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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE YEAR ENDED JULY 31, 1996
COMMISSION FILE NUMBER 0-27830
LYCOS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 04-3277338
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
293 BOSTON POST ROAD WEST, MARLBORO, MASSACHUSETTS 01752
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(508)-229-0717
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK $.01 PAR VALUE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of voting stock held by non-affiliates of the
registrant as of October 24, 1996 was $56,082,787 (based on the last reported
sale price on the Nasdaq National Market on that date).
The number of shares outstanding of the registrant's Common Stock as of
October 24, 1996 was 13,792,896.
DOCUMENTS INCORPORATED BY REFERENCE
Specifically identified information in the definitive Proxy Statement for
the 1996 Annual Meeting of Shareholders to be held on December 18, 1996, is
incorporated by reference into Part III herein.
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LYCOS, INC.
1996 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
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PART I
Item 1. Business............................................................................... 3
Item 2. Properties............................................................................. 13
Item 3. Legal Proceedings...................................................................... 13
Item 4. Submission of Matters to a Vote of Security Holders.................................... 13
Item 4a. Executive Officers of the Registrant................................................... 13
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.................. 15
Item 6. Selected Financial Data................................................................ 16
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.. 17
Item 8. Financial Statements and Supplementary Data............................................ 26
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure... 39
PART III
Item 10. Executive Officers of the Registrant................................................... 39
Item 11. Executive Compensation................................................................. 39
Item 12. Security Ownership of Certain Beneficial Owners and Management......................... 39
Item 13. Certain Relationships and Related Transactions......................................... 39
PART IV
Item 14. Exhibits, Financial Statements Schedules and Reports on Form 8-K....................... 39
Signatures ..................................................................................... 41
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This Report contains "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. Such statements are subject
to certain risks and uncertainties, including without limitation those
discussed in "Factors Affecting the Company's Business, Operating Results and
Financial Condition" section herein. Such forward-looking statements speak
only as of the date on which they are made, and the Company cautions readers
not to place undue reliance on such statements.
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PART I
ITEM 1. BUSINESS
Lycos, Inc., an Internet exploration company, develops and provides guides
to find, index and filter information on the Internet and the World Wide Web
("the Web") that serve as a new medium for information access. The Company's
comprehensive suite of products and services enable users of the Internet to
quickly, easily and accurately identify, select and access the resources and
information of interest to them. The Company provides a family of easy to use,
visually appealing products and services free of charge to users, including:
the Lycos Catalog of the Internet, the a2z Sites by Subject Directory, Point
Top 5% Sites, Pictures and Sounds Index, PeopleFind, Road Maps, Top News, City
Guide, and Club Lycos. Based on information compiled by the Company, the
Company believes that the Lycos products are among the most popular sites on
the Web, serving millions of information requests per day. The Company
generates revenues primarily through selling advertising on its services and
by licensing its products and technology to businesses seeking to enhance the
value of their Internet products and services. The Company's objective is to
establish its Internet navigational products as a branded media service that
is the most widely used place to find information in the world.
INDUSTRY BACKGROUND
The Internet and World Wide Web
The Internet is a global collection of thousands of computer networks
interconnected to enable commercial organizations, educational institutions,
government agencies and individuals to communicate electronically, access and
share information and conduct business. While the Internet was historically
used by a limited number of academic institutions, defense contractors and
government agencies primarily for remote access to host computers and for
sending and receiving electronic mail, commercial organizations and
individuals are increasingly dominating the use of the Internet. Recent
technological advances, including increases in microprocessor speed and the
development of easy-to-use graphical user interfaces, combined with cultural
and business changes, have led to the Internet being integrated into the
operations and strategies of commercial organizations and the activities of
individuals.
Much of the recent growth in Internet use by businesses and individuals has
been driven by the emergence of a network of servers and information available
on the Internet called the World Wide Web. The Web is a network medium that is
rich in content, activities and format. The Web medium includes a wide range
of content such as magazines, news feeds, radio broadcasts, and corporate,
product, educational, research, and political information, as well as
activities, including customer service, electronic commerce, reservations,
banking, games and discussion groups. Due to the increase in the content
available on the Web, the number of users of the Internet has dramatically
increased in the past year. International Data Corporation estimates that the
number of individuals with access to the Internet is projected to reach 199
million users in 1999, of which 125 million users are estimated to be
accessing the Web.
The Web can be accessed using software that allows non-technical users to
easily exploit the capabilities of the Internet. Electronic documents or "Web
pages," which may contain textual, audio and video information, are published
on Web sites in a common format. Each Web site could contain hundreds of Web
pages. Users can view these Web pages by using widely available software
called "Web browsers" such as the Netscape Navigator or the Microsoft Internet
Explorer. Users specify which electronic documents they wish to view with
their Web browser by entering a document's unique electronic Web address, or
Universal Resource Locator ("URL"). Alternatively, users can navigate the Web
by making use of the hypertext link capability of Web documents. Hypertext
links are active areas on a Web page which when selected by a user
automatically cause the browser to display a specific page which can be
located anywhere else on the Web. This feature enables users to move from one
page of content and activity to another related page, without having to know
the underlying address or URL of either document.
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The rapid deployment of the Web has introduced fundamental and structural
changes in the way information can be produced, distributed and consumed,
lowering the cost of publishing information and extending its potential reach.
Companies from many industries are publishing product and company information
or advertising materials and collecting customer feedback and demographic
information interactively. The structure of Web documents allows an
organization to publish significant quantities of product information while
simultaneously allowing each user to view selectively only those elements of
the information which are of particular interest. This feature makes possible
the dynamic tailoring of information delivery to each user's interest in a
cost effective and timely fashion. The Web, by facilitating the publishing and
exchange of information, is dramatically increasing the amount of
information--both relevant and irrelevant--available to users.
Navigating the Web
The rapid growth in the number of users of the Internet and in the number of
Web sites has made it increasingly difficult both for users to find
information relating to a particular interest and for content providers to
inform users of the availability of their particular information and services.
For a person who wants to conduct a fast or focused search, or to casually
browse the Web, the task is often frustrating and unproductive. In addition,
users often find that content providers' descriptions of Web sites and their
content are incomplete, incorrect or non-existent, making for a time consuming
and unrewarding experience.
The difficulty of searching for information or browsing the Web is
compounded by the unorganized, unstructured nature of the Internet; there is
no centralized repository of Web sites or descriptions of their content. Users
must either already know the Web address of a specific site or they must rely
on hypertext links to browse. Content providers face similar difficulties in
making the existence and location of Web sites containing information or
advertising widely known. Current mechanisms for allowing users and publishers
of information to locate each other are often limited in scope, slow and
unreliable. These shortcomings are exacerbated by the continuing growth in the
Internet, the number of Web sites and pages, and the number of interconnecting
hypertext links. In this environment, users and content providers alike seek
methods to identify and access relevant resources easily and effectively.
Catalogs, Directories, Reviews and Resource Guides
To address these needs, users are increasingly relying on catalogs,
directories, reviews and resource guides of information and resources on the
Internet.
Catalogs. Catalogs are computer-generated indexes of Web resources used to
conduct a focused search from detailed information about millions of Web
pages. A catalog must be comprehensive and provide relevant responses to
queries in a timely manner to be useful to a viewer. To maintain its
usefulness, a catalog must be able to scale effectively as the size of the Web
grows and as the number of queries per day increases.
Directories. Directories are manually compiled categorizations of a selected
universe of Web sites organized into broad subject areas. Directories are
useful when an Internet user wishes to browse Web content within general,
popular topics of interest. Deliberately small in scale and focused,
directories provide the Internet user with a quick and easy means of locating
basic summary information on Web sites. To be useful, directories must offer
topics that are of appeal to users and correctly define such topics so that
relevant information is captured.
Reviews. Reviews are brief descriptions and critical assessments of Web
sites. Reviews are useful when an Internet user wishes to find the highest
quality sites within a subject, as identified and evaluated by an independent
source. Reviews are also used by a user as a quick and easy means to stay
current with what's new and most popular on the Web. To be useful, reviews
must be credible, consistent and timely.
Resource Guides. Resource guides are useful and innovative services enabling
users to find and filter information of specific interest. For example,
resource guides allow users to find telephone numbers, stock quotes, addresses
and much more.
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Catalogs, directories, reviews and resource guides also offer content
providers and advertisers the opportunity to make their information more
easily accessible. By enabling access to and filtering of information on the
Web, catalogs, directories, reviews and resource guides are increasingly
functioning as conduits between millions of Internet users and the wealth of
Internet resources.
Although catalogs, directories, reviews and resource guides are enjoying
widespread popularity, many current offerings have limitations. Many catalogs
cannot meet users' requirements for efficient and comprehensive searches
because they are incomplete compared to the size and accelerating growth of
the Internet. Likewise, many catalogs do not provide a high percentage of
relevant responses to queries and are frequently slow due to hardware or
software limitations. Similarly, directories are limited by the quality of any
underlying catalog or database on which they are based. Many current
directories and resource guides cannot be maintained or updated in a timely
manner because they lack the ability to monitor the status of links and home
pages automatically. Finally, Web site reviews have often simply provided
descriptions of the Web site without any critical assessment of its content.
As a result of these limitations, content providers and advertisers cannot
rely on many current catalogs, directories, reviews and resource guides to
identify their content accurately and users cannot rely on them to locate
desired information in a timely or accurate manner, if at all.
Internet as a Mass Medium
The Internet and associated information services are increasingly developing
attributes of conventional mass media where advertising and other revenues are
generated from viewership and use. In light of the strong demographics of
users of the Internet, advertisers are increasingly attracted to the Internet
as a medium for the marketing and sale of products and services.
In contrast to conventional media, the Internet offers capabilities to
target advertising to specific audiences, to measure the popularity of
content, to make timely changes in response thereto, to reach worldwide
audiences cost-effectively and to create innovative and interactive
advertisements. By collecting customer feedback and demographic information,
advertisers can direct highly customized marketing campaigns at defined
targets. In addition, the Internet enables advertisers to transact with
prospective customers much more rapidly than with conventional media.
However, to communicate their message effectively on the Internet,
advertisers need to place their advertisements where targeted audiences will
view them. Catalogs, directories, reviews and resource guides in particular
generate sizable traffic flow and have the ability to monitor and track usage
patterns, consequently offering advertisers a cost-effective means to reach a
broad and demographically appealing audience.
The Company believes that advertisers will seek to advertise on Web sites
that offer a high volume of traffic and feature flexible advertisement
programs capable of reaching targeted audiences. Likewise, the Company
believes that as advertisers increasingly embrace the Internet as an
advertising vehicle, their participation will subsidize in part the creation
and expansion of the information and resources available on the Web which in
turn is expected to stimulate further traffic flow.
THE LYCOS SOLUTION
The Company offers a comprehensive suite of products and services that
enable users to sort, find, filter and access the tremendous amount of
information and resources on the Internet. Without such products, navigating
the Internet would be difficult to impossible. Internet users access the
Company's products and services directly through the Lycos homepage at
www.lycos.com, or through the individual homepages of the Company's other
products such as the a2z Sites by Subject Directory and Point Top 5% Sites by
using Web browsers such as the Netscape Navigator or the Microsoft Internet
Explorer. Since its initial public offering in April 1996, the Company has
introduced six additional guides to information, each of which has rapidly
become widely accepted by users of the Internet. In September 1996, the
Company introduced both a completely new look and feel and
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increased functionality for its products. Each of the Company's products are
integrated such that viewers have access to all of the Company's products and
services from all of the Company's sites. The Company's product offerings
provide viewers with a one-stop information destination.
The Lycos Catalog of the Internet. The Company believes that its Lycos
Catalog is one of the most comprehensive indexes of the Web and is
differentiated from other catalogs based on its size, speed, ability to index
non-textual information, relevancy of search results and ability to scale
along with the continuing growth of Internet content. Using the Lycos Catalog,
a user may enter a search term or terms and review a list of the best matches
from all indexed Web pages, along with a relevancy ranking of those pages,
thereby allowing a user to sort through the information available on the Web
quickly and efficiently. The Lycos Catalog also provides a direct hypertext
link to the actual pages matching the search. As of October 24, 1996, the
Lycos Catalog had indexed nearly 70 million Web pages, up from approximately 4
million in June 1995. The Company believes its Catalog of the Internet to be
the largest in existence based on the number of Web pages currently indexed.
The Company believes that its proprietary indexing technology enables the
Lycos Catalog to service more searches of a larger database while producing
more relevant results. The Company also believes that the Lycos Catalog is
among the most widely used sites in the Internet. Traffic at the Lycos
services grew by over 2000% this year, from 200,000 page views per day in
August 1995 to over 4 million per day in August 1996. The Web address for the
Lycos Catalog is www.lycos.com.
a2z Sites by Subject Directory. The Company's a2z Sites by Subject Directory
("Directory") provides added value to users beyond the search capabilities of
the Lycos Catalog by organizing Web sites by subjects grouped into 16 general
categories, which in turn are divided into over 1,000 subcategories. The
Directory, which is a subset of the Lycos Catalog, organizes collections of
pages grouped into preselected categories. In this manner, viewers may browse
through a series of categories and subcategories such as Science &
Technology--Space & Astronomy--Planets & The Solar System. Users may then view
a listing of the titles with both short descriptions of the sites in the
category and a hypertext link to each site. The Company believes that its
Directory has advantages over competing directories because of the capability
of the Lycos search and indexing technology to index Web pages by popularity,
thereby allowing the Directory to be built upon popular Web sites. The Web
address for the Directory is a2z.lycos.com.
Point Top 5% Sites. Point Top 5% Sites is a collection of critical reviews
of what the Company considers to be among the most popular sites on the Web.
Point Top 5% Sites permits users to focus on high quality sites and read
critical reviews to determine if the sites are likely to be of interest. Each
review includes a link that allows the viewer to visit any chosen site or
destination. Web sites are selected by the Company's editorial staff as a site
of general interest and quality. Informative and entertaining reviews are
prepared by the Company's professional writers and editors. Point Top 5% Sites
provides a numeric rating for the selected Web sites based on content,
presentation and viewer experience that allows users to differentiate among
rated Web sites. The Web address for Point Top 5% Sites is point.lycos.com.
Pictures and Sounds Index. The Company's Pictures and Sounds Index,
introduced in September 1996, allows users to search for pictures, sounds,
video clips and other multimedia files on the Internet. By clicking on
hyperlinks, users can display graphics and listen to sounds from thousands of
Web sites. The Company believes this index offers a unique way for users to
explore everything from pictures of celebrities to new releases from recording
artists. The Pictures and Sounds Index is based on proprietary technology and
the Company believes it is currently the only search and directory service
that offers pictures and sounds indexing. The Web address for Pictures and
Sounds Index is www.lycos.com/lycosmedia.html.
City Guide. A collection of Lycos-authored guides to more than 400 of the
largest cities in the United States, Lycos City Guide gives the virtual
traveler a snapshot of life in each city or town, and provides connections to
Web sites that reflect the special culture and charm of each place. Along with
an editorial abstract capturing the spirit of each city, the Lycos City Guide
offers hotlinks to Web sites that best reflect the hot spots,
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history and day-to-day living of each town. Users may browse the site
organized by categories, including Local Flavor, Vital Statistics, News Links,
Hometown Sports and Weather. Selected sites include practical information on
points of interest, dining and entertainment, as well as unique aspects of
each city. Yellow-page-like searches are also available for area businesses
located in a given city, allowing users to find products and services in these
virtual locales. The Web address for City Guide is cityguide.lycos.com.
PeopleFind. Lycos PeopleFind, a comprehensive home address, email address
and phone number directory, assists users in locating whomever they are
looking for, wherever they are in the United States. Users may simply type a
name and location to get matching lists of people with published phone
numbers. Unlike a telephone book, PeopleFind does not require users to know
where a person lives, allowing them to search for old friends or lost
relatives. The Web address for PeopleFind is www.lycos.com/pplfndr.html.
Road Maps. Lycos Road Maps allows users of the Internet to search on any
street address in the United States and physically map that address with pin-
point accuracy. Once mapped, users may print the map and use it for driving
directions. Maps also list points of interest in many cities and allow users
to browse through an area by clicking on directional buttons. The Company
believes this is one of the most useful services available on the Internet.
The Web address for Road Maps is www.lycos.com/roadmap.html.
Club Lycos. Lycos has launched a member benefits program specifically
designed for its users which provides free membership and discounts on a
variety of products and services. The user simply registers with Lycos and in
return receives a membership card entitling Club Lycos members to receive
nationwide discounts on Avis car rentals, Southwest Airlines tickets, NetGuide
Magazine subscriptions, Compubooks publications, Computer Insurance, atOnce
Software, Save n' Sail Cruises and other popular offerings. The Web address
for Club Lycos is club.lycos.com.
Top News. Lycos Top News provides users with continuously updated links to
news, weather, sports and business stories from major news services around the
world. Lycos news editors write fresh headlines and summaries for the news
stories and users can quickly scan headlines in six news categories, then may
choose to link directly to detailed news services across the Web. The Web
address for Top News is www.topnews.com.
Link Alert. In July 1996, the Company introduced Lycos Link Alert which
allows websites to monitor sites with hypertext links to its site and to those
of its competitors. The product is built upon the data that the Lycos spider
collects and is updated as the Lycos Catalog is updated.
STRATEGY
The Company's objective is to establish its Internet navigational products
and services as the most widely used place to find information in the world.
The Company seeks to leverage its high volume of traffic created by its
products and services into a platform for advertisers to reach their targeted
audience. Key elements in the Company's strategy include:
Provide a One-Stop Information Source. The Company seeks to provide viewers
with a one-stop information destination for identifying, selecting and
accessing resources and information on the Web. The Company has recently
integrated its catalog, directory and review products with a suite of recently
introduced product offerings, including, among others, the Company's Pictures
and Sounds Index, Lycos Road Maps, PeopleFind and City Guide.
Generate a High Volume of Traffic. The Company seeks to draw large numbers
of viewers to the Company's sites by providing its online guides free of
charge to users and making them as widely accessible as possible throughout
the world. The Company has entered into a variety of agreements with such
companies as Microsoft, Netscape, Sprint and Spry to drive traffic to the
Lycos sites. The Company is also heavily focused on building its brand, both
on and off the Web, and believes its brand building will be a major
contributor to traffic.
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Pursue Innovative Advertising Solutions. The Company believes that the
sizable traffic flow generated from its products and services provides an
attractive platform for measurable, targeted, cost-effective and interactive
advertising on the Internet. The Company combines technical skills with
advertising industry expertise to provide differentiated solutions to
advertisers to help them exploit the capabilities of the Internet as an
advertising medium. The Company is actively seeking to develop innovative ways
for advertisers to reach their target audiences through the Internet
effectively. The Company designs and offers customized packages which include
the ability to change advertisements quickly and frequently, to link a
specific search term to an advertisement, to conduct advertising test
campaigns with rapid result delivery and to track daily usage statistics. In
conjunction with an affiliated company, the Company is currently developing
software that will provide it with the ability to target ads based on
demographics and advanced usage patterns.
Multiple Points of Entry. The Company has aggressively pursued a strategy of
licensing its products and technology. Licensing allows the Company to
increase traffic and revenue by leveraging the promotion, marketing and sales
strengths of its partners. At July 31, 1996, the Company had 24 licensing
partners, including: AT&T, Bertelsmann's Telemedia (which operates Lycos
Germany at www.lycos.de), Swedish Post (which operates Lycos Sweden at
www.lycos.se), Focus Online (in Germany at www.netguide.de) and CompuServe.
Continue to Enhance and Expand the Company's Products and Services. Lycos
intends to enhance its products and services with additional content, features
and functionality to maintain its position as a leading provider of guides to
the Internet. The Company's strategy is to differentiate its products and
services from competing companies through the availability of localized and
customized offerings and by expanding the breadth and depth of its services
such that it becomes the world's most widely used place to find information.
The Company also incorporates into its products and services new technologies
developed internally or licensed from other companies that it believes will
further differentiate its offerings and provide viewers with a richer, more
satisfying Internet experience.
Content and Brand Licensing. Lycos is leveraging its current product
offerings and extending the Lycos brand name by licensing its products for use
in other media, such as books and CD-ROMs, for which the Company typically
receives a royalty. In furtherance of its strategy of extending the Lycos
brand name, the Company has created Lycos Press, a three-year joint publishing
effort between the Company and Macmillan Publishing USA's Que imprint.
Macmillan Publishing USA is a division of Simon & Schuster, the world's
largest computer book publisher. Simon & Schuster is the publishing operation
of Viacom, Inc. The first two books in a series of Internet-related titles,
Most Popular Web Sites and Internet International Directory were released in
August 1996 and October 1996, respectively. The books are accompanied by a
CD-ROM which contains the entire book, fully hyperlinked, plus links to other
popular Web sites and an assortment of browsers and other Internet software.
Lycos Press currently plans to publish over twenty books in 1997. The books
are a revenue source for the Company, but also provide exceptional branding
opportunities.
TECHNOLOGY
The foundation of currently available Internet catalogs is a database
comprised of the indexed content and addresses of Web pages. The underlying
database for most Internet catalogs is created through the use of "spiders,"
which are software programs that autonomously roam the Web by following
hypertext links, automatically identifying and collecting material to be
included in the database index. Catalogs also provide retrieval software that
enables a user to conduct a search of the database and extract a list of Web
pages that match the search.
The Lycos Catalog is built with the Company's proprietary spider indexing
technology that enables it to collect and organize information on millions of
Web pages and links in a highly efficient manner. The Lycos technology creates
and stores abstracts of Web pages in the Lycos Catalog database instead of
only indexing limited information such as Web addresses or headers or copying
the full text of indexed Web pages. The
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Company believes that this approach best balances a useful amount of
information without the limitations on scalability and comprehensiveness
imposed by copying full text. The Company's abstracts are a concise summary of
the content and key words of a Web page, as well as its address. These
abstracts include the title, outline, 100 most important words and the smaller
of the first 20 lines or 20% of each page. The Lycos spider eliminates
approximately 50 of the most common function words such as "the," "a," "and,"
"or" and "it," which the Company believes add no value and slow down a search.
The Company's spider technology allows it to differentiate its Lycos Catalog
and related products and services in the following ways:
Size and scale. A catalog with a larger underlying database will generally
produce a higher number of results to a query. As of October 24, 1996, Lycos
had indexed nearly 70 million Web pages which the Company believes is the
largest catalog of Internet resources. By constructing abstracts of Web pages,
Lycos' spider technology facilitates the ability of the Lycos Catalog to scale
proportionally with the growth of the Internet.
Using Popularity to Guide the Exploration. Popular Web pages are more likely
to be interesting and useful. The popularity of Web pages can be measured by
the number of pages on other computers that have hypertext links to that page.
The Company believes that the Lycos spider technology is the only indexing
technology that uses popularity as a basis for searching Web pages. The Lycos
spider explores the most popular pages on the Web by using proprietary
algorithms to track the number of external hypertext links to each Web page.
The Company also uses popularity ranking to determine how frequently the Web
pages should be revisited, ensuring that the most popular pages in the Lycos
Catalog are updated frequently.
Relevancy. Relevancy measures how closely the results of a search conform to
a specific query. The ability of a catalog to deliver relevant responses
depends upon the comprehensiveness of the underlying database and the accuracy
of the retrieval software. The Company believes that its retrieval software,
which uses position, frequency and proximity of words to assign relevancy
scores, together with the comprehensiveness of the Lycos Catalog, enable the
Lycos Catalog to deliver more relevant search results.
Ability to Index Non-Textual Pages. The Internet contains many resources
which are non-textual, such as images, sounds, movies and executable programs.
The Lycos spider extracts the addresses of Web pages while also retaining text
describing each link within those pages thereby indexing non-textual objects
for later search and retrieval by users. The Company believes that its spider
indexing technology differentiates its products and services with the ability
to index these non-textual pages.
Response Speed. In order to be practical for most users, catalogs must
return results to queries quickly. The ability of a catalog to respond quickly
to queries depends fundamentally on its underlying indexing technology. The
Company's use of abstracts reduces the amount of information required to be
stored in the database, resulting in faster responses to queries. Moreover, as
the number of Web pages and viewers increases, the Company believes that its
method of creating abstracts should enable the Company to continue to update
and increase the number of Web pages indexed in the Lycos Catalog without
significantly degrading response time. The Company believes that its
technology enables it to offer one of the fastest performing search and
directory services on the Web.
ADVERTISING SALES AND SERVICES
The Company has to date derived a significant portion of its revenues from
the sale of advertisements on its Web pages. For the year ended July 31, 1996,
advertising revenues represented 85.2% of the Company's total revenues. The
Company has established a direct sales force experienced in the advertising
business to address the new and evolving requirements of the Internet
advertising market. The Company believes that an experienced sales force is
critical to initiating and maintaining relationships with advertisers and
advertising agencies and therefore has hired the majority of its sales force
from the advertising industry. The Company's sales force is based throughout
the United States.
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Advertising revenue is generated by advertisers placing banner
advertisements on any of the multiple screens that are displayed on the
Company's multiple product offerings. The Company's advertising revenues are
derived principally from short-term advertising contracts in which the Company
guarantees a minimum number of impressions (an impression is a one-on-one view
of an advertisement by the end user) for a fixed fee or on a per impression
basis with an established minimum fee. The Company also sells advertising on a
keyword basis that links an advertisement to a specific search term or topic
(for example, when "yellow pages" is searched, a Yellow Pages advertisement
appears). Keyword advertising permits advertisers to target advertisements to
selected audiences. The Company advises advertisers on advertisement placement
and design to enable them to develop more dynamic advertisements and monitor
them for effectiveness. To assist advertisers in monitoring the effectiveness
of their advertisements and making appropriate changes, the Company provides
advertisers with reports showing advertising impressions and the number of
times users "click on" an ad to visit the advertiser's site. The Company's
standard rates for advertising range from $20,000 to $50,000 per million
impressions. These advertising rates vary depending on the extent of the
targeted nature of the advertisement. To date, the duration of the Company's
advertising commitments have ranged from one week to five years.
LICENSING OF PRODUCTS AND TECHNOLOGY
The Company licenses its products and technology to leading corporations to
facilitate the establishment of its products and services as a ubiquitous,
branded media service. The Company's strategy is to license its products and
technology to a range of companies seeking to enhance the value of their
Internet products and services, including Internet service providers,
telecommunications companies, online service providers, software providers and
publishers. In its license arrangements, the Company generally receives a
license fee, maintenance fees for product updates and, where applicable, a
share of the advertising revenues, subscription fees or product sales received
by licensees. The Company's license agreements generally have terms of one to
three years. The Company generally co-brands its products with the products
offered by the licensee in order to preserve and enhance the Company's brand
recognition. The Company's product offerings enable its licensees to provide a
comprehensive set of Internet navigational services to their viewers and to
maintain the up-to-date information required by their viewers to keep up with
the rapid growth of the Internet without incurring the extensive costs
associated with the internal development of such products. In addition, the
Company's licensing arrangements enable the Company to create multiple points
of entry and alternative distribution channels for the Company's products and
services, build brand awareness, and expand without the associated
infrastructure costs. As of July 31, 1996, Lycos had 24 such licensees
including several European mirror sites and one Japanese site.
RESEARCH AND PRODUCT DEVELOPMENT
The Company believes that its future success will depend in large part on
its ability to continue to enhance its products and services and to develop
other products and services based on or complementary to its core catalog and
search and indexing technology. An important factor in the future success of
the Lycos Catalog will be the Company's ability to provide more content,
functionality and features than those typically available in other competitive
offerings and to continually refine the search and indexing technology such
that the Lycos Catalog will be able to scale with the growth in Web pages.
Accordingly, the Company's product development efforts are focused on
enhancing its offerings with these features as well as expanding the
capabilities of the Lycos Catalog by improving its user interface and
interoperability with other Web technologies. In order to respond to rapidly
changing competitive and technological conditions, the Company may seek to
enhance or expand its product offerings through acquisitions of complementary
technologies, products or businesses.
The Company is also incorporating new technologies of other portfolio
companies of CMG@Ventures, L.P. ("CMG@Ventures") that it believes will further
differentiate its offerings and provide viewers with a richer, more satisfying
Internet experience. For example, the Company has entered into a letter
agreement with Black Sun Interactive, Inc. ("Black Sun"), whereby the Company
and Black Sun will cross-license certain technology. Under this agreement, the
Company offers a three-dimensional chat product based on a Virtual Reality
Modeling
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Language ("VRML") browser developed by Black Sun. VRML is a new technological
advance that allows real time, three dimensional navigation of simulated
computer generated environments. With this chat product, users are able to
communicate with one another in a variety of information communities (based on
Point Top 5% Sites subject areas) with the added benefit of graphics
representing the individuals in any conversation.
For the Inception Period and the year ended July 31, 1996, the Company's
research and development expenses were $15,940 and $906,951, respectively, or
318.8% and 17.2% of total revenues, respectively. The Company has not
capitalized any software development costs. In addition, for the year ended
July 31, 1996, the Company recorded $452,000 of in process research and
development expense in connection with the acquisition of Point Communications
Corporation ("Point Communications").
COMPETITION
The market for Internet products and services is highly competitive. In
addition, the Company expects the market for Internet advertising, to the
extent it develops, to be intensely competitive. There are no substantial
barriers to entry, and the Company expects that competition will continue to
intensify. Although the Company believes that the diverse segments of the
Internet market will provide opportunities for more than one supplier of
products and services similar to those of the Company, it is possible that a
single supplier may dominate one or more market segments. The Company believes
the principal competitive factors in this market are name recognition,
performance, ease of use, variety of value-added services, functionality and
features and quality of support. A number of companies offer competitive
products addressing certain of the Company's target markets. The primary
competitors of the Company's products and services are other Internet catalog,
directory and review services, including America Online's Web Crawler, Excite
Inc., Digital Equipment Corporation's Alta Vista, Infoseek Corporation, Open
Text Corporation and Yahoo! Corporation. In addition, the Company competes
with metasearch services that allow a user to search the databases of several
catalogs and directories simultaneously. The Company also competes indirectly
with database vendors that offer information search and retrieval capabilities
with their core database products. In the future, the Company may encounter
competition from providers of Web browser software and other Internet products
and services that incorporate search and retrieval features into their
offerings. Many of the Company's existing competitors, as well as a number of
potential new competitors, have significantly greater financial, technical and
marketing resources than the Company. The Company may also compete with online
services and other Web site operators as well as traditional offline media
such as print and television for a share of advertisers' total advertising
budgets. There can be no assurance that the Company will be able to compete
successfully against its current or future competitors or that competition
will not have a material adverse effect on the Company's business, results of
operations and financial condition.
PROPRIETARY RIGHTS AND LICENSES
The Lycos search and indexing technology was developed primarily by Dr.
Michael Mauldin as a faculty member at Carnegie Mellon University ("CMU"). In
June 1995, the Company, CMU, CMG@Ventures and CMGI Information Services, Inc.
("CMGI") entered into a license agreement ("License Agreement") pursuant to
which CMU granted to the Company a perpetual, worldwide right to use and
sublicense the Lycos search and indexing technology and the Lycos Catalog and
other intellectual property rights associated therewith, including the "Lycos"
and "The Lycos Catalog of the Internet" trademarks and the domain name
Lycos.com, subject to the payment of certain specified royalties. The license
has been granted to the Company on an exclusive basis, but is non-exclusive
with respect to certain subcomponents of the licensed technology and is
subject to two licenses to third parties which were assigned to the Company
and to the rights of the United States Government to use an earlier version of
the licensed technology. As part of the License Agreement, CMU retained the
rights to use internally and for non-commercial research, educational or
academic purposes the Lycos Catalog and any improvements and revisions, any
technology, product or process developed by the Company which is based on the
licensed technology and any technology, product or process developed by Dr.
Mauldin and employees under his direction at CMU and made available to the
Company under the License Agreement. The key search and indexing technology
underlying the Lycos Catalog, as well as the Lycos Catalog and Lycos
trademarks and logo, is licensed to or owned by CMU and licensed to the
Company pursuant to the License Agreement. In addition,
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the Company has the exclusive right to use these trademarks in connection with
the sale of other products and services not based on or utilizing the licensed
technology for a royalty payment based on the revenues derived from such
products or services. CMU has filed an application to register the "Lycos"
trademark in the United States.
The License Agreement provided for an initial license fee of $500,000 paid
by the Company to CMU plus the issuance to CMU of twenty percent of the
initial common equity of the Company. In addition, pursuant to the License
Agreement, the Company made further payments to CMU in an amount equal to 50%
of gross revenues received from all sources until such payments totaled
$750,000. All amounts due to CMU under this Agreement were paid as of July 31,
1996. The License Agreement is perpetual and irrevocable, but is terminable if
the Company ceases to carry on any business providing the licensed technology,
if the Company fails to pay CMU the royalties specified therein or if the
Company fails to maintain adequate insurance coverage for CMU.
The Company is also required to pay to CMU an additional $525,000 (which is
not subject to the receipt of any revenues by the Company) pursuant to two
licenses granted by CMU, which were assigned to the Company. As of July 31,
1996, the Company had paid an aggregate of $200,000 to CMU pursuant to these
licenses.
The Company relies upon copyright law, trade secret protection and
confidentiality and/or license agreements with its employees, customers and
others to protect its proprietary technology. Effective trademark, copyright
and trade secret protection may not be available in every foreign country in
which the Company's products are distributed. CMU has no patent protection for
the Lycos search and indexing technology. Although CMU has filed a patent
application with respect to the Lycos search and indexing technology, there
can be no assurance that such patent will be granted. There can be no
assurance that the steps taken by the Company or CMU to protect their
proprietary technology will be adequate to prevent misappropriation of their
technology by third parties, or that third parties will not be able to
independently develop similar technology. In addition, there can be no
assurance that other parties will not assert technology infringement claims
against the Company.
Lycos(TM) is a trademark of Carnegie Mellon University and PointSM is a
service mark of Point Communications, a wholly-owned subsidiary of the
Company. a2zSM is a service mark of the Company. All other trademarks and
service marks used in this Annual Report on Form 10-K are the property of
their respective owners.
EMPLOYEES
As of July 31, 1996, Lycos employed 60 persons, including 27 in sales and
marketing, 25 in research and development, product development and service
operations, and 8 in finance and administrative functions. The Company also
employs independent contractors for software development, documentation,
artistic design and editorial reviews. None of the Company's employees are
represented by a labor union and Lycos considers its employee relations to be
good.
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ITEM 2. PROPERTIES
The Company's executive offices are located in two facilities in
Marlborough, Massachusetts consisting of approximately 8,700 square feet,
under leases that expire in February 1997 and October 2000. The Company also
leases a facility of approximately 4,900 square feet in Pittsburgh,
Pennsylvania under a lease that expires in November 2000, used for research
and development, sales and service operations. The Company also has a sales
office in New York City of approximately 1,000 square feet, under a lease
which expires in November 2000. The Company also leases, on a short-term
basis, a sales office in San Francisco, California. Although the Company
believes that its current facilities are adequate for its current needs, the
Company is seeking to expand its existing facilities to support its growth.
The Company believes that additional space will be available on acceptable
terms.
The Company maintains substantially all of its computer systems at its
Pittsburgh, Pennsylvania site. The Company's operations are dependent in part
upon its ability to protect its operating systems against physical damage from
fire, floods, earthquakes, power loss, telecommunications failures, break-ins
and similar events. Despite the implementation of network security measures by
the Company, its servers are also vulnerable to computer viruses, break-ins
and similar disruptive problems. The occurrence of any of these events could
result in interruptions, delays or cessations in service to users of the
Company's products and services which could have a material adverse effect on
the Company's business, results of operations and financial condition.
ITEM 3. LEGAL PROCEEDINGS
The Company is not currently involved in any legal proceedings that it
believes could have, either individually or in the aggregate, a material
adverse effect on its business or financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the last
quarter of the fiscal year ended July 31, 1996.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by Item 10 of Form 10-K with respect to executive
officers of the Company is set forth below. Executive officers of the Company
are elected by the Board of Directors on an annual basis and serve until their
successors have been duly elected and qualified. There are no family
relationships among any of the executive officers or directors of the Company.
The executive officers of the Company are:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Robert J. Davis.......... 40 President, Chief Executive Officer and Director
Edward M. Philip......... 31 Chief Financial Officer and Secretary
Benjamin P. Bassi........ 40 Vice President of Business Development
William M. Townsend...... 32 Vice President of Advertising
Sangam Pant.............. 31 Vice President of Engineering
Mark G. Simmer........... 36 Vice President of Online Publishing
Jan R. Horsfall.......... 36 Vice President of Marketing
</TABLE>
Robert J. Davis has served as President and Chief Executive Officer of the
Company since June 1995. From January 1993 to June 1995, Mr. Davis served as
Vice President of Sales at Cambex Corporation, a manufacturer of computer-
related products. From January 1982 to January 1993, Mr. Davis was employed by
Wang Laboratories, a computer manufacturer, in various sales and marketing
positions, including Director of United
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States Commercial Sales and Marketing and Director of Worldwide Marketing. Mr.
Davis holds a Bachelor of Science degree, with highest honors, from
Northeastern University and a Master in Business Administration from Babson
College.
Edward M. Philip has served as Chief Financial Officer and Secretary of the
Company since December 1995. From July 1991 to December 1995, Mr. Philip was
employed by The Walt Disney Company where he served in various finance
positions, most recently as Vice President and Assistant Treasurer. From
September 1989 to May 1991, Mr. Philip attended Harvard Business School. From
August 1987 to June 1989, Mr. Philip was an investment banker at Salomon
Brothers Inc, an investment banking firm. Mr. Philip received a Bachelor of
Science degree in Economics and Mathematics from Vanderbilt University and a
Master in Business Administration from Harvard Business School.
Benjamin P. Bassi has served as Vice President of Business Development of
the Company since October 1995. From March 1992 to October 1995, Mr. Bassi was
employed by Object Design, Inc., an object-oriented database software company,
where he served in various positions, including Vice President of North
America and Vice President of Business Development. From April 1985 to March
1992, Mr. Bassi was employed by McDonnell Douglas Systems Integration, where
he served in various positions, including Manager of Strategic Accounts and
Northeast District Manager. Mr. Bassi received a Bachelor of Science degree in
Chemical Engineering from Syracuse University.
William M. Townsend has served as Vice President of Advertising of the
Company since August 1995. From August 1994 to August 1995, Mr. Townsend
served as Vice President and Director of Marketing Services for Ketchum
Advertising, an advertising agency. From October 1989 to August 1994, Mr.
Townsend served as President of Townsend Advertising Corporation, an
advertising agency. Mr. Townsend received a Bachelor of Arts degree in Art
from The College of Wooster in Wooster, Ohio.
Sangam Pant has served as Vice President of Engineering of the Company since
April 1996. From December 1994 to March 1996, Mr. Pant was employed by AT&T
where he served as Director of Internet infrastructure development with AT&T's
New Media Services. Prior to his work with AT&T, Mr. Pant led the design and
development of database systems at Interchange Network Company, and directed
software development efforts for Ziff-Davis and Digital Equipment Corporation.
Mr. Pant received a Master of Science degree in Electrical Engineering from
the University of Florida, and a Bachelor of Engineering degree in Electronics
Engineering from Maharaja Sayajirao University in Barod India. Mr. Pant is
currently obtaining a graduate degree from the Wharton School of Business in
the Executive MBA program. Mr. Pant also holds three patents and has published
numerous papers in the area of distributed computing and database systems.
Mark G. Simmer has served as Vice President of Online Publishing for the
Company since October 1996, and previously served as its Editor-in-Chief since
March 1996. Mr. Simmer served as a consultant to Point Communications,
developing Point NOW (now Lycos Top News), a news service blending Web-based
news from across the world. From 1985 to 1995, Mr. Simmer served in various
capacities with Seattle-based King Broadcasting Company, most recently as
Managing Editor. Projects he supervised have won Emmy Awards from the Seattle
Chapter of the National Academy of Television Arts and Sciences, as well as
national awards from the Robert F. Kennedy foundation and Investigative
Reporters and Editors. Mr. Simmer graduated with honors from Willamette
University in Oregon. He did his graduate studies at the University of
Missouri-Columbia School of Journalism, and from 1987 to 1989, served as
Adjunct Professor of Communication Studies at Whitworth College.
Jan R. Horsfall has served as Vice President of Marketing of the Company
since October 1996. Mr. Horsfall was formerly the Vice President of Brand
Strategy for The Valvoline Company. In that capacity, Mr. Horsfall directed
all consumer promotion, online interactive development, product portfolio
management, consumer research and trade marketing. Previously, Mr. Horsfall
was the director of marketing and advertising for Valvoline, and has held
various sales and marketing positions with the company since 1982. Mr.
Horsfall holds a Bachelor of Science degree in marketing from Colorado State
University, and completed the Executive Development Program for Senior
Management at the University of Indiana at Bloomington.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Common Stock of the Company has traded on the NASDAQ Stock Market under
the symbol LCOS since the Company's initial public offering on April 2, 1996.
Prior to that time, there was no public market for the Company's Common Stock.
The following table sets forth the high and low last reported sale prices for
the Company's Common Stock for the period indicated as reported by the NASDAQ
Stock Market.
<TABLE>
<CAPTION>
YEAR FISCAL QUARTER ENDED HIGH LOW
---- -------------------- ------ ------
<C> <S> <C> <C>
1996 April 30, 1996 (commencing April 2, 1996)....................$29.25.$14.00
July 31, 1996.............................................. 19.25 5.88
1997 October 31, 1996 (through October 24, 1996)................ 12.75 5.75
</TABLE>
As of October 24, 1996, the Company had 13,792,896 shares of Common Stock
held by approximately seventy-seven shareholders of record. This does not
reflect persons or entities who hold their stock in nominee or "street" name
through various brokerage firms.
The Company has not paid dividends on its Common Stock. The Company
anticipates it will continue to reinvest earnings to finance future growth,
and therefore does not intend to pay dividends in the foreseeable future. In
addition, the covenants contained in the Company's line of credit prohibit the
Company from paying cash dividends.
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ITEM 6. SELECTED FINANCIAL DATA
The selected data presented below under the caption Consolidated Statements
of Operations Data with respect to the year ended July 31, 1996 and the period
from Inception (June 1, 1995) to July 31, 1995 ("Inception Period") and under
the caption Consolidated Balance Sheet Data at July 31, 1996 and July 31,
1995, are derived from the consolidated financial statements of the Company
and its subsidiary, which financial statements have been audited by KPMG Peat
Marwick LLP, independent certified public accountants. The following selected
consolidated financial data should be read in conjunction with the
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Consolidated Financial Statements and Notes thereto
included elsewhere in this report.
<TABLE>
<CAPTION>
YEAR ENDED INCEPTION
JULY 31, 1996 PERIOD
------------- -------------
<S> <C> <C>
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Revenues:
Advertising...................................... $ 4,478,474 $ --
License and product.............................. 778,753 5,000
----------- ----------
Total revenues................................. 5,257,227 5,000
Cost of revenues................................... 4,752,621 27,576
----------- ----------
Gross profit................................... 504,606 (22,576)
Operating expenses:
Research and development......................... 906,591 15,940
In process research & development(1)............. 452,000 --
Sales and marketing.............................. 3,221,576 29,530
General and administrative....................... 1,726,646 37,335
----------- ----------
Total operating expenses....................... 6,306,813 82,805
----------- ----------
Operating loss..................................... (5,802,207) (105,381)
Interest income, net............................... 714,369 --
----------- ----------
Net loss........................................... $(5,087,838) $ (105,381)
=========== ==========
Net loss per share(2).............................. $ (0.42) $ (0.01)
=========== ==========
Shares used in computing net loss per share:....... 11,992,415 11,012,764
=========== ==========
<CAPTION>
JULY 31, 1996 JULY 31, 1995
------------- -------------
<S> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Working capital.................................... $39,973,810 $ 329,411
Total assets....................................... 53,660,575 1,316,655
Long-term obligations, net of current portion...... -- --
Total stockholders' equity......................... $44,106,157 $1,144,619
</TABLE>
- --------
(1) Reflects in process research and development expense recorded in
connection with the Company's acquisition of Point Communications.
(2) Net loss per share is calculated using the weighted average number of
common and common equivalent shares outstanding during the respective
periods. See Note 1 of Notes to Consolidated Financial Statements.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The matters discussed in this report contain forward-looking statements that
involve risks and uncertainties. The Company's actual results could differ
materially from those discussed herein. Factors that could cause or contribute
to such differences include, but are not limited to, those discussed in
"Factors Affecting the Company's Business, Operating Results and Financial
Condition" as well as those discussed in this section and elsewhere in this
Report.
RESULTS OF OPERATIONS
Revenues. Net sales for the year ended July 31, 1996 totaled $5.3 million
versus $5,000 in the period from inception (June 1, 1995) to July 31, 1995
("Inception Period"). As of July 31, 1996, the Company had deferred revenues
of $3.1 million attributable to license agreements for which there are
significant obligations of the Company remaining, and billings in excess of
revenues of $1.4 million, attributable to billings in excess of revenues on
advertising contracts.
Advertising revenues. Advertising revenues were $4.5 million for the year
ended July 31, 1996 representing 85% of total revenues. The Company did not
have any advertising revenues in the Inception Period.
The Company's advertising revenues are derived principally from the sale of
advertising on its Internet web sites. Advertising contracts vary in duration
from one week to five years. Advertising contracts are principally sold as
either: (1) a "general rotation" contract under which a customer is guaranteed
a minimum number of impressions; (2) a "key word" contract in which a customer
purchases the right to specified words and the customer's advertisement is
shown as those words are "searched"; and (3) a combination of general rotation
and key word contracts.
License and product revenues. License and product revenues were $779,000 for
the year ended July 31, 1996, representing 15% of total revenues. All license
and product revenues in the Inception Period were derived from one customer
and totaled $5,000, representing 100% of total revenues. For the year ended
July 31, 1996, the increase in license and product revenue is attributable
primarily to the addition of over twenty new licensees during the year,
including, among others, AT&T, Bertelsmann's Telemedia, CompuServe, Simon &
Schuster, Swedish Post and Xaxon.
Cost of revenues. Cost of revenues were $4.8 million for the year ended July
31, 1996, representing 90% of total revenues. Cost of revenues for the
Inception Period totaled $28,000, representing 552% of total revenues. Cost of
revenues consist primarily of expenses associated with the ongoing
enhancement, maintenance and support of the Company's products and services,
including compensation, consulting fees, equipment, networking and other
related indirect costs. Cost of revenues also includes amortization costs
associated with the Company's License Agreement with CMU and the cost of the
Company's "Premier Provider" Agreement with Netscape Communications
Corporation ("Netscape"), as further described below.
In April 1996, the Company entered into a one year "Premier Provider"
Agreement ("the Agreement") with Netscape pursuant to which the Company was
designated one of five "Premier Providers" of search and navigation services
accessible from the "Net Search" button on the Netscape browser. Under the
terms of the Agreement, the Company is obligated to make installment payments
totaling $5 million over the term of the Agreement. The Company recognizes the
cost of this agreement ratably over the term of the Agreement, thus, included
in cost of revenues for the year ended July 31, 1996 is the pro-rated portion
of the contract since the service commenced in April 1996.
Operating expenses
Research and Development. Research and development expenses were $907,000
for the year ended July 31, 1996, representing 17% of total revenues for the
year. During the Inception Period, research and development
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expenses were $16,000, or 319% of total revenues. Research and development
expenses consist primarily of equipment and salary costs. The overall increase
in research and development spending was primarily due to increased
engineering staffing required to continue to develop and enhance the Company's
product lines.
In addition, during the year, the Company recorded $452,000 of in process
research and development expense related to the acquisition of Point
Communications. To date, all research and development costs have been expensed
as incurred. The Company believes that significant investments in research and
development are required to remain competitive. As a consequence, the Company
expects to continue to commit substantial resources to research and
development in the future.
Sales and Marketing. Sales and marketing expenses were $3.2 million for the
year ended July 31, 1996, representing 61% of total revenues for the year.
During the period ended July 31, 1995, sales and marketing expenses were
$30,000, representing 591% of total revenues for the period. Sales and
marketing expenses consist primarily of compensation, advertising, public
relations, trade shows, travel and costs of marketing literature. The spending
increases were due to the addition of sales and marketing personnel, increased
commissions and expenses associated with the Company's expanded advertising,
marketing and public relations campaign. The Company expects continued
increases in sales and marketing expenses in future periods.
General and Administrative. General and administrative expenses were
approximately $1.7 million for the year ended July 31, 1996, representing 33%
of total revenues. During the period ended July 31, 1995, general and
administrative expenses were $37,000, representing 747% of total revenues.
General and administrative expenses consist primarily of compensation, rent
expenses and fees for professional services. The increases in spending were
primarily due to the expansion of the Company's corporate infrastructure,
including the addition of finance and administrative personnel, installation
of information systems and increased costs for professional services.
Interest Income, net. Interest income, net, was approximately $714,000 for
the year ended July 31, 1996, resulting primarily from the investment of net
proceeds received upon the closing of the Company's initial public offering in
April 1996. There was no interest income in the Inception Period.
Income taxes. The Company has not recorded an income tax benefit because it
has incurred net operating losses since inception. As of July 31, 1996, the
Company had approximately $5.1 million in Federal and state net operating loss
carryforwards. Of this amount, approximately $380,000 relates to the
acquisition of Point Communications and will reduce goodwill when utilized.
The Federal net operating losses will expire beginning in 2010 if not
utilized. The state net operating losses will expire beginning in 2000 if not
utilized. A portion or all of net operating loss carryforwards which can be
utilized in any year may be limited by changes in ownership of the Company,
pursuant to Section 382 of the Internal Revenue Code and similar statutes.
New accounting pronouncements. During October 1995, the Financial Accounting
Standards Board issued Statement No. 123 ("SFAS 123") which establishes a fair
value based method of accounting for stock based compensation plans. While the
Company is studying the impact of the pronouncement, it continues to account
for employee stock options under APB Opinion No. 25, Accounting for Stock
Issued to Employees. SFAS 123 will be effective for fiscal years beginning
after December 15, 1995, or fiscal 1997 for the Company.
LIQUIDITY AND CAPITAL RESOURCES
Prior to its initial public offering, the Company financed its operations
primarily from proceeds of the private sale of equity securities and, to a
lesser extent, operating leases. On April 2, 1996, the Company completed an
initial public offering of its common stock in which 3,000,000 shares of
common stock were issued at a price of $16.00 per share. On April 12, 1996,
pursuant to the exercise of an over-allotment option granted to the
underwriters of the Company's initial public offering, the Company issued an
additional 135,000 shares of its common stock at $16.00 per share. Proceeds
from the offering were approximately $46 million, net of underwriting
discounts and other related costs.
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At July 31, 1996, the Company had cash and cash equivalents of approximately
$44 million. The Company regularly invests excess funds in short-term money
market funds, government securities, and commercial paper. At July 31, 1996,
the Company also has available a bank revolving credit facility providing for
borrowings up to $1.0 million.
The Company used cash from operations of approximately $1.0 million in the
year ended July 31, 1996, due primarily to the net loss, as well as increases
in accounts receivable and license fees receivable. The Company's primary
investing activity during the year has been, and further expenditures are
anticipated to be, for the purchase of computers and office equipment to
support the Company's growth. During the year ended July 31, 1996, the Company
also used approximately $750,000 for payments under the License Agreement.
At July 31, 1996 the Company had deferred revenues of $3.1 million
representing license fees to be earned in the future on noncancelable license
agreements. In addition, the Company had billings in excess of revenues from
advertising contracts of $1.4 million at July 31, 1996.
In April 1996, the Company entered into the Agreement with Netscape pursuant
to which the Company was designated one of five "Premier Providers" of search
and navigation services accessible from the "Net Search" button on the
Netscape browser. Under the terms of the Agreement, the Company is obligated
to make installment payments totaling $5 million over the term of the
Agreement.
From time to time the Company expects to evaluate the acquisition of
products, businesses and technologies that complement the Company's business.
Currently, however, the Company does not have any understandings, commitments
or agreements with respect to any such material acquisitions.
The Company currently believes that available funds, cash flows expected to
be generated by operations, if any, and the existing credit facility will be
sufficient to fund its working capital and capital expenditures requirements
for the next twelve months. Thereafter, the Company may need to raise
additional funds. The Company may need to raise additional funds sooner in
order to fund more rapid expansion, to develop new or enhanced products and
services, to respond to competitive pressures or to acquire complementary
businesses or technologies. If additional funds are raised through the
issuance of equity securities, the percentage ownership of the stockholders of
the Company will be reduced, stockholders may experience additional dilution,
and such equity securities may have rights, preferences or privileges senior
to those of the Company's Common Stock. There can be no assurance that
additional financing will be available when needed on terms favorable to the
Company or at all. If adequate funds are not available or are not available on
acceptable terms, the Company may be unable to develop or enhance products or
services, take advantage of future opportunities or respond to competitive
pressures, which could have a material adverse effect on the Company's
business, results of operations or financial condition.
FACTORS AFFECTING THE COMPANY'S BUSINESS, OPERATING RESULTS AND FINANCIAL
CONDITION
Extremely Limited Operating History; Anticipation of Continued Losses. The
Company was founded in June 1995 and for the fiscal year ended July 31, 1996
generated revenues of $5,257,227. Accordingly, the Company has an extremely
limited operating history upon which an evaluation of the Company and its
prospects can be based. The Company and its prospects must be considered in
light of the risks, expenses and difficulties frequently encountered by
companies in their early stage of development, particularly companies in new
and rapidly evolving markets. The Company has achieved only limited revenues
to date. The limited operating history of the Company makes the prediction of
future results of operations difficult or impossible, and therefore, there can
be no assurance that the Company will sustain revenue growth or achieve
profitability. The Company has incurred significant losses since inception and
expects to continue to incur significant losses on a quarterly and annual
basis for the foreseeable future. As of July 31, 1996, the Company had an
accumulated deficit of $5,193,219. See "Selected Financial Data" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Results of Operations."
19
<PAGE>
Potential Fluctuations in Quarterly Results. As a result of the Company's
extremely limited operating history, the Company does not have historical
financial data for any significant period of time on which to base planned
operating expenses. The Company's expense levels are based in part on its
expectations as to future revenues and to a large extent are fixed. Quarterly
sales and operating results generally depend on the advertising revenues,
license fees and other revenues received within the quarter, which are
difficult to forecast. Since the Company's expense levels are based upon
anticipated advertising and licensing revenue, the Company may not be able to
adjust spending in a timely manner to compensate for any unexpected revenue
shortfall. Accordingly, any significant shortfall in relation to the Company's
expectations would have an immediate adverse impact on the Company's business,
results of operations and financial condition. In addition, the Company plans
to significantly increase its operating expenses to fund greater levels of
research and development, increase its sales and marketing operations, develop
new distribution channels, broaden its customer support capabilities and
establish brand identity and strategic alliances. In the future, leading Web
sites, browser providers and other distribution channels may require payments
or other consideration for listing the Company's products and services such as
the Company's arrangement with Netscape. To the extent that such expenses
precede or are not subsequently followed by increased revenues, the Company's
business, results of operations and financial condition will be materially
adversely affected. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Results of Operations."
The Company's operating results may fluctuate significantly in the future as
a result of a variety of factors, some of which are outside of the Company's
control. These factors include general economic conditions, specific economic
conditions in the Internet industry, usage of the Internet, demand for
Internet advertising, seasonal trends in advertising sales, the advertising
budgeting cycles of individual advertisers, capital expenditures and other
costs relating to the expansion of operations, the introduction of new
products or services by the Company or its competitors, the mix of the
services sold and the channels through which those services are sold and
pricing changes. As a strategic response to a changing competitive
environment, the Company may elect from time to time to make certain pricing,
service or marketing decisions or acquisitions that could have a material
adverse effect on the Company's business, results of operations and financial
condition. The Company believes that period to period comparisons of its
operating results are not meaningful and should not be relied upon for an
indication of future performance. The Company also expects that, in the
future, it may experience seasonality in its business, with advertising
impressions (and therefore revenues) being somewhat lower during the summer
months, when usage of the Company's products and services may be expected to
decline. Due to all of the foregoing factors, it is possible that in some
future quarter, 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
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Results of Operations."
Developing Market; Unproven Acceptance of the Company's Products and
Services; Uncertain Adoption of the Internet as an Advertising Medium. The
market for the Company's products and services has only recently begun to
develop, is rapidly evolving and is characterized by an increasing number of
market entrants who have introduced or developed products and services for use
on the Internet. The Company's market is highly dependent upon the increased
use of the Internet for information publication, distribution and commerce,
and on the development of the Internet as an advertising medium. The Company's
future operating results will depend upon the emergence of the Internet
advertising market, the successful implementation of the Company's advertising
program and its ability to establish licensing relationships with leading
Internet businesses. There can be no assurance, however, that the Internet
advertising market will develop as an attractive and sustainable medium, that
the Company will achieve market acceptance of its products and services or
that the Company will be able to execute its business plan successfully. As is
typical in the case of a new and rapidly evolving industry, demand and market
acceptance for recently introduced products and services are subject to a high
level of uncertainty. The industry is young and has few proven products.
Moreover, critical issues concerning the commercial use of the Internet
(including security, reliability, cost, ease of use and access, quality of
service and acceptance of advertising) remain unresolved and may impact the
growth of Internet use or the placement of advertisements on the Internet. If
widespread commercial use of the Internet does not develop, or if the Internet
20
<PAGE>
does not develop as an attractive medium for advertising, the Company's
business, results of operations and financial condition will be materially
adversely affected.
Because the market for the Company's products and services is new and
evolving, it is difficult to predict the size of this market and growth rate,
if any. There can be no assurance that the market for the Company's products
and services will develop or that demand for the Company's products or
services will emerge or become sustainable. If the market fails to develop,
develops more slowly than expected or becomes saturated with competitors, or
if the Company's products and services do not achieve or sustain market
acceptance, the Company's business, results of operations and financial
condition will be materially adversely affected. See "Business--Industry
Background."
Reliance on Advertising Revenues. The Company derives substantially all of
its revenues from the sale of advertisements on its Web pages. For the fiscal
year ended July 31, 1996, advertising revenues represented approximately 85%
of the Company's total revenues. The Company's strategy is to continue to
develop advertising and other methods of generating revenues through the use
of its products and services. The Company is in the early stages of licensing
its products and technology and in implementing its advertising program. The
Company's ability to generate significant advertising revenues will depend,
among other things, on advertisers' acceptance of the Internet as an
attractive and sustainable medium, the development of a large base of users of
the Company's products and services possessing demographic characteristics
attractive to advertisers and the expansion of the Company's advertising sales
force. In addition, there is fluid and intense competition in the sale of
advertising on the Internet, resulting in a wide range of rates quoted by
different vendors for a variety of advertising services which makes it
difficult to project future levels of advertising revenues which will be
realized generally or by any specific Company. Further, significant and
consistent investment on the Internet by many advertisers is dependent upon
validation that the Internet is an effective advertising medium, which
validation has not yet occurred and which is essential to the achievement of
steady and predictable advertising revenues. See "Business--Industry
Background" and "Business--Advertising Sales and Services."
Dependence on Third Party Relationships. The Company is dependent on a
number of third party relationships to create traffic on the Company's Web
sites and consequently generate revenues. These relationships include
arrangements relating to the positioning of the Company's products and
services on Web browsers such as that offered by Netscape and license
agreements. In April 1996, the Company entered into a one-year "Premier
Provider" Agreement with Netscape pursuant to which the Company was designated
one of five "Premier Providers" of search and navigation services accessible
from the "Net Search" button on the Netscape browser. Under the terms of this
Agreement, the Company is obligated to make installment payments totaling $5
million over the term of the Agreement. For the fiscal year ended July 31,
1996, a significant portion of the traffic to the Company's Web sites was
derived through the Netscape browser. The Company cannot anticipate the impact
on its traffic of any changes Netscape may make to its service or browser or
the effect on advertising revenues that may be generated from such traffic.
The termination of the Company's relationship with Netscape could
significantly reduce the traffic on the Company's Web sites.
The Company is dependent on its license arrangements with Internet and
online service providers such as AT&T, CompuServe, Focus Online (Germany) and
Swedish Post. The Company is also dependent on Web site operators that provide
links to the Company's Web sites. Although the Company views these
relationships as important direct and indirect factors in the generation of
revenues, most of the Company's arrangements do not require future minimum
commitments to use the Company's services or to provide access or links to the
Company's products or services, are not exclusive and generally have a term of
one to three years. In addition, there can be no assurance that the Company's
licensees regard their relationship with the Company as important to their own
respective businesses and operations, that they will not re-assess their
commitment to the Company's products or services at any time in the future or
that they will not develop their own competitive products or services. There
can be no assurance that the Company's existing relationships will result in
sustained business partnerships, successful product or service offerings or
the generation of significant revenues for the Company. Failure of one or more
of the Company's license relationships to achieve or maintain market
acceptance or
21
<PAGE>
commercial success or the termination of one or more successful license
relationships could have a material adverse effect on the Company's business,
results of operations or financial condition. In addition, the termination of
the Company's position on a Web browser or the grant to a competitor of an
exclusive arrangement with respect to positioning on a Web browser would
significantly reduce traffic on the Company's Web sites which would have a
material adverse effect on the Company's business, results of operations and
financial condition. See "Business--Licensing of Products and Technology."
Intense Competition. The market for Internet products and services is highly
competitive. In addition, the market for Internet advertising is intensely
competitive. There are no substantial barriers to entry, and the Company
expects that competition will continue to intensify. Although the Company
believes that the diverse segments of the Internet market will provide
opportunities for more than one supplier of products and services similar to
those of the Company, it is possible that a single supplier may dominate one
or more market segments. The Company believes that the principal competitive
factors in this market are name recognition, performance, ease of use, variety
of value-added services, functionality and features and quality of support. A
number of companies offer competitive products addressing certain of the
Company's target markets. The primary competitors of the Company's products
and services are other Internet catalog, directory and review services,
including America Online's Web Crawler, Excite Inc., Digital Equipment
Corporation's Alta Vista, Infoseek Corporation, Open Text Corporation and
Yahoo! Corporation. In addition, the Company competes with metasearch services
that allow a user to search the databases of several catalogs and directories
simultaneously. The Company also competes indirectly with database vendors
that offer information search and retrieval capabilities with their core
database products. In the future, the Company may encounter competition from
providers of Web browser software and other Internet products and services
that incorporate search and retrieval features into their offerings. Many of
the Company's existing competitors, as well as a number of potential new
competitors, have significantly greater financial, technical and marketing
resources than the Company. The Company may also be adversely affected by
competition from licensees of its products and technology. There can be no
assurance that the Company's competitors will not develop Internet products
and services that are superior to those of the Company or that achieve greater
market acceptance than the Company's offerings. Moreover, a number of the
Company's current advertising customers, licensees and partners have also
established relationships with certain of the Company's competitors, and
future advertising customers, licensees and partners may establish similar
relationships. The Company may also compete with online services and other Web
site operators as well as traditional offline media such as print and
television for a share of advertisers' total advertising budgets. There can be
no assurance that the Company will be able to compete successfully against its
current or future competitors or that competition will not have a material
adverse effect on the Company's business, results of operations and financial
condition. See "Business--Competition."
Management of Growth; Need to Establish Infrastructure; Additional
Personnel. The rapid execution necessary for the Company to successfully offer
its products and services and implement its business plan in a rapidly
evolving market requires an effective planning and management process. The
Company's rapid growth has placed, and is expected to continue to place, a
significant strain on the Company's managerial and operational resources. To
manage its growth, the Company must continue to implement and improve its
operational and financial systems and to expand, train and manage its employee
base. Further, the Company will be required to manage multiple relationships
with various customers and other third parties. There can be no assurance that
the Company has made adequate allowances for the costs and risks associated
with this expansion and transition, that the Company's systems, procedures or
controls will be adequate to support the Company's operations or that the
Company's management will be able to achieve the rapid execution necessary to
successfully offer the Company's products and services and implement its
business plan. The Company's future operating results will also depend on its
ability to expand its advertising sales and business development organizations
and expand its support organization commensurate with the growth of its
business. If the Company is unable to manage growth effectively, the Company's
business, results of operations and financial condition will be materially
adversely affected. See "Business--Employees."
22
<PAGE>
Risks Associated with International Expansion. International sales accounted
for approximately 7.3% of the Company's revenues for the fiscal year ended
July 31, 1996. As part of its business strategy, the Company is seeking
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 will face new
competitors. In addition, the ability of the Company to enter the
international markets will be dependent upon the Company's ability to create
localized versions of its products and services. There can be no assurance
that the Company will be successful in creating localized versions of its
products and services 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 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. There can be no assurance that one or more of such factors will
not have a material adverse effect on any international operations established
by the Company and, consequently, on the Company's business, operating results
and financial condition.
Dependence on the Internet. The use of the Company's products and services
will depend in large part upon the development of an infrastructure for
providing Internet access and services. Because global commerce and online
exchange of information on the Internet and other similar open wide area
networks are new and evolving, it is difficult to predict with any assurance
whether the Internet will prove to be a viable commercial marketplace. The
Internet has experienced, and is expected to continue to experience,
significant growth in the number of users and amount of traffic. There can be
no assurance that the Internet infrastructure will continue to be able to
support the demands on it by this continued growth. In addition, the Internet
could lose its viability due to delays in the development or adoption of new
standards and protocols (for example, the next-generation Internet Protocol)
to handle increased levels of Internet activity, or due to increased
governmental regulation. There can be no assurance that the infrastructure or
complementary services necessary to make the Internet a viable commercial
marketplace will be developed, or, if developed, that the Internet will become
a viable commercial marketplace for products and services such as those
offered by the Company. In particular, the Internet is an unproven medium for
paid advertising sponsorship of services such as the Company's. If the
necessary infrastructure or complementary services or facilities are not
developed, or if the Internet does not become a viable commercial marketplace,
the Company's business, results of operations and financial condition will be
materially adversely affected. See "Business--Industry Background."
Risk of Capacity Constraints and System Failure Relating to the Lycos
Products and Services. A key element of the Company's strategy is to generate
a high volume of traffic to its products and services, which the Company makes
available free of charge to users of the Internet. Accordingly, the
performance of the Company's products and services is critical to the
Company's reputation, its ability to attract advertisers to the Company's Web
sites and market acceptance of these products and services. Any system failure
that causes interruptions in the availability or increases response time of
the Company's products and services 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
licensees. An increase in the volume of searches conducted through the
Company's products and services could strain the capacity of the software or
hardware deployed by the Company or the capacity of the Company's network
infrastructure, which could lead to slower response time or system failures.
Any failure to expand the capacity of the Company's hardware or network
infrastructure on a timely basis or on commercially reasonable terms could
have a material adverse effect on the Company's business, results of
operations and financial condition. In addition, as the number of Web pages
and users increase, there can be no assurance that the Company's products and
services will be able to scale proportionately. The Company is also dependent
upon Web browsers and Internet and online service providers for access to its
23
<PAGE>
products and services and users have experienced difficulties due to system
failures unrelated to the Company's systems, products and services. The
Company is also dependent on hardware suppliers for prompt delivery,
installation and service of servers and other equipment and services used to
provide its products and services. Substantially all of the Company's hardware
operations are located at its computer facility located in Pittsburgh,
Pennsylvania. There can be no assurance that a system failure at this location
would not adversely affect the performance of the Company's products and
services. This system is vulnerable to damage from fire, floods, earthquakes,
power loss, telecommunications failures, break-ins and similar events. The
Company does not presently have a disaster recovery plan. Despite the
implementation of network security measures by the Company, its servers are
also vulnerable to computer viruses, break-ins and similar disruptive
problems. Computer viruses, break-ins or other problems caused by third
parties could lead to interruptions, delays or cessation in service to users
of the Company's products and services. The occurrence of any of these risks
could have a material adverse effect on the Company's business, results of
operations and financial condition. See "Business--Properties."
Technological Change and New Products. The market for Internet products and
services is characterized by rapidly changing technology, evolving industry
standards and customer demands, and frequent new product introductions and
enhancements. These market characteristics are exacerbated by the emerging
nature of this market and the fact that many companies are expected to
introduce new Internet products in the near future. The Company's future
success will depend in significant part on its ability to continually improve
the performance, features and reliability of the Lycos Catalog in response to
both evolving demands of the marketplace and competitive product offerings,
and there can be no assurance that the Company will be successful in doing so.
In addition, a key element of the Company's business strategy is the
development, introduction and integration of new products that capitalize on
the increasing use of the Internet. There can be no assurance that the Company
will be successful in developing or integrating such products or services or
that such products and services will meet with market acceptance. In addition,
new product releases by the Company, whether improved versions of the Lycos
Catalog or introductions of new products, may contain undetected errors that
require significant design modifications, resulting in a loss of customer
confidence and viewer support and adversely affecting the use of the Company's
products and services and, consequently, the Company's business, results of
operations or financial condition. See "Business--Research and Product
Development."
Dependence on Key Personnel. The Company's performance is substantially
dependent on the performance of its executive officers and key employees, all
of whom have worked together for only a short period of time. The Company does
not have in place key person life insurance policies on any of its employees.
The loss of the services of any of its executive officers or other key
employees could have a material adverse effect on the business, results of
operations or financial condition of the Company. The Company is heavily
dependent upon its ability to attract, retain and motivate skilled technical
and managerial personnel. The Company's future success also depends on its
continuing ability to identify, hire, train and retain other highly qualified
technical and managerial personnel. Competition for such personnel is intense,
and there can be no assurance that the Company will be able to attract,
assimilate or retain other highly qualified technical and managerial personnel
in the future. The inability to attract, hire or retain the necessary
technical and managerial personnel could have a material adverse effect upon
the Company's business, results of operations or financial condition. See
"Business--Employees."
Government Regulation and Legal Uncertainties. The Company is not currently
subject to direct regulation by any government agency, other than regulations
applicable to businesses generally, and there are currently few laws or
regulations directly applicable to access to or commerce on the Internet. Due
to the increasing popularity and use of the Internet, it is possible that a
number of laws and regulations may be adopted with respect to the Internet,
covering issues such as privacy, copyrights, obscene or indecent
communications and the pricing, 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 Company's
products and increase the Company's cost of doing business, expose the Company
to significant liabilities associated with content available on or through its
products and services or otherwise have an adverse effect on the Company's
24
<PAGE>
business, results of operations or financial condition. Moreover, the
applicability to the Internet of existing laws governing issues such as
property ownership, libel and personal privacy is uncertain. Any such new
legislation or regulation could have a material adverse effect on the
Company's business, results of operations or financial condition.
Liability for Information Retrieved from the Internet. Because materials may
be downloaded by the online or Internet services operated or facilitated by
the Company or the Internet access providers with which it has a relationship
and be subsequently distributed to others, there is a potential that claims
will be made against the Company for defamation, negligence, copyright or
trademark infringement or other theories based on the nature and content of
such materials, including claims based on the Company providing access to
obscene, lascivious or indecent information. Such claims have been brought,
and sometimes successfully pressed, against online services in the past.
Although the Company carries general liability insurance, the Company's
insurance may not cover potential claims of this type, or may not be adequate
to indemnify the Company for all liability that may be imposed. Any imposition
of liability that is not covered by insurance or is in excess of insurance
coverage could have a material adverse effect on the Company.
25
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
<TABLE>
<CAPTION>
PAGE
----
<C> <S> <C>
PART I. FINANCIAL INFORMATION
Item 1 Consolidated Financial Statements:
Independent Auditors' Report................................... 27
Consolidated Balance Sheets July 31, 1996 and July 31, 1995.... 28
Consolidated Statements of Operations Year ended July 31, 1996
and the period from inception (June 1, 1995) to July 31,
1995.......................................................... 29
Consolidated Statements of Stockholders' Equity................ 30
Consolidated Statements of Cash Flows Year ended July 31, 1996
and the period from inception (June 1, 1995) to July 31,
1995.......................................................... 31
Notes to Consolidated Financial Statements..................... 32
PART II. FINANCIAL STATEMENT SCHEDULES
</TABLE>
All schedules have been omitted since they are either not applicable, not
required or the information is included elsewhere herein.
26
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Lycos, Inc.:
We have audited the accompanying consolidated balance sheets of Lycos, Inc.
and subsidiary as of July 31, 1996 and 1995 and the related consolidated
statements of operations, stockholders' equity and cash flows for the year
ended July 31, 1996 and for the period from inception (June 1, 1995) to July
31, 1995. These consolidated financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the consolidated financial
statements are free of material misstatement. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used for significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Lycos,
Inc. and subsidiary at July 31, 1996 and July 31, 1995 and the results of
their operations and their cash flows for the year ended July 31, 1996 and for
the period from inception (June 1, 1995) to July 31, 1995, in conformity with
generally accepted accounting principles.
KPMG Peat Marwick LLP
Boston, Massachusetts
September 3, 1996
27
<PAGE>
LYCOS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JULY 31, JULY 31,
1996 1995
----------- ----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........................... $44,142,187 $ 446,447
Accounts receivable, less allowance for doubtful
accounts of $200,000 at July 31, 1996.............. 3,293,925 5,000
License fee receivable.............................. 1,032,405 --
Prepaid expenses.................................... 981,711 --
----------- ----------
Total currrent assets............................. 49,450,228 451,447
----------- ----------
Property and equipment, less accumulated
depreciation......................................... 1,405,768 77,708
Long-term license fees receivable..................... 951,816 --
License agreement, net................................ 1,513,466 787,500
Goodwill, net......................................... 171,682 --
Other assets.......................................... 167,615 --
----------- ----------
Total assets...................................... $53,660,575 $1,316,655
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.................................... $ 2,741,879 $ 44,074
Accured expenses.................................... 1,746,418 6,355
Deferred revenues................................... 3,148,422 --
Billings in excess of revenues...................... 1,402,432 --
Due to related parties.............................. 437,267 71,607
----------- ----------
Total current liabilities......................... 9,476,418 122,036
----------- ----------
Deferred income taxes................................. 78,000 50,000
Stockholders' equity:
Preferred stock, $.01 par value; 5,000,000 shares
authorized, none issued or outstanding............. -- --
Common stock, $.01 par value; 40,000000 shares
authorized, 13,792,896 shares at July 31, 1996 and
10,000,000 shares at July 31, 1995 issued and
outstanding........................................ 137,929 100,000
Additional paid-in capital.......................... 49,537,608 1,237,000
Deferred compensation............................... (376,161) (87,000)
Accumulated deficit................................. (5,193,219) (105,381)
----------- ----------
Total stockholders' equity........................ 44,106,157 1,144,619
----------- ----------
Commitments
Total liabilities and stockholders' equity........ $53,660,575 $1,316,655
=========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
28
<PAGE>
LYCOS, INC
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR INCEPTION
ENDED (JUNE 1, 1995)
JULY 31, TO JULY 31,
1996 1995
----------- --------------
<S> <C> <C>
REVENUES:
Advertising....................................... $ 4,478,474 $ --
License and product............................... 778,753 5,000
----------- ----------
Total revenues.................................. 5,257,227 5,000
Cost of revenues.................................... 4,752,621 27,576
----------- ----------
Gross profit.................................... 504,606 (22,576)
Operating expenses:
Research and development.......................... 906,591 15,940
In process research and development............... 452,000 --
Sales and marketing............................... 3,221,576 29,530
General and administrative........................ 1,726,646 37,335
----------- ----------
Total operating expenses........................ 6,306,813 82,805
----------- ----------
Operating loss...................................... (5,802,207) (105,381)
Interest income, net................................ 714,369 --
----------- ----------
Net loss............................................ $(5,087,838) $ (105,381)
=========== ==========
Net loss per share.................................. $ (0.42) $ (0.01)
=========== ==========
Shares used in computing net loss per share......... 11,992,415 11,012,764
=========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
29
<PAGE>
LYCOS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
------------------- PAID-IN DEFERRED ACCUMULATED
SHARES AMOUNT CAPITAL COMPENSATION DEFICIT TOTAL
---------- -------- ----------- ------------ ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Issuance of common stock
in connection with the
formation of the
Company................ 8,000,000 $ 80,000 $ 920,000 $ -- $ -- $ 1,000,000
Capital contribution
related to License
Agreement.............. 2,000,000 20,000 230,000 -- -- 250,000
Deferred compensation
related to grant of
stock options.......... -- -- 87,000 (87,000) -- --
Net loss................ -- -- -- -- (105,381) (105,381)
---------- -------- ----------- --------- ----------- -----------
Balances at July 31,
1995................... 10,000,000 100,000 1,237,000 (87,000) (105,381) 1,144,619
Capital contribution.... -- -- 1,000,000 -- -- 1,000,000
Capital contribution
related to License
Agreement.............. -- -- 250,000 -- -- 250,000
Issuance of common stock
in connection with
acquisition of Point
Communications......... 526,316 5,263 536,737 -- -- 542,000
Issuance of common stock
pursuant to certain
preemptive rights...... 131,580 1,316 327,634 -- -- 328,950
Issuance of common stock
in connection with
Initial Public
Offering, net of
offering costs......... 3,135,000 31,350 45,662,732 -- -- 45,694,082
Deferred compensation
related to grant of
stock options.......... -- -- 523,505 (523,505) -- --
Amortization of deferred
compensation........... -- -- -- 234,344 -- 234,344
Net loss................ -- -- -- -- (5,087,838) (5,087,838)
---------- -------- ----------- --------- ----------- -----------
Balances at July 31,
1996................... 13,792,896 $137,929 $49,537,608 $(376,161) $(5,193,219) $44,106,157
========== ======== =========== ========= =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
30
<PAGE>
LYCOS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED INCEPTION
JULY 31, (JUNE 1, 1995) TO
1996 JULY 31, 1996
----------- -----------------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss....................................... $(5,087,838) $(105,381)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Amortization of deferred compensation........ 234,344 --
Depreciation and amortization................ 642,218 13,817
Allowance for doubtful accounts.............. 200,000 --
In process research and development expense.. 452,000 --
Changes in operating assets and liabilities:
Accounts receivable.......................... (3,454,950) (5,000)
License fees receivable...................... (1,984,221) --
Prepaid expenses............................. (981,711) --
Other assets................................. (167,615) --
Accounts payable............................. 2,600,071 44,074
Accrued expenses............................. 1,735,693 6,355
Deferred revenues............................ 3,125,285 --
Billings in excess of revenues............... 1,402,432 --
Due to related parties....................... 295,660 71,607
Deferred income taxes........................ 28,000 --
----------- ---------
Net cash provided by (used in) operating
activities.................................... (960,632) 25,472
----------- ---------
INVESTING ACTIVITIES
Purchase of property and equipment............. (1,632,079) (79,025)
Payments under License Agreement............... (750,000) (500,000)
Cash acquired through acquisition of Point
Communications................................ 17,137 --
----------- ---------
Cash used in investing activities.............. (2,364,942) (579,025)
----------- ---------
FINANCING ACTIVITIES
Proceeds from issuance of common stock, net of
issuance costs................................ 46,021,314 1,000,000
Proceeds from capital contribution............. 1,000,000 --
----------- ---------
Net cash provided by financing activities...... 47,021,314 1,000,000
----------- ---------
Increase in cash and cash equivalents.......... 43,695,740 446,447
Cash and cash equivalents at beginning of
year.......................................... 446,447 --
----------- ---------
Cash and cash equivalents at end of period..... $44,142,187 $ 446,447
----------- ---------
Schedule of non-cash financing and investing
activities:
Issuance of common stock for License
Agreement................................... $ 300,000 $ 300,000
Recognition of deferred tax liability related
to License Agreement........................ 50,000 50,000
Assets and liabilities recognized upon
acquisition of Point
Communications.............................
Accounts receivable........................ 33,975
Property and equipment..................... 47,496
Goodwill................................... 186,633
Accounts payable........................... 97,734
Deferred revenues.......................... 23,137
Accrued expenses........................... 4,370
Due to related parties..................... 70,000
</TABLE>
See accompanying notes to consolidated financial statements.
31
<PAGE>
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company
Lycos, Inc. ("Lycos" or the "Company"), which operates in one industry
segment, provides guides for finding information on the Internet's World Wide
Web. The Company was formed in June 1995 by CMG@Ventures, L.P.
("CMG@Ventures") to license on an exclusive basis (with certain limited
exceptions) from Carnegie Mellon University ("CMU" or the "Licensor") the
Lycos Internet search and indexing technology (see Note 3).
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiary, Point Communications Corporation ("Point
Communications"), from the date of acquisition. All significant intercompany
balances and transactions have been eliminated. The Company's fiscal year end
is July 31.
Initial Public Offering
On April 2, 1996, the Company completed an initial public offering of its
common stock in which 3,000,000 shares of common stock were issued at a price
of $16.00 per share. On April 12, 1996, pursuant to the exercise of an over-
allotment option granted to the underwriters of the Company's initial public
offering, the Company issued an additional 135,000 shares of its common stock
at a price of $16.00 per share.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with original
or remaining maturities of three months or less to be cash equivalents. At
July 31, 1996, the Company had no investments with maturities greater than
three months.
Property and Equipment
Property and equipment are stated at cost, net of accumulated amortization
and depreciation. Property and equipment are depreciated on a straight-line
basis over the estimated useful lives of the assets (three to five years).
Leasehold improvements are amortized on a straight-line basis over the lesser
of the estimated useful life of the asset or the lease term.
Intangibles
In connection with an acquisition accounted for as a purchase (see Note 4),
the Company recorded goodwill based on the excess of the purchase price over
the identifiable tangible and intangible net assets of the acquiree on the
date of purchase. Goodwill is reported at cost, net of accumulated
amortization, and is being amortized over its estimated useful life of five
years.
Licensed technology is being amortized on a straight-line basis over its
five-year economic life.
Revenue Recognition
The Company's advertising revenues are derived principally from short-term
advertising contracts in which the Company guarantees a minimum number of
impressions for a fixed fee or on a per impression basis with an established
minimum fee. Revenues from advertising are recognized as the services are
performed.
The Company's license and product revenues are derived principally from
product licensing fees and fees from maintenance and support of its products.
License and product revenues are generally recognized upon delivery provided
that no significant Company obligations remain and collection of the
receivable is probable. In
32
<PAGE>
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
cases where there are significant remaining obligations, the Company defers
such revenue until those obligations are satisfied. Fees from maintenance and
support of the Company's products including revenues bundled with the initial
licensing fees are deferred and recognized ratably over the service period.
Research and Development Costs
Research and development expenditures are expensed as incurred. Software
development costs are required to be capitalized when a product's
technological feasibility has been established by completion of a working
model of the product and ending when a product is available for general
release to customers. To date, completion of a working model of the Company's
products and general release have substantially coincided. As a result, the
Company has not capitalized any software development costs since such costs
have not been significant.
Advertising Costs
The Company expenses advertising production costs as incurred. Advertising
expense was approximately $567,000 for the year ended July 31, 1996.
Income Taxes
The Company records income taxes using the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and the tax effect of net operating loss carryforwards. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply
to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period
that includes the enactment date.
Concentration of Credit Risk
Substantially all of the Company's excess cash has been invested in highly
liquid investments with maturities of three months or less with a major bank.
The Company performs ongoing credit evaluations of its customers' financial
conditions and generally does not require collateral on accounts receivable.
The Company maintains allowances for credit losses and such losses have been
within management's expectations. No single customer accounted for greater
than 10% of total revenues during the year ended July 31, 1996.
The Company's services are provided to customers in several industries
primarily in North America. Sales to foreign customers for the year ended July
31, 1996 were approximately $385,000. Accounts receivable, license fees
receivable and deferred revenue from foreign customers at July 31, 1996 were
approximately $512,000, $534,000 and $1,075,000, respectively.
Financial Instruments
The recorded amounts of financial instruments approximate their fair market
values.
Per Share Amounts
Net loss per share is computed using the weighted average number of shares
of common stock and dilutive common equivalent shares outstanding during the
period. Pursuant to the Securities and Exchange Commission
33
<PAGE>
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Staff Accounting Bulletins, such computations include all common and common
equivalent shares issued within twelve months of the filing date of the
Company's initial public offering in April 1996 as if they were outstanding
for all periods presented using the treasury stock method and the anticipated
initial public offering price. Fully diluted and primary earnings per share
are the same for all periods presented.
Accounting for Impairment of Long-Lived Assets
In accordance with Financial Accounting Standards Board Statement No. 121,
the Company records impairment losses on long-lived assets used in operations
when indicators of impairment are present and the undiscounted cash flows
estimated to be generated by those assets are less than the assets' carrying
amount.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
License Fees Receivable
License fees receivable are comprised of fees to be earned in the future on
license agreements existing at the balance sheet date.
Deferred Revenue
Deferred revenue is comprised of license fees to be earned in the future on
noncancelable license agreements existing at the balance sheet date.
2. PROPERTY AND EQUIPMENT
Property and equipment, at cost, consist of the following:
<TABLE>
<CAPTION>
JULY 31, JULY 31,
1996 1995
---------- --------
<S> <C> <C>
Computers and equipment................................... $1,495,481 $76,994
Furniture and fixtures.................................... 79,290 2,032
Leasehold improvements.................................... 89,644 --
Software.................................................. 46,690 --
---------- -------
1,711,105 79,026
Less accumulated depreciation and amortization............ (305,337) (1,318)
---------- -------
$1,405,768 $77,708
========== =======
</TABLE>
3. LICENSE AGREEMENT
In connection with the formation of the Company, the Company, CMU,
CMG@Ventures and CMG Information Services, Inc. ("CMGI") entered into a
license agreement ("License Agreement") pursuant to which CMU granted the
Company a perpetual, exclusive (with certain limited exceptions), worldwide
license to use the Lycos Internet search and indexing technology and the Lycos
Catalog. The Company initially paid a $500,000 licensing fee and made
additional payments equal to 50% of certain cash receipts, as defined,
totaling an additional $750,000. All amounts due under the License Agreement
were paid as of July 31, 1996. The
34
<PAGE>
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Company also issued 2,000,000 shares of common stock in connection with this
Agreement. Accumulated amortization under the License Agreement at July 31,
1996 and July 31, 1995 was $336,535 and $12,500, respectively.
4. ACQUISITION OF POINT COMMUNICATIONS CORPORATION
On October 12, 1995, the Company acquired all of the outstanding shares of
Point Communications, a development stage company involved in developing
systems design and creating database software and the related database for
purposes of reviewing and ranking sites on the Internet. In connection with
such acquisition, accounted for as a purchase, the Company issued 526,316
shares valued at $542,000 (based on an independent valuation). The former
owner of Point Communications also received an option to purchase an
additional 343,248 shares at an exercise price of $2.00 per share. The option
has a ten-year term and became vested upon the closing of the Company's
initial public offering in April 1996.
The purchase price was allocated as follows:
<TABLE>
<S> <C>
In process research and development.................................. $ 452,000
Goodwill............................................................. 186,000
Other assets, principally cash and receivables....................... 99,000
Liabilities assumed.................................................. (195,000)
---------
$ 542,000
=========
</TABLE>
Purchased research and development expensed at the time of acquisition
represents the estimated current fair value (using the Cost-to-Create
valuation method) of a specifically identifiable project under development
which did not meet the accounting criteria for capitalization. Accumulated
amortization on goodwill was $14,951 at July 31, 1996. The unaudited pro forma
operating results assuming the acquisition took place at the Company's
inception date (June 1, 1995) are presented below. The operating results of
Point Communications during the year ended July 31, 1996 reflect the operating
results of Point Communications through October 12, 1995, the date of
acquisition.
<TABLE>
<CAPTION>
YEAR ENDED JULY 31, 1996 LYCOS POINT COMBINED
- ------------------------ ----------- -------- -----------
<S> <C> <C> <C>
Revenues....................................... $ 5,257,227 $ 35,517 $ 5,292,744
Operating expenses............................. 10,345,065 166,442 10,511,507
----------- -------- -----------
Net loss....................................... $ 5,087,838 $130,925 $ 5,218,763
=========== ======== ===========
<CAPTION>
INCEPTION TO JULY 31, 1995
- --------------------------
<S> <C> <C> <C>
Revenues....................................... $ 5,000 -- $ 5,000
Operating expenses............................. 110,381 71,937 182,318
----------- -------- -----------
Net loss....................................... $ 105,381 $ 71,937 $ 177,318
=========== ======== ===========
Total assets................................. $ 1,316,655 $ 49,636 $ 1,366,291
=========== ======== ===========
</TABLE>
5. BANK LINE OF CREDIT
The Company has available a bank line of credit in the amount of $1,000,000.
Borrowings under the line are secured by all of the Company's assets,
excluding intellectual property, and bear interest at the bank's prime rate
plus 0.5%. The line matures on June 1, 1997. As of July 31, 1996, there were
no borrowings outstanding under this credit facility. The credit facility
prohibits the Company from paying cash dividends on its common stock.
35
<PAGE>
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
6. COMMITMENTS
The Company leases its facilities and certain other equipment under
operating lease agreements expiring through 2001. Future noncancelable minimum
payments as of July 31, 1996 under these leases for each fiscal year end are
as follows:
<TABLE>
<S> <C>
1997........................................................... $1,000,573
1998........................................................... 971,570
1999........................................................... 749,193
2000........................................................... 174,708
2001........................................................... 36,319
Thereafter..................................................... 579
----------
$2,932,942
==========
</TABLE>
Rent expense for the year ended July 31, 1996 was $318,500.
In April 1996, the Company entered into a one year "Premier Provider"
agreement ("the Agreement") with Netscape pursuant to which the Company was
designated one of five "Premier Providers" of search and navigation services
accessible from the "Net Search" button on the Netscape browser. Under the
terms of the Agreement, the Company is obligated to make installment payments
totaling $5 million over the term of the Agreement. The Company recognizes the
cost of this agreement ratably over the term of the agreement, thus, included
in Cost of revenues for the year ended July 31, 1996 is the pro-rated portion
of the contract since the service commenced in April 1996.
The Company is subject to legal proceedings and claims which arise in the
ordinary course of its business. In the opinion of management, the amount of
ultimate liability with respect to these actions will not materially affect
the financial position of the Company.
7. STOCKHOLDERS' EQUITY
1995 Stock Option Plan
During 1995, the Company adopted the 1995 Stock Option Plan (the "1995
Plan") under which nonqualified stock options to purchase common stock may be
granted to officers and other key employees. Under the Plan, options to
purchase 1,000,000 shares of common stock may be granted at an exercise price
determined by the Board of Directors. Options granted are exercisable in five
equal installments beginning one year after date of grant, except that the
vesting of certain options are subject to acceleration upon the occurrence of
certain events. Options under the 1995 Plan expire six years from date of
grant.
A summary of option activity under the 1995 Stock Option Plan is as follows:
<TABLE>
<CAPTION>
SHARES PRICE
-------- ------------
<S> <C> <C>
Outstanding at June 1, 1995............................. -- --
Granted............................................... 560,000 $0.01
Terminated............................................ -- --
--------
Outstanding at July 31, 1995............................ 560,000 0.01
Granted............................................... 589,776 0.01-16.00
Terminated............................................ (195,304) 0.01- 9.60
--------
Outstanding at July 31, 1996............................ 954,472 $0.01-$16.00
========
Exercisable at July 31, 1996............................ 197,920 $0.01-$ 9.60
========
</TABLE>
36
<PAGE>
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Pursuant to the License Agreement, CMG@Ventures has agreed to sell to the
Company a number of shares of common stock equal to the shares issuable upon
exercise of options granted under the 1995 Plan and the 1996 Plan (as defined
below) prior to the initial public offering at a price equal to the exercise
price of the options as such options are exercised.
The Company has recorded deferred compensation expense of $610,505 for the
difference between the grant price and the estimated fair value (determined by
independent valuations or by reference to third party transactions) of certain
of the Company's stock options granted. This amount is being amortized over
the vesting period of the individual options on a straight-line basis,
determined separately for each portion of the options that vest in each year.
Deferred compensation expense recognized for the year ended July 31, 1996 was
approximately $234,000.
1996 Stock Option Plan
On February 2, 1996, the 1996 Stock Option Plan (the "1996 Plan") was
adopted by the Board of Directors. A maximum of 1,000,000 shares of common
stock may be issued pursuant to the 1996 Plan upon exercise of options. Under
the 1996 Plan, incentive stock options may be granted to employees and
officers of the Company and non-qualified stock options may be granted to
consultants, employees and officers of the Company. The exercise price of such
incentive stock options cannot be less than the fair market value of the
common stock on the date of grant, or less than 110% of fair market value in
the case of employees or officers holding 10% or more of the voting stock of
the Company. The Compensation Committee of the Board of Directors has the
authority to select optionees and to determine the terms of the options
granted. Options under the 1996 Plan expire ten years from the date of grant.
A summary of option activity under the 1996 Stock Option Plan is as follows:
<TABLE>
<CAPTION>
SHARES PRICE
------- -------------
<S> <C> <C>
Outstanding at July 31, 1995............................. -- --
Granted................................................ 120,750 $ 6.00-$17.75
Terminated............................................. (31,000) 13.00- 17.00
------- -------------
Outstanding at July 31, 1996............................. 89,750 $ 6.00-$17.75
======= =============
Exercisable at July 31, 1996............................. -- --
======= =============
</TABLE>
1996 Employee Stock Purchase Plan
On February 2, 1996, the 1996 Employee Stock Purchase Plan (the "1996
Purchase Plan") was adopted by the Company's Board of Directors. The 1996
Purchase Plan authorizes the issuance of a maximum of 250,000 shares of common
stock pursuant to the exercise of nontransferable options granted to
participating employees. The 1996 Purchase Plan is administered by the
Compensation Committee of the Board of Directors. All employees of the Company
are eligible to participate in the 1996 Purchase Plan. Employees who own 5% or
more of the Company's stock and directors who are not employees of the Company
may not participate in this plan. Employees elect to have deducted from 1%-10%
of their base compensation. The exercise price for the option is the lesser of
85% of the fair market value of the common stock on the first or last business
day of the purchase period (6 months). An employee's rights under the 1996
Purchase Plan terminate upon his or her voluntary withdrawal from the Plan at
any time or upon termination of employment.
1996 Non-Employee Director Stock Option Plan
On February 2, 1996, the 1996 Non-Employee Director Stock Option Plan (the
"Director Plan") was approved by the Board of Directors. The Director Plan
authorizes the issuance of a maximum of 100,000 shares of common stock.
The Director Plan is administered by the Board of Directors. Under the
Director Plan each non-employee director first elected to the Board of
Directors after the completion of an initial public offering will receive an
37
<PAGE>
LYCOS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
option for 10,000 shares on the date of his or her election. The exercise
price per share for all options granted under the Director Plan will be equal
to the fair market value of the common stock as of the date of grant. All
options vest in three equal installments beginning on the first anniversary of
the date of grant. Options under the Director Plan will expire 10 years from
the date of grant and are exercisable only while the optionee is serving as a
director of the Company. As of July 31, 1996, 10,000 options had been granted
and remained outstanding under the plan. No options were exercisable as of
July 31, 1996.
In September 1996 the Company canceled 84,732 options previously granted to
employees under the 1995 Plan and 1996 Plan at various exercise prices and
granted an equivalent number of additional options to those same employees
pursuant to the 1996 Plan at an exercise price of $9.60 per share.
In September 1996, the Company also granted an additional 350,000 options to
employees at an exercise price of $11.13 per share pursuant to the 1996 Plan.
8. INCOME TAXES
As of July 31, 1996, the Company had approximately $5.1 million in Federal
and state net operating loss carryforwards. Of this amount, approximately
$380,000 relates to the acquisition of Point Communications and will reduce
goodwill when utilized. The Federal net operating losses will expire beginning
in 2010 if not utilized. The state net operating losses will expire beginning
in 2000 if not utilized.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities used for financial
reporting purposes and those used for income tax purposes. As of July 31,
1996, the Company had deferred tax assets of $2.2 million which relate
primarily to the net operating loss carryforward which has been offset in
total by a valuation allowance. The Company's deferred tax liability relates
solely to the difference in bases of acquired assets.
A portion or all of net operating loss carryforwards which can be utilized
in any year may be limited by changes in ownership of the Company, pursuant to
Section 382 of the Internal Revenue Code and similar statutes.
9. RELATED PARTY TRANSACTIONS
CMGI has provided the Company with accounting, systems and related services
for which $48,000 in fees were charged at estimated fair market value in the
year ended July 31, 1996. The Company has also purchased certain employee
benefits (including 401(k) plan participation by employees of the Company) and
insurance (including property and casualty insurance) through CMGI and CMGI
has guaranteed the Company's obligations under a lease for office space used
for research and development, sales and service operations. Amounts due CMGI
are included in due to related parties on the consolidated balance sheets.
Also included in due to related parties are amounts due for reimbursement of
administrative expenses and computer equipment purchased on the Company's
behalf by Carnegie Mellon University.
Concurrent with its formation, the Company entered into a consulting
agreement with Dr. Michael L. Mauldin, who has subsequently became an employee
of the Company, with respect to the licensed technology. Total payments under
the consulting agreement, all in the period from inception (June 1, 1995) to
July 31, 1995, was $15,900 and are categorized as research and development in
the accompanying statements of operations.
In addition to amounts paid to CMU in connection with the License Agreement
(see Note 3), the Company was also required to pay to CMU an additional
$525,000 pursuant to two licenses granted by CMU which were assigned to the
Company. As of July 31, 1996, the Company had paid an aggregate of $200,000 to
CMU pursuant to these licenses.
The Company has entered into strategic business partnerships with companies
under common control by CMG@Ventures. As of July 31, 1996, transactions
pursuant to these strategic business partnerships were not material.
38
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
In accordance with General Instruction G(3) to Form 10-K, except as
indicated in the following sentence, the information called for by Items 10,
11, 12 and 13 is incorporated by reference from the registrant's definitive
proxy statement pursuant to Regulation 14A for the Annual Meeting of
Shareholders to be held on December 18, 1996. As permitted by General
Instruction G(3) to Form 10-K and Instruction 3 to Item 401 (b) of Regulation
S-K, the information on executive officers called for by Item 10 is included
in Part I of this Annual Report on Form 10-K.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statements and Schedules
The Financial Statements and Schedules filed as part of this Annual Report
on Form 10-K are listed in the index under Item 8.
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the quarter ended
July 31, 1996.
(c) List of Exhibits.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
------- ----------------------
<C> <S>
2.1* Agreement and Plan of Reorganization between the Company, Point
Acquisition Corporation, Point Communications Corporation, and
Christopher Kitze, dated October 12, 1995.
2.2* Agreement of Merger between Point Acquisition Corporation and
Point Communications Corporation, dated October 12, 1995
3.1* Certificate of Incorporation of the Company, as amended.
3.2* Form of Restated Certificate of Incorporation of the Company.
3.3* By-Laws of the Company, as amended.
3.4* Form of By-Laws of the Company, as amended and restated.
4.1* Specimen stock certificate representing the shares of Common
Stock.
10.1* Subscription Agreement between the Company and CMG@Ventures,
dated June 16, 1995.
10.2* Subscription Agreement between the Company and CMU, dated June
16, 1995.
10.3* Subscription Agreement between the Company and Dr. Mauldin,
dated June 16, 1995.
10.4* Subscription Agreement between the Company and Dr. Mauldin,
dated February 9, 1996.
10.5* Subscription Agreement between the Company and CMU, dated
February 9, 1996.
10.6* License Agreement among CMU, CMGI, CMG@Ventures, and the
Company, dated June 16, 1995, as amended.
10.7* Amendment and Waiver to License Agreement among CMU, CMGI,
CMG@Ventures, the Company and Dr. Mauldin, dated February 9,
1996.
</TABLE>
39
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
------- ----------------------
<C> <S>
10.10* Stockholders' Agreement between the Company and Christopher
Kitze, dated October 12, 1995.
10.11* Right of First Refusal Agreement between the Company and
Christopher Kitze, dated October 12, 1995.
10.12* Registration Rights Agreement among the Company, CMU,
CMG@Ventures, the Company and Dr. Mauldin, dated February 9,
1996.
10.13* Consulting, Non-Compete, Invention and Non-Disclosure Agreement
between the Company and Dr. Mauldin, dated June 16, 1995.
10.14* Non-Competition, Non-Disclosure and Developments Agreement
between Point Communications Corporation and Christopher Kitze,
dated October 12, 1995.
10.15* Letter Agreement between Robert J. Davis and the Company dated
October 12, 1995.
10.16* Lycos, Inc. 1995 Stock Option Plan.
10.17* Lycos, Inc. 1996 Stock Option Plan
10.18* Lycos, Inc. 1996 Non-Employee Director Stock Option Plan.
10.19* Lycos, Inc. 1996 Employee Stock Purchase Plan.
10.20* Option Agreement between the Company and Christopher Kitze,
dated October 12, 1995.
10.21* Option Agreement between the Company and Dr. Mauldin, dated
February 9, 1996.
10.22* Option Agreement between the Company and CMU, dated February 9,
1996.
10.23* Letter Agreement between Fleet Bank of Massachusetts, N.A. and
the Company, dated January 31, 1996.
10.24* Office lease between Everett Realty Company and Point
Communications, dated July 13, 1995.
10.25* Office lease between Rosewood III Associates, L.P. and the
Company, dated August 29, 1995, as amended.
10.26* Office lease between Wilpen, Inc. and the Company dated October
19, 1995.
10.27* Form of Indemnity Agreement.
10.28* Amendment to License Agreement among CMU, CMGI and the Company,
dated March 4, 1996.
10.29** Agreement between the Company and Netscape Communications
Corporation
11.1 Computation of Shares Used in Computing Net Loss Per Share.
21.1* Subsidiaries of the Company.
23.1 Consent of KPMG Peat Marwick LLP.
</TABLE>
- --------
* Incorporated by reference from the Company's Registration Statement on Form
S-1 (Registration No. 333-1354).
** Incorporated by reference from the Company's Quarterly Report on Form 10-Q
for the quarterly period ended April 30, 1996.
40
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED
ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
Lycos, Inc.
/s/ Robert J. Davis
By: _________________________________
ROBERT J. DAVIS PRESIDENT AND
CHIEF EXECUTIVE OFFICER (PRINCIPAL
EXECUTIVE OFFICER)
Date: October 28, 1996
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON ITS BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
SIGNATURE TITLE DATE
/s/ Robert J. Davis President, Chief October 28,
- ------------------------------------- Executive Officer, 1996
ROBERT J. DAVIS (Principal
Executive Officer),
and Director
/s/ Edward M. Philip Chief Financial October 28,
- ------------------------------------- Officer (Principal 1996
EDWARD M. PHILIP Financial and
Accounting Officer)
/s/ David S. Wetherell Director October 28,
- ------------------------------------- 1996
DAVID S. WETHERELL
/s/ Daniel J. Nova Director October 28,
- ------------------------------------- 1996
DANIEL J. NOVA
/s/ John J. Connors, Jr. Director October 28,
- ------------------------------------- 1996
JOHN J. CONNORS, JR.
41
<PAGE>
EXHIBIT 11.1
LYCOS, INC.
COMPUTATION OF NET LOSS PER SHARE (1)
<TABLE>
<CAPTION>
THREE MONTHS INCEPTION
ENDED YEAR ENDED (JUNE 1, 1995)
JULY 31, JULY 31, TO JULY 31,
1996 1996 1995
------------ ----------- --------------
<S> <C> <C> <C>
Common stock, beginning of period... 13,792,896 10,000,000 10,000,000
Cheap stock shares relating to SAB
No. 83(2).......................... 1,086,956 1,086,956
Weighted average common shares out-
standing during the period......... 979,651
Treasury stock buyback.............. (74,192) (74,192)
----------- ----------- -----------
13,792,896 11,992,415 11,012,764
=========== =========== ===========
Net loss............................ $(2,205,996) $(5,087,838) $ (105,381)
Primary net loss per share.......... $ (0.16) $ (0.42) $ (0.01)
=========== =========== ===========
</TABLE>
- --------
(1) Fully diluted net loss per share has not been separately presented, as the
amounts would not be materially different from primary net loss per share.
(2) Pursuant to Securities and Exchange Commission Staff Accounting Bulletin
No. 83, certain common and common equivalent shares issued by the Company
during the twelve months immediately preceding the initial filing of the
registration statement relating to the Company's initial public offering
have been included in the calculation of weighted average shares, using
the treasury stock method and the initial public offering price, as if
these shares were outstanding for all periods prior to the initial public
offering.
<PAGE>
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
The Board of Directors and Stockholders
Lycos, Inc.:
We consent to the incorporation by reference in the registration statement
(No. 333-13715) on Form S-8 of Lycos, Inc. of our report dated September 3,
1996 relating to the consolidated balance sheets of Lycos, Inc. and subsidiary
as of July 31, 1996 and 1995 and the related consolidated statements of
operations, stockholders' equity and cash flows for the year ended July 31,
1996 and for the period from inception (June 1, 1995) to July 31, 1995, which
report appears in the July 31, 1996 annual report on Form 10-K of Lycos, Inc.
KPMG Peat Marwick LLP
Boston, Massachusetts
October 25, 1996
