U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
---
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
---
EXCHANGE ACT OF 1934
For the transition period from_________________________ to
Commission file number 1-11797
INFOSEEK CORPORATION
(Exact name of registrant as specified in its charter)
CALIFORNIA 77-0353450
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1399 MOFFETT PARK DRIVE
SUNNYVALE, CA 94089
(Address of principal executive offices)
408-543-6000
(Registrant's telephone number, including area code)
Check whether the registrant: (1) filed all reports required to be filed by
Section 13 or 15 (d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes X No
----- -----
As of October 31, 1998, there were 31,522,782 shares of the registrant's common
stock outstanding.
PART I FINANCIAL INFORMATION NUMBER
ITEM 1: Financial Statements
Condensed Consolidated Balance Sheets as of September 30,
1998 and December 31, 1997............................... 3
Condensed Consolidated Statements of Operations for the
Three And Nine Months Ended September 30, 1998 and 1997.. 4
Condensed Consolidated Statements of Cash Flows for the Nine
Months Ended September 30, 1998 and 1997................. 5
Notes to Condensed Consolidated Financial Statements.......... 6
ITEM 2: Management's Discussion and Analysis of Financial Conditions
and Results of Operations.................................. 12
PART II OTHER INFORMATION
ITEM 6: Exhibits and Reports on Form 8-K.............................. 44
Signatures .............................................................. 45
2
PART I: FINANCIAL INFORMATION
ITEM 1. Financial Statements
INFOSEEK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- -------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 6,801 $ 3,323
Short-term investments 47,740 28,116
Accounts receivable, net 7,619 6,921
Prepaid to service providers 5,838 ---
Other current assets 998 648
------------- -------------
Total current assets 68,996 39,008
Property and equipment, net 15,177 10,488
Direct acquisition costs 2,825 ---
Deposits and other assets 3,315 1,993
------------- -------------
Total assets $ 90,313 $ 51,489
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 6,717 $ 4,861
Accrued payroll and related expenses 2,191 1,630
Accrued liabilities to service providers 1,558 4,221
Other accrued liabilities 2,418 2,262
Deferred revenue 4,789 2,564
Accrued restructuring and other charges --- 1,877
Short-term obligations 2,942 2,575
------------- -------------
Total current liabilities 20,615 19,990
Long-term obligations 2,981 4,493
Shareholders' equity:
Common stock 121,292 76,000
Accumulated deficit (53,724) (48,030)
Deferred compensation (717) (753)
Notes receivable from shareholders (134) (211)
------------- -------------
Total shareholders' equity 66,717 27,006
------------- -------------
Total liabilities and shareholders' equity $ 90,313 $ 51,489
============= =============
See notes to condensed consolidated financial statements.
3
INFOSEEK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
1998 1997 1998 1997
--------- --------- --------- ---------
Revenues $ 19,196 $ 8,381 $ 50,715 $ 22,407
Costs and expenses:
Hosting, content and
website costs 3,278 1,567 7,956 4,397
Research and development 2,635 1,777 7,432 5,879
Sales and marketing 12,704 8,329 35,144 22,520
General and administrative 3,953 1,947 7,876 5,242
Restructuring and other
charges --- --- --- 7,349
--------- --------- --------- ---------
Total cost and expenses 22,570 13,620 58,408 45,387
--------- --------- --------- ---------
Operating loss (3,374) (5,239) (7,693) (22,980)
Interest income, net 747 287 1,999 1,066
--------- --------- --------- ---------
Net loss $ (2,627) $ (4,952) $ (5,694) $ (21,914)
========= ========= ========= =========
Basic and diluted net
loss per share $ (0.08) $ (0.19) $ (0.19) $ (0.83)
Shares used in computing basic
and diluted net loss per share 31,421 26,434 30,512 26,270
See notes to condensed consolidated financial statements.
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INFOSEEK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------
1998 1997
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (5,694) $ (21,914)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 5,185 3,920
Amortization of unearned compensation 314 717
Changes in assets and liabilities:
Accounts receivable (698) (1,828)
Prepaid to Service Providers (5,838) ---
Deposits and other current assets (1,672) (1,084)
Direct acquisition costs (2,825) ---
Accounts payable 1,856 (1,219)
Accrued payroll and related expenses 561 (237)
Accrued liabilities to service providers (2,663) 2,357
Other accrued liabilities 156 229
Deferred revenue 2,225 854
Accrued restructuring and other charges (1,877) 2,904
---------- ----------
Net cash used in operating activities (10,970) (15,301)
INVESTING ACTIVITIES
Purchase of available-for-sale short-term investments (147,907) (29,667)
Proceeds from sales and maturities of available-
for-sale investments 128,283 44,428
Purchases of property and equipment (9,170) (8,018)
---------- ----------
Net cash provided by (used) in investing activities (28,794) 6,743
FINANCING ACTIVITIES
Proceeds from term loan 133 5,539
Repayments of term loan (1,982) (815)
Proceeds from sale of common stock, net 45,091 2,587
---------- ----------
Net cash provided by financing activities 43,242 7,311
---------- ----------
Net increase (decrease) in cash and cash equivalents 3,478 (1,247)
Cash and cash equivalents at beginning of period 3,323 3,788
---------- ----------
Cash and cash equivalents at end of period $ 6,801 $ 2,541
========== ==========
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Cash paid for interest amounted to $517,000 and $436,000 for the nine months
ended September 30, 1998 and 1997 respectively. Unearned compensation related to
stock options amounted to $352,000 for the nine months ended September 30, 1998.
There was no unearned compensation for the nine months ended September 30, 1997.
See notes to condensed consolidated financial statements.
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INFOSEEK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND BASIS OF PRESENTATION
Infoseek Corporation (the "Company") provides Internet search and navigation
technology, products and services that use the Web to connect its viewers'
personal, work and community lives. As a "connected" media company, the Company
is able to segment viewers by interest area, providing advertisers with focused
and targeted audiences. The Infoseek Service is a comprehensive Internet gateway
that combines search and navigation with directories of relevant information
sources and content sites, offers chat and instant messaging for communicating
shared interests and facilitates the purchase of related goods and services. The
Company conducts its business within one industry segment.
The condensed consolidated financial information as of September 30, 1998 and
for the nine month periods ended September 30, 1998 and 1997 included herein is
unaudited and has been prepared by the Company in accordance with generally
accepted accounting principles and reflects all adjustments, consisting only of
normal recurring adjustments, which in the opinion of management are necessary
to state fairly the Company's financial position, results of operations, and
cash flows for the periods presented. The December 31, 1997 balance sheet was
derived from audited financial statements at that date. All significant
intercompany transactions and balances have been eliminated.
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 the disclosure of
contingent assets and liabilities at the date of the financial statements as
well as the reported amounts of revenue and expenses during the reporting
period. Actual results will differ from those estimates, and such differences
may be material to the financial statements. These condensed consolidated
financial statements should be read in conjunction with the Company's audited
consolidated financial statements for the year ended December 31, 1997 included
in the Company's current report Form 8-K, as filed on May 22, 1998 and as
amended on August 10, 1998, with the Securities and Exchange Commission. The
results of operations for the nine months ended September 30, 1998 are not
necessarily indicative of the results to be expected for any future periods.
As more fully described in Note 7, the Company merged with WebChat
Communications, Inc., ("WebChat") in April 1998 in a pooling-of-interests
transaction. The condensed consolidated financial statements for 1997 and 1998
have been restated to include the financial position, results of operations and
cash flows of WebChat.
Amounts shown in previous consolidated statements of operations prior to the
filing of the amended Form 8-K on August 10, 1998 which were formally titled
"Costs of Revenues" have been retitled "Hosting, Content and Website Costs".
Hosting, Content and Website Costs consist primarily of costs associated with
the enhancement, maintenance and support of the Company's Web sites, including
telecommunications costs and equipment depreciation. Hosting, Content and
Website Costs also include costs associated with the licensing of certain third-
party technologies.
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2. FOLLOW-ON PUBLIC OFFERING
In February 1998, the Company completed a follow-on public offering and issued
3,450,000 shares of its common stock to the public at a price of $13.44 per
share. The Company received proceeds from the offering of approximately
$43,015,000 net of underwriting discounts, commissions and other offering costs.
3. NET LOSS PER SHARE
In 1997, the Financial Accounting Standards Board issued Statement No. 128,
Earnings Per Share. Statement No. 128 replaced the calculation of primary and
fully diluted earnings per share with basic and diluted earnings per share.
Unlike primary and fully diluted earnings per share, outstanding nonvested
shares are not included in the computations of basic and diluted earnings per
share until the time-based vesting restriction has lapsed. Basic earnings per
share also excludes any dilutive effects of options, warrants and convertible
securities. Diluted net loss per share does not include options, warrants or
convertible securities, as they would be antidilutive for all periods presented.
Diluted earnings per share is very similar to the previously reported fully
diluted earnings per share.
The following table sets forth the computation of basic and diluted earnings per
share (in thousands, except per share amounts):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
1998 1997 1998 1997
--------- --------- --------- ---------
Net loss and numerator for basic
and diluted net loss per share $ (2,627) $ (4,952) $ (5,694) $ (21,914)
========= ========= ========= =========
Weighted average of common
shares and denominator for basic
and diluted net loss per share 31,421 26,434 30,512 26,270
========= ========= ========= =========
Basic and diluted net loss per share $ (0.08) $ (0.19) $ (0.19) $ (0.83)
========= ========= ========= =========
4. NEW ACCOUNTING PRONOUNCEMENT
The Company has adopted the American Institute of Certified Public Accountants
Statement of Position, Software Revenue Recognition (SOP 97-2) effective the
first quarter of 1998. The adoption did not have a significant affect on the
Company's revenue recognition policy.
5. COMPREHENSIVE INCOME
The Company has adopted Statement of Financial Accounting Standards No. 130
(SFAS No. 130), "Reporting Comprehensive Income". SFAS No. 130 establishes new
rules for reporting and display of comprehensive income and its components,
however, the adoption of this statement has no impact on the Company's net loss
or shareholders' equity. SFAS No. 130 requires unrealized
7
gains or losses on the Company's available-for-sale securities, which prior to
adoption were reported separately in shareholders' equity, to be included in
other comprehensive income. During the third quarter and nine month period ended
September 1998, unrealized gains or losses from available-for-sale securities
were not significant.
6. RESTRUCTURING AND OTHER CHARGES
During the second quarter of 1997, the Company recorded restructuring and other
charges of approximately $7,400,000, of which approximately $6,200,000 related
to the discontinuance of certain business arrangements, which were determined to
be non-strategic, and approximately $1,200,000 related to management changes. Of
these restructuring charges, approximately $5,000,000 involved cash outflows,
all of which have been completed as of June 30, 1998. Non-cash restructuring
charges of approximately $2,400,000 relate primarily to the write-down of
certain non-strategic business assets which were written off in June 1997. There
have been no material changes to the restructuring plan or in the estimates of
the restructuring costs.
7. BUSINESS COMBINATION
On April 17, 1998, the Company acquired WebChat in a tax-free reorganization in
which a wholly owned subsidiary of the Company was merged directly into WebChat.
The Company has exchanged approximately 316,000 shares of Infoseek Corporation
common stock and has reserved approximately 11,000 shares for WebChat options
assumed by the Company. Each share exchanged represents 0.03 shares of common
stock of the Company for each share of common and preferred stock of WebChat.
Merger related costs, which were not significant, were expensed in the second
quarter of 1998. The merger has been accounted for under the pooling-of-
interests method.
The following information shows net revenue and net loss of the separate
companies during the periods prior to the April 17, 1998 merger. The combined
amount shows net revenue and net loss subsequent to the April 17, 1998 merger
(in thousands):
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
1998 1997
---------- ----------
Net revenue
Infoseek $ 19,731 $ 22,090
WebChat 168 317
Combined 30,816 ---
---------- ----------
Total $ 50,715 $ 22,407
========== ==========
Net loss
Infoseek $ (1,630) $ (20,533)
WebChat (472) (1,381)
Combined (3,592) ---
---------- ----------
Total $ (5,694) $ (21,914)
========== ==========
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8. SIGNIFICANT AGREEMENTS
Through April 30, 1998, the Company's agreement with Netscape provided for
payments up to an aggregate of $12,500,000 in cash and reciprocal advertising
($10,000,000 in cash and $2,500,000 in reciprocal advertising) to be one of four
non-exclusive premiere providers of navigational services (along with Excite,
Lycos, and Yahoo!). The Netscape arrangement was subsequently extended through
May 31, 1998. The payments to Netscape were being recognized ratably over the
term of the agreement.
As of June 1, 1998, the Company entered into a one-year agreement with Netscape
with terms that provide for the Company to pay, based on impressions delivered,
up to an aggregate of $12,500,000 in cash to be one of the six non-exclusive
premier providers of navigational services (along with Excite, Netscape, Lycos,
Alta Vista, and LookSmart). Under terms of the agreement, the Company will
receive 15% of premiere provider rotations--the pages served to visitors who
have not selected a preferred provider. The payments to Netscape are being
recognized ratably over the term of the agreement. On November 11, 1998, the
Company received notice from Netscape of their intent to either terminate the
contract or negotiate a new agreement to afford Infoseek with different
positioning or a lower rotation percentage on the Netscape site on pricing terms
to be mutually agreed. While the Company and Netscape are currently in the
process of negotiating a new agreement, there can be no assurance that Netscape
will be willing to renew the agreement with the Company on commercially
equivalent terms or on other terms that may be satisfactory to the Company, if
at all. If no new agreement were entered into between Netscape and Infoseek, the
current agreement would terminate in the first quarter of 1999. Pages sourced
from Netscape have declined from 30% a year ago to 13% in June 1998 and 12% in
September 1998 and a loss of Netscape sourced pages could have an adverse impact
on the Company's business, results of operations and financial condition and
prospects. As of September 30, 1998, the Company has a cash commitment ranging
from a minimum of $4,150,000 to a maximum of $12,500,000 depending on the level
of traffic delivered by Netscape in connection with this agreement.
Under the terms of these agreements, the Company recognized $1,877,000 and
$2,500,000 of sales and marketing expense during the three month periods ended
September 30, 1998 and 1997, respectively. During the nine month periods ended
September 30, 1998 and 1997, the Company recognized $6,595,000 and $5,416,000,
respectively.
The Company also had an agreement with Microsoft to provide navigational
services on certain Microsoft web sites through which the Company also receives
traffic. In exchange for such traffic, the Company makes available to Microsoft
advertising space on the Infoseek service free of charge. Effective October 1,
1998, the Company terminated its existing agreement with Microsoft and entered
into a new agreement with Microsoft to become one of five premier providers of
search and navigation services on Microsoft's network of Internet products and
services. Under the terms of the new twelve month Microsoft agreement, the
Company is obligated to pay an aggregate of $10,675,000 for a guaranteed minimum
number of impressions on both Microsoft's Internet Explorer search feature and
Microsoft's website. The Company will also pay, based on the number of
impressions delivered, for additional impressions on both Internet Explorer and
Microsoft's website, up to a maximum of $18,000,000. The accounting treatment
for the Microsoft agreement will result in amortizing the obligated amount over
the one-year term of the agreement, beginning in the quarter ended December 31,
1998, the quarter when the service is launched.
In addition, the Company recently entered into an agreement with WebTV Networks,
Inc. ("WebTV") pursuant to which the Company will be the exclusive provider of
search and directory services to WebTV. Under this two year agreement, the
Company is responsible for managing
9
advertising sales for all of WebTV's search traffic and the substantial majority
of WebTV's current non-search traffic. Pursuant to the agreement, the Company is
obligated to make cash payments to WebTV totaling $26 million, with $15 million
of such amount being payable in advance for the first five quarters during which
the agreement is in effect and the remaining $11 million being payable ratably
over the last three quarters of the agreement term. Such payments by the Company
are subject to reimbursement in the event that WebTV is unable to deliver a
minimum of 4.5 billion impressions over the life of the agreement. The Company
is to receive all of the revenue generated from such advertising sales up to a
pre-determined amount that is in excess of the Company's total payment
obligations to WebTV under the agreement, with allocations of such revenue
between the Company and WebTV being made beyond this pre-determined amount.
9. PROPOSED TRANSACTIONS
In June 1998, the Company entered into agreements with Starwave Corporation
("Starwave"), a Washington corporation, and with The Walt Disney Company, a
Delaware corporation, and certain Disney subsidiaries (collectively "Disney")
relating to an acquisition of Starwave by the Company through a merger and
exchange of shares (the "Starwave Acquisition") pursuant to an Agreement and
Plan of Reorganization (the "Reorganization Agreement"). In accordance with the
Agreement and Plan of Reorganization, the Company will issue 25,511,922 shares
of Infoseek Delaware common stock for all outstanding Starwave shares. The
Company will also reserve 2,626,078 shares of Infoseek Delaware common stock, in
connection with outstanding stock options of Starwave, to be assumed by the
Company. The fair value of the Company's shares and options to be issued is
approximately $897.8 million. In addition, the Company will incur direct
acquisition costs of approximately $22.0 million, which will be included in the
purchase price of Starwave. The total purchase price of Starwave is therefor
approximately $919.8 million. The Starwave acquisition is to be accounted for as
a purchase transaction. In addition, conditioned upon and subject to
consummation of the proposed Merger, Disney will purchase an additional
2,642,000 unregistered shares of Infoseek Delaware common stock and a warrant,
subject to vesting, to purchase an additional 15,720,000 unregistered shares of
Infoseek Delaware common stock (the "Warrant") in exchange for approximately
$70.0 million in cash and a $139.0 million five-year promissory note. The
warrant will enable Disney to achieve a majority stake in the Company over
time. The agreements are subject to customary closing conditions including
shareholder approvals and governmental regulatory approvals. As a result, the
Company filed with the Securities and Exchange Commission a joint proxy
statement for a special meeting of shareholders of Infoseek Corporation and
Starwave Corporation, to be held on November 18, 1998, to approve the
Reorganization Agreement and the issuance of common stock and warrants to
Disney.
In addition, the Company and Disney have proposed to establish a strategic
relationship concerning the development, launch and promotion of a planned new
Internet portal service (the "New Portal Service") that would combine certain
content, promotion, brands and technologies of Infoseek, Starwave and its joint
ventures relating to ESPN SportsZone, ABCNews.com and certain Disney web sites.
In connection with the New Portal Service, a subsidiary of Disney has agreed to
provide, and the Company has agreed to purchase $165 million in promotional
support and activities over five years.
In July 1998, the Company entered into an agreement to acquire Quando, Inc., an
Oregon corporation, in exchange for approximately $17 million, subject to
adjustment, in shares of the Company's common stock. Quando creates and
licenses regularly-updated customized directories,
10
including shopping guides, event guides, content directories, audio clip
libraries, review guides and data for website rating guides. The transaction is
subject to customary closing conditions including shareholder approval by Quando
and is expected to close after the closing of the transactions with Disney
described above. The Company expects to account for this acquisition as a
purchase transaction.
11
ITEM 2: Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Management's Discussion and Analysis of Financial Condition and Results of
Operations contains forward-looking statements within the meaning of Section 27A
of the Securities Act and Section 21E of the Exchange Act. Actual results could
differ materially from those projected in the forward-looking statements as a
result of a number of factors, including those, set forth in "Risk Factors"
beginning on page 24.
OVERVIEW
Infoseek was formed in August 1993 to develop and provide Internet and World
Wide Web search and navigational services. From inception to March 31, 1995, the
Company's operations were limited and consisted primarily of start-up
activities, including recruiting personnel, raising capital, research and
development, and the negotiation and execution of an agreement to license an
information retrieval search engine.
The Company introduced its first products and services in 1995. Through the
third quarter of 1997, the Company's strategic focus was on developing its
capabilities as an Internet search and navigation service. In response to rapid
growth and a change in the Internet search and navigation market, the Company's
Board of Directors, in the second quarter of 1997, hired a new Chief Executive
Officer, Harry Motro, to evolve the strategic vision of the Company while
continuing to leverage the Company's core strength in search and navigation. Mr.
Motro and Founder Steven Kirsch recruited a number of new members to the
executive management team to execute the Company's strategy of building Infoseek
brand awareness; creating a richer viewer experience; maximizing value for the
Company's advertisers; providing intranet search products; and enhancing
Infoseek's search and navigation service. In June 1997, the Company took a
restructuring charge of approximately $7,400,000 related to the discontinuance
of certain non-strategic business arrangements and management changes.
Beginning in early 1997, the Company began to license its Ultraseek Server
product to corporate customers for use on their intranet and public Web site
search applications. Such licensing revenues represented approximately 11% of
total revenues for both the three and nine month periods ended September 30,
1998. For the three and nine month periods ended September 30, 1997, licensing
revenues represented approximately 10% and 6%, respectively. Gross margins from
licensing Ultraseek and advertising revenues are not materially different; thus
a change in the level of this licensing business (either an increase or decrease
in relative percentage of revenue) is not expected to have a material effect on
the Company's gross margin or profit margin in the future.
In October 1997, the Company launched an enhanced version of the Infoseek
Service, with easy to navigate "channels" (now numbering 18) that integrate
search results with relevant information, services, products and communities on
the Internet. The enhanced version of the Infoseek Service provides the Company
with a platform for creating content and marketing partnerships that enrich the
viewer's experience while enabling advertisers sponsors and partners to more
effectively target viewers.
Beginning with the October 1997 launch of the enhanced version of the Infoseek
Service, the Company began to sell channel sponsorships to advertisers, sponsors
and partners. Through the
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third quarter 1998, the Company entered into various sponsor and partnership
agreements covering 12 of the Company's 18 channels. The duration of the
Company's sponsorship and partnership agreements range from two months to three
years and revenues are generally recognized ratably over the term of the
agreements, provided that minimum impressions are met, and are included in
advertising revenues.
The Company's third quarter 1998 revenues of approximately $19,196,000
represents a 129% increase as compared to the third quarter 1997 revenues of
approximately $8,381,000. Average daily page views increased to 21.4 million in
September 1998 from 20.3 million average daily page views in June 1998. Through
September 1998, the Company derived a substantial majority of its revenues from
the sale of advertisements and sponsorships on its Web pages. These revenues
accounted for approximately 89% of total revenues during the third quarter of
1998 compared with 90% during the third quarter of 1997. For the nine months
ended September 30, 1998, advertising and sponsorship revenues accounted for
approximately 89% of the total revenues compared with 94% for the same period of
1997. Most of the Company's contracts with advertising customers have terms of
three months or less, with options to cancel at any time.
The Company's significant growth and limited operating history in a rapidly
evolving industry makes it difficult to manage operations and predict future
operating results. The Company has incurred significant net losses since
inception and expects to continue to incur significant losses on a quarterly and
annual basis in 1998 and in subsequent fiscal periods. As of September 30, 1998,
the Company had an accumulated deficit of $53,724,000. The Company and its
prospects must be considered in light of the risks, costs and difficulties
frequently encountered by companies in their early stage of development,
particularly companies in the new and rapidly evolving Internet market. There
can be no assurance that the Company will be able to address any of these
challenges. Although the Company has experienced significant revenue growth in
1997 and 1998, there can be no assurance that this growth rate will be sustained
or that revenues will continue to grow or that the Company will achieve
profitability. In 1997 and 1998, the Company significantly increased its
operating expenses as a result of a substantial increase in its sales and
marketing operation, development of new distribution channels, broadening of its
customer support capabilities and funding of greater levels of research and
development. Further increases in operating expenses are planned in the future.
To the extent that any such expenses are not timely followed by increased
revenues, the Company's business, results of operations, financial condition and
prospects would be materially adversely affected.
As a result of the Company's limited operating history as well as the recent
emergence of both the Internet and intranet markets addressed by the Company,
the Company has neither internal nor industry-based historical financial data
for any significant period of time upon which to project revenues or base
planned operating expenses. The Company expects that its results of operations
may also fluctuate significantly in the future as a result of a variety of
factors, including: the proposed Starwave Acquisition (as described below),
the preview launch of the planned new portal service to be called the Go
Network (the "New Portal Service"), the continued rate of growth; usage and
acceptance of the Internet and intranets as information media; the rate of
acceptance of the Internet as an advertising medium and a channel of commerce;
demand for the Company's products and services; the advertising budgeting
cycles of individual advertisers; the introduction and acceptance of new,
enhanced or alternative products or services by the Company or by its
competitors; the Company's ability to anticipate and effectively adapt to a
developing market and to rapidly changing technologies; the Company's ability
to attract, retain and motivate qualified personnel; initiation,
implementation, renewal or expiration of significant contracts with Borders
OnLine, Inc.,
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AT&T, N2K, Microsoft, Netscape and others; pricing changes by the Company or its
competitors; specific economic conditions in the Internet and intranet markets;
general economic conditions; and other factors. Substantially all of the
Company's revenues have been generated from the sale of advertising and
sponsorships, and the Company expects to continue to derive substantially all of
its revenues from selling advertising and related products for the foreseeable
future. Moreover, most of the Company's contracts with advertising customers
have terms of three months or less. Advertising revenues are tightly related to
the amount of traffic on the Company's Web site, which is seasonal and
inherently unpredictable. Accordingly, future sales and operating results are
difficult to forecast. In addition, the Company has relied on the purchase of
traffic from Netscape, Microsoft and others as a significant portion of the
Company's total traffic. As previously discussed, the Company entered into its
agreement with Netscape in June 1998. Under the new agreement, the Company is
purchasing 15% of Netscape's available search traffic, which traffic has
decreased from 30% from a year ago. On November 11, 1998, the Company received
notice from Netscape of their intent to either terminate the contract or
negotiate a new agreement to afford Infoseek with different positioning or a
lower rotation percentage on the Netscape site on pricing terms to be mutually
agreed. While the Company and Netscape are currently in the process of
negotiating a new agreement, there can be no assurance that Netscape will be
willing to renew the agreement with the Company on commercially equivalent terms
or on other terms that may be satisfactory to the Company, if at all. If no new
agreement were entered into between Netscape and Infoseek, the current agreement
would terminate in the first quarter of 1999. Traffic on the core Infoseek
search service increased 17% in September 1998 compared to June 1998 and saw
reduced dependence on traffic purchased from Netscape. September traffic from
lower-revenue generating pages, namely chat pages, were down 10% from the month
of June 1998. In addition, page views sourced from Netscape declined from 13% of
total page views in June 1998 to 12% of total page views in September 1998.
While the Company believes that it now has a better balance in the sources of
its traffic, as Netscape comprised only 12% of total traffic and Microsoft
provided 9% of total traffic in the month of September, 1998 if total traffic
declines or does not continue growing and if the Company and Netscape are unable
to reach a new agreement it could result in an adverse impact on the Company's
business, results of operations and financial condition and prospects.
The Company's expense levels are based, in part, on its expectations as to
future revenues and, to a significant extent, are relatively fixed at least in
the short term. The Company may not be able to adjust spending in a timely
manner to compensate for any future revenue shortfall. Accordingly, any
significant shortfall in relation to the Company's expectations would have an
immediate material adverse impact on the Company's business, results of
operations, financial condition and prospects.
In addition, the Company may elect from time to time to make certain pricing,
service or marketing decisions or acquisitions that could have a short-term
material adverse effect on the Company's business, results of operations,
financial condition and prospects and which may not generate the long-term
benefits intended. From time to time, the Company has entered into and may
continue to enter into strategic relationships with companies for cross service
advertising, such as the Company's relationships with United Parcel Service of
America, Inc. ("UPS"). The Company's revenues have in the past been, and may in
the future continue to be partially dependent on its relationship with its
strategic partners. Such strategic relationships have and may continue to
include substantial one-time or up front payments from the Company's partners.
Accordingly, the Company believes that its quarterly revenues are likely to vary
significantly in the future, that period-to-period comparisons are not
necessarily meaningful and that such comparisons should not necessarily be
relied upon as an indication of the Company's future performance. Due to the
foregoing factors, it is likely that in future periods, the Company's operating
results may be below the expectations of public market analysts and investors.
In such event, the price of the Company's common stock would likely be
materially adversely affected. See "Risk Factors--Limited Operating History;
Historical Losses; Anticipation of Continued Losses," "--Potential Fluctuations
in Future Results," "--Relationship With Netscape; Reliance on Third Party
Sources of Traffic" and
14
"--Developing Market; Unproven Acceptance of Internet Advertising and of the
Company's Products and Services."
On April 17, 1998, the Company acquired WebChat Communications, Inc. ("WebChat")
in a tax-free reorganization in which a wholly owned subsidiary of the Company
was merged directly into WebChat. The Company has exchanged approximately
316,000 shares of Infoseek Corporation common stock and has reserved
approximately 11,000 shares of Infoseek common stock shares for WebChat options
assumed by the Company. The exchange ratio was 0.03 shares of common stock of
the Company for each share of the common and preferred stock of WebChat. Merger
related costs, which were not significant, were expensed in the second quarter
of 1998. The merger has been accounted for under the pooling-of-interests
method.
In June 1998, the Company entered into agreements with Starwave Corporation
("Starwave"), a Washington corporation, and with The Walt Disney Company, a
Delaware corporation, and certain Disney subsidiaries (collectively "Disney")
relating to an acquisition of Starwave by the Company through a merger and
exchange of shares (the "Starwave Acquisition") pursuant to an Agreement and
Plan of Reorganization (the "Reorganization Agreement"). In accordance with the
Agreement and Plan of Reorganization, the Company will issue 25,511,922 shares
of Infoseek Delaware common stock for all outstanding Starwave shares. The
Company will also reserve 2,626,078 shares of Infoseek Delaware common stock, in
connection with outstanding stock options of Starwave, to be assumed by the
Company. The fair value of the Company's shares and options to be issued is
approximately $897.8 million. In addition, the Company will incur direct
acquisition costs of approximately $22.0 million, which will be included in
the purchase price of Starwave. The total purchase price of Starwave is
therefor approximately $919.8 million. The Starwave acquisition is to be
accounted for as a purchase transaction. In addition, conditioned upon and
subject to consummation of the proposed Starwave Acquisition, Disney will
purchase an additional 2,642,000 unregistered shares of Infoseek Delaware
common stock and a warrant, subject to vesting, to purchase an additional
15,720,000 unregistered shares of Infoseek Delaware common stock (the
"Warrant") in exchange for approximately $70.0 million in cash and a $139.0
million five-year promissory note. The warrants will enable Disney to achieve
a majority stake in the Company over time. The agreements are subject to
customary closing conditions including shareholder approvals and governmental
regulatory approvals. As a result, the Company filed with the Securities and
Exchange Commission a joint proxy statement for a special meeting of
shareholders of Infoseek Corporation and Starwave Corporation, to be held on
November 18, 1998, to approve the Reorganization Agreement and the
transactions contemplated thereby, including the issuance of common stock and
warrants to Disney.
In addition, the Company and Disney have proposed to establish a strategic
relationship concerning the development, launch and promotion of a planned new
Internet portal service (the "New Portal Service") that would combine certain
content, promotion, brands and technologies of Infoseek, Starwave and its
joint ventures relating to ESPN SportsZone, ABCNews.com and certain Disney web
sites (the "Joint Ventures"). In connection with the New Portal Service, a
subsidiary of Disney has agreed to provide, and the Company has agreed to
purchase $165 million in promotional support and activities over five years.
Because the proposed acquisition of Starwave will be accounted for under the
"purchase" method of accounting, the purchase price will be allocated to the
acquired assets and liabilities of Starwave. An in-process research and
development charge, preliminarily estimated to be approximately $74.4 million,
will be recorded in the quarter the Starwave Acquisition is consummated. In
addition,
15
intangible assets related to developed technology and assembled workforce are
preliminarily estimated at approximately $49.4 million and will be amortized
over two years. Intangible assets related to goodwill and the Joint Ventures
were preliminarily estimated to be approximately $645.8 million and $179.5
million, respectively, which will be amortized over ten years. In addition,
the combined companies expect to incur increased operating expenditures
associated with the expanded operations of the combined companies' business
and the development, launch and promotion of the planned New Portal Service.
In this regard, the Company has agreed to use commercially reasonable efforts
to meet certain spending requirements for the planned New Portal Service
pursuant to the terms of a license agreement between Infoseek and Disney
related to the New Portal Service (the "License Agreement"). Subject to
adjustment by unanimous vote of the two member advisory committee established
pursuant to a product management agreement between Infoseek and Disney (the
"Product Management Agreement"), these spending requirements for the New
Portal Service for the first three years are $40.5 million, $58.3 million and
$64.8 million, respectively. Thereafter such requirements are to be set by
unanimous vote of the advisory committee, provided that, if no amount is
agreed to by the advisory committee, such amount shall be based on the prior
year's spending requirement as adjusted for projected growth based upon
changes in the consumer price index or certain other metrics. In addition,
pursuant to a promotional services agreement (the "Promotional Services
Agreement"), Infoseek has agreed to purchase $165 million in promotional
services over a five-year period for the New Portal Service. The amounts spent
on the purchase of promotional services under the Promotional Services
Agreement apply towards the spending requirements under the License Agreement.
As a result, after the Starwave Acquisition, Infoseek (sometimes referred to
as the "combined companies" after the Starwave Acquisition) is expected to be
delayed beyond the time frame in which Infoseek California or Starwave, as
independent entities, may have otherwise achieved profitability. Management
currently estimates that the combined companies would not achieve
profitability until at least 2002 and, excluding the amortization of goodwill
and other intangibles associated with the Starwave Merger, until at least
2000. The foregoing estimates of the time period in which the combined
companies would not achieve profitability and statements concerning the New
Portal Service are forward-looking-statements that are subject to risks and
uncertainties. Actual results may vary materially as a result of a number of
factors, including but not limited to those set forth under "Risk Factors--
Risks Related to the Combined Companies, the Mergers and Related Transactions--
Uncertainties Relating to Integration of Operations," "--Risks Related to
Development, Launch and Acceptance of Planned New Portal Service," and "--
Risks of Acquisition Strategy."
On July 24, 1998, Infoseek entered into an agreement to acquire Quando in
exchange for approximately $17 million, subject to adjustment, in shares of
Infoseek Common Stock. Quando creates and licenses regularly-updated
customized directories, including shopping guides, event guides, content
directories, audio clip libraries, review guides, and data for website rating
guides. The transaction is subject to customary closing conditions, including
shareholder approval by Quando, and is expected after the closing of the
Mergers. Infoseek expects to account for the Quando acquisition as a purchase
transaction and expects to incur write-offs related to in-process research and
development of approximately $9.4 million in the quarter ending December 31,
1998 in connection with this transaction. In addition, intangible assets
related to goodwill, developed technology and assembled workforce are
preliminarily estimated at approximately $12.6 million and will be amortized
over two years. The foregoing statements concerning the proposed acquisition
of Quando are forward looking statements which involve risks and
uncertainties, including those discussed under "RiskFactors--Risks Related to
the Combined Companies, The Mergers and Related Transactions--Risks of
Acquisition Strategy."
16
RESULTS OF OPERATIONS
Total Revenue
For the three months ended September 30, 1998 and 1997, total revenues were
$19,196,000, and $8,381,000, respectively. For the nine months ended September
30, 1998 and 1997, total revenues were $50,715,000 and $22,407,000,
respectively.
During the third quarter and through the first nine months of 1998 and 1997, the
Company derived a substantial majority of its revenues from the sale of
advertisements and sponsorships on its Web pages. Advertising revenues in the
three months ended September 30, 1998 and 1997 were $16,992,000 and $7,543,000,
respectively, representing 89% and 90% of total revenues in such periods. For
the nine months ended September 30, 1998 and 1997, advertising revenues were
$45,044,000 and $21,062,000, respectively, representing 89% and 94% of total
revenues in these periods. The growth in advertising and related revenues is
attributable to the increased use of the Internet for information publication,
distribution and commerce coupled with the development and acceptance of the
Internet as an advertising medium and increased viewer traffic on the Infoseek
Service. The Company expects to continue to derive a substantial majority of its
revenues for the foreseeable future from selling advertising and sponsorship
space on its Web sites. Advertising revenues are derived principally from
short-term advertising contracts in which the Company guarantees a minimum
number of impressions (displays of an advertisement to the viewer) for a fixed
fee. Advertising revenues are recognized ratably over the term of the contract
during which services are provided and are stated net of customer discounts. To
the extent minimum guaranteed impressions are not met, the Company defers
recognition of the corresponding revenue until the remaining guaranteed
impression levels are achieved. Deferred revenue is comprised of billings in
excess of recognized revenue related to advertising contracts.
Also included in advertising revenues is the exchange by the Company of
advertising space on the Company's Web sites for reciprocal advertising space or
traffic in other media publications or other Web sites or receipt of applicable
goods and services. Revenues from these exchange transactions are recorded as
advertising revenues at the estimated fair value of the goods and services
received and are recognized when both the Company's advertisements and
reciprocal advertisements are run or applicable goods or services are received.
Although such revenues have not exceeded 10% of total revenues in any period to
date, the Company believes these exchange transactions are of value,
particularly in the marketing of the Infoseek brand, and expects to continue to
engage in these transactions in the future.
In late 1997, the Company released an enhanced version of its service which now
features 18 "channels," designed to bring together topical information,
services, products and communities on the Web. The enhanced version of the
service provides additional opportunities for revenue from the sale of channel
sponsorships and in some circumstances enables the Company to share in a portion
of the revenue generated by its viewers with these channel sponsors. Revenue
generated by channel sponsors is included in advertising revenues and is
recognized on a straight-line basis over the terms of the agreements provided
that minimum impressions are met.
The balance of total revenues was derived from the licensing of the Ultraseek
Server product to businesses for internal use in their intranets, extranets or
public sites. This licensing revenue represented approximately 11% and 10% of
total revenue for the three months ended September
17
30, 1998 and 1997, respectively. For the nine months ended September 30, 1998
and 1997, licensing revenue represented approximately 11% and 6%, respectively.
The Company's current business model is to generate revenues through the sale of
advertising on the Internet. There can be no assurance that current advertisers
will continue to purchase advertising space and services from the Company or
that the Company will be able to successfully attract additional advertisers.
Costs and Expenses
The Company's operating expenses have increased in absolute dollars during the
third quarter and through the first nine month of 1998 compared to the third
quarter and the first nine months of 1997 as the Company has expanded its
business and the marketing of its services and products. The Company expects
operating expenses to continue to increase in dollar amount in the future as the
Company continues to expand its business.
The Company recorded aggregate deferred compensation of $6,018,000 in connection
with certain stock options granted through 1998 of which $352,000 was recorded
during the quarter ended September 30, 1998 associated with stock options
grants. The amortization of such deferred compensation is being charged to
operations over the vesting periods of the options, which are typically four
years. For the three months ended September 30, 1998 and 1997, the Company
amortized $121,000 and $380,000, respectively, related to stock options. For
the nine months ended September 30, 1998 and 1997, the Company amortized
$314,000 and $717,000, respectively. The amortization of this deferred
compensation will continue to have an adverse effect on the Company's results of
operations primarily through 1999.
In addition, on August 28, 1998 Infoseek entered into an agreement with WebTV
pursuant to which Infoseek will be the exclusive provider of search and
directory services to WebTV. Under this two year agreement, Infoseek is
responsible for managing advertising sales for all of WebTV's search traffic and
the substantial majority of WebTV's current non-search traffic. Pursuant to the
agreement, Infoseek is obligated to make cash payments to WebTV totaling $26
million, with $15 million of such amount being payable in advance for the first
five quarters during which the agreement is in effect and the remaining $11
million being payable ratably over the last three quarters of the agreement
term. Such payments by Infoseek are subject to reimbursement in the event that
WebTV is unable to deliver a minimum of 4.5 billion impressions over the life of
the agreement. Infoseek is to receive all of the revenue generated from such
advertising sales up to a pre-determined amount that is in excess of Infoseek's
total payment obligations to WebTV under the agreement, with allocations of such
revenue between Infoseek and WebTV being made beyond this pre-determined amount.
There can be no assurance that Infoseek will be able to sell the available
advertising inventory of WebTV under this agreement or be able to collect the
receivables resulting from such advertising sales, which could have a material
adverse effect on Infoseek's business, results of operations and financial
condition.
Hosting, Content and Website Costs
For the three months ended September 30, 1998 and 1997, hosting, content and
website costs were $3,278,000, and $1,567,000, respectively. For the nine months
ended September 30, 1998 and 1997, hosting, content and website costs were
$7,956,000 and $4,397,000, respectively. Hosting,
18
content and website costs consist primarily of costs associated with the
enhancement, maintenance and support of the Company's Web sites, including
telecommunications costs and equipment depreciation. Hosting, content and
website costs also include costs associated with the licensing of certain third-
party technologies. Hosting, content and website costs increased in the three
and nine months ended September 30, 1998 and 1997 as the Company added
additional equipment and personnel to support its Web sites and as royalties due
to certain third parties increased. The Company expects its hosting, content and
website costs will continue to increase in absolute dollars and possibly as a
percentage of revenues as it upgrades equipment and maintenance and support
personnel and adds content partners to meet the growing demands for Web
services.
Research and Development
For the three months ended September 30, 1998 and 1997 research and development
expenses were $2,635,000 and $1,777,000, respectively. For the nine months ended
September 30, 1998 and 1997, research and development expenses were $7,432,000
and $5,879,000, respectively. Research and development expenses consist
principally of personnel costs, consulting and equipment depreciation. Costs
related to research, design and development of products and services have been
charged to research and development expense as incurred.
The increase in research and development expenses for the three and nine months
ended September 30, 1998 over the comparable periods in 1997 was primarily the
result of on-going enhancements to the Infoseek Service and the development and
implementation of new technology and products. The Company believes that a
significant level of product development expenses is required to continue to
remain competitive in its industry. Accordingly, the Company anticipates that it
will continue to devote substantial resources to product development and that
these costs are expected to continue to increase in dollar amount in future
periods.
Sales and Marketing
For the three months ended September 30, 1998 and 1997, sales and marketing
expenses were $12,704,000, and $8,329,000, respectively. For the nine months
ended September 30, 1998 and 1997, sales and marketing expenses were $35,144,000
and $22,520,000, respectively. Sales and marketing expenses consist primarily
of compensation of sales and marketing personnel, advertising and promotional
expenses.
Sales and marketing expenses for the three month and nine month period ended
September 30, 1998 and 1997 included payments made to Netscape pursuant to an
arrangement for the listing of the Company's service on the Netscape Web page.
Through April 30, 1998, the Company's agreement with Netscape provided for
payments up to an aggregate of $12,500,000 in cash and reciprocal advertising
($10,000,000 in cash and $2,500,000 in reciprocal advertising) to be one of four
non-exclusive premiere providers of navigational services (along with Excite,
Lycos, and Yahoo!). The Netscape arrangement was subsequently extended through
May 31, 1998. The payments to Netscape were being recognized ratably over the
term of the agreement.
As of June 1, 1998, the Company entered into a one-year agreement with Netscape
with terms that provide for the Company to pay, based on impressions delivered,
up to an aggregate of $12,500,000 in cash to be one of the six non-exclusive
premier providers of navigational services (along with Excite, Netscape, Lycos,
Alta Vista, and LookSmart). Under terms of the agreement, the Company will
receive 15% of premiere provider rotations--the pages served to visitors who
have not selected a preferred provider. The payments to Netscape are being
recognized ratably over the term of the agreement. On November 11, 1998, the
Company received notice from Netscape of their intent to either terminate the
contract or negotiate a new agreement to afford Infoseek with different
positioning or a lower rotation percentage on the Netscape site on pricing terms
to be mutually agreed. While the Company and Netscape are currently in the
19
process of negotiating a new agreement, there can be no assurance that Netscape
will be willing to renew the agreement with the Company on commercially
equivalent terms or on other terms that may be satisfactory to the Company, if
at all. If no new agreement were entered into between Netscape and Infoseek, the
current agreement would terminate in the first quarter of 1999. Pages sourced
from Netscape have declined from 30% a year ago to 13% in June 1998 and 12% in
September 1998 and a loss of Netscape sourced pages could have an adverse impact
on the Company's business, results of operations and financial condition and
prospects. As of September 30, 1998, the Company has a cash commitment ranging
from a minimum of $4,150,000 to a maximum of $12,500,000 depending on the level
of traffic delivered by Netscape in connection with this agreement.
Under the terms of these agreements, the Company recognized $1,877,000 and
$2,500,000 of sales and marketing expense during the three month periods ended
September 30, 1998 and 1997, respectively. During the nine month periods ended
September 30, 1998 and 1997, the Company recognized $6,595,000 and $5,416,000,
respectively.
In addition, in July 1997, the Company entered into an agreement with Netscape
whereby it was designated as a premier provider of international search and
navigational guide services for the Netscape Net Search Program, for 10 Netscape
local Web sites. The Company's agreement with Netscape provides for payments of
up to a maximum aggregate of $1,219,000 in cash and reciprocal advertising over
the one-year term of the agreement. During the nine months ended September 30,
1998, the Company recognized sales and marketing expenses of approximately
$200,000, under this agreement as a component of sales and marketing expense
(none for the three and nine months ended September 30, 1997).
The Company also has an agreement with Microsoft to provide navigational
services on certain Microsoft web sites through which Infoseek also receives
traffic. In exchange for such traffic, the Company makes available to Microsoft
advertising space on the Infoseek service free of charge. Effective October 1,
1998, Infoseek terminated its existing agreement with Microsoft and entered into
a new agreement with Microsoft to become one of five premier providers of search
and navigation services on Microsoft's network of Internet products and
services. Under the terms of the new twelve month Microsoft agreement, Infoseek
is obligated to pay an aggregate of $10,675,000 for a guaranteed minimum number
of impressions on both Microsoft's Internet Explorer search feature and
Microsoft's website. Infoseek will also pay, based on the number of impressions
delivered, for additional impressions on both Internet Explorer and Microsoft's
website, up to a maximum of $18,000,000. The accounting treatment for the
Microsoft agreement will result in amortizing the obligated amount over the one-
year term of the agreement, beginning in the quarter ended December 31, 1998,
the quarter when the service is launched.
At the end of the terms of the respective agreements with Netscape and
Microsoft, there can be no assurance that these agreements with Netscape and
Microsoft or other similar agreements can or will be renewed on terms
satisfactory to the Company. If the Company is unable to renew these or other
similar agreements on favorable terms or is otherwise unable to develop viable
alternative distribution channels to Netscape and Microsoft or is otherwise
unable to offset a reduction in traffic from these or other third party sources,
advertising revenues would be adversely affected, resulting in the Company's
business, results of operations, financial condition and prospects being
materially and adversely affected. See "Risk Factors--Relationship with
Netscape; Reliance on Third Party Sources of Traffic".
The increase in sales and marketing expenses for the nine months ended September
30, 1998 over 1997 was also the result of hiring additional sales and marketing
personnel and an increase in promotional and advertising activity including
advertising campaigns in both 1998 and 1997,
20
including television. The Company expects to increase the amount of promotional
and advertising expenses and anticipates hiring additional sales representatives
in future periods.
General and Administrative
For the three months ended September 30, 1998 and 1997 general and
administrative expenses were $3,953,000, and $1,947,000, respectively. For the
nine months ended September 30, 1998 and 1997, general and administrative
expenses were $7,876,000 and $5,242,000, respectively. General and
administrative expenses consist primarily of compensation of administrative and
executive personnel, facility costs and fees for professional services.
The increase in general and administrative expenses for the three months and
nine months ended September 30, 1998 over the comparable periods in 1997 was the
result of hiring additional administrative and executive staff and adding
infrastructure to manage the expansion of the business. The Company anticipates
that its general and administrative expenses will continue to increase in dollar
amount as the Company continues to expand its administrative and executive
staff.
In connection with the Mergers and the Related Transactions, Infoseek has
incurred direct costs associated with the Mergers of approximately $2.8 million
as of September 30, 1998 and estimates that it will incur total direct costs of
approximately $22.0 million associated with the Mergers, which will be accounted
for as part of the purchase price of the transactions. The $22.0 million in
merger costs includes approximately $5.0 million for liabilities related to
involuntary employee termination benefits and relocations of Starwave employees
and $5.0 million for costs to exit other Starwave activities, primarily
operating leases of Starwave. In the event the proposed Mergers are not
consummated, the Company will need to write-off the $2.8 million of direct costs
to operations. The combined companies expect to incur additional integration
costs of up to $5.0 million of which $1.4 million were included in the results
for the quarter ended September 30, 1998. These integration costs will affect
future operations and do not qualify as liabilities in connection with a
purchase business combination. There can be no assurance that the combined
companies will not incur additional material charges in subsequent quarters to
reflect additional costs associated with the Mergers or other transactions. See
"Risk Factors--Risks Relating to the Combined Companies, the Mergers and Related
Transactions--Amortization of Goodwill and Increased Operating Costs Will Delay
Profitability of Combined Companies," "--Costs of Integration; Transaction
Expenses," and "--Risks of Acquisition Strategy."
Restructuring and Other Charges
During the second quarter of 1997, the Company recorded restructuring and other
charges of approximately $7,400,000, of which approximately $6,200,000 related
to the discontinuance of certain business arrangements which were determined to
be non-strategic, and approximately $1,200,000 related to management changes. Of
these restructuring charges, approximately $5,000,000 involved cash outflows,
all of which have been completed as of June 30, 1998. Non-cash restructuring
charges of approximately $2,400,000 related primarily to the write-down of
certain non-strategic business assets which were written off in June 1997. There
were no material changes to the restructuring plan or in the estimates of the
restructuring costs.
21
Income Taxes
Due to the Company's loss position, there was no provision for income taxes for
any of the periods presented. At December 31, 1997, the Company had federal and
state net operating loss carry forwards of approximately $42,600,000 and
$28,300,000, respectively. The federal net operating loss carry forwards will
expire beginning in 2009 through 2012, if not utilized, and the state net
operating loss carry forwards will expire in the years 1999 through 2002.
Certain future changes in the share ownership of the Company, as defined in the
Tax Reform Act of 1986 and similar state provisions, may restrict the
utilization of carry forwards. A valuation allowance has been recorded for the
entire deferred tax asset as a result of uncertainties regarding the realization
of the asset due to the lack of earnings history of the Company.
Year 2000 Compliance
Infoseek is aware of the issues associated with the programming code in existing
computer systems as the year 2000 approaches. The "year 2000 problem" is
pervasive and complex as virtually every computer operation will be affected in
some way by the rollover of the two-digit year value to 00. The issue is whether
computer systems will properly recognize date sensitive information when the
year changes to 2000. Systems that do not properly recognize such information
could generate erroneous data or cause a system to fail.
Infoseek management has conducted a review of Infoseek's exposure to the year
2000 problem, including working with computer systems and software vendors to
assure that they are prepared for the year 2000. Based on this review and
discussions with such vendors, Infoseek currently believes that its internal
systems are year 2000 compliant (with the exception of a single system, which is
scheduled to be replaced as part of a regular upgrade program and is not
material to Infoseek's operations). Infoseek does not expect to further incur
any significant operating expenses or invest in additional computer systems to
resolve issues relating to the year 2000 problem, with respect to both its
information technology and product and service functions.
Notwithstanding the foregoing, significant uncertainty exists concerning the
effects of the year 2000 problem, including uncertainty with respect to
assurances made by Infoseek's vendors. Further, Infoseek has not investigated
year 2000 compliance of third parties who are not vendors of Infoseek, and
Infoseek has no control over such third parties' compliance. For example, the
failure of any site to which a link appears on the Infoseek Service could result
in the loss of such link and therefore reduce the breadth of services offered
through links from the Infoseek Service, which may in turn materially adversely
affect the Infoseek Service and the value of user traffic and advertisers using
such service. Any failure of Infoseek or its viewers, customers, linked sites,
advertisers or other third parties to be year 2000 compliant could materially
affect the business, results of operations, financial conditions and prospects
of Infoseek.
LIQUIDITY AND CAPITAL RESOURCES
From inception through May 1996, the Company financed its operations and met its
capital expenditure requirements primarily from proceeds derived from the
issuance of equity, convertible debt securities and equipment term loans. In
February 1998, the Company completed a follow-on public offering and received
approximately $43,015,000 net of underwriting discounts,
22
commissions and other offering costs. The proceeds will be used for general
corporate purposes, including expansion of its sales and marketing efforts, and
capital expenditures.
For the first nine months ended September 30, 1998, operating activities used
cash of $10,970,000 due primarily to the Company's net loss and increases in
deposits and other current assets, direct acquisition costs and a decrease in
accrued liabilities to service providers offset by increases in depreciation and
amortization and deferred revenue. For the nine month period ended September
30, 1997, operating activities used cash of $15,301,000 due primarily to the
Company's net loss partially offset by increases in accrued restructuring and
other charges, depreciation and amortization and deferred revenue. For the nine
months ended September 30, 1998, investing activities used cash of $28,794,000
primarily related to the net purchases of short-term investments. For the nine
months ended September 30, 1997, investing activities provided net cash of
$6,743,000, primarily associated with the sale of short-term investments.
Financing activities generated cash of $43,242,000, and $7,311,000, in the nine
months ended September 30, 1998 and 1997, respectively, primarily from the
Company's follow-on public offering in February 1998 and equipment term loans in
1997.
The Company has commitments for its facilities under operating lease agreements
and expects to continue to incur significant capital expenditures to support
expansion of the Company's business. Furthermore, from time to time the Company
expects to evaluate the acquisition of products, businesses and technologies
that complement the Company's business.
The Company had $54,541,000 in cash, cash equivalents and short-term investments
at September 30, 1998. The Company currently anticipates that its cash, cash
equivalents, short-term investments, and cash flows generated from advertising
revenues will be sufficient to meet its anticipated needs for working capital
and other cash requirements through at least September 30, 1999. Thereafter,
the Company may need to raise additional funds. The Company may need to raise
additional funds sooner, however, in order to fund more rapid expansion, to
develop new or enhance existing services or products, to respond to competitive
pressures or to acquire complementary products, businesses or technologies. If
additional funds are raised through the issuance of equity or convertible debt
securities, the percentage ownership of the shareholders of the Company will be
reduced, shareholders may experience additional dilution and such securities may
have rights, preferences or privileges senior to those of the holders of the
Company's common stock. There can be no assurance that additional financing will
be available on terms favorable to the Company, or at all. If adequate funds are
not available or are not available on acceptable terms, the Company's ability to
fund expansion, take advantage of acquisition opportunities, develop or enhance
services or products or respond to competitive pressures would be significantly
limited. Such limitation could have a material adverse effect on the Company's
business, results of operations, financial condition and prospects. The estimate
of the period for which the Company expects its available funds to be sufficient
to meet its capital requirements is a forward-looking statement that involves
risks and uncertainties. There can be no assurance that the Company will be able
to meet its working capital and other cash requirements for this period as a
result of a number of factors including but not limited to those described under
"Risk Factors--Future Capital Needs; Uncertainty of Additional Financing".
23
RISK FACTORS
In evaluating the Company's business, investors should carefully consider the
following risk factors in addition to the other information set forth herein.
These Risk Factors contain forward-looking statements within the meaning of
Section 27A of the Securities Act and Section 21E of the Exchange Act. Actual
results could differ materially from those projected in the forward-looking
statements as a result of a number of factors. As used in this section, unless
the context otherwise requires, "Starwave" refers to Starwave as well as that
portion of Starwave's business that is conducted through the Joint Ventures.
RISKS RELATED TO INFOSEEK'S BUSINESS
Limited Operating History; Historical Losses; Anticipation of Continued Losses.
The Company's limited operating history makes it difficult to manage operations
and predict future operating results. The Company has incurred significant net
losses since inception and expects to continue to incur significant losses on a
quarterly and annual basis in 1998 and may do so in subsequent fiscal periods.
As of September 30, 1998, the Company had an accumulated deficit of $53,724,000.
The Company and its prospects must be considered in light of the risks, costs
and difficulties frequently encountered by companies in their early stage of
development, particularly companies in the new and rapidly evolving Internet
market. There can be no assurance that the Company will be able to address any
of these challenges. Although the Company has experienced significant revenue
growth in 1997 and the first half of 1998, there can be no assurance that this
growth rate will be sustained or that revenues will continue to grow or that the
Company will achieve profitability. In 1997 and the first nine month of 1998,
the Company significantly increased its operating expenses as a result of a
substantial increase in its sales and marketing efforts, development of new
distribution channels, expansion of its customer support capabilities and to
fund greater levels of research and development. Further increases in operating
expenses are planned during fiscal 1998. To the extent that any such expenses
are not timely followed by increased revenues, the Company's business, results
of operations, financial condition and prospects would be materially adversely
affected.
Relationship with Netscape; Reliance on Third Party Sources of Traffic and
Advertising Sales. The Company relies in part on third party sources of
traffic to its web site, including Netscape and Microsoft, among others,
pursuant to contractual arrangements which generally have terms of one year or
less. For the year ended December 31, 1997 and the first nine months ended
September 30, 1998, approximately 46% and 35% of the aggregate page views on the
Company's web site were generated by traffic derived from third party sources.
Since March 1995, the Company has been a featured provider of navigational
services on the Web page of Netscape. In 1996 and 1997 and during the first nine
months of 1998, approximately 65%, 33% and 16%, respectively, of all page views
served on the Infoseek Service came from traffic attributable to the Netscape
web page. As of June 1, 1998, the Company entered into a one-year agreement with
Netscape with terms that provide for the Company to pay, based upon the level of
impressions delivered, up to an aggregate of $12,500,000 in cash to be one of
the six non-exclusive premier providers of navigational services (along with
Excite, Netscape, Lycos, Alta Vista, and LookSmart). Under terms of the
agreement, which expires May 31, 1999 (unless sooner terminated as described
below), the Company will receive 15% of premier provider rotations--the pages
served to visitors who have not selected a preferred provider. The payments to
Netscape are being recognized ratably over the term of the agreement. On
November 11, 1998, the Company received notice from Netscape of their intent
to either terminate the contract or negotiate a new agreement to afford
Infoseek with different positioning or a lower rotation percentage on the
Netscape site on pricing terms to be mutually agreed. While the Company and
Netscape are currently in the process of negotiating a new agreement, there
can be no assurance that Netscape will be willing to renew the agreement with
the Company on commercially equivalent terms or on other terms that may be
satisfactory to the Company, if at all. If no new agreement were entered into
between Netscape and Infoseek, the current agreement would terminate in the
first quarter of 1999. The Company also has an agreement with Microsoft to
become one of five premier providers of search and navigational
24
services on Microsoft's network of Internet products and services. Under the
agreement with Microsoft which expires in September 1999, the Company is
obligated to pay an aggregate of $10,675,000 for a guaranteed minimum number of
impressions on both Microsoft's Internet Explorer search feature and Microsoft's
website. The Company will also pay, based on the number of impressions
delivered, for additional impressions on both Internet Explorer and Microsoft's
website, up to a maximum of $18,000,000. The accounting treatment for the
Microsoft agreement will result in amortizing the obligated amount over the one-
year term of the agreement, beginning in the quarter ended December 31, 1998,
the quarter when the service is launched. At the end of the agreement term,
there can be no assurance that these or other similar agreements can or will be
renewed on terms satisfactory to the Company. If the Company is unable to renew
these or other similar agreements on favorable terms or is otherwise unable to
develop viable alternative distribution channels to Netscape or Microsoft or is
otherwise unable to offset a reduction in traffic from these or other third
party sources, advertising revenues would be adversely affected, resulting in
the Company's business, results of operations, financial condition and prospects
being materially and adversely affected. In addition, the Company recently
entered into an agreement with WebTV Networks, Inc. ("WebTV") pursuant to which
the Company will be the exclusive provider of search and directory services to
WebTV. Under this two year agreement, the Company is responsible for managing
advertising sales for all of WebTV's search traffic and the substantial majority
of WebTV's current non-search traffic. Pursuant to the agreement, the Company is
obligated to make cash payments to WebTV totaling $26 million, with $15 million
of such amount being payable in advance for the first five quarters during which
the agreement is in effect and the remaining $11 million being payable ratably
over the last three quarters of the agreement term. Such payments by the Company
are subject to reimbursement in the event that WebTV is unable to deliver a
minimum of 4.5 billion impressions over the life of the agreement. The Company
is to receive all of the revenue generated from such advertising sales up to a
pre-determined amount that is in excess of the Company's total payment
obligations to WebTV under the agreement, with allocations of such revenue
between the Company and WebTV being made beyond this pre-determined amount.
There can be no assurance that the Company will be able to sell the available
advertising inventory of WebTV under this agreement or be able to collect the
receivables resulting from such advertising sales, which could have a material
adverse effect on the Company's business, results of operations and financial
condition. See "the Company Management's Discussion and Analysis of Financial
Condition and Results of Operations."
Potential Fluctuations in Future Results. As a result of the Company's limited
operating history as well as the recent emergence of both the Internet and
intranet markets addressed by the Company, the Company has neither internal nor
industry-based historical financial data for any significant period of time upon
which to project revenues or base planned operating expenses. The Company
expects that its results of operations may also fluctuate significantly in the
future as a result of a variety of factors, including: the continued rate of
growth, usage and acceptance of the Internet and intranets as information media;
the rate of acceptance of the Internet as an advertising medium and a channel of
commerce; demand for the Company's products and services; the advertising
budgeting cycles of individual advertisers; the introduction and acceptance of
new, enhanced or alternative products or services by the Company or by its
competitors; the Company's ability to anticipate and effectively adapt to a
developing market and to rapidly changing technologies; the Company's ability to
attract, retain and motivate qualified personnel; initiation, implementation,
amendment, renewal or expiration of significant contracts with Borders Group,
Inc. ("Borders OnLine"), Microsoft, Netscape and others; pricing changes by the
Company or its competitors; specific economic conditions in the Internet and
intranet markets; general economic conditions; and
25
other factors. Substantially all of the Company's revenues have been generated
from the sale of advertising, and the Company expects to continue to derive
substantially all of its revenues from selling advertising and related products
for the foreseeable future. Moreover, most of the Company's contracts with
advertising customers have terms of three months or less. Advertising revenues
are tightly related to the amount of traffic on the Company's web site, which is
inherently unpredictable. Accordingly, future sales and operating results are
difficult to forecast. The Company's expense levels are based, in part, on its
expectations as to future revenues and, to a significant extent, are not
expected to decrease, at least in the short term. The Company may not be able to
adjust spending in a timely manner to compensate for any future revenue
shortfall. Accordingly, any significant shortfall in relation to the Company's
expectations would have an immediate material adverse impact on The Company's
business, results of operations, financial condition and prospects.
In addition, The Company may elect from time to time to make certain pricing,
service or marketing decisions or acquisitions that could have a short-term
material adverse effect on The Company's business, results of operations,
financial condition and prospects and which may not generate the long-term
benefits intended. From time to time, The Company has entered into and may
continue to enter into strategic relationships with companies for cross service
advertising, such as The Company's relationship with United Parcel Service of
America, Inc. ("UPS"). The Company's revenues have in the past been, and may in
the future continue to be, partially dependent on its relationship with its
strategic partners. Such strategic relationships have and may continue to
include substantial one-time or up front payments from The Company's partners.
Accordingly, The Company believes that its quarterly revenues are likely to vary
significantly in the future, that period-to-period comparisons are not
necessarily meaningful and that such comparisons should not necessarily be
relied upon as an indication of The Company's future performance. Due to the
foregoing factors, it is likely that in future periods, The Company's operating
results may be below the expectations of public market analysts and investors.
In such event, the price of The Company's common stock would likely be
materially adversely affected.
Risks Associated with Brand Development. The Company believes that
establishing and maintaining the Infoseek brand is a critical aspect of its
efforts to attract and expand its audience and that the importance of brand
recognition will increase due to the growing number of Internet sites and the
relatively low barriers to entry. Promotion and enhancement of the Infoseek
brand will depend largely on the Company's success in providing high-quality
products and services and in designing and implementing effective media
promotions, which success cannot be assured. In order to attract and retain
Internet users and to promote and maintain the Infoseek brand in response to
competitive pressures, the Company believes it is necessary to increase
substantially its financial commitment to creating and maintaining a distinct
brand loyalty among consumers. If the Company is unable to provide high-quality
products and services, design and implement effective media promotions or
otherwise fails to promote and maintain its brand, or if the Company incurs
excessive expenses in an attempt to improve its products and services or promote
and maintain its brand, The Company's business, results of operations, financial
condition and prospects would be materially and adversely affected.
Intense Competition. The market for Internet and intranet products and
services is highly competitive, and The Company expects that competition will
continue to intensify. The market for Internet and intranet search and
navigational services has only recently begun to develop, and The Company cannot
predict with any certainty how competition will affect The Company, its
26
competitors or its customers. The Company also believes that the Internet market
increasingly will require portal services to integrate a more robust array of
multimedia content and services. As such, The Company believes that its future
success in part will depend upon its ability to effectively and timely integrate
such content and services, including but not limited to further advancements in
search and directory and other technologies and functionality, development of
on-line communities, implementation of electronic commerce and provision of rich
and diverse multimedia content. There can be no assurance that The Company will
be able to compete successfully or that the competitive pressures faced by the
Company, including those listed below, will not have a material adverse effect
on the Company's business, results of operations, financial condition and
prospects. The Company believes it faces numerous competitive risks, including
the following:
Competition from Consolidated Internet Products. 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, Netscape has recently announced that it has signed a two-year
strategic partnership with Excite to build out content based channels
jointly for Netscape's Web site and to create co-branded search, thereby
competing directly with the Company. The Web browser offered by Microsoft,
another widely-used browser and substantial source 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. Microsoft recently licensed products and services from Inktomi
Corporation ("Inktomi"), a direct competitor of the Company, and has
announced that it will feature and promote Inktomi services in the
Microsoft Network and other Microsoft online properties. The Company
expects that such search services may be tightly integrated into the
Microsoft operating system, the Internet Explorer browser and other
software applications, and that Microsoft will promote such services
within the Microsoft Network or through other Microsoft-affiliated end-
user services such as MSNBC or WebTV. In addition, entities that sponsor or
maintain high-traffic Web sites or that provide an initial point of entry
for Internet viewers, 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. For example, AOL is currently a
significant shareholder of Excite and offers Excite's WebCrawler and
NetFind as the exclusive Internet search and retrieval services for use by
AOL's subscribers. Continued or increased competition from such
consolidations, integration and strategic relationships involving
competitors of the Company could have a material adverse effect on the
Company's business, results of operations, financial condition and
prospects.
Competition from existing search and navigational competitors. Many
companies currently offer directly competitive products or services
addressing Web search and navigation, including DEC/AltaVista, Excite,
HotBot, Inktomi, Lycos, CNET and Yahoo! In addition, the Company's
Ultraseek Server product competes directly with intranet products and
services offered by companies such as DEC/AltaVista, Lycos, Open Text and
Verity. The Web browsers currently offered by Netscape and Microsoft,
which are the two most widely-used browsers, incorporate prominent search
buttons and similar features, such as features
27
based on "push" technologies, that direct search traffic to competing
services, including those that may be developed or licensed by Microsoft or
Netscape in enhancements or later versions of these or other products. Many
of the Company's existing competitors, as well as a number of potential new
competitors, have significantly greater financial, technical, marketing and
distribution resources than the Company.
Competition from Internet and other advertising media. The Company also
competes with online services, other Web site operators and advertising
networks, as well as traditional media such as television, radio and print
for a share of advertisers' total advertising budgets. Additionally, a
large number of Web sites and online services (including, among others, the
Microsoft Network, MSNBC, AOL and other Web navigation companies such as
Excite, Lycos and Yahoo!) offer informational and community features, such
as news, stock quotes, sports coverage, yellow pages and e-mail listings,
weather news, chat services and bulletin board listings that are
competitive with the services currently offered or proposed to be offered
by the Company. Moreover, the Company believes that the number of companies
selling Web-based advertising and the available inventory of advertising
space have recently increased substantially. Accordingly, the Company may
face increased pricing pressure for the sale of advertisements and
reductions in the Company's advertising revenues.
Low barriers to entry for new search and navigational companies. The
Company believes that the costs associated with developing technologies,
products and services that compete with those offered by the Company are
relatively low. As a result, as the market for Internet and intranet search
and navigational products develops, other companies may be expected to
offer similar products and services and directly and indirectly compete
with the Company for advertising revenues.
Reliance on Advertising Revenues. The Company has derived a substantial
majority of its revenues to date from the sale of advertisements and expects to
continue its dependence on advertising and related products, including channel
sponsorships and, to a lesser extent, the sale of the Ultramatch advertising
management system and the Ultraseek Server intranet product. The Company's
current business model of generating revenues through the sale of advertising on
the Internet, which is highly dependent on the amount of traffic on the
Company's web site, is relatively unproven. The Internet as an advertising
medium has not been available for a sufficient period of time to gauge its
effectiveness as compared with traditional advertising media. In addition, most
of the Company's current advertising customers have limited or no experience
using the Internet as an advertising medium, have not devoted a significant
portion of their advertising expenditures to such advertising and may not find
such advertising to be effective for promoting their products and services
relative to advertising in traditional media. There can be no assurance that
current advertisers will continue to purchase advertising space and services
from the Company or that sufficient impressions will be achieved or available,
or that the Company will be able to successfully attract additional advertisers.
Furthermore, with the rapid growth of available inventory on the Internet and
the intense competition among sellers of advertising space, it is difficult to
project future levels of advertising revenues and pricing models that will be
adopted by the industry or individual companies. In addition, the ability to
quickly develop new business models which will generate additional revenue
sources may be vital for the Company to remain competitive in its marketplace.
Accordingly, there can be no assurance that the Company will be successful in
generating significant future advertising revenues or other source of revenues;
failure to do so could have a
28
material adverse effect on the Company's business, results of operations,
financial condition and prospects.
Technological Change and New Products and Services. The market for Internet
products and services is characterized by rapid technological change, changing
customer needs, frequent new product introductions and evolving industry
standards. 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 and services in the near future. The Company's future success
will depend on its ability to continually and, on a timely basis, introduce new
products, services and technologies and to continue to improve the performance,
features and reliability of the Company's products and services in response to
both evolving demands of the marketplace and competitive product offerings.
In the fourth quarter of 1997, the Company released an enhanced version of its
service which currently features 18 "channels," designed to bring together
topical information, services, products and communities on the Web. The enhanced
version of the service provides additional opportunities for revenue from the
sale of channel sponsorships as well as provides an opportunity for the Company
to share in a portion of the revenue facilitated by its viewers with these
channel sponsors. Continued market acceptance of this new version and successful
conclusion of sponsorship arrangements are integral to the Company's
competitiveness and viability. Most of the Company's additional channel
sponsorship and partnership arrangements are dependent on an increasing level of
viewer traffic. If the Company is unable to renew its relationship with
Netscape, or if viewer traffic is otherwise materially adversely affected, the
Company may be unable to retain its channel sponsorship and partnership
arrangements. In addition, there can be no assurance that this new sponsorship
service or any other new or proposed product or service will attain market
acceptance, experience technological sustainability or be free of errors that
require significant design modifications or that the business model to generate
revenues will be successful. Failure of the Company to successfully design,
develop, test, market and introduce other new and enhanced technologies and
services, or any enhancements of the Company's current search technology, or the
failure of the Company's recently introduced products and services to achieve
market acceptance could have a material adverse effect upon the Company's
business, results of operations, financial condition and prospects.
Due to rapid technological change, changing customer needs, frequent new product
and service introductions and evolving industry standards, timeliness of
introduction of these new products and services is critical. Delays in the
introduction of new products and services may result in customer dissatisfaction
and may delay or cause a loss of advertising revenue. There can be no assurance
that the Company will be successful in developing new products or services or
improving existing products and services that respond to technological changes
or evolving industry standards, that the Company will not experience
difficulties that could delay or prevent the successful development,
introduction and marketing of new or improved products and services, or that its
new products and services will adequately meet the requirements of the
marketplace and achieve market acceptance. If the Company is unable to develop
and introduce new or improved products or services in a timely manner in
response to changing market conditions or customer requirements, the Company's
business, results of operations, financial condition and prospects could be
materially adversely affected.
29
Management of Growth. The Company has recently experienced and may continue to
experience rapid growth, which has placed, and could continue to place, a
significant strain on the Company's limited personnel and other resources.
Competition for engineering, sales and marketing personnel is intense, and there
can be no assurance that the Company will be successful in attracting and
retaining such personnel or that the Company will be able to manage such growth
effectively. To succeed, the Company will need to continue to implement and
improve its operational, financial and management information systems and to
hire, train, motivate and manage its employees. In particular, the Company has
experienced difficulty in hiring and retaining the personnel necessary to
support the growth of the Company's business. The failure of the Company to
successfully manage any of these issues would have a material adverse effect on
the Company's business, results of operations, financial condition and
prospects. The Company's ability to manage its growth will require a significant
investment in and upgrade to its existing internal management information
systems to support increased accounting and other management related functions,
and a new advertising inventory management analysis system to provide enhanced
internal reporting and customer feedback on advertising. These system upgrades
and replacements will impact almost all phases of the Company's operations (i.e.
planning, advertising implementation and management, finance and accounting).
These systems are currently scheduled to become operational in 1999. There can
be no assurance that the Company will not experience problems, delays or
unanticipated additional costs in implementing these systems or in the use of
its existing system that could have a material adverse effect on the Company's
business, results of operations, financial condition and prospects, particularly
in the period or periods in which these systems are brought online.
Capacity Constraints and System Failure; Advertising Management System. A key
element of the Company's strategy is to generate a high volume of traffic to its
products and services. 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 market acceptance of these products
and services. Any system failure that causes interruptions or that increases
response time of the Company's products and services would result in less
traffic to the Company's web sites and, if sustained or repeated, would reduce
the attractiveness of the Company's products and services to advertisers and
customers. In addition, an increase in the volume of searches conducted through
the Company's products and services could strain the capacity of the software,
hardware or telecommunications lines deployed by the Company, which could lead
to slower response time or system failures. If traffic to the Company's web site
continues to increase, there can be no assurance that the Company's products,
services and systems will be able to scale appropriately. The Company is also
dependent upon web browser companies and Internet and online service providers
for access to its products and services, and viewers have experienced and may in
the future experience difficulties due to system or software failures or
incompatibilities not within the Company's control. 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. Any disruption in the Internet access and service provided by the
Company or its service providers could have a material adverse effect upon the
Company's business, results of operations, financial condition and prospects.
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
continues to evaluate alternative advertising management systems including other
third party and internally developed applications and recently began to evaluate
Starwave's advertising delivery system which it may adopt for its
30
own use if proposed Starwave acquisition occurs. The Company currently
anticipates that this new advertising management system will be installed and
become operational in 1999. The time period in which the Company estimates a new
advertising management system to be operational is a forward looking statement
that is subject to risks and uncertainties and actual results may differ
materially. To the extent that the Company encounters material difficulties in
bringing, or is unable to bring, this new system online, the Company will need
to acquire an alternative solution from a third party vendor or devote
sufficient resources to enhance its current internally developed system. 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 would, among other consequences, reduce revenue and would
have a material adverse effect on the Company's business, results of operations,
financial condition and prospects.
In addition, the Company's operation depends upon its ability to maintain and
protect its computer systems, all of which are located at the Company's
principal offices in Sunnyvale, California. This system is vulnerable to damage
from fire, floods, earthquakes, power loss, telecommunications failures, break-
ins and similar events. Although the Company maintains insurance against fires,
floods, earthquakes and general business interruptions, there can be no
assurance the the amount of coverage will be adequate in any particular case.
The Company does not currently have a disaster recovery plan in effect and does
not have redundant systems for its service at an alternate site. 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 in or temporary cessation of service to users of the
Company's products and services. The occurrence of any of these events would
have a material adverse effect on the Company's business, results of operations,
financial condition and prospects.
Risks Associated with International Expansion. As part of its business
strategy, the Company has begun to seek additional opportunities to expand its
products and services into international markets. The Company believes that such
expansion is important to the Company's ability to continue to grow and to
market its products and services. In marketing its products and services
internationally, however, the Company faces new competitors. In addition, the
Company's success in entering international markets is 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 or 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 and services 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 these 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. In the event that in the future the
combined companies derive a material portion of their revenues from
international operations, the risks of fluctuations in currency exchange rates
will be increased. In such event and at such time, the combined companies will
evaluate whether to engage in a hedging strategy to minimize the
31
risks of such currency fluctuations. There can be no assurance that one or more
of such factors would not have a material adverse effect on any international
operations established by the Company and, consequently, on the Company's
business, results of operations, financial condition and prospects.
Dependence on Key Personnel. The Company's performance is substantially
dependent on the services of the members of its senior management team, as well
as its ability to retain and motivate its officers and key employees. In
addition, the Company has recently hired, and plans to continue to hire, a
number of engineers to design and implement improvements to the integration of
content with its search engine technology, which the Company believes will be a
significant factor in its future ability to compete favorably with other
navigational guides. The Company's future performance depends in significant
part upon the contributions of its senior management personnel, including its
Chairman Steven Kirsch, who is integrally involved in the Company's research and
development efforts. Although the Company provides incentives such as salary,
benefits and option grants (which are typically subject to vesting over four
years) to attract and retain qualified employees, the loss of services of any of
the Company's officers or other key employees would have a material adverse
effect on the Company's business, results of operations, financial condition and
prospects.
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.
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 seeks to protect its software, documentation and other written materials
under trade secret, patent and copyright laws, which afford only limited
protection. The Company holds two United States patents and currently has 10
United States patent applications pending and six foreign patent applications
pending. There can be no assurance that the pending applications will be
approved, or that if issued, such patents will not be challenged, and if such
challenges are brought, that such patents will not be invalidated. There can be
no assurance that the Company will develop proprietary products or technologies
that are patentable, 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 ability
to do business. The Company has registered and applied for registration for
certain service marks and trademarks, and will continue to evaluate the
registration of additional service marks and trademarks, as appropriate. The
Company generally enters into confidentiality agreements with its employees and
with its consultants and customers. Litigation may be necessary to protect the
Company's proprietary technology. Any such litigation may be time-consuming and
costly. Despite
32
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. In addition, the
laws of some foreign countries do not protect proprietary rights to as great an
extent as do the laws of the United States. 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, patents, copyrights, trademarks or other proprietary
rights, that the Company will counterclaim against any such parties in such
actions or that if the Company makes claims against third parties with respect
thereto, that any such party will not counterclaim against the Company in such
actions. For example, the Company is aware of a U.S. patent recently issued to
Carnegie Mellon related to Web spider technology that has been licensed to Lycos
and is currently utilized in the Lycos search engine. While the Company
currently believes, based on a preliminary review of such issued patent and
consultation with its patent counsel, that the technologies employed by the
Company in the Infoseek Service do not infringe the Carnegie Mellon patent,
there can be no assurance that the Company would prevail if Lycos or Carnegie
Mellon claimed the Company infringed such patent. Any such claims or
counterclaims could be time-consuming, result in costly litigation, 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, financial condition and prospects. Such royalty or licensing
agreements, if required, may not be available on terms acceptable to the Company
or at all.
Termination Fees, Options. If the Reorganization Agreement is terminated under
certain circumstances, the Company would be required to pay Starwave a fee of
$17 million plus expenses. In addition, if the Reorganization Agreement is
terminated under circumstances in which Infoseek California is required to pay a
termination fee to Starwave, then Disney shall have the right to exercise one or
both of two options. The first option includes the right to obtain a
nonexclusive, worldwide license for five years, with certain rights to
sublicense, to use Infoseek search and communication technology in connection
with the development, operation and exploitation of Disney's and its affiliates'
online services, in exchange for an annual fee. The second option would enable
Disney to have prominent placement for links of certain online services of
Disney and its affiliates on Infoseek's Internet Service for a term of five
years, and prominent placement of content of Disney and its affiliates within
Infoseek's Internet services in exchange for an annual fee. Exercise of one or
both of the options could have the effect of discouraging certain third parties
from entering into strategic licensing or other transactions with Infoseek
California, including a business combination or acquisition.
RISKS RELATED TO THE COMBINED COMPANIES, THE MERGERS AND RELATED TRANSACTIONS
These Risk Factors are forward-looking statements within the meaning of Section
27A of the Securities Act and Section 21E of the Exchange Act. Such forward-
looking statements are based upon the completion of the proposed transactions
contemplated by the Reorganization Agreement as described below. For purposes
herein, statements referring to Infoseek after the Starwave Acquisition
sometimes refer to the "combined companies" or "Infoseek and Starwave." Actual
33
results could differ materially from those projected in the forward-looking
statements as a result of a number of factors.
As of June 1, 1998, the Company entered into a one-year agreement with Netscape
with terms that provide for the Company to pay, based on impressions delivered,
up to an aggregate of $12,500,000 in cash to be one of the six non-exclusive
premier providers of navigational services (along with Excite, Netscape, Lycos,
Alta Vista, and LookSmart). Under terms of the agreement, the Company will
receive 15% of premiere provider rotations--the pages served to visitors who
have not selected a preferred provider. The payments to Netscape are being
recognized ratably over the term of the agreement. On November 11, 1998, the
Company received notice from Netscape of their intent to either terminate the
contract or negotiate a new agreement to afford Infoseek with different
positioning or a lower rotation percentage on the Netscape site on pricing terms
to be mutually agreed. While the Company and Netscape are currently in the
process of negotiating a new agreement, there can be no assurance that Netscape
will be willing to renew the agreement with the Company on commercially
equivalent terms or on other terms that may be satisfactory to the Company, if
at all. If no new agreement were entered into between Netscape and Infoseek, the
current agreement would terminate in the first quarter of 1999. Pages sourced
from Netscape have declined from 30% a year ago to 13% in June 1998 and 12% in
September 1998 and a loss of Netscape sourced pages could have an adverse impact
on the Company's business, results of operations and financial condition and
prospects. As of September 30, 1998, the Company has a cash commitment ranging
from a minimum of $4,150,000 to a maximum of $12,500,000 depending on the level
of traffic delivered by Netscape in connection with this agreement.
Uncertainties Relating to Integration of Operations. Infoseek and Starwave
have entered into the Reorganization Agreement with the expectation that the
proposed Mergers will result in long-term strategic benefits. These anticipated
benefits will depend in part on whether the companies' respective operations,
including the Joint Ventures, can be integrated in an efficient and effective
manner and there can be no assurance that this will occur. The combination of
the companies will require, among other things, integration of Infoseek's and
Starwave's respective product and service offerings and coordination of the
companies' sales, marketing and research and development efforts. There can be
no assurance that the combined companies will be able to take full advantage of
the combined sales force's efforts. The different geographic locations of the
principal operations of each of Infoseek California, Starwave and the Joint
Ventures will also render such integration more difficult. Further, the combined
companies will have a substantially expanded employee base which will require
substantial dedication of management and other resources. At June 30, 1998
Infoseek employed approximately 280 persons and Starwave employed approximately
330 persons, including employees of Starwave related to the Joint Ventures. In
addition, given the expanded operations of the combined companies, the combined
companies' business will be increasingly influenced by its ability to retain and
recruit qualified management, engineering, and sales and marketing personnel.
The failure to effectively recruit and retain sufficient and qualified personnel
34
for the combined companies' operations would have a material adverse effect on
the business, results of operations, financial condition and prospects of the
combined companies. There is no assurance that the foregoing will be
accomplished smoothly or successfully. The integration of operations following
the Mergers will require the dedication of management resources, which may
distract attention from the day-to-day operations of the combined companies. The
inability of management to successfully integrate the operations of the
companies could have a material adverse effect upon the business, operating
results and financial condition of the combined companies.
Risks Related to Development, Launch and Acceptance of Planned New Portal
Service. Infoseek believes that development, launch and promotion of the New
Portal Service combining certain of the content, promotion, brands and
technologies of Infoseek, Starwave, ABCNews.com, ESPN SportsZone.com and Disney,
among other things, is a critical aspect of the combined companies' efforts to
attract and expand their Internet audience and to differentiate the combined
companies from their competitors and that the importance of this strategy will
increase due to the growing number of Internet sites and the relatively low
barriers to entry in providing Internet content. While Infoseek currently plans
to launch a preview release of the New Portal Service by the end of calendar
year 1998, there can be no assurance that the preview release can be
successfully developed and launched in such time frame and the preview release
of the New Portal Service, as initially launched, will not have all of the
functionality and services currently planned for such service. The foregoing
estimate of the timing of the launch of the planned preview release New Portal
Service is a forward-looking statement that is subject to risks and
uncertainties. Actual results may vary materially as a result of a number of
factors, including but not limited to those set forth below in this paragraph,
and under "--Uncertainties Related to Integration of Operations" and
"--Dependence on Joint Ventures and Third Party Relationships." If consumers do
not perceive the New Portal Service content and experience to be of high
quality, or if the combined companies introduce new Internet sites or enter into
new business ventures that are not favorably received by consumers, the combined
companies will be unsuccessful in expanding their Internet audience. There can
be no assurance that Infoseek and Starwave will be able to successfully develop
and launch the planned New Portal Service on a timely basis, or at all, and the
combined companies are dependent, in part, upon Disney and the Joint Ventures
for successful development and launch of the New Portal Service. In addition,
the New Portal Service will be promoted, in part, by Disney and the quality and
medium of such promotion will be in large part at Disney's discretion. In this
connection, Infoseek has agreed to purchase $165 million of promotional services
over a five year period from ABC for the New Portal Service and there can be no
assurance that Infoseek will be able to offset the costs of these promotional
activities through increased cash flows from operations. Furthermore, in order
to attract users to the planned New Portal Service, and to promote and maintain
awareness of the Go Network brand in response to competitive pressures, the
combined companies will be required to increase their budget for Internet
content and promotion and to increase substantially their financial commitment
to creating and maintaining a distinct brand loyalty among consumers. If the
combined companies are unable to successfully develop, launch and promote the
planned New Portal Service in a timely manner, or if the combined companies
incur excessive expenses in this connection or in an attempt to improve the New
Portal Service or promote and maintain their brands, the combined companies'
businesses, financial condition and operating results will be materially
adversely affected. The Go Network name is a trademark of Disney that is the
subject of a license agreement between Disney and Infoseek, and Infoseek is
dependent upon Disney to enforce the intellectual property in such trademark
against third parties and there can be no assurance that Disney will take
adequate steps to enforce such
35
intellectual property rights or that, if it takes such steps, it will prevail in
such enforcement. See "--Risks Related to Infoseek's Business--Intellectual
Property and Proprietary Rights." In addition, although under the Reorganization
Agreement Disney has agreed for a period of fifteen years following the
effective time of the Mergers or the earlier termination of the License
Agreement not to compete with Infoseek in the United States with respect to a
broadbased Internet portal service for narrowband delivery and Disney and the
ESPN partner and ABCNews partner (and their respective affiliates) pursuant to
the Joint Ventures have agreed not to develop or commercialize narrowband
sports or general news-related products or services in the United States or
Canada, none of the licensing or commercial agreements legally prohibits Disney
from entering into strategic transactions with any of Infoseek's competitors or
from providing Disney content to Infoseek's competitors, and Disney currently
provides certain of its content, subject to the restrictions noted above, to
competitors of Infoseek and maintains a number of web sites not expected to be
linked to the New Portal Service. There can be no assurance that Disney will not
enter into any such agreements which, if competitive to the planned New Portal
Service, could have a material adverse effect upon the success of the New Portal
Service.
Effect of Mergers and Planned Launch of New Portal Service on Service Users and
Customers. There can be no assurance that the present and potential customers
of Starwave and Infoseek will continue their current usage and buying patterns
without regard to the proposed Mergers and related transactions between Infoseek
and Disney. For example, there can be no assurance that large media companies
and certain other competitors of Disney will elect to advertise or provide
content to Infoseek's present Internet service (the "Infoseek Service") or the
New Portal Service. Any significant delay or reduction in sales or orders could
have an adverse effect on the near-term business and results of operations of
the combined companies. In addition, there can be no assurance that the launch
and promotion of the planned New Portal Service will not result in potential
confusion or a decline in loyalty among users or customers of the Infoseek
Service or the websites of Starwave or the Joint Ventures.
Potential Ownership Control By Disney. Upon completion of the proposed Mergers
and related transactions by and between Infoseek and Disney, Disney will own
approximately 43% of the outstanding shares of Infoseek common stock and
warrants (generally vesting over a three-year period) to increase its ownership
to 50.1% with rights to maintain such percentage ownership as well as its
warrant ownership through purchases from Infoseek in the event of dilutive
issuances. However, during a standstill period of three years under a
governance agreement (the "Governance Agreement") (subject to early
termination under certain circumstances), Disney may not increase its
percentage ownership to more than 49.9%. As a result of its current and future
ownership stake, Disney may be able to exercise effective control over many
matters requiring stockholder approval, and has supermajority Board approval
rights for certain Infoseek transactions, including charter or bylaw
amendments, change of control transactions, sales of 15% or more of Infoseek's
assets, issuances of securities representing 15% or more of Infoseek's
outstanding shares or for consideration of $200 million or more, the
incurrence of indebtedness or cash expenditures of $200 million or more, or
any appointment of a new Chief Executive Officer. The Governance Agreement
also provides that so long as Disney maintains an ownership interest in
Infoseek of 25% or more, Disney will be entitled to have its nominees for
director submitted to a vote of stockholders of Infoseek in a number
(initially three of an expanded eight Board seats) sufficient to require the
approval of the Disney nominees for those transactions requiring supermajority
Board approval. Further, since the standstill provisions of the Governance
Agreement terminate on certain occurrences, including a third party tender
offer or a tender offer by Disney for all Infoseek shares, such termination
would
36
permit Disney to acquire greater than 49.9% voting power prior to the expiration
of the three-year period. These provisions, as well as the terms of Disney's
license of certain intellectual property underlying the New Portal Service that
trigger termination of such license in the event a third party acquires 25% or
more of Infoseek's outstanding voting stock, may prevent or discourage tender
offers for Infoseek's common stock or changes in the control of Infoseek unless
the terms are approved by Disney, and thus may preclude any person other than
Disney from acquiring all or substantially all of the outstanding shares of
Infoseek common stock that Disney does not own following completion of the
transactions contemplated by the Reorganization Agreement.
Amortization of Goodwill and Increased Operating Expenditures Will Delay
Profitability of Combined Companies. Because the acquisition of Starwave will
be accounted for under the "purchase" method of accounting, the purchase price
will be allocated to the acquired assets and liabilities of Starwave. An in-
process research and development charge, preliminarily estimated to be
approximately $74.4 million, will be recorded in the quarter the Starwave Merger
is consummated. In addition, intangible assets related to developed technology
and assembled workforce are preliminarily estimated at approximately $49.4
million and will be amortized over two years. Intangible assets related to
goodwill, Joint Ventures and other intangibles were preliminarily estimated to
be approximately $645.8 and $179.5 million, respectively, which will be
amortized over ten years. In addition, the combined companies expect to incur
increased operating expenditures associated with the expanded operations of the
combined companies' business and the development, launch and promotion of the
planned New Portal Service. As a result, the combined companies' profitability
is expected to be delayed beyond the time frame in which Infoseek California or
Starwave, as independent entities, may have otherwise achieved profitability.
Management currently estimates that the combined companies would not achieve
profitability until at least 2002 and, excluding the amortization of goodwill
and other intangibles associated with the Starwave Merger, until at least 2000.
The foregoing estimates of the time period in which the combined companies would
not achieve profitability are forward-looking-statements that are subject to
risks and uncertainties. Actual results may vary materially as a result of a
number of factors, including but not limited to those set forth under "--
Uncertainties Relating to Integration of Operations," "--Risks Related to
Development, Launch and Acceptance of Planned New Portal Service," and "--Risks
of Acquisition Strategy."
Future Capital Needs; Uncertainty of Additional Financing. Infoseek currently
anticipates that its cash, cash equivalents, short-term investments, available
funds under its equipment term loan facility, approximately $70 million of cash
proceeds and the Note in principal amount of $139 million from the sale of
Infoseek common stock and the Warrant to Disney in connection with the
Mergers, and cash flows generated from advertising revenues, will be
sufficient to meet its anticipated needs for working capital and other cash
requirements, assuming completion of the proposed Mergers, through at least
September 30, 1999. Thereafter, Infoseek may need to raise additional funds.
Infoseek may need to raise additional funds sooner, however, in order to fund
more rapid expansion, to develop new or enhance existing services or products,
to respond to competitive pressures or to acquire complementary products,
businesses or technologies. If additional funds are raised through the
issuance of equity or convertible debt securities, the percentage ownership of
the shareholders of Infoseek will be reduced, shareholders may experience
additional dilution and such securities may have rights, preferences or
privileges senior to those of the holders of Infoseek's common stock. There
can be no assurance that additional financing will be
37
available on terms favorable to Infoseek, or at all. If adequate funds are not
available or are not available on acceptable terms, Infoseek's ability to fund
its expansion, take advantage of acquisition opportunities, develop or enhance
services or products or respond to competitive pressures would be significantly
limited. Such limitation could have a material adverse effect on Infoseek's
business, results of operations, financial condition and prospects. See
"Infoseek Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources."
Risk of Future Dilution Related to Disney's Right to Maintain its Ownership
Position. The issuance and sale of additional shares of Infoseek common stock
following the consummation of the transactions contemplated by the
Reorganization Agreement to Disney pursuant to Disney's contractual right to
maintain its percentage ownership of Infoseek common stock and, under certain
circumstances, to obtain additional warrants may have dilutive effects on
Infoseek's earnings per share and will result in share ownership dilution to
Infoseek stockholders. The shares acquired by Disney pursuant to its right to
maintain must be purchased by Disney at a price equal to the price paid in the
transaction giving rise to such right to maintain. See "Description of Related
Agreements--Equity and Governance Agreements."
Dependence on Joint Ventures and Third Party Relationships. The success of the
combined companies will be significantly influenced by the continuation and
integration of Starwave's joint ventures and third party relationships,
especially the ESPN Joint Venture and the ABCNews Joint Venture. The vast
majority of Starwave's economic value is derived from its ESPN SportsZone web
site, which is produced under its joint venture with the ESPN Partner, and its
ABCNews.com web site, which is produced under its joint venture with the ABC
Partner. On a pro forma basis for the twelve months ended December 31, 1997 and
the six months ended June 30, 1998 (assuming that the Representation Agreements
had been in place during such periods), revenues of these Joint Ventures would
have represented 29% of the total corresponding period revenues of the combined
companies. The combined companies' future success will depend to a large extent
on their ability to maintain their relationships with existing co-branding
partners such as ESPN and ABC, and to establish relationships with new partners
for the development of co-branded Internet web sites. A failure to maintain its
relationships with existing co-branding partners, or to develop new
relationships, would significantly curtail the combined companies' ability to
maintain or create interactive services and products that are attractive to
users and advertisers, and could have a material adverse effect on the combined
companies' business, results of operations and financial condition.
Risk of Inability to Achieve Revenue Minimums Under Representation Agreements.
Under a ESPN Representation Agreement and a ABC News Representation
Agreement, Starwave has agreed to act as the representative of the ESPN Joint
Venture and the ABCNews Joint Venture in the sale of advertising and related
services for such Joint Ventures. Pursuant to these agreements, Starwave has
agreed to make quarterly payments to the Joint Ventures equal to the greater of
(i) a guaranteed minimum amount or (ii) revenues actually billed to third
parties (whether or not collected) in the performance of such services, in each
case less Starwave's costs of providing the services and a profit margin. There
can be no assurance that Starwave will be able to sell the guaranteed minimum
amount in any quarterly period or be able to collect the receivables resulting
from such revenue related activities, which could have a material adverse effect
on the combined companies' business, results of operations and financial
condition.
38
Costs of Integration; Transaction Expenses. Infoseek estimates that it will
incur costs of $22.0 million associated with the transactions contemplated by
the Reorganization Agreement, which will be accounted for as part of the
purchase price of the transactions. The $22.0 million of direct costs includes
approximately $5.0 million for liabilities related to involuntary employee
termination benefits and relocations of Starwave employees and $5.0 million for
costs to exit other Starwave activities, primarily operating leases of Starwave.
In the event the proposed Mergers are not consummated, Infoseek will take a
charge of $2.8 million to operating expense. The combined companies expect to
incur additional integration costs of up to $5.0 million of which $1.4 million
were included in the results for the quarter ended September 30, 1998. These
costs will affect future operations and do not qualify as liabilities in
connection with a purchase business combination. There can be no assurance that
the combined companies will not incur additional material charges in subsequent
quarters to reflect additional costs associated with the Starwave Acquisition.
Dependence on Continued Growth in Use of the Internet. Future growth in the
combined companies' revenues will depend on the widespread acceptance and use of
the Internet and other interactive online platforms as a source of information
and entertainment and as a vehicle for commerce in goods and services. Rapid
growth in the use of and interest in the Internet is a recent phenomenon, and
there can be no assurance that acceptance and use of the Internet will continue
to develop or that a sufficient base of users will emerge to support the
combined companies' businesses. 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) remain
unresolved and may negatively affect the growth of Internet use or the
attractiveness of the Internet for advertising and online transactions. The
Internet may not be accepted as a viable commercial medium for a number of
reasons, including potentially inadequate development of the necessary network
infrastructure, failure to develop or untimely development of critical enabling
technologies, or inadequate commercial support for Internet-based advertising.
To the extent that the Internet continues to experience an increase in users, an
increase in frequency of use or an increase in the bandwidth requirements of
users, there can be no assurance that the Internet infrastructure will be able
to support the demands placed upon it. The widespread deployment of cable modems
and other higher bandwidth enabling technologies has to date experienced delays,
and continuing delays in the development and deployment of such technologies
could slow the growth in the use of the Internet. In addition, the Internet
could lose its viability as a commercial
39
medium due to delays in the development or adoption of new standards and
protocols required to handle increased levels of Internet activity, or as the
result of increased government regulation. Changes in or insufficient
availability of telecommunications services to support the Internet also could
result in slower response times and could adversely affect use of the Internet
generally and of the combined companies' Internet services in particular. In
addition, corporations and other networks providing access to the Internet may
restrict access to certain sites or hours of usage, which could limit access to
and reduce traffic on the combined companies' services. If use of the Internet
does not continue to grow or grows more slowly than expected, the Internet
infrastructure does not effectively support growth that may occur, or access to
the Internet or the combined companies' services is otherwise restricted, the
combined companies' business, financial condition and operating results would be
materially adversely affected.
Risks of Acquisition Strategy. The combined companies believe that it may be
necessary to enter into joint ventures or other strategic relationships in
addition to those contemplated by the proposed Starwave Acquisition and the
related agreements, or to make acquisitions of complementary products,
technologies or businesses in order to remain competitive. The failure of
Infoseek to execute such a strategy may lead to decreased market share, viewer
traffic or brand loyalty, which may have a material adverse effect on
Infoseek's business, results of operations, financial condition and prospects.
Pursuant to this strategy, on July 24, 1998, Infoseek agreed to acquire
Quando, an Internet company with electronic commerce capabilities, to
complement Infoseek's existing technologies. Infoseek expects to account for
the Quando acquisition as a purchase transaction and expects to incur write-
offs related to in-process research and development of approximately $9.4
million in the quarter ending December 31, 1998 in connection with the Quando
acquisition. In addition, intangible assets related to goodwill, developed
technology and assembled workforce are preliminarily estimated at
approximately $12.6 million and will be amortized over two years. In addition,
acquisition transactions are accompanied by a number of risks, including,
among other things, the difficulty of integrating the operations and personnel
of the acquired companies, the potential disruption of the combined companies'
ongoing businesses, the inability of management to maximize the financial and
strategic position of the combined companies through the successful
incorporation of acquired technology or content and rights into the combined
companies' products and media properties, expenses associated with the
transactions, additional expenses associated with amortization of acquired
intangible assets, the maintenance of uniform standards, controls, procedures
and policies, the impairment of relationships with employees and customers as
a result of any integration of new management personnel, and the potential
unknown liabilities associated with acquired businesses. There can be no
assurance that the combined companies would be successful in overcoming these
risks or any other problems encountered in connection with such acquisitions.
In addition, no assurance can be given that any other acquisitions will or
will not occur, that if an acquisition does occur it will not materially and
adversely affect the combined companies or that any such acquisition will be
successful in enhancing the combined companies' businesses. If the combined
companies proceed with additional significant acquisitions in which the
consideration consists of cash, a substantial portion of the combined
companies' available cash could be used to consummate the acquisitions. If the
combined companies were to consummate one or more acquisitions in which the
consideration consisted of stock, stockholders of Infoseek could suffer
dilution of their interests in Infoseek.
In addition, following the Mergers and related transactions with Disney,
Infoseek may not (and, if Disney elects to obtain control when eligible to do
so, may not) be able to account for subsequent acquisitions as pooling-of-
interests and, as a result, may have to recognize significant goodwill
40
related to the acquisition of intangibles, the amortization of which would
adversely affect Infoseek's subsequent results of operations, and may incur
charges for acquired in-process technology in the period in which the
acquisition occurs that would adversely affect Infoseek's results of operations
in such period.
Internet Security and Electronic Commerce Risks. Concerns over the security of
online transactions and the privacy of users may inhibit the growth of the
Internet generally, particularly as a means of conducting commercial
transactions. A party who is able to circumvent either of the combined
companies' security measures could misappropriate confidential or proprietary
information or cause interruptions in the combined companies' online operations.
The combined companies expect to expend significant capital and resources to
protect against the threat of such security breaches or to alleviate problems
caused by such breaches, but there can be no assurance that the combined
companies' efforts in this regard will be successful. To the extent that
activities of the combined companies or third party contractors involve the
storage and transmission of confidential or proprietary information, such as
computer software or credit card numbers, security breaches could expose the
combined companies to a risk of loss or litigation and possible liability. There
can be no assurance that contractual provisions attempting to limit the combined
companies' liability in such areas will be successful or enforceable, or that
other parties will accept such contractual provisions as part of the combined
companies' agreements. Neither Infoseek nor Starwave currently maintains
insurance against the foregoing risks (other than standard business interruption
and crime insurance, to the extent applicable). To the extent that the combined
companies derive a material portion of revenue from electronic commerce in the
future, the combined companies will evaluate obtaining additional insurance for
these risks. To the extent the combined companies do not or are unable to obtain
adequate insurance at such time, security breaches into the combined companies'
systems, if substantial or repeated, could have a material adverse effect on the
combined companies' business, results of operations and financial condition.
Developing Market; Unproven Acceptance of Internet Advertising and of the
Combined Companies' Products and Services. The combined companies' future
success is highly dependent upon the increased use of the Internet and intranets
for information publication, distribution and commerce. The market for the
combined companies' products and services has only recently begun to develop, is
rapidly evolving and is characterized by an increasing number of market entrants
with products and services for use on the Internet and intranets. Most of
Infoseek's and Starwave's advertising customers have only limited experience
with the Internet as an advertising medium, have not yet devoted a significant
portion of their advertising expenditures to Internet-based advertising, and may
not find such advertising to be effective for promoting their products and
services relative to traditional print and broadcast media. No standards have
been widely accepted for the measurement of the effectiveness of Internet based
advertising, and there can be no assurance that such standards will develop
sufficiently to support the Internet as a significant advertising medium. The
Internet industry is young and has few proven products and services. In
particular, because the combined companies expect to derive substantially all of
their revenues in the foreseeable future from sales of Internet advertising, the
future success of the combined companies is highly dependent on the development
of the Internet as an advertising medium. If the market fails to continue to
develop, develops more slowly than expected or becomes saturated with
competitors, or if the combined companies' products and services do not achieve
or sustain acceptance by Internet users or advertisers, the combined companies'
business, results of operations, financial condition and prospects would be
materially adversely affected. The combined companies believe that advertising
sales in traditional media, such as television, are generally lower
41
in the first and third calendar quarters of each year as compared with the
respective preceding quarters and that advertising expenditures fluctuate
significantly with economic cycles. Depending on the extent to which the
Internet is accepted as an advertising medium, seasonality and cyclicality in
the level of advertising expenditures generally could become more pronounced for
this medium. Seasonality and cyclicality in advertising expenditures generally,
or with respect to Internet-based advertising specifically, could have a
material adverse effect on the combined companies' business, financial condition
and operating results.
Government Regulation and Legal Uncertainties. Infoseek and Starwave are not
currently subject to direct regulation by any government agency, other than
regulations generally applicable to businesses, and there are currently few laws
or regulations directly applicable to access to or commerce on the Internet. A
number of legislative and regulatory proposals are under consideration by
federal, state and foreign governmental organizations, and it is possible that a
number of laws or regulations may be adopted with respect to the Internet
covering issues such as user privacy, pricing and characteristics and quality of
products and services. The adoption of any such laws or regulations may decrease
the growth of the Internet, which could in turn decrease the demand for the
combined companies' products, increase the combined companies' cost of doing
business, or otherwise have an adverse effect on the combined companies'
business, results of operations, financial condition and prospects. Moreover,
the applicability to the Internet of existing laws governing issues such as
property ownership, copyright, trade secret, libel and personal privacy is
uncertain and developing. Any such new legislation or regulation, or application
or interpretation of existing laws, could have a material adverse effect on the
combined companies' business, results of operations, financial condition and
prospects.
Year 2000 Compliance. Infoseek and Starwave are aware of the issues associated
with the programming code in existing computer systems as the year 2000
approaches. The "year 2000 problem" is pervasive and complex as virtually every
computer operation will be affected in some way by the rollover of the two-digit
year value to 00. The issue is whether computer systems will properly recognize
date sensitive information when the year changes to 2000. Systems that do not
properly recognize such information could generate erroneous data or cause a
system to fail.
Infoseek management has conducted a review of Infoseek's exposure to the year
2000 problem, including working with computer systems and software vendors to
assure that they are prepared for the year 2000. Based on this review and
discussions with such vendors, Infoseek currently believes that its internal
systems are year 2000 compliant (with the exception of a single system, which is
scheduled to be replaced as part of a regular upgrade program and is not
material to Infoseek's operations). Infoseek does not expect to further incur
any significant operating expenses or invest in additional computer systems to
resolve issues relating to the year 2000 problem, with respect to both its
information technology and product and service functions.
Starwave Management is conducting a review of Starwave's exposure to the year
2000 problem, including working with computer system, data feed and software
vendors to assure that they are prepared for the year 2000. Based on this review
and discussions with such vendors, Starwave currently believes that its
internally developed systems are year 2000 compliant (with the exception of two
systems, which are scheduled to be replaced as part of a regular upgrade
program). Starwave does not expect to further incur any significant operating
expenses or significant investment in additional computer systems to resolve
issues relating to the year 2000 problem, with respect to both its information
technology and product and service functions. Starwave has also inventoried,
42
and is in the process of contacting, third party software and data feed vendors
to assure their systems are year 2000 compliant.
Notwithstanding the foregoing, significant uncertainty exists concerning the
effects of the year 2000 problem, including uncertainty with respect to
assurances made by Infoseek's and Starwave's vendors. Further, neither Infoseek
nor Starwave has investigated year 2000 compliance of third parties who are not
vendors of Infoseek or Starwave, respectively, and neither Infoseek nor Starwave
has control over such third parties' compliance. For example, the failure of any
site to which a link appears on the Infoseek Service or a Starwave website could
result in the loss of such link and therefore reduce the breadth of services
offered through links from the Infoseek Service or the Starwave website,
respectively, which may in turn materially adversely affect the Infoseek Service
or the Starwave website and the value of user traffic and advertisers using such
service or website. Any failure of Infoseek, Starwave or their respective
viewers, customers, linked sites, advertisers or other third parties to be year
2000 compliant could materially affect the business, results of operations,
financial conditions and prospects of Infoseek and/or Starwave.
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ITEM 6. Exhibits and Reports on Form 8-K
a) Exhibit
27.1 Financial Data Schedule
b) Reports on Form 8-K
The Company filed a current report on Form 8-K on May 22, 1998 which was
amended on August 10, 1998 reporting the consolidated financial
statements and the condensed consolidated financial statements which give
retroactive effect to the merger of a wholly owned subsidiary of the
Company with and into WebChat Communications, Inc. on April 17, 1998. The
transaction was accounted for as a pooling-of-interests.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INFOSEEK CORPORATION
By: /s/ Remo Canessa
Remo Canessa
Vice President, Chief Financial Officer
(Principal Accounting and Financial Officer)
Dated: November 16, 1998
By: /s/ Leslie E. Wright
Leslie E. Wright
Vice President, Chief Operating Officer
Dated: November 16, 1998
45