letter Agreement between Robert J. Davis and Registrant dated
February 7, 1996.
10.14***** Amendment to Letter Agreement between Robert J. Davis and
Registrant dated as of August 27, 1999.
10.15***** Amendment to Employment Letter Agreement between Edward M. Philip
and Registrant dated as of August 27, 1999.
10.16* Lycos, Inc. 1995 Stock Option Plan.
10.17* Lycos, Inc. 1996 Stock Option Plan.
64
Exhibit
Number Description Of E xhibit
------- -----------------------
10.18* Lycos, Inc. 1996 Non-Employee Director Stock Option Plan.
10.19* Lycos, Inc. 1996 Employee Stock Purchase Plan.
10.20* Form of Indemnity Agreement between Registrant and its executive
officers and directors.
10.21* Amendment to License Agreement among CMU, CMGI and Registrant,
dated March 4, 1996.
10.22***+ Agreement between Registrant and Bertelsmann Internet Services
GmbH dated as of May 1, 1997.
10.23*****+ First Amendment Agreement between Bertelsmann Internet Services
GmbH and Registrant, dated as of November 12, 1998.
10.24*** Office sublease between Praxis International and Registrant dated
December 4, 1996.
10.25**** Leggat McCall Properties Lease, dated January 30, 1998.
10.26*****+ Information Services Agreement between Inktomi Corporation and
Wired Digital, Inc., dated as of May 1, 1999.
10.27*****+ Joint Venture Agreement between Registrant and Singapore
Telecommunications Limited dated as of September 13, 1999.
10.28*****+ Joint Venture Agreement between Registrant and Mirae Corporation
dated as of March 19, 1999.
10.29*****+ Premier Provider Agreement between Netscape Communications
Corporation and Registrant dated as of June 10, 1999.
10.30*****+ Joint Venture Agreement among Registrant, Sumitomo Corp. and
Internet Initiative Japan, Inc. dated as of March 5, 1998, as
amended by the Agreement by and among Registrant, Sumitomo Corp.,
Sumisho Computer Systems Corp. and Internet Initiative Japan, Inc.
dated June 29, 1998.
11.1 Computation of Shares Used in Computing Basic and Diluted Net Loss
Per Share.
21.1 Subsidiaries of the Registrant.
23.1 Independent Accountants' Consent.
27 Financial Data Schedule.
- --------
As Previously filed.
* Incorporated by reference from the Registrant's Registration Statement
on Form S-1 (Registration No. 333-1354).
** Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the quarterly period ended April 30, 1996 (File No. 0-27830).
*** Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the quarterly period ended April 30, 1997 (File No. 0-27830).
**** Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the quarterly period ended April 30, 1998 (File No. 0-27830).
***** Incorporated by reference from the Registrant's Registration Statement
on Form S-4 (Registration No. 333-88749).
+ Confidential material omitted and filed separately with the Securities
and Exchange Commission.
65
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
/s/ Robert J. Davis
By: _________________________________
Robert J. Davis
President and Chief Executive
Officer (Principal Executive
Officer)
Date: October 29, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on its behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Robert J. Davis President, Chief Executive October 29, 1999
______________________________________ Officer (Principal
Robert J. Davis Executive Officer) and
Director
/s/ Edward M. Philip Chief Operating Officer, October 29, 1999
______________________________________ Chief Financial Officer
Edward M. Philip (Principal Financial
Officer), Accounting
Officer and Secretary
/s/ Daniel J. Nova Director October 29, 1999
______________________________________
Daniel J. Nova
/s/ John M. Connors, Jr. Director October 29, 1999
______________________________________
John M. Connors, Jr.
/s/ Richard Sabot Director October 29, 1999
______________________________________
Richard Sabot
/s/ Peter Lund Director October 29, 1999
______________________________________
Peter Lund
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