In the Midst of a Merger, Lycos Looks to the Books

The SEC is questioning how Lycos accounted for in-process R&D of recent mergers.
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SAN FRANCISCO -- As if the reaction of

Lycos

(LCOS)

investors to its proposed merger with

USA Networks

(USAI) - Get Report

wasn't enough, now Lycos has a potential accounting problem on its hands.

Numbers disclosed in documents that the Internet outfit filed in its proposed merger with

Wired Ventures

suggest that the

Securities and Exchange Commission

is taking a hard look at how Lycos has been accounting for the in-process research-and-development costs of Lycos' acquisitions in 1998, such as

Tripod

and

WhoWhere

.

In-process R&D is an arcane but quarrelsome issue between tech companies and regulators these days. Tech companies are increasingly buying smaller companies with great promise but little book value. The premium they pay to book value can either be amortized over a number of years -- dragging down earnings in the process -- or written off as a one-time charge of R&D projects in development.

The pain of an immediate write-off is quick, if more intense -- like yanking off a Band-Aid instead of peeling slowly. But regulators have shown concern when more than 75% of the value of acquisitions are written off this way.

In its fiscal year ended July 1998, Lycos bought three companies --

GuestWorld

,

Wise Wire

and Tripod -- for a total of $104.4 million. The in-process R&D charges it took related to the three buyouts were 87% of the acquisition costs. (The charges for GuestWorld exceeded the price Lycos paid for it.) In the quarter ended October, Lycos took another in-process $15.4 million charge related to its purchase of WhoWhere.

Two people close to Lycos told

TSC

that the SEC had been in contact with the company about its accounting for the in-process charges as they appeared in the proposed acquisition of Wired Ventures. The SEC spent 55 days poring over the document, nearly double the time it usually allots for such a task. The SEC declined to comment for this story on any discussions with Lycos.

Recent filings tell part of the story. In the S-4 filed on Nov. 25, Lycos disclosed a pro-forma statement that combined Wired and Lycos operations. All of the in-process R&D costs in the combined statement came from Lycos operations, none from Wired. Lycos accounted for these costs as it has traditionally done in its 10-Ks and 10-Qs: They were listed as operating expenses and a one-time write-off.

But when Lycos filed an amended S-4 on Feb. 2, after the SEC had time to make comments, the accounting for the pro forma combined statement was different: In-process R&D charges were no longer listed as an operating expense. Instead they were eliminated from the pro forma statement.

"The SEC asked us to take that out of the consolidated statement," said a Lycos spokesman. "They were trying to show the results on a go-forward basis." The SEC hasn't asked Lycos to restate its actual earnings, the spokesman said. But he added that the SEC hasn't yet formally responded to the amended S-4 either, so there could be more questions ahead.

A restatement of earnings, should one come, could mean the $106.6 million in aggregate in-process R&D charges that Lycos has taken during the past five quarters could be spread out over a period of 20 quarters at an average of $5.3 million a quarter. That would be another $5 million Lycos would need to earn to get its numbers where it had forecast them.

Lycos has posted operating losses for the past 12 quarters. Two of those quarters showed net profits, but only because nonoperating income nudged the company into the black.

First Call's

consensus of analysts, which projects a loss of 4 cents a share in the quarter ended in January, sees Lycos returning to profitability later in 1999.

Any changes to earnings statements may not be a huge detriment to Lycos. Not only are investors used to seeing an Internet company such as Lycos go years without profits, but the whole in-process R&D issue seems to be less of a concern for investors. Most know that the SEC is sending out letters to 150 tech companies.

And besides, as one hedge fund manager points out, Lycos is responding quickly to any SEC concerns. It's when a company fights the regulators that investors get nervous. The SEC may well continue to set a few examples for companies that seem to be abusing the in-process write-offs, but it may delay action on the others until the

Financial Accounting Standards Board

weighs in on the matter.

In any case, the more immediate concern for Lycos remains whether this will affect its proposed buyout of Wired, or -- more importantly -- its proposed merger with USA Networks.

"In the abstract, it could affect the deal," said a source close to Lycos who asked not to be named. "You have a merger of two public companies, one of which is buying a third company. If the SEC keeps coming back a second time with new comments and new issues, at what point does one of them just walk away?"