<PAGE>
 
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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, 1998
                        COMMISSION FILE NUMBER 0-27830

                                  LYCOS, INC.
            (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

            DELAWARE                                           04-3277338
  (STATE OR OTHER JURISDICTION                               (IRS EMPLOYER
OF INCORPORATION OR ORGANIZATION)                         IDENTIFICATION NO.)

           400-2 TOTTEN POND ROAD, WALTHAM, MASSACHUSETTS 02451-2000
         (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)

                                (781) 370-2700
             (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

          SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
                                     NONE

          SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
                          COMMON STOCK $.01 PAR VALUE

    Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
                                [X] Yes [_] No

    Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
                                [_] Yes [X] No

    The aggregate market value of voting stock held by non-affiliates of the
registrant as of October 26, 1998 was $1,104,811,295 (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 26, 1998 was 42,992,690.

                      DOCUMENTS INCORPORATED BY REFERENCE

    Specifically identified information in the definitive Proxy Statement for
the 1998 Annual Meeting of Shareholders to be held on December 16, 1998, is
incorporated by reference into Part III herein.

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                                  LYCOS, INC.

                         1998 FORM 10-K ANNUAL REPORT

                               TABLE OF CONTENTS

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  PART I
  ======

Item 1.    Business................................................................     1

Item 2.    Properties..............................................................    11

Item 3.    Legal Proceedings.......................................................    11

Item 4.    Submissions of Matters to a Vote of Security Holders....................    11

Item 4a.   Executive Officers of the Registrant....................................    11

  PART II
  =======

Item 5.    Market for Registrant's Common Equity and Related Stockholder Matters...    14

Item 6.    Selected Financial Data.................................................    14

Item 7.    Management's Discussion and Analysis of Financial Condition and Results   
           of Operations...........................................................    16

Item 8.    Financial Statements and Supplementary Data.............................    34

Item 9.    Changes in and Disagreements with Accountants on Accounting and
           Financial Disclosure....................................................    62

 PART III
 ========

Item 10.   Executive Officers of the Registrant....................................    62


Item 11.   Executive Compensation..................................................    62

Item 12.   Security Ownership of Certain Beneficial Owners and Management..........    62

Item 13.   Certain Relationships and Related Transactions..........................    62

 PART IV
 =======

Item 14.   Exhibits, Financial Statements Schedules and Reports on Form 8-K........    62 

  Signatures.......................................................................    64
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THIS ANNUAL REPORT ON FORM 10-K ("REPORT") CONTAINS FORWARD-LOOKING STATEMENTS
WHICH INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS COULD DIFFER
MATERIALLY FROM THOSE SET FORTH IN THE FORWARD-LOOKING STATEMENTS AS A RESULT OF
A NUMBER OF FACTORS, INCLUDING THOSE SET FORTH IN THIS ANNUAL REPORT UNDER THE
HEADINGS "FACTORS AFFECTING THE COMPANY'S BUSINESS, OPERATING RESULTS AND
FINANCIAL CONDITION".

                                    PART I

ITEM 1.   BUSINESS

COMPANY OVERVIEW

     Lycos, "Your Personal Internet Guide," is a "New Generation Online Service"
that offers a network of globally branded media properties and aggregated
content distributed primarily through the World Wide Web. Under the "Lycos
Network" brand, the Company provides guides to online content, aggregated third
party content, Web search and directory services and community and
personalization features. The Company seeks to draw a large number of viewers to
its Websites by providing a one-stop destination for identifying, selecting and
accessing resources, services, content and information on the Web. The Company's
recent acquisitions of Tripod and Angelfire allow Lycos to offer Internet users
the ability to create personal homepages and join interest-based communities.

     Since its inception in June 1995, the Company has rapidly expanded into a
global Internet Network used daily by millions of people throughout the world.
The Company is one of the leading online media services in terms of traffic,
revenues and user reach, serving millions of information requests per day.
According to RelevantKnowledge, the Company's Websites attracted over 19 million
unique users during August 1998 and, according to Media Metrix, approximately
37% of all Web users visited the Company's Websites in such month. The Company
generates revenues primarily through selling advertising and sponsorships,
electronic commerce and by licensing its products and technology. The Company's
Websites have become a widely accepted advertising medium for several prominent
companies, including Coca-Cola, Disney, General Motors, Hilton, IBM, Proctor and
Gamble and Visa. The Company has established electronic commerce and sponsorship
relationships with several companies, including AT&T, Barnes & Noble, Fleet Bank
and Preview Travel. In addition, Lycos has established strategic licensing and
technological alliances with some of the world's leading corporations, including
such companies as Bertelsmann, Sumitomo, Microsoft and Viacom.

     The Company's ability to easily adapt its technology in a variety of
languages has made its service a popular global Internet destination, widely
accessible to users throughout the world. In order to expand the international
distribution of the Company's services, in May 1997, the Company entered into a
joint venture with Bertelsmann AG to launch local versions of the Lycos service
throughout Europe, and, in March 1998, the Company entered into a joint venture
agreement with Sumitomo Corp. and Internet Initiative Japan, Inc. ("IIJ") to
offer a localized version of the Lycos service in Japan. The Company currently
offers localized versions of the Lycos service in Austria, Belgium, France,
Germany, Italy, Japan, Luxembourg, Spain, Sweden, Switzerland, the Netherlands
and the United Kingdom.

STRATEGY


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     The Company's objective is to continue to draw a large number of viewers to
the Lycos Network by providing a network of globally branded media properties
and aggregated content to users free of charge and making them as easily
accessible as possible throughout the world.

Key elements of the Company's strategy include:

Aggressively Extend Brand Name Recognition. The Company believes that continuing
to enhance its brand name recognition will be increasingly important as greater
numbers of consumers look to the Internet as a key source of information,
entertainment and commercial activity. The Company seeks to continue its brand
expansion through advertising campaigns, personalization of its product line,
international alliances and distribution relationships. The Company is also
extending the Lycos brand name by licensing its products for use in other media,
such as books and CD-ROMs.

Enhance, Expand and Personalize the Company's Content and Services. Lycos
intends to enhance its products and services with additional content, features
and functionality to maintain its position as a leading New Generation Online
Service. The Company's strategy is to differentiate its products and services
from competing companies and increase user loyalty and retention through the
availability of personalized offerings and by expanding the breadth and depth of
its services such that it maintains its position as one of the most popular
destinations on the Web. In order to expand the Company's product offerings, the
Company has completed acquisitions of businesses, technologies, content and
services that are complementary or related to the Company's operations and may
pursue other acquisitions in the future. The Company also incorporates into its
products and services new technologies developed internally or licensed from
other companies which it believes will further differentiate its offerings and
provide viewers with a richer, more satisfying Internet experience.

Expand Online Community. The Company seeks to make the Lycos service the first
and most frequent stop for Internet users. The Company believes one of the most
effective ways to achieve this is through the creation of a sense of online
community which, in turn, results in increased user affinity to the site.
Products and services such as free personal homepages, personalized e-mail,
topic-based chat services, and personal homepage searches are designed to create
a sense of community among users. By establishing a sense of community, the
Company believes that users will both visit the site more frequently and remain
at the site for a longer duration. The Company believes that community building
will be a major source of traffic and brand loyalty in the future.

Create Innovative Advertising Solutions. The Company believes that the traffic
flow generated from its products and services provides an attractive platform
for measurable, targeted, cost-effective and interactive advertising on the
Internet. The Company combines technical skills with advertising industry
expertise to provide differentiated solutions to advertisers, helping them
exploit the capabilities of the Internet as an advertising medium. The Company
actively seeks to develop innovative ways for advertisers to reach their target
audiences through the Internet. The Company designs and offers customized
packages which include the ability to change advertisements quickly and
frequently, to link a specific advertisment to a search term or topic, to target
advertisements based on user patterns and demographics, to conduct advertising
test campaigns with rapid result delivery and to track daily usage statistics.

Pursue Value-Added Electronic Commerce Solutions. The Company believes that Web-
based electronic commerce will continue to grow as an increasing number of
businesses and consumers embrace the Internet as a viable method of purchasing
goods and services. The Company's strategy is to integrate its commerce
offerings into the Lycos service based on the user's information needs. By
integrating the commerce transaction into the online community and navigational
process, the Company believes it will be able to better target products to
potential customers and thereby achieve better results than those achieved by
non-targeted electronic commerce sites and online malls. For example, through
the Company's arrangement with Barnes & Noble, a user who types a search query
on a particular topic will be presented with a link to the Barnes & Noble
Website which contains a list of books on the related topic.

Expand Distribution Through Strategic Alliances. In order to increase traffic to
the Company's Websites and to extend the Lycos brand internationally, the
Company seeks to enter into strategic relationships with business partners who
offer content, technology and distribution capabilities as well as marketing and
cross-promotional opportunities. In addition, the Company seeks to partner with
key aggregators of users such as AT&T, Microsoft

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and Netscape in order to drive additional traffic to its sites. The Company also
seeks to broaden its offering of localized versions of its products and services
to users outside the United States. By creating sites in native languages with
local content that are hosted locally, the Company believes that it can improve
the experience for the international user. The Company has adopted a strategy of
partnering with large local companies when entering a new international market
in order to leverage the promotion, marketing and sales strengths of its
partners and reduce the costs associated with global expansion. In addition, the
Company believes local partners provide local expertise and infrastructure that
give Lycos an advantage over its competitors.

RECENT ACQUISITIONS

     In February 1998, Lycos completed the acquisition of Tripod. Based in
Williamstown, Massachusetts, Tripod was founded in 1992 and is one of the
largest and fastest growing communities on the Internet, with a particular
emphasis on the 18-34 year-old demographic. Tripod provides its registered
members with the ability to utilize Tripod's personal publishing tools to create
free personal homepages on the Internet. Tripod's proprietary Homepage Builder
technology allows Tripod members to build free personal Internet homepages in a
quick and user-friendly manner. These homepages are both built and maintained on
Tripod's Website (www.tripod.com). The user-created homepages can then be linked
by the user to any of the community "pods" maintained by Tripod. Within the
interest-based community pods, user-created homepages are combined with
professional content from Tripod's editorial staff. Similar to Lycos, Tripod
derives its revenues primarily from advertising, sponsorships and electronic
commerce.

     In April 1998, Lycos acquired WiseWire, a leader in delivering targeted
content to Websites. WiseWire finds, filters and organizes content on the
Internet using proprietary intelligent agent technology while building online
communities through content personalization. WiseWire offers a series of
products which personalize content to specific customer needs. For instance,
WiseWire's Community Directory product offers a dynamic online directory of
continually updated content, hierarchically organized allowing end-users to
contribute to the evolution and quality of information. WiseWire's automated
processing and categorization of Websites into a directory format offers more
current listings to users and a less expensive ongoing cost structure for the
Company compared to traditional manually created directories.

     In June 1998, Lycos acquired GuestWorld, the Web's largest provider of free
online guestbook services. Launched in 1996, GuestWorld provides free,
electronic guestbook services to an organically formed community of users who
have homepages on the Web. The service allows visitors to register and comment
on a person's homepage and automatically compiles visitors' e-mail addresses,
making it easy for the homepage owner to stay in touch with guests, respond to
comments, and inform them of site updates.

     In August 1998, Lycos acquired WhoWhere?. Located in Mountain View,
California, WhoWhere? offers a complete line of Web-based applications,
including its leading directory services, popular MailCity e-mail service and
Angelfire, a provider of free homepage building services. WhoWhere?'s suite of
communication applications for the Internet and other open networks enable
people and businesses worldwide to seamlessly find, communicate and collaborate
with each other. Lycos plans to continue to expand WhoWhere?'s highly successful
co-branding model to license its services to other companies aiming for
increased site traffic and brand affinity.

     With the addition of these unique features, the Lycos Network becomes the
most complete hub, providing patented search, comprehensive directories,
personal homepages, e-mail, loyal and diverse communities and popular shopping
functions.


PRODUCTS

     The Company offers a comprehensive suite of products and services through
its network of globally branded media properties. The Company's Websites
provide users with premier Internet navigation functionality,

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personalized information resources and online community products. These products
and services are developed internally by the Company or licensed by the Company
from third parties.

PREMIER NAVIGATION FUNCTIONALITY

     Lycos offers its users the ability to quickly and easily find information
on the Web by searching through the Company's index of Web documents. Lycos'
primary search and navigation products include:

     The Lycos Search. Using the Lycos Search, a user may enter a search term or
terms and review a list of the best matches from all indexed Web pages. The
search results also provide a direct hypertext link to the actual pages matching
the search. The Company believes that its proprietary Lycos Search provides one
of the most comprehensive indices of the Web and is differentiated from other
catalogs based on its speed, ability to index non-textual information (e.g.,
pictures and sounds) and relevancy of search groups and personal homepages.

     Lycos Guides and Directories. In order to give users an easy-to-use
framework in which to efficiently explore and utilize the wealth of content on
the Internet, Lycos maintains a series of Web Guides and directories, including
Web Guides, Top 5% Sites, CityGuide and WhoWhere?. Lycos' topic-based Web Guides
provide categorized areas of interest that enable users to browse through
groupings of related information. Web Guide topics include, among others,
Business, Education, Entertainment, Fashion, Sports and Travel. Each of the Web
Guides contains a news briefing on each topic area and hypertext links to topic
sites that allow users to find relevant information quickly. The Web Guides
incorporate the WiseWire technology, which is an automated system of compiling
data into a directory format, enabling the Company to offer a more current
directory to users. Top 5% Sites guide is a collection of critical reviews of
what the Company considers to be among the most popular sites on the Web. 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. Similarly, CityGuide is a
collection of guides to more than 1,200 cities throughout the world which gives
the virtual traveler a snapshot of life in each city or town and provides
hypertext links to Websites that best reflect the hot spots, history and day-to-
day living of each city. WhoWhere?'s directories offer a variety of
comprehensive services that make it easy to find people and businesses on the
Internet.

PERSONALIZED CONTENT AND INFORMATION RESOURCES

     In order to provide the most personalized and comprehensive experience to
the Lycos user, the Company has developed and integrated a series of products
which allow the user to quickly and easily obtain relevant information. By
providing the ability for users to personalize their Lycos experience and access
personally important information, the Company believes it provides a value-added
service to users which increases their overall utilization of the Company's
Websites. Lycos' personal information resource products include the following:

Personal Guide and Email. The Personal Guide by Lycos automatically delivers a
personalized view of the Lycos service, including news, weather, stock quotes,
sports scores, horoscopes, lottery results, local television listings and
Website reviews, all based on the user's personal specifications. Tailored to
each individual's preferences, the Personal Guide enhances and personalizes the
user's Internet experience by eliminating unwanted information and quickly
filtering the most relevant information to the user. The Personal Guide also
features a unique contact management service which allows the Lycos Personal
Guide user to maintain a linked, self-updating address book and scheduler. Lycos
also offers its users a free personalized Web-based e-mail account, known as
Lycosmail, which can be accessed using an easy-to-use interface from any
computer with an Internet connection. As Lycosmail users do not need to change
their e-mail addresses when they move or change Internet service providers, the
same e-mail address can be used indefinitely from any location and computer.

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Personal and Business News. The Lycos News service provides comprehensive,
around-the-clock coverage of news from around the world and allows users to
search news stories provided by leading news sources such as Reuters. Personal
financial information is also accessible through the Company's StockFind product
offering. StockFind provides financial information on publicly held companies,
mutual funds, money market funds and the major financial indices and allows
users to chart stock prices, track their personal investment portfolios and
receive the latest business and company-specific news. Similarly, Lycos'
Companies Online, built in cooperation with Dun & Bradstreet, provides
searchable access to a vast amount of information on more than 100,000 public
and private companies, organized into 14 different industry groups. This service
offers a way for users to gather highly relevant information, including
management, annual sales, ownership structure and DUNS number, and provides a
direct link to the Company's Website.

Reference Services. Lycos provides a vast array of products for its users to
locate other individuals, businesses, products and places. PeopleFind, a
comprehensive home address, e-mail address and phone number directory, assists
users in locating individuals worldwide. Yellow Pages, offered in cooperation
with GTE, allows users to locate businesses throughout the United States by
searching according to category, business name, business address or keyword.
Furthermore, once the user locates a business or a service provider, the user is
able to obtain contact information as well as directions to and a map of the
business location. Lycos Classifieds offers a convenient way for users to both
buy and sell goods and services online. Additionally, Lycos' RoadMaps product
allows users to search for and obtain driving directions to any street address
in the United States and map that address.

ONLINE COMMUNITY PRODUCTS

     Lycos believes that as the Internet continues to grow, online communities
will become an increasingly important aspect of a user's online experience.
Communities are groupings of Internet users organized around topics or areas of
interest in such a way that the user actively contributes to both the dialogue
and content within the community. Lycos believes that as users become involved
with the various Lycos online community products and services, they become more
likely to return to the site in the future. Consequently, Lycos seeks to develop
an active, loyal user base by building significant community features into the
Lycos Network through the following online products:

Chat. Chat creates a "virtual community" in which a participant can interact in
real-time group or one-on-one discussions or participate in moderated events,
buddy lists and bulletin boards. Lycos' chat rooms are arranged around multiple
topics of interest including romance, entertainment and current events.

Homepages. Through Tripod and Angelfire, Lycos provides users with the ability
to create free personal homepages which are built and maintained on the
Company's Websites. Utilizing a variety of proprietary personal publishing
tools, users are able to quickly and easily create fully personalized Web-based
homepages with proprietary Homepage Builder technology. On the Tripod site,
personal homepages can be linked to any of the over 140 community pods currently
maintained by Tripod. Within the community pods, Tripod's editorial staff
provides content and organization among a variety of issues and areas of
interest. Tripod's and Angelfire's Websites can be found at www.tripod.com and
www.angelfire.com, respectively.


ADVERTISING

  The Company currently derives a substantial portion of its revenues from the
sale of advertisements on its Websites, primarily through banner advertisements
and sponsorships. Advertising contracts are primarily sold as: (1) a "run of
site" contract under which a customer is guaranteed a number of impressions; (2)
a "key word" contract in which a customer purchases the right to advertise in
connection with specified word searches; or (3) a "targeted" contract where the
customer purchases a specified number of impressions in one of the Web Guides or
on a specified page or service.

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  Advertising revenue is generated by placing banner advertisements on any of
the Web pages that are displayed on the Company's Websites. From each
advertisement banner, a viewer can link directly to the advertiser's Website,
thus affording the advertiser the opportunity to directly interact with a
potential customer. The Company's advertising revenues are derived principally
from advertising contracts, which generally have a term of one to twelve months,
in which the Company guarantees a 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 "automobile" is searched, an automotive or car
manufacturer advertisement appears) and in Web Guides that link an advertisement
to a topic of interest. Keyword and Web Guide advertising permit advertisers to
target advertisements to selected audiences.

  The Company advises customers on advertisement placement and design, enabling
them to develop more dynamic advertisements and monitor the advertisements for
effectiveness. To facilitate these services, the Company provides advertisers
with online reports showing advertising impressions and the number of times
users "click" on an ad to visit the advertiser's site. The Company's standard
rates for advertising range from $16 to $100 per one thousand impressions
depending on such factors as the contract length, ad placement within the site
and the targeted nature of the ads.

  The Company employs an experienced, direct sales force to address the new and
evolving requirements of the Internet advertising market. The Company has hired
the majority of its sales force from the advertising industry because it
believes that an experienced sales force is critical to initiate and maintain
relationships with advertisers and advertising agencies. The Company employs
advertising sales personnel in New York, San Francisco, Boston, Pittsburgh,
Chicago, Dallas, Philadelphia, Atlanta and Los Angeles. International
advertising territories are handled primarily by the Company's joint venture
partners in Europe and in Japan. See "--Strategic Alliances."

ELECTRONIC COMMERCE

     Lycos believes electronic commerce is a natural extension of the Company's
search and navigation services. Through electronic commerce, the Company
partners with merchants to integrate their products into the Lycos service,
making them available for sale to the Company's users. In its electronic
commerce arrangements, the Company generally receives a fixed fee and a share of
the proceeds from online sales. In addition, the Company benefits from
promotional and branding opportunities available from its merchant partners
which create greater demand for the Company's online services. In furtherance of
its strategy to pursue electronic commerce opportunities, during the first
quarter of fiscal 1998, the Company began selling advertising placements and
links separate from the space normally reserved for banner advertisements. These
arrangements are known as sponsorships because they typically involve the
placement of an advertisement or link in a topical Web Guide or on a search
results page as though the advertiser was sponsoring the content on a specific
page. The ad or link is programmed to appear prominently on the same place on
the page each time that page of the Web Guide is called for by the user.

     These electronic commerce agreements typically have one to three year
terms. In some instances, the Company has entered into exclusive sponsorship
arrangements for certain commercial categories.  The Company's electronic
commerce relationships include, among others, agreements with the following
entities:

     American Greeting Corporation--providing Lycos users with the opportunity
               to send traditional and electronic greeting cards;

     AT&T--providing Internet access for Lycos Online as well as the ability for
               Lycos users to purchase telecommunication services over the
               Internet;

     AutoConnect, LLC--providing Lycos users with the opportunity to purchase
               used cars through Lycos' Auto Web Guide, the Lycos Shopping
               Network and other contextually relevant areas on the Company's
               Website;

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     Barnes & Noble, Inc.--providing Lycos users with the opportunity to 
               purchase books throughout the Company's Website;

     CDnow, Inc.--providing Lycos users with the opportunity to purchase compact
               discs and other music-related items;

     Fleet Credit Card Services--providing Lycos users with a Lycos Network
               branded credit card; and

     Preview Travel, Inc.--providing Lycos users with the opportunity to book
               travel arrangements from contextually relevant areas on the
               Company's Website.

     Lycos believes that the market for electronic commerce will continue to
demonstrate significant growth and that the Company is well positioned to offer
vendors an attractive medium through which they may participate in the
electronic commerce market. 

LICENSING

     The Company licenses its products and technology to leading corporations to
establish and promote its products and services as a ubiquitous, branded media
service. The Company's strategy is to license its products and technology to a
wide-range of companies seeking to enhance the value of their Internet products
and services. These companies include media companies, telecommunications
companies, online service providers, Internet companies, software providers and
publishers. In most arrangements, the Company receives a license fee,
maintenance fees for product updates and, where applicable, a share of the
advertising revenues, subscription fees or product sales received by licensees.
The agreements generally have terms of one to three years. The Company generally
co-brands its products with the products offered by the partner in order to
preserve and enhance Lycos brand recognition. The Company's product offerings
enable its partners to provide a comprehensive set of Internet navigational
services and to maintain the up-to-date information required by their viewers to
keep up with the rapid growth of the Internet without incurring the extensive
costs associated with the internal development of such products. In addition,
the Company's licensing arrangements enable the Company to create multiple
points of entry and alternative distribution channels for the Company's products
and services, build brand awareness, and expand without the associated
infrastructure costs. Lycos has licensed its technology and brand to numerous
partners, including Bertelsmann, GTE, Microsoft and Viacom. See "--Strategic
Alliances."

BRANDING

     As one of the most popular sites on the Web, the Company believes that it
has a strong, global brand name and presence. Lycos markets itself as "Your
Personal Internet Guide" which supports Lycos' strategy of providing a
contemporary "New Generation Online Service" combining navigation and community.
The Company's strategy is to build brand awareness through an integrated plan
utilizing online and traditional media, public relations and promotions. The
Company's media campaign has included traditional media such as broadcast and
cable television, local radio and print advertising in consumer and trade
magazines. The Company also significantly cross-promotes through advertising in
online media. In addition, the Company is the sponsor of a NASCAR race car in
the Busch Grand National Series and is the sponsor of a joint marketing program
with New Line Cinema. The Company plans to continue to promote its brand through
traditional and online media in order to increase brand awareness and increase
usage of the Lycos Network.

STRATEGIC ALLIANCES

     In order to increase traffic to the Company's Websites and to extend the
Lycos brand internationally, the Company seeks to enter into strategic
relationships with business partners who offer content, technology and

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distribution capabilities as well as marketing and cross-promotional
opportunities. In furtherance of this strategy, the Company has established the
following strategic relationships:

Lycos Europe. In May 1997, the Company entered into a joint venture agreement
with Bertelsmann Internet Services to create localized versions of the Lycos
search and navigation service throughout Europe. The joint venture, named Lycos
Bertelsmann GmbH & Co. KG ("Lycos Bertelsmann"), is owned 50% by Lycos and 50%
by Bertelsmann, and was formed to develop local Internet navigation centers for
up to 37 Eastern and Western European countries. Bertelsmann Internet Services,
a subsidiary of Bertelsmann AG (the world's third-largest media company), has
committed to provide $10 million in start-up capital, infrastructure and
employees for the venture while Lycos provides the core technology, technical
expertise and the Lycos brand name. The joint venture leverages Bertelsmann's
expansive media network to secure content, distribution and local presence with
Lycos' technology and brand to create a formidable strategic alliance.

Lycos Japan. In March 1998, Lycos established Lycos Japan KK as the basis for a
joint venture to promote and operate a Japanese version of Lycos' Website.
Lycos' joint venture partners are Sumitomo Corp., one of the largest
conglomerates in Japan, and Internet Initiative Japan ("IIJ"), Japan's largest
Internet service provider. Lycos owns 40% of the joint venture.

Microsoft Premier Search Provider.  On September 17, 1998, the Company signed a 
one year agreement to be a premium provider of search services on the Microsoft 
start page and from the search buttons imbedded in the Internet Explorer 
browser. This premier positioning on the start page and browser provide branding
and traffic to the Lycos site.  See "Risk Factors--Dependence on Netscape, 
Microsoft and other Third Party Relationships."

AT&T WorldNet. In April 1998, the Company entered into an agreement with AT&T
WorldNet to provide users of the Company's Websites a variety of AT&T services.
One such service, co-branded as "Lycos Online Powered by AT&T WorldNet Service,"
will provide users with an easily accessible portal to the Web and will serve as
the user's gateway to AT&T's telecommunications services that can be ordered and
billed electronically. Through this alliance, Lycos will also offer various
services and content on AT&T's Websites.

Netscape Premier Search and Navigation Provider. On May 19, 1998, the Company
renewed its one year "Premier Provider" agreement with Netscape for an
additional one-year term. As a result, the Company has been designated as a
"Premier Provider" of search and navigation services accessible from the "Net
Search" button on the Netscape browser through May 31, 1999. This premier
positioning on this highly-trafficked service provides branding and promotion as
well as a source of distribution for the Company's products and services. See
"Risk Factors--Dependence on Netscape, Microsoft and Other Third Party
Relationships."

Strategic Investments. Lycos has recently made strategic investments in two
Internet service companies whose products are integrated into the Lycos
services. In March 1998, Lycos acquired a 9.9% ownership stake in GlobeComm,
Inc. (iName), a leading global provider of free Web-based e-mail products, in
exchange for shares of the Company's Common Stock valued at $4.0 million at the
time of the transaction. Additionally, in April 1998, Lycos acquired a 14.8%
ownership stake in Sage Enterprises, Inc. (PlanetAll) in exchange for shares of
the Company's Common Stock valued at $2.5 million at the time of the
transaction. In August 1998, Amazon.com acquired all of the outstanding stock of
PlanetAll. Lycos received 107,377 shares of Amazon.com common stock valued at
approximately $11.6 million in exchange for its shares of PlanetAll.


TECHNOLOGY


                                       8
<PAGE>
 
The Company believes that its innovative, proprietary technology favorably
differentiates Lycos from its competitors. Currently, the underlying database
for most Internet search engines 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. The Lycos database (i.e. the Lycos Catalog) is continually updated
with the Company's patented spider indexing technology that enables it to
efficiently collect and organize information on millions of Web pages and links.
The Company's patented spider technology and proprietary retrieval technology
differentiate the Lycos Catalog and related products and services in the
following ways:

Using Popularity to Guide the Exploration. The Lycos spider technology uses
popularity as a basis for searching Web pages. The Lycos spider determines 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
most frequently.

Relevancy. The ability of a catalog to deliver relevant responses which closely
match the search query of the user 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 search engine, enables 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.
The Company believes that its spider indexing technology differentiates its
products and services with the ability to index these non-textual, multimedia
pages.

Advanced Search Functionality. Lycos offers users an advanced search
functionality which allows users to control the order in which their results are
ranked by adjusting the importance of key search metrics. Users are guided on
how to best use the array of search operators available for adjusting searches
to deliver results which specifically meet their search needs. The Company
believes it is the only major Internet navigation service to allow users to
personally rank the relevancy of key search metrics when performing a search.

The Lycos search and indexing technology was developed at Carnegie Mellon
University ("CMU"). In June 1995, the Company entered into a license agreement
with CMU (the "License Agreement") pursuant to which CMU granted to the Company
a perpetual, worldwide right to use and sub-license 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. The key search and indexing technology underlying the
Lycos Catalog, as well as the Lycos Catalog and Lycos trademarks and logo, are
licensed to or owned by CMU and licensed to the Company pursuant to the License
Agreement.

CMU has been issued a patent in the United States relating to Lycos' search and
indexing technology. There can be no assurance that such patent will not be
challenged, and if such challenges are brought, that the patent will not be
invalidated.

Lycos(R) is a registered trademark of CMU. All other trademarks and service
marks used in this Report are the property of Lycos or their respective
owners.

The Company's success depends significantly upon its proprietary technology. The
Company currently relies on a combination of patent, copyright and trademark
laws, trade secrets, confidentiality procedures and contractual provisions to
protect its proprietary rights. The Company generally enters into
confidentiality agreements with its employees and with its consultants and
partners. The Company has registered and applied for registration of certain
service marks and trademarks, and will continue to evaluate the registration of
additional service marks and trademarks, as appropriate. There can be no
assurance that the Company will develop proprietary products or technologies
that are patentable, that any issued patent will provide the Company with any
competitive advantages

                                       9
<PAGE>
 
or will not be challenged by third parties, or that the patents of others will
not have a material adverse effect on the Company's ability to do business.
Despite the Company's efforts to protect its proprietary rights, unauthorized
parties may attempt to copy aspects of the Company's products or services or to
obtain and use information that the Company regards as proprietary. In addition,
the laws of some foreign countries do not protect proprietary rights to as great
an extent as do the laws of the United States. There can be no assurance that
the Company's means of protecting its proprietary rights will be adequate or
that the Company's competitors will not independently develop similar technology
or duplicate the Company's products or design around patents issued to the
Company or other intellectual property rights of the Company.

     There have been substantial amounts of litigation in the computer industry
regarding intellectual property rights. There can be no assurance that third
parties will not in the future claim infringement by the Company with respect to
current or future products, trademarks or other proprietary rights, or that the
Company will counterclaim against any such parties in such actions. Any such
claims or counterclaims could be time-consuming, result in costly litigation,
diversion of management's attention, cause product release delays, require the
Company to redesign its products or require the Company to enter into royalty or
licensing agreements, any of which could have a material adverse effect upon the
Company's business, results of operations and financial condition. Such royalty
or licensing agreements, if required, may not be available on terms acceptable
to the Company or at all. See "Risk Factors--Intellectual Property and
Proprietary Rights."

COMPETITION

     The market for Internet products and services is highly competitive.
Furthermore, the Company expects the market for Internet advertising to become
intensely competitive. The Company believes the principal competitive factors in
this market are name recognition, performance, ease of use, variety of value-
added services, features and quality of support.

     A number of companies currently offer competitive products in the Company's
target markets. The primary competitors of the Company's products and services
are other companies providing online services and include America Online
(including CompuServe), Compaq Corporation's Alta Vista, Excite Inc. (including
WebCrawler), Infoseek Corporation, Microsoft's Start, Netscape's Netcenter,
Prodigy Services, Inc., NBC's Snap and Yahoo! Inc. In addition, a number of
companies offering Internet products and services, including direct competitors
of the Company, recently have begun to integrate multiple features within the
products and services they offer to consumers. Integration of Internet products
and services is occurring through development of competing products and through
acquisitions of, or entering into joint ventures and/or licensing arrangements
involving, competitors of the Company. For example, the Web browsers offered by
Netscape and Microsoft, which are the two most widely-used browsers and
substantial sources of traffic for the Company, may incorporate and promote
information search and retrieval capabilities in future releases or upgrades
that could make it more difficult for Internet viewers to find and use the
Company's products and services. Microsoft recently licensed products and
services from Inktomi Corporation ("Inktomi"), a direct competitor of the
Company, and has announced that it will feature and promote Inktomi services in
the Microsoft Network and other Microsoft online properties.

     The Company understands that such search services will be tightly
integrated into the Microsoft operating system, the Internet Explorer browser,
and other software applications, and that Microsoft will promote such services
within the Microsoft Network or through other Microsoft-affiliated end-user
services such as MSNBC or WebTV Networks, Inc. Also, many large media companies
have announced that they are contemplating developing or acquiring Internet
navigation services and are attempting to become "gateway" sites for Web users.
In the event such companies develop such "portal" sites, the Company could lose
a substantial portion of its user traffic, which would have a material adverse
effect on the Company's business, results of operations and financial condition.
Further, entities that sponsor or maintain high-traffic Websites or that provide
an initial point of entry for Internet viewers, such as the Regional Bell
Operating Companies or ISPs such as America Online, Inc., and Prodigy Services,
Inc. currently offer and can be expected to consider further development,
acquisition or licensing of Internet search and navigation functions competitive
with those offered by the Company, or could take actions that make it more
difficult for viewers to find and use the Company's products and services.
Continued or increased competition from such consolidations, integration and
strategic relationships involving competitors of the Company could have a
material adverse effect on the Company's business, results of operations,
financial condition and prospects.


                                      10
<PAGE>
 
The Company also competes directly with metasearch services that allow a user to
search the databases of several catalogs and directories simultaneously and
indirectly with database vendors that offer information search and retrieval
capabilities with their core database products. Tripod and Angelfire compete
with other community-based Websites including GeoCities, Inc. 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. Furthermore, the
Company may also compete with online services and other Website operators as
well as traditional offline media such as print and television for a share of
advertisers' total advertising budgets. See "Risk Factors--Intense Competition."

EMPLOYEES

     As of October 26, 1998, Lycos employed 456 persons, including 183 in sales
and marketing, 220 in research and development, product development and service
operations and 53 in finance and administrative functions. The Company also
employs 44 independent contractors for software development, documentation,
artistic design and editorial reviews. None of the Company's employees is 
represented by a labor union and Lycos considers its employee relations to be
good.

ITEM 2.   PROPERTIES

     The Company's corporate headquarters is located in an approximately 77,000
square foot office facility in Waltham, Massachusetts, under a lease which
expires in June 2003. The Company also leases facilities in Pittsburgh,
Pennsylvania under separate leases that expire in March 2000, November 2000 and
April 2001, used for research and development, sales and service operations. The
Company also maintains a sales office in New York, New York under a lease which
expires in April 2002 and a sales office in San Francisco, California under a
lease which expires in March 2002. Lycos also maintains corporate offices for
Tripod in Williamstown, Massachusetts, under a lease which expires in July 1999
and in Mountain View, California for WhoWhere? under a lease which expires in
2002.  The Company believes that its current facilities are adequate for its
current needs.

The Company maintains substantially all of its computer systems at its
Pittsburgh, Pennsylvania site and the Santa Clara, California and Waltham,
Massachusetts sites of Exodus Communications, Inc. The Company's operations are
dependent in part upon its ability to protect its operating systems against
physical damage from fire, floods, earthquakes, power loss, telecommunications
failures, break-ins or other similar events. Furthermore, despite the
implementation of network security measures by the Company, its servers are also
vulnerable to computer viruses, break-ins and similar disruptive problems. The
occurrence of any of these events could result in interruptions, delays or
cessations in service to users of the Company's products and services which
could have a material adverse effect on the Company's business, results of
operations and financial condition.

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, financial condition, results of operations or cash
flows.

ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended July 1998.

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.

                                      11
<PAGE>
 
  The executive officers of the Company are:

<TABLE>
<CAPTION>
NAME                      AGE  POSITION
----                      ---  --------
<S>                       <C>  <C>
   Robert J. Davis......   42  President, Chief Executive Officer and Director
   Edward M. Philip.....   33  Chief Operating Officer, Chief Financial Officer
                               and Secretary
   Sangam Pant..........   33  Vice President of Engineering
   Mark G. Simmer.......   38  Vice President of Online Media
   Jan R. Horsfall......   38  Vice President of Marketing
   David G. Peterson....   41  Vice President of Advertising Sales
   Thomas E. Guilfoile..   34  Vice President of Finance and Administration
   Jeffrey J. Crown.....   39  Vice President of Business Development
   William Peabody......   28  Chief Executive Officer of Tripod
</TABLE>

  Robert J. Davis has served as President, Chief Executive Officer and Director
of the Company since its inception in June 1995. From January 1993 to June 1995,
Mr. Davis served as Vice President of Sales at Cambex Corporation, a
manufacturer of computer-related products. From January 1982 to January 1993,
Mr. Davis was employed by Wang Laboratories, a computer manufacturer, in various
sales and marketing positions, including Director of United States Commercial
Sales and Marketing and Director of Worldwide Marketing. Mr. Davis holds a
Bachelor of Science degree, with highest honors, from Northeastern University
and a Master in Business Administration from Babson College.

  Edward M. Philip has served as Chief Financial Officer and Secretary of the
Company since December 1995 and Chief Operating Officer since December 1996.
From July 1991 to December 1995, Mr. Philip was employed by The Walt Disney
Company where he served in various finance positions, most recently as Vice
President and Assistant Treasurer. From September 1989 to May 1991, Mr. Philip
attended Harvard Business School. From August 1987 to June 1989, Mr. Philip was
an investment banker at Salomon Brothers Inc. Mr. Philip received a Bachelor of
Science degree in Economics and Mathematics from Vanderbilt University and a
Master in Business Administration from Harvard Business School.

  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 Baroda, India. Mr. Pant is
currently obtaining a graduate degree from the Wharton School of Business in the
Executive Master of Business Administration 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 Media for the Company
since October 1996, and previously served as its Editor-in-Chief since March
1996. From 1995 to 1996, Mr. Simmer served as a consultant to Point
Communications, a Website ratings and review service acquired by Lycos in
October 1995. From 1985 to 1995, Mr. Simmer was a Managing Editor and Executive
Producer for Seattle-based King Broadcasting Company. Projects he supervised
have won awards from the Seattle Chapter of the National Academy of Television
Arts and Sciences, the Associated Press, and the Robert F. Kennedy Foundation.
Mr. Simmer holds a Bachelor of Science degree in Political Science from
Willamette University and completed the graduate professional program at the
University of Missouri School of Journalism. From 1987 to 1989, Mr. Simmer also
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 held various sales and marketing
positions with that 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.

                                      12
<PAGE>
 
  David G. Peterson has served as Vice President of Advertising Sales of the
Company since December 1996. From 1985 to 1996, Mr. Peterson served in various
sales positions at International Data Group (''IDG''), most recently as
Associate Publisher of Computerworld, where he was responsible for all U.S.
advertising sales operations and managed seven regional offices. Previously, Mr.
Peterson also held such positions within IDG as Vice President of Eastern
Advertising Sales, Regional Vice President of New England Advertising Sales and
District Manager. Mr. Peterson holds a Bachelor of Arts degree in Economics from
the University of New Hampshire and a Master of Business Administration from
Northeastern University.

  Thomas E. Guilfoile has served as Vice President of Finance and Administration
since December 1996 and Controller since February 1996. From July 1986 to
January 1996, Mr. Guilfoile was employed by Ernst & Young LLP, most recently as
Senior Manager in the Entrepreneurial Services Group. While at Ernst and Young,
Mr. Guilfoile provided both audit and consulting services to both privately held
and publicly traded organizations, primarily in the high-tech area with a focus
on companies in the Information, Communications and Entertainment industries. A
Certified Public Accountant, Mr. Guilfoile is a member of the American Institute
of Certified Public Accountant's and the Massachusetts Society of Certified
Public Accountants; and a former member of the Board of Directors of the Smaller
Business Association of New England. Mr. Guilfoile holds a Bachelor of Business
Administration degree in accounting from the University of Notre Dame.

  Jeffrey J. Crown has served as Vice President of Business Development since
July 1997 and previously served as Director of Business Development since
January 1996. Mr. Crown was formerly the Director of Sales and Marketing for
Xyvision, Inc. and has 15 years of technical sales and marketing experience at
McDonnell Douglas and Auto-trol Technology Corporation. Mr. Crown holds a
Bachelor of Science in Marketing/Industrial Sales from Penn State University.

  William Peabody is the founder of Tripod, Inc. and has served as its Chief
Executive Officer since its inception in 1994.  Mr. Peabody holds a Bachelors
degree in Political Philosophy and Sociology from Williams College.

                                      13
<PAGE>
 
                                    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
    ----      --------------------                                -----  -----
    <S>       <C>                                                 <C>    <C> 
    1999      October 31, 1998 (through October 26, 1998).......  39.94  20.06 
 
    1998      October 31, 1997..................................  21.00   8.13
              January 31, 1998..................................  21.00  12.63
              April 30, 1998....................................  39.57  17.60
              July 31, 1998.....................................  53.63  24.16
 
    1997      October 31, 1996..................................   6.38   2.88
              January 31, 1997..................................   9.38   4.75
              April 30, 1997....................................  11.37   6.00
              July 31, 1997.....................................   9.63   5.60
 
    1996      April 30, 1996 (commencing April 2, 1996).........  14.63   7.00
              July 31, 1996.....................................   9.63   2.94
</TABLE>

As of October 26, 1998, the Company had 42,992,690 shares of Common Stock held
by approximately 776 shareholders of record. This does not reflect persons or
entities who hold their stock in nominee or "street" name through various
brokerage firms.

The Company has not paid any cash dividends on its Common Stock. The Company
anticipates it will reinvest earnings to finance future growth, and therefore
does not intend to pay dividends in the foreseeable future.

ITEM 6.   SELECTED FINANCIAL DATA

The selected financial data presented below under the caption Consolidated
Statements of Operations Data with respect to the years ended July 31, 1998,
1997, 1996 and for the period from Inception (June 1, 1995) to July 31, 1995 and
under the caption Consolidated Balance Sheet Data at July 31, 1998, 1997, 1996
and 1995 are derived from the consolidated financial statements of the Company
and its subsidiary, which financial statements have been audited by KPMG 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>
                                                                                                       INCEPTION
                                                     YEAR ENDED      YEAR ENDED      YEAR ENDED     (JUNE 1, 1995)
                                                   JULY 31, 1998   JULY 31, 1997   JULY 31, 1996   TO JULY 31, 1995
                                                 ---------------   -------------   -------------   ---------------- 
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
<S>                                                <C>             <C>             <C>             <C>
Revenues:
 Advertising.....................................   $ 41,768,607     $17,417,388     $ 4,478,474   $             --
 Electronic commerce, license and other..........     14,291,698       4,855,654         778,753              5,000
                                                 ---------------   -------------   -------------   ---------------- 
  Total revenues.................................     56,060,305      22,273,042       5,257,227              5,000
 
Cost of revenues (1).............................     12,513,259       4,335,941       2,900,808             27,576
                                                 ---------------   -------------   -------------   ----------------  
  Gross profit...................................     43,547,046      17,937,101       2,356,419            (22,576)
Operating expenses:
 Research and development........................      9,477,708       4,301,267         906,591             15,940
 In process research & development (2)...........     91,239,055              --         452,000                 --
</TABLE> 

                                      14
<PAGE>
 
<TABLE> 
 <S>                                               <C>             <C>             <C>             <C> 
 Sales and marketing (1).........................     35,035,754      19,126,317       4,747,805             29,530
 General and administrative......................      5,631,104       2,718,763       1,692,362             37,335
 Amortization of intangible assets...............      2,131,735         540,416         359,868                 --
                                                   -------------   -------------   -------------   ----------------  
  Total operating expenses.......................    143,515,356      26,686,763       8,158,626             82,805
                                                   -------------   -------------   -------------   ----------------     
Operating loss...................................    (99,968,310)     (8,749,662)     (5,802,207)          (105,381)
 
Interest income..................................      3,051,747       2,130,472         714,369                 --
                                                   -------------   -------------   -------------   ----------------   
Net loss.........................................   $(96,916,563)    $(6,619,190)    $(5,087,838)       $  (105,381)
                                                   =============   =============   =============   ================  
Basic and diluted net loss per share (3).........         $(3.13)         $(0.24)         $(0.21)            $(0.01)
                                                   =============   =============   =============   ================  
Shares used in computing net loss per share (4)..     30,932,982      27,589,486      23,984,830         22,025,528
                                                   =============   =============   =============   ================  
 
</TABLE> 

<TABLE> 
<CAPTION> 
                                                   JULY 31, 1998     JULY 31, 1997   JULY 31, 1996      JULY 31, 1995      
                                                   -------------     -------------   -------------      -------------      
CONSOLIDATED BALANCE SHEET DATA:
<S>                                                <C>               <C>             <C>                <C> 
Working capital..................................   $146,921,549     $38,129,429     $39,973,810        $   329,411
Total assets.....................................   $248,758,257     $65,419,009     $53,660,575        $ 1,316,655
Long-term portion of deferred revenues,
  net of current portion.........................   $ 26,159,754     $ 5,100,000              --                 --
Total stockholders' equity.......................   $168,686,595     $37,647,027     $44,106,157        $ 1,144,619
</TABLE>

(1)  Certain amounts in 1997 and 1996, which were previously included in the
     consolidated income statement under the caption "Cost of revenues", have
     been reclassified as "Sales and marketing" expense for all periods
     presented. This reclassification conforms the Company's presentation to
     industry practice. This change in classification has no effect on
     previously reported net loss or net loss per share.

(2)  Reflects "In process research & development" expense recorded in connection
     with the Company's acquisitions.

(3)  Net loss per share is calculated using the weighted average number of
     common stock and common stock equivalent shares outstanding during the
     respective periods. See Note 1 of Notes to Consolidated Financial
     Statements.

(4)  Reflects Company two for one stock split effective August 25, 1998.

                                      15
<PAGE>
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

  The matters discussed in this Report contain forward-looking statements that
involve risks and uncertainties. The Company's actual results could differ
materially from those discussed herein. Factors that could cause or contribute
to such differences include, but are not limited to, those discussed in
"Factors Affecting the Company's Business, Operating Results and Financial
Condition" as well as those discussed in this section and elsewhere in this
Report.


FISCAL 1998 COMPARED TO FISCAL 1997

RESULTS OF OPERATIONS

  Revenues.   Total revenues for the year ended July 31, 1998 increased $33.8
million or 152%, to $56.1 million from $22.3 million for the previous year ended
July 31, 1997 primarily  as a result of the growth in the number and size of
advertising contracts as well as an increase in the number and value of
electronic commerce agreements. As of July 31, 1998 deferred revenues increased
289% to $56.9 million attributable to license and electronic commerce agreements
for which there are significant obligations of the Company remaining, compared
to $14.6 million at July 31, 1997. Billings in excess of revenues decreased $1.7
million, or 71%, to $682,000, compared to $2.4 million at July 31, 1997. This
decrease is attributable primarily to improvements in Lycos' billing policies
during 1998.

  Advertising Revenues.   Advertising revenues increased $24.4 million or 140%,
to $41.8 million for the year ended July 31, 1998 representing 75% of total
revenues. For the previous year ended July 31, 1997, advertising revenues were
$17.4 million representing 78% of total revenues. The increase in advertising
revenue was attributable primarily to an increase in the number of advertisers
as well as growth in the average contract size and value.

  The Company currently derives a substantial portion of its revenues from the
sale of advertisements on its Websites, primarily through banner advertisements
and sponsorships. Advertising contracts are primarily sold as: (1) a "run of
site" contract under which a customer is guaranteed a number of impressions; (2)
a "key word" contract in which a customer purchases the right to advertise in
connection with specified word searches; or (3) a "targeted" contract where the
customer purchases a specified number of impressions in one of the Web Guides or
on a specified page or service.

  Electronic Commerce, License and Other Revenues. Electronic commerce, license
and other revenues increased $9.4 million or 194%, to $14.3 million for the year
ended July 31, 1998, representing 25% of total revenues. For the previous year
ended July 31, 1997, electronic commerce, license and other revenues were $4.9
million, representing 22% of total revenues. For the year ended July 31, 1998,
the increase in electronic commerce, license and other revenues is attributable
primarily to the addition of several new partners during the year, including,
among others, AT&T, Barnes and Noble, Microsoft and CDnow.

  Electronic commerce revenues are derived principally from "slotting fees" paid
for selective positioning and promotion within the Company's suite of products
as well as from royalties from the sale of goods and services from the Company's
websites.  The Company's license and product revenues are derived principally
from product licensing fees and fees from maintenance and support of its
products. Electronic commerce, license and product revenues are generally
recognized upon delivery provided that no significant Company obligations remain
and collection of the receivable is probable. In cases where there are
significant remaining obligations, the Company defers such revenue until those
obligations are satisfied. Fees from maintenance and support of the Company's
products including revenues bundled with the initial licensing fees are deferred
and recognized ratably over the service period.

  Cost of Revenues.   Cost of revenues increased $8.2 million or 189%, to $12.5
million for the year ended July 31, 1998, representing 22% of total revenues.
Cost of revenues for the previous year ended July 31, 1997 were $4.3 million,
representing 19% of total revenues. Cost of revenues consist primarily of
expenses associated with the 

                                      16
<PAGE>
 
ongoing maintenance and support of the Company's products and services,
including compensation, consulting fees, equipment costs, networking and other
related indirect costs.

OPERATING EXPENSES

  Research and Development.   Research and development expenses increased $5.2
million or 120%, to $9.5 million for the year ended July 31, 1998, representing
17% of total revenues for the year, but declined 2% as a percentage of total
revenues. For the year ended July 31, 1997, research and development expenses
were $4.3 million, or 19% of total revenues.  Research and development expenses
consist primarily of equipment and salary costs. The overall increase in
research and development expenses was primarily due to increased engineering
staffing to continue to develop and enhance the Company's growing product
offerings. The Company believes that significant investment in research and
development is required to remain competitive. As a consequence, the Company
expects to continue to commit substantial resources to research and development
in the future.

  In-process research and development.  Upon consummation of the Tripod,
WiseWire, and GuestWorld acquisitions, the Company's management made certain
assessments with respect to the determination of all identifiable assets
resulting from, or to be used in, research and development activities as of the
respective acquisition dates. Each of these activities was evaluated as of the
respective acquisition dates so as to determine their stage of development and
related fair value.  The Company's review, as of the acquisition date, indicated
that the in-process research and development had not reached a state of
technological feasibility and evidenced no alternative future use. In the case
of in-process projects, the Company made estimates to quantify the cost-to-
complete for each project, identifying the project date of introduction, the
estimated life of the project, the project's "fit" within the Company's own in-
process research projects, the revenues to be generated in each future period
and the corresponding operating expenses and other charges to apply to this
revenue stream. In order to determine the value of the earnings stream
attributable to the in-process research and development, the excess earnings
from the projects were calculated by deducting the earnings stream attributable
to all other assets including working capital and tangible assets. Based upon
these assumptions, after-tax cash flows attributable to the in-process
project(s) were determined, appropriately discounted back to its respective net
present value, taking into account the uncertainty surrounding the successful
development of the purchased in-process projects.

  In order to assess the reasonableness of the conclusions reached under the 
Excess Earnings (Discounted Future Earnings) method, the value of the 
technologies was also estimated using a Relief from Royalty approach. Under this
approach, the value of the technologies is estimated to be the present value of
the after tax amounts that the Company would otherwise be required to pay to
third parties to obtain access to the subject technologies, if it did not
already own them. In applying the method, management estimated a royalty rate
and forecasted an estimated royalty stream for the in-process technologies. The
estimated royalty rate used was based on existing Lycos contracts for the
licensing of similar technologies.

  GuestWorld and WiseWire are both development stage companies that had not 
generated significant commercial revenue at their respective acquisition dates 
and were loss making. Neither company had completed development of 
technologically robust or commercially viable products or services. Significant
uncertainty existed in relation to the introduction of such products or 
services.

  Lycos' management has considered the possible existence or value of other 
intangible assets such as patents, copyrights, brand names, customers lists, 
etc. However, management at both companies had been focused on completing the 
development projects underway and they had not undertaken the development of 
other intangible assets. Accordingly, Lycos' management believes that the value 
of any other such assets at the respective acquisition dates to be minimal 
or zero.

  The purchase price paid for GuestWorld and WiseWire reflected payment for 
incomplete technology. Should the in-process projects fail, the value of Lycos' 
investment in these incomplete technologies would be diminimous or zero.

  In the case of Tripod, management does believe that other intangible assets
had been created by management at the acquisition date. As a result, in addition
to valuing in-process research and development, management has also allocated a
proportion of the purchase price, based on their respective fair values, to
existing technology employed in the creation and management of pods as well as
to other intangible assets associated with the existing community members.

  As a result of this analysis, the Company expensed approximately $91.2 million
representing purchased in-process research and development that has not yet
reached technological feasibility and has no alternative future use.  See Note 4
to the Consolidated Financial Statements.

  Sales and Marketing.   Sales and marketing expenses increased $15.9 million or
83%, to $35.0 million for the year ended July 31, 1998, representing 62% of
total revenues for the year. For the year ended July 31, 1997, sales and
marketing expenses were $19.1 million, representing 86% of total revenues, but
declined 23% as a percentage of total revenues.  Sales and marketing expenses
consist primarily of compensation, advertising, public relations, trade shows,
travel and costs of marketing literature. The spending increases were due to the
addition of sales and marketing personnel, increased commissions, and expenses
associated with the Company's expanded advertising, marketing and public
relations campaign. The Company expects continued increases in sales and
marketing expenses in future periods. Sales and marketing expenses also includes
the cost of the Company's "Premier 

                                      17
<PAGE>
 
Provider" Agreements with Netscape, which totaled $4.3 million, $4.5 million and
$1.5 million in the fiscal years ended July 31, 1998, 1997 and 1996,
repesctively.

  General and Administrative.   General and administrative expenses increased
$2.9 million or 107%, to $5.6 million for the year ended July 31, 1998,
representing 10% of total revenues. For the year ended July 31, 1997, general
and administrative expenses were $2.7 million, representing 12% of total
revenues.  General and administrative expenses consist primarily of
compensation, amortization, fees for professional services and other  general
corporate overhead costs. The increases in spending were primarily due to the
expansion of the Company's corporate infrastructure, including the addition of
finance and administrative personnel, increased amortization costs relating to
the Company's acquisitions and increased costs for professional services.

  Amortization of Intangible Assets.  Amortization of intangible assets
increased $1.6 million or 294%, to $2.1 million for the year ended July 31,
1998, representing 4% of revenues.  The increase is attributable to increased
amortization related to developed technology and goodwill and other intangible
assets recorded upon the acquisitions of Tripod, WiseWire and GuestWorld.  In
addition, the Company wrote-off $98,000 of goodwill related to Point
Communications and $830,000 related to its license agreement with Carnegie
Mellon University.  See Notes 4 and 11 to the Consolidated Financial Statements.

  Interest Income.   Interest income increased $921,000 or 43%, to $3.1 million
for the year ended July 31, 1998, representing 5% of total revenues.  Interest
income was approximately $2.1 million for the year ended July 31, 1997,
representing 10% of total revenues.  Interest income is derived primarily from
the investment of net proceeds received upon the closing of the Company's public
offerings of common stock in April 1996 and June 1998.

  Income Taxes.   The Company has not recorded an income tax expense or benefit
because it has incurred net operating losses since Inception. As of July 31,
1998, the Company had approximately $38 million in Federal and State net
operating loss carryforwards. Of this amount, approximately $13 million relates
to the acquisitions of Point Communications, Tripod, Inc., WiseWire Corporation,
and GuestWorld, Inc. and will reduce goodwill when utilized. The Federal net
operating losses will expire beginning in 2007 if not utilized. The State net
operating losses will expire beginning in 1998 if not utilized. A portion or all
of net operating loss carryforwards which can be utilized in any year may be
limited by changes in ownership of the Company, pursuant to Section 382 of the
Internal Revenue Code and similar statutes.

ACQUISITIONS

Tripod, Inc.

  On February 11, 1998, the Company acquired Tripod, Inc. in a stock-for-stock
transaction valued at approximately $61.5 million.  The transaction was
accounted for as a purchase, and accordingly, the purchase price was allocated
to the assets acquired and liabilities assumed based on their respective fair
values.  In connection with the acquisition, the Company recorded a one-time
charge related to in-process research and development of $51.6 million.

WiseWire Corporation

On April 30, 1998, the Company acquired WiseWire Corporation in a stock-for-
stock transaction valued at approximately $39.4 million.  The transaction was
accounted for as a purchase, and accordingly, the purchase price was allocated
to the assets acquired and liabilities assumed based on their respective fair
values.  In connection with the acquisition, the Company recorded a one-time
charge related to in-process research and development of $36 million.

GuestWorld, Inc.

  On June 16, 1998, the Company acquired GuestWorld, Inc. in a stock-for-stock
transaction valued at approximately $3.6 million.  The transaction was accounted
for as a purchase, and accordingly, the purchase price was allocated to the
assets acquired and liabilities assumed based on their respective fair values.
In connection with the acquisition, the Company recorded a one-time charge
related to in-process research and development of $3.6 million.


                                      18
<PAGE>
 
FISCAL 1997 COMPARED TO FISCAL 1996

RESULTS OF OPERATIONS

  Revenues.   Total revenues for the year ended July 31, 1997 increased $17.0
million or 324%, to $22.3 million from $5.3 million for the previous year ended
July 31, 1996 as a result of the growth in the number of advertisers, average
contract size and value. As of July 31, 1997 deferred revenues increased 371% to
$14.6 million attributable to license agreements for which there are significant
obligations of the Company remaining, compared to $3.1 million at July 31, 1996.
Billings in excess of revenues increased $1.0 million, or 71%, to $2.4 million
attributable to billings in excess of revenues on advertising contracts,
compared to $1.4 million at July 31, 1996.

  Advertising Revenues.   Advertising revenues increased $12.9 million or 287%,
to $17.4 million for the year ended July 31, 1997 representing 78% of total
revenues. For the previous year ended July 31, 1996, advertising revenues were
$4.5 million representing 85% of total revenues.

  The Company derived a substantial portion of its revenues from the sale of
advertisements on its Websites, primarily through banner advertisements and
sponsorships. Advertising contracts are primarily sold as: (1) a "run of site"
contract under which a customer is guaranteed a number of impressions; (2) a
"key word" contract in which a customer purchases the right to advertise in
connection with specified word searches; or (3) a "targeted" contract where the
customer purchases a specified number of impressions in one of the Web Guides or
on a specified page or service.

  Electronic Commerce, License and Other Revenues. Electronic commerce, license
and other revenues increased $4.1 million or 524%, to $4.9 million for the year
ended July 31, 1997, representing 22% of total revenues. For the previous year
ended July 31, 1996, license, product and other revenues were $779,000,
representing 15% of total revenues. For the year ended July 31, 1997, the
increase in license, product and other revenue is attributable primarily to the
addition of several new partners during the year, including, among others,
Bertelsmann, Blockbuster and GTE.

  Cost of Revenues.   Cost of revenues increased $1.4 million or 49%, to $4.3
million for the year ended July 31, 1997, representing 19% of total revenues.
Cost of revenues for the previous year ended July 31, 1996 were $2.9 million,
representing 55% of total revenues. As a percentage of total revenues Cost of
revenues decreased 35% during the year ended July 31, 1997. Cost of revenues
consist primarily of expenses associated with the ongoing maintenance and
support of the Company's products and services, including compensation,
consulting fees, equipment costs, networking and other related indirect costs.
During 1997 the Company reclassified certain amounts in both 1997 and 1996
relating to the Company's agreements with Netscape from Cost of revenues to
Sales and marketing expense. See "Sales and Marketing".

OPERATING EXPENSES

  Research and Development.   Research and development expenses increased $3.4
million or 374%, to $4.3 million for the year ended July 31, 1997, representing
19% of total revenues for the year. For the year ended July 31, 1996, research
and development expenses were $907,000, or 17% of total revenues. As a
percentage of total revenues, research and development expenses increased 2%
during the year ended July 31, 1997. Research and development expenses consist
primarily of equipment and salary costs. The overall increase in research and
development expenses was primarily due to increased engineering staffing to
continue to develop and enhance all of the Company's different product lines.

  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 increased $14.4 million or
303%, to $19.1 million for the year ended July 31, 1997, representing 86% of
total revenues for the year. For the year ended July 31, 1996, sales and
marketing expenses were $4.7 million, representing 90% of total revenues. As a
percentage of total revenues, sales and marketing expenses decreased 4% during
the year ended July 31, 1997. Sales and marketing expenses


                                      19
<PAGE>
 
consist primarily of compensation, advertising, public relations, trade shows,
travel and costs of marketing literature. The spending increases were due to the
addition of sales and marketing personnel, increased commissions, and expenses
associated with the Company's expanded advertising, marketing and public
relations campaign. The Company expects continued increases in sales and
marketing expenses in future periods. Sales and marketing expenses also includes
the cost of the Company's "Premier Provider" Agreements with Netscape which
totaled $4.5 million and $1.5 million in fiscal years ending July 31, 1997 and
1996, respectively.

  General and Administrative.   General and administrative expenses increased
$1.0 million or 59%, to $2.7 million for the year ended July 31, 1997,
representing 12% of total revenues. For the year ended July 31, 1996, general
and administrative expenses were $1.7 million, representing 32% of total
revenues. As a percentage of total revenues, general and administrative expenses
decreased 20% during the year ended July 31, 1997. 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.

  Amortization of Intangible Assets.  Amortization of intangible assets
increased $180,548 or 50%, to $540,000 for the year ended July 31, 1997,
representing 2% of revenues.  The increase is attributable to a full year
amortization of the goodwill arising on the acquisition of Point Communications,
ocurring in October 1995.

  Interest Income.   Interest income increased $1.4 million or 194%, to $2.1
million for the year ended July 31, 1997, representing 9% of total revenues.
Interest income was approximately $714,000 for the year ended July 31, 1996,
representing 14% of total revenues. As a percentage of total revenues, interest
income decreased 5% during the year ended July 31, 1997. Interest income is
primarily from the investment of net proceeds received upon the closing of the
Company's initial public offering in April 1996.

  Income Taxes.   The Company has not recorded an income tax benefit because it
has incurred net operating losses since Inception. As of July 31, 1997, the
Company had approximately $3.5 million in Federal and State net operating loss
carryforwards. Of this amount, approximately $276,000 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.

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 6,000,000 shares of common
stock were issued at a price of $8.00 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 270,000
shares of its common stock at $8.00 per share. Proceeds from the offering were
approximately $46.0 million, net of offering costs.

  On June 4, 1998, 4,500,000 of the Company's shares were sold under a
registration statement filed with the Securities Exchange Commission, filed on
May 15, 1998.  Of the 4,500,000 shares sold, 4,000,000 shares were sold by the
Company and 500,000 were sold by CMG Information Services, Inc ("CMGI").  The
Company did not receive any proceeds from the sale of shares by CMGI.  Proceeds
to the Company were approximately $95 million.  The Underwriters exercised an
option to purchase 675,000 additional shares of Common Stock, resulting in
additional proceeds to the Company of approximately $16 million.

  At July 31, 1998, the Company had cash and cash equivalents of approximately
$153.7 million. The Company regularly invests excess funds in short-term money
market funds, government securities and commercial paper.

  The Company used cash from operations of approximately $2.8 million in the
year ended July 31, 1998, due primarily to the net loss, as well as increases in
accounts receivable, electronic commerce and license fees receivable and prepaid
expenses. The Company's primary investing activity during the year has been, and
further expenditures 


                                      20
<PAGE>
 
are anticipated to be, for the purchase of computers and office equipment to
support the Company's continued growth. During the year ended July 31, 1998, the
Company also used approximately $2.5 million for payments under the 1997 and
1998 Agreements with Netscape.

  At July 31, 1998, the Company had deferred revenues of $56.9 million
representing primarily license and electronic commerce fees to be earned in the
future on noncancelable license and electronic commerce agreements. In addition,
the Company had billings in excess of revenues from advertising contracts of
$680,000 at July 31, 1998.

  In April 1998, the Company purchased 1,915,709 shares of Series B Convertible
Participating Preferred Stock of Sage Enterprises, Inc. ("PlanetAll") through
the issuance of 100,904 shares of Lycos common stock, valued at $3.3 million.
The investment is carried at cost and represents an approximate 14.1% interest
in PlanetAll.

  In August 1998, all of the outstanding capital stock of PlanetAll was acquired
by Amazon.com in a stock-for-stock transaction valued at approximately $87
million.  Of the total of 800,000 shares issued by Amazon.com, the Company
received 107,377 shares valued at approximately $11.6 million, as of the
acquisition date, in exchange for its shares of PlanetAll.  See Notes 2 and 7 to
the Consolidated Financial Statements.

  In March 1998, the Company purchased 1,000,000 shares of Class A Preferred
Stock of GlobeComm, Inc. ("GlobeComm") through the issuance of 200,124 shares of
Lycos common stock, valued at $4,577,837. The investment, carried at cost, and 
initially represented an approximate 9.85% stake in GlobeComm on a fully diluted
basis. GlobeComm is the owner of iName, a leading provider of lifetime
personalized e-mail addresses and advanced e-mail services. Lycos provides free
e-mail services to users based on iName's advanced products.

  The Company is obligated to make payments totaling approximately $19 million
under contracts to provide search and navigation services between June 1998 and
September 1999. No payments had been made under these agreements as of July 31,
1998.

  From time to time, the Company expects to evaluate the acquisition of
products, businesses and technologies that complement the Company's business. As
of the date of this Report other than those noted herein, the Company does not
have any understandings, commitments or agreements with respect to any such
material acquisitions.

  The Company currently believes that available funds and cash flows expected to
be generated by operations, if any, will be sufficient to fund its working
capital and capital expenditures requirements for at least the next twelve
months. Thereafter, the Company may need to raise additional funds. The Company
may need to raise additional funds sooner in order to fund more rapid expansion,
to develop new or enhanced products and services, to respond to competitive
pressures or to acquire complementary businesses or technologies. If additional
funds are raised through the issuance of equity securities, the percentage
ownership of the stockholders of the Company will be reduced, stockholders may
experience additional dilution, and such equity securities may have rights,
preferences or privileges senior to those of the Company's Common Stock. There
can be no assurance that additional financing will be available when needed on
terms favorable to the Company or at all. If adequate funds are not available or
are not available on acceptable terms, the Company may be unable to develop or
enhance products or services, take advantage of future opportunities or respond
to competitive pressures, which could have a material adverse effect on the
Company's business, results of operations or financial condition.

YEAR 2000 COMPLIANCE

  Many currently installed computer systems and software products are coded to
accept only two-digit entries in the date code field and cannot distinguish 21st
century dates from 20th century dates. These date code fields will need to
distinguish 21st century dates from 20th century dates and, as a result, many
companies' software and computer systems may need to be upgraded or replaced in
order to comply with such "Year 2000" requirements.
 
  State of Readiness.  The Company has evaluated the year 2000 readiness of the
hardware and software products sold by the Company ("Products"), the information
technology systems used in its operations ("IT Systems"),  and its non-IT
Systems, such as building security, voice mail and other systems.  The Company's
evaluation covered the following phases: (i) identification of all Products, IT
Systems, and non-IT Systems; (ii) assessment of repair or 


                                      21
<PAGE>
 
replacement requirements; (iii) repair or replacement; (iv) testing; (v)
implementation; and (vi) creation of contingency plans in the event of year 2000
failures. The evaluation was completed in 1998. Based on this evaluation, the
Company believes it is year 2000 compliant.

  However, the assessment of whether a complete system or device in which a
product or system is embedded will operate correctly for an end-user depends in
large part on the year 2000 compliance of the product or system's other
components, many of which are supplied by parties other than the Company.  The
supplier of the Company's current financial and accounting software has informed
the Company that such software is year 2000 compliant. Further, the Company
relies, both domestically and internationally, upon various vendors,
governmental agencies, utility companies, telecommunications service companies,
delivery service companies and other service providers who are outside of the
Company's control.  There is no assurance that such parties will not suffer a
year 2000 business disruption, which could have a material adverse effect on the
Company's financial condition and results of operations.

  Costs.  To date, the Company has not incurred any material expenditures in
connection with identifying or evaluating year 2000 compliance issues.  Most of
its expenses have related to the opportunity cost of time spent by employees of
the Company evaluating its software, the current versions of its products, and
year 2000 compliance matters generally.

  Contingency Plan.  The Company has not developed a year 2000-specific
contingency plan.  If year 2000 compliance issues are discovered, the Company
then will evaluate the need for contingency plans relating to such issues.

SUBSEQUENT EVENTS

Acquisition of WhoWhere? Inc.

  On August 13, 1998, the Company acquired WhoWhere? Inc. in a stock-for-stock
transaction valued at approximately $158.2 million. The transaction is 
intended to be accounted for as a purchase, and accordingly, the purchase price
will be allocated to assets acquired and liabilities assumed based on their
respective fair values. In connection with this acquistion, the Company will
record a one-time charge related to in-process research and development of
between $10 million to $20 million in the first quarter of fiscal 1999. See Note
7 to the Consolidated Financial Statements.

Acquisition of Sage Enterprises, Inc.

  In August 1998, pursuant to an Agreement and Plan of Merger, Amazon.com
acquired all of the outstanding capital stock of Sage Enterprises, Inc. 
(PlanetAll). Amazon.com issued approximately 800,000 shares of Amazon.com common
stock, par value $.01 per share valued at approximately $87 million. Of the
total of 800,000 shares issued by Amazon.com, the Company received 107,377
shares valued at approximately $11.6 million at the time of acquisition in
exchange for its shares of PlanetAll. See Notes 2 and 7 to the Consolidated
Financial Statements.

Acquisition of Wired Ventures, Inc.

  On October 5, 1998, the Company entered into a definitive merger agreement to
acquire Wired Ventures Inc. ("Wired") in a stock-for-stock transaction valued at
approximately $83 million, net of cash to be acquired and the value of shares
issuable to the holders of options to purchase common stock of Wired which are
exercised prior to the closing of the acquisition. The transaction is intended
to be accounted for as a purchase, and accordingly, the purchase price will be
allocated to assets acquired and liabilities assumed based on their respective
fair values. Subject to several conditions,


                                      22
<PAGE>
 
including approval of Wired's shareholders, the transaction is expected to close
in the second quarter of fiscal 1999. See Note 7 to the Consolidated Financial
Statements.

NEW ACCOUNTING PRONOUNCEMENTS

     In June 1997, the Financial Accounting Standards Board issued Statement No.
130 ("SFAS 130") "Reporting Comprehensive Income". This statement
establishes standards for reporting and display of comprehensive income and its
components (revenues, expenses, gains and losses) in a full set of general-
purpose financial statements. This statement is effective for fiscal years
beginning after December 15, 1997. Reclassification of financial statements for
earlier periods provided for comparative purposes is required. The Company
expects to adopt SFAS 130 for the year ending July 31, 1999. The Company
believes that this pronouncement will not have a material adverse affect on its
results of operations.

  In June 1997, the Financial Accounting Standards Board issued Statement No.
131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and Related
Information". This statement establishes standards for the way that public
business enterprises report information about operating segments in annual
financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
shareholders. This statement is effective for financial statements for periods
beginning after December 15, 1997. The Company expects to adopt SFAS 131 for the
year ending July 31, 1999.  Because the Company operates within a single
operating segment, adoption of this statement is currently not expected to have
a material impact on the Company's consolidated financial statements and
footnote disclosures.

  In October 1997, the American Institute of Certified Public Accountants issued
Statement of Position 97-2 ("SOP 97-2"), "Software Revenue Recognition", which
provides guidance on applying generally accepted accounting principles in
recognizing revenue on software transactions and supersedes SOP 91-1, "Software
Revenue Recognition". The Company expects to adopt SOP 97-2 for its fiscal year
ending July 31, 1999 and does not anticipate any material impact on its revenue
recognition policies.

  In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-1("SOP 98-1"), "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use", which establishes guidelines
for the accounting for the costs of all computer software developed or obtained
for internal use.  The Company is required to adopt SOP 98-1 effective August 1,
1999. The adoption of SOP 98-1 is not expected to have a material impact on the
Company's consolidated financial statements.

  In April, 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-5 ("SOP 98-5"), "Reporting on the Costs of Start-Up
Activities." The statement is effective for fiscal years beginning after
December 15, 1998. The statement requires costs of start-up activities and
organization costs to be expensed as incurred. The Company is required to adopt
SOP 98-5 effective August 1, 1999. The adoption of SOP 98-5 is not expected to
have a material impact on the Company's consolidated financial statements.

  In June 1998, the Financial Accounting Standards Board issued Statement No.
133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging
Activities", which requires that all derivative instruments be recorded on the
balance sheet at their fair value. Changes in the fair value of derivatives are
recorded each period in current earnings or other comprehensive income,
depending on whether a derivative is designated as part of a hedge transaction
and, if it is, the type of hedge transaction. For fair-value hedge transactions
in which the Company is hedging changes in an asset's, liability's or firm
commitment's fair value, changes in the fair value of the derivative instrument
will generally be offset in the income statement by changes in the hedged item's
fair value. For cash flow hedge transactions, changes in the fair value of the
derivative instrument will be reported in comprehensive income. The gains and
losses on the derivative instrument that are reported in other comprehensive
income will be reclassified as earnings in the periods in which earnings are
impacted by the variability of the cash flows of the hedged item. The
ineffective portion of all hedges will be recognized in current period earnings.
The Company currently expects to adopt SFAS 133 for the year ending July 31,
1999.  Management has determined there will be no impact on its results of
operations or financial position resulting from the adoption of SFAS 133 because
the Company currently does not hold derivative instruments.


                                      23
<PAGE>
 
FACTORS AFFECTING THE COMPANY'S BUSINESS, OPERATING RESULTS AND FINANCIAL
CONDITION

  The following risk factors should be considered in conjunction with the other
information included in this Report. This Report (including the documents
incorporated by reference herein) may include forward-looking statements that
involve risks and uncertainties. In addition to those risk factors discussed
elsewhere in this Report, the Company identifies the following risk factors
which could affect the Company's actual results and cause actual results to
differ materially from those in the forward-looking statements.

  Limited Operating History; Anticipation of Continued Losses. The Company was
founded in June 1995 and for the years ended July 31, 1998 and 1997 generated
revenues of $56.1 million and $22.3 million, respectively. Accordingly, the
Company has a 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 stages of development, particularly companies in new
and rapidly evolving markets. These risks include the Company's ability to
continue to develop and extend the "Lycos" brand; the Company's ability to
maintain premier positions on high traffic Web access points such as its
arrangements with Netscape Communications Corp. ("Netscape") and Microsoft
Corporation ("Microsoft") or to enter into additional distribution relationships
and strategic alliances; the ability of the Company to maintain and increase
levels of traffic on its Websites; the ability of the Company to continue to
develop or acquire content, features and functionality for its services; the
development of equal or superior services or products by competitors; the
failure of the market to adopt the Web as an advertising or commercial medium;
the reduction in market prices for Web-based advertising as a result of
competition or otherwise; the Company's ability to effectively generate
commerce-related revenues through sponsored services and placements in Lycos
services; and the Company's success in attracting, retaining and motivating
qualified personnel. There can be no assurance that the Company will be
successful in addressing such risks. The limited operating history of the
Company makes the prediction of future results of operations difficult or
impossible, and therefore, the recent revenue growth experienced by the Company
should not be taken as indicative of the rate of growth, if any, that can be
expected in the future. The Company has incurred significant losses since
inception. The Company reported a loss of $3.13 per share (a $0.12 loss per
share before amortization and one-time acquisition related charges) for the
year ended July 31, 1998 and there can be no assurance that the Company will
sustain revenue growth or return to profitability in the future. As of July 31,
1998, the Company had an accumulated deficit of $108.7 million. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and Consolidated Financial Statements.

  Potential Fluctuations in Quarterly Results. As a result of the Company's
limited operating history, the Company does not have historical financial
data for any significant period of time on which to base planned operating
expenses. The Company's expense levels are based in part on its expectations as
to future revenues and to a certain extent are fixed. Quarterly sales and
operating results generally depend on the advertising, electronic commerce,
license fees and other revenues received within the quarter, which are difficult
to forecast. Because the Company's expense levels are based upon anticipated
advertising, electronic commerce and licensing revenue, the Company may not be
able to adjust spending in a timely manner to compensate for any unexpected
revenue shortfall. Accordingly, any significant shortfall in relation to the
Company's expectations would have an immediate adverse impact on the Company's
business, results of operations and financial condition.

  In addition, the Company plans to significantly increase its operating
expenses to fund greater levels of research and development, increase its sales
and marketing operations, develop new distribution channels, broaden its
customer support capabilities, maintain brand identity and pursue strategic
alliances. In the future, leading Websites, browser providers and other
distribution channels may require payments or other consideration in exchange
for providing access to the Company's products and services, such as the
Company's agreements with Netscape and Microsoft. Additionally, the Company may
incur costs pertaining to the introduction or enhancement of services offered by
the Company or the acquisition of businesses or technologies. To the extent that
such expenses precede or are not subsequently followed by increased revenues,
the Company's business, results of operations and financial condition could be
materially adversely affected.

  The Company's operating results may fluctuate significantly in the future as a
result of a variety of factors, some of which are outside of the
Company's control. These factors include general economic conditions, specific
economic conditions in the Internet industry, usage of the Internet, the level
of traffic to the Company's Websites, 


                                      24
<PAGE>
 
demand for Internet advertising and electronic commerce, the addition or loss of
advertisers or electronic commerce sponsors, seasonal trends in advertising
sales, the advertising budgeting cycles of individual advertisers, capital
expenditures and other costs relating to the expansion of operations, incurrence
of costs relating to acquisitions, the introduction of new products or services
by the Company or its competitors, the mix of the services sold, the channels
through which those services are sold, and pricing changes. As a strategic
response to a changing competitive environment, the Company may elect from time
to time to make certain pricing, service or marketing decisions or acquisitions
that could have a material adverse effect on the Company's business, results of
operations and financial condition. Due to the nascent nature of the Internet
industry, the Company believes that period to period comparisons of its
operating results are not meaningful and should not be relied upon for an
indication of future performance. The Company also has experienced, and expects
to continue to experience, seasonality in its business, with user traffic on the
Company's Websites and the Websites of its partners being lower during the
summer and year-end vacation and holiday periods, when usage of the Web and the
Company's services has typically declined. Due to all of the foregoing factors
and others that the Company cannot predict, it is possible that in some future
quarter, the Company's operating results may be below the expectations of
analysts and investors. In such event, the price of the Company's Common Stock
would likely be materially adversely affected. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."

  Reliance on Advertising Revenues; Risks Related to Sponsorships. The Company
derives a significant portion of its revenues from the sale of advertisements on
its Web pages. For the fiscal year ended July 31, 1998, advertising revenues
represented approximately 75% of the Company's total revenues. The Company's
strategy is to continue to develop advertising and other methods of generating
revenues through the use of its products and services.

  The Company's ability to increase its advertising revenues will depend, among
other things, on advertisers' acceptance of the Internet as an attractive and
sustainable medium, the development of a large base of users of the Company's
products and services possessing demographic characteristics attractive to
advertisers, the expansion of the Company's advertising sales force and the
development of the Internet as an attractive platform for electronic commerce.
In addition, there is fluid and intense competition in the sale of advertising
on the Internet, resulting in a wide range of rates quoted and a variety of
pricing models offered by different vendors for a variety of advertising
services, which makes it difficult to project future levels of advertising
revenues that will be realized generally or by any specific company.  It is also
difficult to predict which pricing models will be adopted by the industry or
advertisers. For example, advertising rates based on the number of "click
throughs" from the Company's network to advertisers' pages, instead of rates
based solely on the number of impressions, could materially adversely affect the
Company's revenues. In addition, "filter" software programs that limit or remove
advertising from the Web user's desktop are available. The widespread adoption
of such software by users could have a material adverse effect on the viability
of advertising on the Web. Accordingly, there can be no assurance that the
Company will be successful in generating significant future advertising
revenues, and the failure to do so would have a material adverse effect on the
Company's business, results of operations and financial condition. Further,
significant and consistent investment on the Internet by many advertisers is
dependent upon validation that the Internet is an effective advertising medium,
which validation has not yet occurred and which is essential to the achievement
of steady and predictable advertising revenues. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Business--
Advertising."

  The Company has entered into sponsorship arrangements with third parties to
provide sponsored services and placements on the Company's Websites in addition
to traditional banner advertising. In connection with these arrangements, the
Company may receive sponsorship fees as well as a portion of transaction
revenues received by such third party sponsors from users originated through the
Company's Websites, in return for minimum levels of user impressions or click
throughs to be provided by the Company. To the extent implemented, these
arrangements expose the Company to potentially significant financial risks,
including the risk that the Company fails to deliver required minimum levels of
user impressions or click throughs (in which case, these agreements typically
provide for adjustments to the fees payable thereunder or "make good" periods)
and that third party sponsors do not renew the agreements at the end of their
terms. Certain of these arrangements also require the Company to integrate
sponsors' content with the Company's services, which requires the dedication of
resources and significant programming and design efforts to accomplish. There
can be no assurance that the Company will be able to attract additional sponsors
or that it will be able to renew existing sponsorship arrangements when they
expire. In addition, the Company has granted exclusivity provisions to certain
of its sponsors, and may in the future grant


                                      25
<PAGE>
 
additional exclusivity provisions. Such exclusivity provisions may have the
effect of preventing the Company, for the duration of such exclusivity
arrangements, from accepting advertising or sponsorship arrangements within a
particular subject matter in the Company's Websites or across the Company's
entire service. The inability of the Company to enter into further sponsorship
or advertising arrangements as a result of its exclusivity arrangements could
have a material adverse effect on the Company's business, results of operations
and financial condition. See "Business--Advertising" and "--Electronic
Commerce."

  The Internet as a commercial endeavor has been in existence for a short period
of time. The costs of establishing a Website are low, and new online service
providers, content providers and advertisers are being launched regularly. Many
of these companies are funded with venture capital and other forms of financing
before they have proven both that their particular industry segment and their
business strategy will be successful. Those companies that are unable to prove
themselves successful before their initial funding is depleted may find it
difficult or impossible to secure additional funding. The failure of any of the
Company's advertisers or electronic commerce sponsors to pay amounts due to the
Company on a timely basis could have a material adverse effect on the Company's
business, results of operations and financial condition.

  Dependence on Netscape, Microsoft and Other Third Party Relationships. The
Company is dependent on a number of third party relationships, including its
relationships with Netscape and Microsoft, to create traffic on the Company's
Websites and consequently generate revenues. These relationships include
arrangements relating to the positioning of the Company's products and services
on Web browsers such as those offered by Netscape and Microsoft, and on other
sites through license agreements in which Internet sites are linked to or
otherwise utilize the Company's services. For the fiscal year ended July 31,
1998, a material portion of the traffic to the Company's Websites was derived
through the Netscape and Microsoft browsers. In May 1998, the Company renewed
its one-year "Premier Provider" Agreement with Netscape (the "Netscape
Agreement") pursuant to which the Company is designated as a "Premier Provider"
of search and navigation services accessible from the "Net Search" button on the
Netscape browser through May 31, 1999. Under the terms of the Netscape
Agreement, Netscape will commit 15% of its search exposures during the one-year
term of the Netscape Agreement to the Company's search services. In September
1998, the Company signed a one-year agreement with Microsoft (the "Microsoft
Agreement") pursuant to which the Company is designated as a premium provider of
search services on the Microsoft start page and from the search buttons imbedded
in the Internet Explorer broswer. Because Netscape and Microsoft provide only
exposures from their respective services (as compared to a number of users who
"click through" to the Company's Websites), there can be no assurance that the
Netscape Agreement and Microsoft Agreement will provide the Company's Websites
with material amounts of traffic. Netscape has recently announced a two year
agreement with Excite, Inc. in which Netscape will commit an aggregate of 50% of
its search exposures during the first year of the agreement to Excite's search
services and Netscape's own branded search service (which will be powered by
Excite) and Netscape will commit an aggregate of 75% of its search exposures
during the second year of the agreement to Netscape's branded search service and
Excite's search services. This agreement will limit the number of search
exposures which Netscape may make available to other providers of search
services, including the Company, in the future. Although each of the Netscape
Agreement and Microsoft Agreement may only be terminated under certain limited
circumstances, if the Company were unable to continue as a premier provider for
either Netscape or Microsoft, the Company's Websites could lose a material
portion of their traffic, traffic on competing services could substantially
increase, and the Company's Websites could otherwise become less attractive to
advertisers, which would have a material adverse effect on the Company's
business, results of operations and financial condition. A traffic reduction
could, in turn, result in advertisers on the Company's Websites, including
sponsors and partners, terminating their contracts with the Company, as such
contracts are typically of short duration and terminable on relatively short
notice, or reducing the number of impressions purchased. Furthermore, the
Company's contracts with advertisers and sponsors generally guarantee a minimum
number of page views, and a failure to achieve the minimum page views could
result in a reduction in payments to the Company or compel the Company to
provide "make good" impressions if such minimums are not met. If the Company is
unable to maintain its relationships with third parties to create traffic on the
Company's Websites or is otherwise unable to offset a reduction in traffic,
advertising revenues would be materially adversely affected, resulting in a
material adverse affect on the Company's business, results of operations and
financial condition. See "Business--Strategic Alliances."

  The Company is also dependent on Website operators that provide links to the
Company's Websites and, for certain elements of the Company's properties, the
Company licenses technology and related databases from third parties, including
telephone directories, e-mail, chat, street mapping and other similar services.
The Company believes that certain of its third party relationships are important
to its ability to attract traffic and advertisers.  Any 


                                      26
<PAGE>
 
errors, failures or delays experienced in connection with these third party
technologies and information services could alienate the Company's users and
adversely affect the Company's brand and its business. Although the Company
views these relationships as important direct and indirect factors in the
generation of revenues, most of the Company's arrangements do not include
minimum commitments to use the Company's services or to provide access or links
to the Company's products or services in the future, are not exclusive and
generally have a term of only one to three years. In addition, there can be no
assurance that the Company's partners regard their relationship with the Company
as important to their own respective businesses and operations, that they will
not reassess their commitment to the Company's products or services at any time
in the future, or that they will not develop their own competitive products or
services. There can be no assurance that the Company's existing relationships
will result in sustained business partnerships, successful product or service
offerings or the generation of significant revenues for the Company. Failure of
one or more of the Company's partnering relationships to achieve or maintain
market acceptance or commercial success, or the termination of one or more
successful partnering relationships, could have a material adverse effect on the
Company's business, results of operations and financial condition. In addition,
the termination of the Company's position on a Web browser, or the grant to a
competitor of an exclusive arrangement with respect to positioning on a Web
browser, would significantly reduce traffic on the Company's Websites, which
would have a material adverse effect on the Company's business, results of
operations and financial condition.

  Intense Competition. The market for Internet products and services is highly
competitive. In addition, the market for Internet advertising and electronic
commerce arrangements is intensely competitive and the Company expects that
competition will continue to intensify. Although the Company believes that the
diverse segments of the Internet market will provide opportunities for more than
one supplier of products and services similar to those of the Company, it is
possible that a single supplier may dominate one or more market segments.  The
Company believes that the principal competitive factors in this market are name
recognition, distribution arrangements, performance, ease of use, a variety of
value-added services, functionality and features, and quality of support.

  A number of companies offer competitive products addressing certain of the
Company's target markets. The primary competitors of the Company's products and
services are other companies providing online services, including America Online
(including CompuServe), Compaq's Alta Vista, Excite Inc. (including WebCrawler),
Infoseek Corporation, Microsoft's Start, Netscape's Netcenter, Prodigy Services,
Inc., Snap and Yahoo! Inc. In addition, a number of companies offering Internet
products and services, including direct competitors of the Company, recently
have begun to integrate multiple features within the products and services they
offer to consumers. Integration of Internet products and services is occurring
through development of competing products and through acquisitions of, or
entering into joint ventures and/or licensing arrangements involving,
competitors of the Company. For example, the Web browsers offered by Netscape
and Microsoft, which are the two most widely-used browsers and substantial
sources of traffic for the Company, may incorporate and promote information
search and retrieval capabilities in future releases or upgrades that could make
it more difficult for Internet viewers to find and use the Company's products
and services. Microsoft recently licensed products and services from Inktomi
Corporation ("Inktomi"), a direct competitor of the Company, and has announced
that it will feature and promote Inktomi services in the Microsoft Network and
other Microsoft online properties. The Company expects that such search services
may be tightly integrated into the Microsoft operating system, the Internet
Explorer browser, and other software applications, and that Microsoft will
promote such services within the Microsoft Network or through other Microsoft-
affiliated end-user services such as MSNBC or WebTV Networks, Inc. In addition,
many large media companies have announced that they are contemplating developing
or acquiring Internet navigation services and are attempting to become "gateway"
sites for Web users. In the event these companies develop such "portal" sites,
the Company could lose a substantial portion of its user traffic, which would
have a material adverse effect on the Company's business, results of operations
and financial condition. Further, entities that sponsor or maintain high-traffic
Websites or that provide an initial point of entry for Internet viewers, such as
the Regional Bell Operating Companies or Internet Service Providers ("ISPs")
such as America Online, Inc. and Prodigy Services, Inc., currently offer and can
be expected to consider further development, acquisition or licensing of
Internet search and navigation functions competitive with those offered by the
Company, or could take actions that make it more difficult for viewers to find
and use the Company's products and services. Consolidations, integration and
strategic relationships involving competitors of the Company could have a
material adverse effect on the Company's business, results of operations and
financial condition.

  The Company also competes with metasearch services that allow a user to search
the databases of several catalogs and directories simultaneously. The Company
also competes indirectly with database vendors that offer 


                                      27
<PAGE>
 
information search and retrieval capabilities with their core database products.
Tripod and Angelfire compete with other community-based Websites, including
GeoCities, Inc. 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. There can be no assurance that the Company's
competitors will not offer Internet products and services that are superior to
those of the Company or that achieve greater market acceptance than the
Company's offerings. Moreover, a number of the Company's current advertising
customers and partners have established relationships with certain of the
Company's competitors, and future advertising customers and partners may
establish similar relationships. The Company competes with online services and
other Website operators as well as traditional off-line media, such as print and
television, for a share of advertisers' total advertising budgets. There can be
no assurance that the Company will be able to compete successfully against its
current or future competitors or that competition will not have a material
adverse effect on the Company's business, results of operations and financial
condition. See "Business--Competition."

  Risks Associated with Brand Development.   The Company believes that
establishing and maintaining the "Lycos Network" brand is a crucial aspect of
its efforts to continue to expand and attract its Internet audience and that the
importance of brand recognition will increase in the future due to the growing
number of Internet sites and the relatively low barriers to entry. Promotion and
enhancement of the "Lycos Network" brand will depend largely on the Company's
ability to provide consistently high-quality products and services, which cannot
be assured. If consumers do not perceive the Company's existing products and
services to be of high quality, or if the Company introduces new products and
services or enters into new business ventures that are not favorably received by
consumers, the Company will be unsuccessful in promoting and maintaining its
brand, and will risk diluting its brand and decreasing the attractiveness of its
audiences to advertisers.

  Developing Market; Unproven Acceptance of the Company's Products and Services;
Uncertain Adoption of the Internet as an Advertising Medium. The market for the
Company's products and services has only recently begun to develop, is rapidly
evolving and is characterized by an increasing number of market entrants who
have introduced or developed products and services for use on the Internet. The
Company's market is highly dependent upon the increased use of the Internet for
information publication and distribution, commerce, and on the development of
the Internet as an advertising medium. The Company's future operating results
will depend upon the growth of the Internet advertising and commerce markets,
the successful implementation of the Company's advertising program and the
Company's ability to establish electronic commerce and licensing relationships
and other strategic alliances. There can be no assurance, however, that the
Internet advertising or commerce market will develop as an attractive and
sustainable medium, that the Company will achieve or sustain market acceptance
of its products and services or that the Company will be able to execute its
business plan successfully. As is typical in the case of a new and rapidly
evolving industry, demand and market acceptance for recently introduced products
and services are subject to a high level of uncertainty. The industry is young
and has few proven products. Moreover, critical issues concerning the commercial
use of the Internet (including security, reliability, cost, ease of use and
access, quality of service and acceptance of advertising and electronic
commerce) remain unresolved and may impact the growth of the Internet, or the
placement of advertisements on the Internet or the growth of the Internet as a
means of electronic commerce. If commercial use of the Internet does not grow,
if the Internet does not develop as an attractive medium for advertising or
electronic commerce, or if the Internet infrastructure does not effectively
support growth that may occur, the Company's business, results of operations and
financial condition would likely be materially adversely affected.

  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 would likely be
materially adversely affected.  See "Business--Strategy."


                                      28
<PAGE>

  Risks Associated with Potential Acquisitions and Investments. The Company has
completed, and may in the future pursue, acquisitions of companies, technologies
or assets that complement the Company's business. There can be no assurance that
the Company will be able to identify additional suitable acquisition candidates
available for sale at reasonable prices, consummate any acquisition or
successfully integrate any acquired business (including Tripod, WiseWire,
GuestWorld, WhoWhere? and Wired) into the Company's operations. Acquisitions may
result in the potentially dilutive issuance of equity securities, the incurrence
of additional debt, the write-off of in-process research and development or
software acquisition and development costs, and the amortization of expenses
related to goodwill and other intangible assets, any of which could have a
material adverse effect on the Company's business, results of operations and
financial condition. For example, for the year ended July 31, 1998, the Company
recorded an in-process research and development expense of approximately $91.2
million and goodwill and other intangible assets of approximately $11.2 million
in connection with the acquisitions of Tripod, WiseWire and GuestWorld. The
valuation of the acquired in-process research and development used by the
Company in making its determination as to the amount of in-process research and
development expense was supported by valuation studies prepared by an
independent third party appraiser. In September 1998, a representative of the
Securities and Exchange Commission (the "SEC") provided the American Institute
of Certified Public Accountants with quidance as to the factors to be considered
in the valuation of in-process research and development. Although the Company
believes that the amount of the recorded in-process research and development
expense is reasonable when applying these factors, there can be no assurance
that the SEC will not review the Company's valuations, which review could result
in the Company making adjustments to the reported amounts of in-process research
and development expense for the year ended July 31, 1998. Any such adjustment
could result in an increase in the amount of goodwill recorded with respect to
the acquisition of Tripod, WiseWire or GuestWorld, which would result in higher
amortization expenses and, therefore, adversely affect the Company's future
operating results. Acquisitions would involve numerous additional risks,
including difficulties in the assimilation of the operations, services, products
and personnel of the acquired company, the diversion of management's attention
from other business concerns along with the risks involved in entering markets
in which the Company has little or no experience. Problems with an acquired
business could have a material adverse effect on the performance of the Company.
The Company has made, and may in the future make, investments in companies
involved in the development of technologies or services that are complementary
or related to the Company's operations. The Company has recently made
investments in companies that are in an early stage of development and may be 
expected to incur substantial losses. There can be no assurance that any
investments in such companies will result in any return, nor can there be any
assurance as to the timing of any such return, or that the Company will not
suffer the loss of its entire investment. See "Business--Recent Acquisitions"
and "--Strategic Alliances."

  Management of Growth; Need to Establish Infrastructure; Additional Personnel.
The rapid execution necessary for the Company to successfully offer its products
and services and implement its business plan in a rapidly evolving market
requires an effective planning and management process. The Company's rapid
growth has placed, and is expected to continue to place, a significant strain on
the Company's managerial and operational resources. To manage its growth, the
Company must continue to implement and improve its operational and financial
systems and to expand, train and manage its employee base. Further, the Company
will be required to manage multiple relationships with various customers and
other third parties. There can be no assurance that the Company has made
adequate allowances for the costs and risks associated with this expansion and
transition, that the Company's systems, procedures or controls will be adequate
to support the Company's operations, or that the Company's management will be
able to achieve the rapid execution necessary to offer successfully the
Company's products and services and implement its business plan. The Company's
future operating results will also depend on many factors, including its ability
to expand its advertising sales and business development organizations and
expand its support organization commensurate with the growth of its business. If
the Company is unable to manage growth effectively, the Company's business,
results of operations and financial condition could be materially adversely
affected. See "Item 4A--Executive Officers of the Registrant."

  Risks Associated with International Expansion. International sales, primarily
from licensing the Company's products and services, accounted for less than 10%
of the Company's revenues for the fiscal year ended July 31, 1998. As part of
its business strategy, the Company is seeking opportunities to expand its
products and services into international markets. In this regard, in May 1997,
the Company formed Lycos Bertelsmann GmbH & Co. KG in conjunction with
Bertelsmann AG to offer Lycos search services in Europe; and in March 1998, the
Company entered into a joint venture with Sumitomo Corp. and Internet Initiative
Japan, Inc. ("IIJ") to offer search services in Japan. The Company believes that
this 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 international markets will be dependent upon
the Company's ability to create localized versions of its products and services.
There can be no assurance that the Company will be successful in creating
localized versions of its products and services, marketing or distributing its
products abroad or that, if the Company is successful, its


                                      29
<PAGE>
 
international revenues will be adequate to offset the expense of establishing
and maintaining international operations. To date, the Company has limited
experience in marketing and distributing its products internationally. In
addition to the uncertainty as to the Company's ability to establish an
international presence, there are certain difficulties and risks inherent in
doing business on an international level, such as compliance with regulatory
requirements and changes in those requirements, export restrictions, export
controls relating to technology, tariffs and other trade barriers, protection of
intellectual property rights, difficulties in staffing and managing
international operations, longer payment cycles, problems in collecting accounts
receivable, political instability, fluctuations in currency exchange rates and
potentially adverse tax consequences. There can be no assurance that one or more
of such factors will not have a material adverse effect on any international
operations established by the Company and, consequently, on the Company's
business, results of operations and financial condition. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
Consolidated Financial Statements.

  Dependence on the Internet. The use of the Company's products and services
will depend in large part upon the development by others of an infrastructure
for providing Internet access and services. Because global commerce and online
exchange of information on the Internet and other similar open wide area
networks are new and evolving, it is difficult to predict with any certainty
whether the Internet will prove to be a viable commercial marketplace. The
Internet may not prove to be a viable commercial marketplace for a number of
reasons, including lack of acceptable security technologies, potentially
inadequate development of the necessary infrastructure, such as a reliable
network backbone, or timely development and commercialization of performance
improvements, including high speed modems. In addition, to the extent that the
Internet continues to experience significant growth in the number of users and
level of use, there can be no assurance that the Internet infrastructure will
continue to be able to support the demands placed upon it by such potential
growth or that the performance or reliability of the Web will not be adversely
affected by this continued growth. In addition, the Internet could lose its
commercial viability due to delays in the development or adoption of new
standards and protocols (for example, the next generation Internet Protocol) to
handle increased levels of Internet activity. There can be no assurance that the
infrastructure or complementary services necessary to make the Internet a viable
commercial marketplace will be developed or, if developed, that the Internet
will become a viable commercial marketplace for products and services such as
those offered by the Company. In particular, the Internet has only recently
become a medium for advertising and electronic commerce. If the necessary
infrastructure or complementary services or facilities are not developed, or if
the Internet does not become a viable commercial marketplace or platform for
advertising and electronic commerce, the Company's business, results of
operations and financial condition will be materially adversely affected.

  Risk of Capacity Constraints and System Failure; Advertising Management
System. 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 Websites and the market acceptance of these
products and services. Any system failure that causes interruptions in the
availability, or increases response time, of the Company's products and services
could result in less traffic to the Company's Websites and, if sustained or
repeated, could reduce the attractiveness of the Company's products and services
to advertisers and partners. An increase in the volume of searches conducted
through the Company's products and services could strain the capacity of the
software or hardware deployed by the Company or the capacity of the Company's
network infrastructure, which could lead to slower response time or system
failures. 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 increases, there can be no assurance that the Company's products and
services will be able to scale proportionately.

  The Company is dependent upon Web browsers and Internet and online service
providers for access to its products and services, and users have experienced
difficulties due to browser and provider system failures unrelated to the
Company's systems, products and services. The Company is also dependent on
hardware suppliers for prompt delivery, installation and service of servers and
other equipment and services used to provide its products and services.
Substantially all of the Company's hardware operations are located at its
computer facility located in Pittsburgh, Pennsylvania and the Santa Clara, 
California and Waltham, Massachusetts sites of Exodus Communications, Inc.  
The Company also outsources a portion of its hardware operations to third
parties. There can be no assurance that a system failure at any of these
locations would not adversely affect the performance of the Company's products
and services. This system is vulnerable to damage from fire, floods,
earthquakes, power loss, telecommunications failures, break-ins and similar
events. The Company does not presently have a comprehensive


                                      30
<PAGE>
 
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." The
process of managing advertising within large, high traffic Websites such as the
Company's is an increasingly important and complex task. The Company licenses
from a third party an advertising management system. To the extent that the
Company encounters system failures or material difficulties in the operation of
this system, the Company could be unable to deliver banner advertisements and
sponsorships through its Websites. Any extended failure of, or material
difficulties encountered in connection with, the Company's advertising
management system may expose the Company to "make good" obligations with its
advertising customers, which, by displacing advertising inventory, among other
consequences, would reduce revenue and would have a material adverse effect on
the Company's business, results of operations and financial condition. See
"Business--Advertising."

  Technological Change and New Products. The market for Internet products and
services is characterized by rapidly changing technology, evolving industry
standards and customer demands, and frequent new product introductions and
enhancements. These market characteristics are exacerbated by the emerging
nature of this market and the fact that many companies are expected to introduce
new Internet products in the near future. The Company's future success will
depend in significant part on its ability to continually improve the
performance, features and reliability of the Lycos search and navigation
services in response to both evolving demands of the marketplace and competitive
product offerings, and there can be no assurance that the Company will be
successful. In addition, a key element of the Company's business strategy is the
development, introduction and integration of new products that capitalize on the
increasing use of the Internet. There can be no assurance that the Company will
be successful in developing or integrating such products or services or that
such products and services will meet with market acceptance. In addition, new
product releases by the Company may contain undetected errors that require
significant design modifications, resulting in a loss of customer confidence and
viewer support, which will adversely affect the use of the Company's products
and services and, consequently, the Company's business, results of operations
and financial condition. See "Business--Strategy" and "--Technology;
Intellectual Property and Property Rights."

  Intellectual Property and Proprietary Rights. The Company's success depends
significantly upon its proprietary technology.  The Company currently relies on
a combination of copyright and trademark laws, trade secrets, confidentiality
procedures and contractual provisions to protect its proprietary rights.  The
Company generally enters into confidentiality agreements with its employees and
with its consultants and partners. The Company has registered and applied for
registration of certain service marks and trademarks, and will continue to
evaluate the registration of additional service marks and trademarks, as
appropriate. In addition, Carnegie Mellon University ("CMU") has been issued a
patent in the United States relating to Lycos' search and indexing technology,
which has been licensed to the Company on a perpetual basis. There can be no
assurance that such patent will not be challenged, and if such challenges are
brought, that the patent will not be invalidated. There also can be no assurance
that the Company will develop proprietary products or technologies that are
patentable, that any issued patent will provide the Company with any competitive
advantages or will not be challenged by third parties, or that the patents of
others will not have a material adverse effect on the Company's ability to do
business. Despite the Company's efforts to protect its proprietary rights,
unauthorized parties may attempt to copy aspects of the Company's products or
services or to obtain and use information that the Company regards as
proprietary. The laws of some foreign countries do not protect proprietary
rights to as great an extent as do the laws of the United States and the Company
does not currently have any patents or patent applications pending in any
foreign country. There can be no assurance that the Company's means of
protecting its proprietary rights will be adequate or that the Company's
competitors will not independently develop similar technology or duplicate the
Company's products or design around patents issued to the Company or other
intellectual property rights of the Company.  There have been substantial
amounts of litigation in the computer industry regarding intellectual property
rights. There can be no assurance that third parties will not in the future
claim infringement by the Company with respect to current or future products,
trademarks or other proprietary rights, that the Company will counterclaim
against any such parties in such actions or that if the Company makes claims
against third parties with respect thereto, that any such party will not
counterclaim against the Company in such actions. Any such claims or
counterclaims could be time-consuming, result in costly litigation, diversion of
management's attention, cause product release delays, require the Company to
redesign its products or require the Company to enter into royalty or licensing
agreements, any of which could have a material adverse effect upon the Company's
business, results of operations and financial 


                                      31
<PAGE>
 
condition. Such royalty or licensing agreements, if required, may not be
available on terms acceptable to the Company, or at all. See "Business--
Technology; Intellectual Property and Proprietary Rights."

  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 Web.  However,
due to the increasing popularity and use of the Web, it is possible that a
number of laws and regulations may be adopted with respect to the Web, covering
issues such as user privacy, pricing, characteristics and quality of products
and services. The adoption of any additional laws or regulations may decrease
the growth of the Web, which could in turn decrease the demand for the Company's
services and products or increase the Company's cost of doing business or
otherwise have a material adverse effect on the Company's business, results of
operations or financial condition. Due to the global nature of the Web, it is
possible that, although transmission of the Company's services originate from
its operations centers in New Jersey, Pennsylvania, Massachusetts and California
the governments of other states and foreign countries might attempt to regulate
the Company's transmissions or prosecute the Company for violations of their
laws. There can be no assurance that violations of local laws will not be
alleged or charged by state or foreign governments, that the Company might not
unintentionally violate such law or that such laws will not be modified, or new
laws enacted, in the future. It is also possible that states or foreign
countries may seek to impose sales taxes on out of state companies that engage
in commerce over the Internet. In the event that states or foreign countries
succeed in imposing sales or other taxes on Internet commerce, the growth of the
use of the Internet for commerce could slow substantially. Any of the foregoing
developments could have a material adverse effect on the Company's business,
results of operations or financial condition.

  Dependence on Key Personnel. The Company's performance is substantially
dependent on the performance of its executive officers and key employees, all of
whom have worked together for only a short period of time. The Company does not
have in place key person life insurance policies on any of its employees.  The
loss of the services of any of its executive officers or other key employees
could have a material adverse effect on the business, results of operations or
financial condition of the Company. The Company is heavily dependent upon its
ability to attract, retain and motivate skilled technical and managerial
personnel. The Company's future success also depends on its continuing ability
to identify, hire, train and retain other highly qualified technical and
managerial personnel. Competition for such personnel is intense, and there can
be no assurance that the Company will be able to attract, hire, assimilate or
retain other highly qualified technical and managerial personnel in the future.
The inability to attract, hire, assimilate or retain the necessary technical and
managerial personnel could have a material adverse effect upon the Company's
business, results of operations or financial condition. See "Item 4A--"Executive
Officers of the Registrant."

  Liability for Information Retrieved from the Internet.  Because material may
be downloaded by the online or Internet services operated or facilitated by the
Company or the Internet access providers with which the Company has
relationships, and be subsequently distributed to others, it is possible that
claims will be made against the Company on the basis of defamation, negligence,
copyright or trademark infringement or other theories based on the nature and
content of such materials, including claims based on the Company providing
access to obscene, lascivious or indecent information. 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's business, results of operations or financial
condition.

  Volatility of Stock Price. The price of the Company's Common Stock has been
and may continue to be subject to wide fluctuations in response to a number of
events and factors, such as quarterly variations in results of operations,
announcements of new technological innovations or new products and media
properties by the Company or its competitors, changes in financial estimates and
recommendations by securities analysts, the operating and stock price
performance of other companies that investors may deem comparable to the
Company, and news 


                                      32
<PAGE>
 
relating to trends in the Company's markets. In addition, the stock market in
general, and the market prices for Internet-related companies in particular,
have experienced extreme volatility that often has been unrelated to the
operating performance of such companies. These broad market and industry
fluctuations may adversely affect the price of the Company's Common Stock,
regardless of the Company's operating performance. See "Item 5--Market for
Registrant's Common Equity and Related Stockholder Matters."

  Year 2000 Compliance.  Many currently installed computer systems and software
products are coded to accept only two-digit entries in the date code field and
cannot distinguish 21st century dates from 20th century dates. These date code
fields will need to distinguish 21st century dates from 20th century dates and,
as a result, many companies' software and computer systems may need to be
upgraded or replaced in order to comply with such "Year 2000" requirements.
 
  State of Readiness.  The Company is in the process of evaluating the year 2000
readiness of the hardware and software products sold by the Company
("Products"), the information technology systems used in its operations ("IT
Systems"),  and its non-IT Systems, such as building security, voice mail and
other systems.  The Company currently anticipates that the Project  will cover
the following phases: (i) identification of all Products, IT Systems, and non-IT
Systems; (ii) assessment of repair or replacement requirements; (iii) repair or
replacement; (iv) testing; (v) implementation; and (vi) creation of contingency
plans in the event of year 2000 failures.

  The Company has completed its assessment of all current versions of its
Products and believes they are year 2000 compliant.   Even so, the assessment of
whether a complete system or device in which a Product is embedded will operate
correctly for an end-user depends in large part on the year 2000 compliance of
the system's other components, most of which are supplied by parties other than
the Company.  The supplier of the Company's current financial and accounting
software has informed the Company that such software is year 2000 compliant.
Further, the Company relies, both domestically and internationally, upon various
vendors, governmental agencies, utility companies, telecommunications service
companies, delivery service companies and other service providers who are
outside of the Company's control.  There is no assurance that such parties will
not suffer a year 2000 business disruption, which could have a material adverse
effect on the Company's financial condition and results of operations.

  During the first half of fiscal 1999, the Company intends to (i) conduct an
internal review of the year 2000 compliance of all prior versions of its
Products and (ii) circulate a questionnaire to vendors and customers with whom
the Company has material relationships to obtain information about their year
2000 compliance.  Until such information is obtained, the Company will not be
able to effectively evaluate whether any remediation efforts will be required
with respect to its IT Systems (except as described above), non-IT Systems or
prior versions of its Products.

  Costs.  To date, the Company has not incurred any material expenditures in
connection with identifying or evaluating year 2000 compliance issues.  Most of
its expenses have related to the opportunity cost of time spent by employees of
the Company evaluating this software, the current versions of the Products, and
year 2000 compliance matters generally. At this time, the Company does not
possess the information necessary to estimate the potential impact of year 2000
compliance  issues relating to its other IT-Systems, non-IT Systems, prior
versions of its Products, its vendors, its customers, and other parties.  Such
impact, including the effect of a year 2000 business disruption, could have a
material adverse effect on the Company's financial condition and results of
operations.

  Contingency Plan.  The Company has not yet developed a year 2000-specific
contingency plan.  If year 2000 compliance issues are discovered, the Company
then will evaluate the need for contingency plans relating to such issues.
 

                                      33
<PAGE>
 
ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

<TABLE> 
<CAPTION> 
PART I.   FINANCIAL INFORMATION                                                                          PAGE
                                                                                                         ----   
<S>       <C>                                                                                           <C>
Item 1    Consolidated Financial Statements:
          
          Independent Auditors' Report ...............................................................     35
          
          Consolidated Balance Sheets at July 31, 1998 and 1997.......................................     36
          Consolidated Statements of Operations for the years ended July 31, 1998, 1997, and 1996.....     37
          Consolidated Statements of Stockholders' Equity for the years ended July 31, 1998, 1997, and 
          1996........................................................................................     38
          Consolidated Statements of Cash Flows for the years ended July 31, 1998, 1997 and 1996......     39
          Notes to Consolidated Financial Statements..................................................     41
</TABLE>

PART II.  FINANCIAL STATEMENT SCHEDULES

     All schedules have been omitted since they are either not applicable, not
required, or the information is included elsewhere herein.


                                      34
<PAGE>
 
                          INDEPENDENT AUDITORS' REPORT


The Board of Directors
Lycos, Inc.:

     We have audited the accompanying consolidated balance sheets of Lycos, Inc.
as of July 31, 1998 and 1997 and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the years in the
three year period ended July 31, 1998. These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.

     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

     In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Lycos, Inc. at July 31, 1998 and 1997, and the results of its operations and
cash flows for each of the years in the three year period ended July 31, 1998,
in conformity with generally accepted accounting principles.



/s/ KPMG Peat Marwick LLP



Boston, Massachusetts
August 18, 1998


                                      35
<PAGE>
 
                                  LYCOS, INC.

                          CONSOLIDATED BALANCE SHEETS


<TABLE>
<CAPTION>
                                                                           JULY 31, 1998       JULY 31, 1997
                                                                           -------------       -------------
<S>                                                                        <C>                 <C>          
                                 ASSETS                                                                     
Current assets:                                                                                             
    Cash and cash equivalents ...........................................  $ 153,728,200       $  40,766,258
    Accounts receivable, less allowance for doubtful accounts of                                            
      $1,208,000 and $554,000 at July 31, 1998 and 1997, respectively....     10,958,470           6,634,262
    Electronic commerce and license fees receivable......................     30,223,986           9,065,806
    Prepaid expenses.....................................................      5,559,842           4,278,418
    Other current assets.................................................        326,292                  -- 
                                                                           -------------       -------------
        Total current assets.............................................    200,796,790          60,744,744
                                                                           -------------       -------------
Property and equipment, less accumulated depreciation and amortization...      3,960,059           2,397,600
Electronic commerce and license fees receivable..........................     21,537,371             650,000
Investments..............................................................      8,874,568                  --
Intangible assets, less accumulated amortization.........................     10,310,475           1,243,050
Other assets.............................................................      3,278,994             383,615 
                                                                           -------------       -------------
        Total assets.....................................................  $ 248,758,257       $  65,419,009
                                                                           =============       =============
                                                                                                            
                            LIABILITIES AND STOCKHOLDERS' EQUITY                                            
Current liabilities:                                                                                        
    Accounts payable.....................................................  $   4,873,302       $   3,289,513
    Accrued expenses.....................................................     17,589,700           7,387,707
    Deferred revenues....................................................     30,730,390           9,541,566
    Billings in excess of revenues.......................................        681,849           2,387,424
    Due to related parties...............................................             --               9,105 
                                                                           -------------       -------------
        Total current liabilities........................................     53,875,241          22,615,315

Deferred revenues........................................................     26,159,754           5,100,000
Deferred income taxes....................................................         36,667              56,667 
                                                                           -------------       -------------
                                                                              26,196,421           5,156,667
                                                                                                            
Commitments and contingencies                                                                               
                                                                                                            
Stockholders' equity:                                                                                       
    Preferred stock, $.01 par value; 5,000,000 shares authorized, none                                      
      issued or outstanding..............................................             --                  --
    Common stock, $.01 par value; 80,000,000 shares authorized,                                             
      38,991,436 shares at July 31, 1998 and 27,593,240 at July 31, 1997                                    
      issued and outstanding.............................................        389,916             275,932
      Additional paid-in capital.........................................    278,126,582          49,368,940
      Deferred compensation..............................................       (116,338)           (185,436)
      Accumulated deficit................................................   (108,728,972)        (11,812,409)
      Treasury stock, at cost, 708,674 shares at July 31, 1998...........       (984,593)                 -- 
                                                                           -------------       -------------
        Total stockholders' equity.......................................    168,686,595          37,647,027
                                                                           -------------       -------------
        Total liabilities and stockholders' equity.......................  $ 248,758,257       $  65,419,009
                                                                           =============       ============= 
</TABLE>

         See accompanying notes to consolidated financial statements.


                                      36
<PAGE>
 
                                  LYCOS, INC.

                     CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                                             YEAR ENDED
                                                       -----------------------------------------------------

                                                       JULY 31, 1998       JULY 31, 1997       JULY 31, 1996
                                                       -------------       -------------       -------------
<S>                                                    <C>                 <C>                 <C>
Revenues:
 Advertising.......................................    $  41,768,607       $  17,417,388       $   4,478,474
 Electronic commerce, license and other............       14,291,698           4,855,654             778,753
                                                       -------------       -------------       -------------
     Total revenues................................       56,060,305          22,273,042           5,257,227
Cost of revenues...................................       12,513,259           4,335,941           2,900,808
                                                       -------------       -------------       -------------
     Gross profit..................................       43,547,046          17,937,101           2,356,419

Operating expenses:
 Research and development..........................        9,477,708           4,301,267             906,591
 In process research and development...............       91,239,055                  --             452,000
 Sales and marketing...............................       35,035,754          19,126,317           4,747,805
 General and administrative........................        5,631,104           2,718,763           1,692,362
 Amortization of intangible assets.................        2,131,735             540,416             359,868
                                                       -------------       -------------       -------------
     Total operating expenses......................      143,515,356          26,686,763           8,158,626
                                                       -------------       -------------       -------------
Operating loss.....................................      (99,968,310)         (8,749,662)         (5,802,207)
Interest income....................................        3,051,747           2,130,472             714,369
                                                       -------------       -------------       -------------
Net loss...........................................    $ (96,916,563)      $  (6,619,190)      $  (5,087,838)
                                                       =============       =============       =============
Basic net loss per share...........................    $       (3.13)      $       (0.24)      $       (0.21)
                                                       =============       =============       =============
Shares used in computing basic net loss per share..       30,932,982          27,589,486          23,984,830
                                                       =============       =============       =============
</TABLE>

         See accompanying notes to consolidated financial statements.


                                      37
<PAGE>
 
                                  LYCOS, INC.

                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                          ADDITIONAL    
                                    COMMON STOCK           PAID-IN        DEFERRED       ACCUMULATED      TREASURY STOCK   
                                SHARES       AMOUNT        CAPITAL      COMPENSATION       DEFICIT       SHARES     AMOUNT    
                            ------------------------------------------------------------------------------------------------
<S>                         <C>            <C>          <C>           <C>              <C>             <C>        <C>         
Balances at July 31, 1995...  20,000,000    $ 200,000   $  1,137,000      $ (87,000)    $    (105,381)       --           -- 
Capital contribution........          --           --      1,000,000             --                --        --           -- 
Capital contribution                                                                                                        
 related to License                                   
     Agreement..............          --           --        250,000             --                --        --           --   
Issuance of common stock                                                                                                    
 in connection with                                   
     acquisitions...........   1,052,632       10,526        531,474             --                --        --           --
Issuance of common stock                                                                                                    
 pursuant to certain                                  
     preemptive rights......     263,160        2,632        326,318             --                --        --           --   
Issuance of common stock                                                                                                    
 in connection with Initial                           
     Public Offering, net of                                                                                                      
      offering costs........   6,270,000       62,700     45,631,382             --                --        --           --   
Deferred compensation                                                                                                       
 related to grant of stock                            
     options................          --           --        523,505       (523,505)               --        --           -- 
Amortization of deferred                              
 compensation...............          --           --             --        234,344                --        --           --  
Net loss....................          --           --             --             --        (5,087,838)       --           -- 
                            ------------------------------------------------------------------------------------------------
Balances at July 31, 1996...  27,585,792    $ 275,858   $ 49,399,679      $(376,161)    $  (5,193,219)       --           -- 
Issuance of common stock                                                                                                    
 in connection with                                   
 Employee Stock Purchase                                                                                                    
 Plan.......................       7,448           74         18,328            --                --        --           --      
Cancellation of options.....          --           --        (49,067)       49,067                --        --           -- 
Amortization of deferred                              
 compensation...............          --           --             --       141,658                --        --           --    
Net loss....................          --           --             --            --        (6,619,190)       --           -- 
                            ------------------------------------------------------------------------------------------------
Balances at July 31, 1997...  27,593,240    $ 275,932  $  49,368,940     $(185,436)    $ (11,812,409)       --           -- 
Issuance of common stock                                                                                                    
 in connection with                                   
     Employee Stock                                                                                                         
      Purchase Plan.........       8,588           86         65,956            --                --        --           --     
Cancellation of options.....          --           --        (22,562)       22,562                --        --           -- 
Issuance of common stock                                                                                                    
 in connection with                                   
 exercise of stock options..   2,047,020       20,470      3,221,724            --                --    61,556         (307)   
Treasury stock in                                     
 connection with exercise                             
     of stock options.......          --           --             --            --                --   608,184     (467,589) 
Issuance of common stock                                                                                                    
 in connection with                                   
 exercise of warrants.......     207,228        2,072      1,361,516            --                --    18,836     (113,581)      
Issuance of common stock                                                                                                    
 in connection with                                   
 strategic investments,                                                                                                     
 net of offering costs......     301,028        3,012      7,879,431            --                --        --           -- 
Issuance of common stock                                                                                                    
 and warrants                                         
     in connection with                                                                                                     
      acquisitions..........   4,149,142       41,492    104,807,563            --                --    20,098     (403,116)
Issuance of common stock                              
 in connection with                                   
Secondary Public Offering,                            
 net of offering                                                                                                            
     costs..................   4,675,000       46,750    111,144,116            --                --        --           -- 
Issuance of common stock                                                                                                    
 in connection with                                                
     services rendered......      10,190          102        299,898            --                --        --           -- 
Amortization of deferred                                           
 compensation...............          --           --             --        46,536                --        --           -- 
Net loss....................          --           --             --            --       (96,916,563)       --           -- 
                            ------------------------------------------------------------------------------------------------
Balances at July 31, 1998...  38,991,436   $  389,916  $ 278,126,582     $(116,338)    $(108,728,972)  708,674    $(984,593)
                            ------------------------------------------------------------------------------------------------

<CAPTION> 
                                      TOTAL
                                 --------------
<S>                              <C>
Balances at July 31, 1995..        $  1,144,619
Capital contribution.......           1,000,000
Capital contribution             
 related to License                             
     Agreement.............             250,000 
Issuance of common stock         
 in connection with                             
     acquisitions..........             542,000 
Issuance of common stock         
 pursuant to certain                            
     preemptive rights.....             328,950 
Issuance of common stock         
 in connection with                             
     Initial Public              
      Offering, net of           
      offering costs.......          45,694,082 
Deferred compensation            
 related to grant of stock                      
     options...............                  -- 
Amortization of deferred                
 compensation..............             234,344 
Net loss...................          (5,087,838)
                                 --------------
Balances at July 31, 1996..        $ 44,106,157
Issuance of common stock         
 in connection with                      
 Employee Stock Purchase         
 Plan.......................             18,402 
Cancellation of options.....                 --
Amortization of deferred                
 compensation...............            141,658  
Net loss....................         (6,619,190)
                                 --------------
Balances at July 31, 1997...       $ 37,647,027
Issuance of common stock         
 in connection with                     
     Employee Stock              
      Purchase Plan.........             66,042  
Cancellation of options.....                 --
Issuance of common stock         
 in connection with                   
 exercise of stock options..          3,241,887 
Treasury stock in                
 connection with exercise              
     of stock options.......           (467,589) 
Issuance of common stock         
 in connection with                   
 exercise of warrants.......          1,250,007 
Issuance of common stock         
 in connection with                   
 strategic investments,          
 net of offering costs......          7,882,443 
Issuance of common stock         
 and warrants                       
     in connection with          
      acquisitions..........        104,445,939 
Issuance of common stock         
 in connection with               
Secondary Public Offering, 
 net of offering                 
     costs..................        111,190,866       
Issuance of common stock         
 in connection with                     
     services rendered......            300,000 
Amortization of deferred                
 compensation...............             46,536 
Net loss....................        (96,916,563)
                                 --------------
Balances at July 31, 1998...       $168,686,595
                                 -------------- 
</TABLE> 

          See accompanying notes to consolidated financial statements.

                                      38
<PAGE>
 
                                  LYCOS, INC.

                     CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE> 
<CAPTION> 
                                                                                     YEAR ENDED
                                                                 -----------------------------------------------
                                                                  July 31, 1998    July 31, 1997   July 31, 1996
                                                                 --------------   --------------  --------------
<S>                                                              <C>              <C>             <C> 
OPERATING ACTIVITIES
Net loss.......................................................   $(96,916,563)    $(6,619,190)    $(5,087,838)
Adjustments to reconcile net loss to net cash  used in
operating activities:
   Amortization of deferred compensation.......................         46,536         141,658         234,344
   Depreciation and amortization...............................      3,656,867       1,269,064         642,218
   Allowance for doubtful accounts.............................        654,000         405,000         200,000
   In process research and development expense.................     91,239,055              --         452,000
   Issuance of common stock for services rendered..............        300,000              --              --
Changes in operating assets and liabilities:
   Accounts receivable.........................................     (4,768,973)     (3,745,337)     (3,454,950)
   Electronic commerce and license fees receivable.............    (42,045,551)     (7,731,585)     (1,984,221)
   Prepaid expenses............................................     (1,258,140)     (3,296,707)       (981,711)
   Other current assets........................................       (326,292)             --              --
   Other assets................................................     (2,895,379)       (216,000)       (167,615)
   Accounts payable............................................        774,033         547,634       2,600,071
   Accrued expenses............................................      8,343,512       5,641,289       1,735,693
   Deferred revenues...........................................     42,155,798      11,493,144       3,125,285
   Billings in excess of revenues..............................     (1,705,575)        984,992       1,402,432
   Due to related parties......................................         (9,105)       (428,162)        295,660
   Deferred income taxes.......................................        (20,000)        (21,333)         28,000
                                                                 --------------   --------------  -------------      
Net cash used in operating activities..........................     (2,775,777)     (1,575,533)       (960,632)
                                                                 --------------   --------------  -------------      
INVESTING ACTIVITIES
Purchase of property and equipment.............................     (1,091,988)     (1,818,798)     (1,632,079)
Payments under License Agreement...............................             --              --        (750,000)
Cash acquired through acquisitions, net........................      2,540,619              --          17,137
Investment in Joint Venture....................................       (992,125)             --              --
                                                                 --------------   --------------  -------------      
Net cash provided by (used in) investing activities............        456,506      (1,818,798)     (2,364,942)
                                                                 --------------   --------------  -------------      
FINANCING ACTIVITIES
Proceeds from issuance of common stock, net of offering costs..    111,190,866          18,402      46,021,314
Proceeds from exercise of stock options........................      3,241,887              --              --
Proceeds from issuance of common stock under Employee                    
Stock Purchase Plan............................................         66,042              --              --
Proceeds from exercise of warrants.............................      1,250,007              --              --
Proceeds from capital contribution.............................             --              --       1,000,000
Cash used to repurchase treasury stock.........................       (467,589)             --              --
                                                                 --------------   --------------  -------------      
Net cash provided by financing activities......................    115,281,213          18,402      47,021,314
                                                                 --------------   --------------  -------------      
Net increase (decrease) in cash and cash equivalents...........    112,961,942      (3,375,929)     43,695,740
Cash and cash equivalents at beginning of year.................     40,766,258      44,142,187         446,447
                                                                 --------------   --------------  -------------      
Cash and cash equivalents at end of year.......................   $153,728,200     $40,766,258     $44,142,187
                                                                 ==============   ==============  =============      
</TABLE>
  
                                      39
<PAGE>
 
                                  LYCOS, INC.

              CONSOLIDATED STATEMENTS OF CASH FLOWS--(CONTINUED)

<TABLE>
<CAPTION>
                                                                                        YEAR ENDED
                                                                      ---------------------------------------------
 
                                                                        JULY 31, 1998  JULY 31, 1997  JULY 31, 1996
                                                                      ---------------  -------------  -------------
<S>                                                                     <C>            <C>            <C>
Schedule of non-cash financing and investing activities:
    Issuance of common stock for License Agreement....................  $          --  $          --       $300,000
    Recognition of deferred tax liability related to License
  Agreement...........................................................             --             --         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
 Issuance of common stock upon acquisition of Tripod, Inc.,                                       --             --
  WiseWire, Corp., and GuestWorld, Inc................................   $104,445,939
 Assets and liabilities recognized upon acquisition of Tripod, Inc.,                              --             --
  WiseWire Corp., and GuestWorld, Inc.
     Accounts receivable..............................................        209,235             --             --
     Prepaid expenses.................................................         23,284             --             --
     Property and equipment...........................................      1,995,601             --             --
     Developed technology.............................................      8,651,195             --             --
     Goodwill and other intangible assets.............................      2,547,965             --             --
     Accounts payable.................................................        809,756             --             --
     Accrued expenses.................................................      1,858,481             --             --
     Deferred revenues................................................         92,780             --             --
 Issuance of common stock in connection with strategic                                                              
   investments........................................................      7,882,443             --             --
</TABLE>

         See accompanying notes to consolidated financial statements.

                                      40
<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.

     The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries, from their respective dates of acquisition.
All significant intercompany balances and transactions have been eliminated.

Joint Ventures

     On May 1, 1997, the Company entered into a joint venture agreement with
Bertelsmann Internet Services to create localized versions of the Lycos search
and navigation service throughout Europe. The new company, named Lycos
Bertelsmann GmbH & Co. KG ("Lycos Bertelsmann"), is owned 50% by Lycos and 50%
by Bertelsmann. Bertelsmann Internet Services, a subsidiary of Bertelsmann AG,
has committed to provide capital, infrastructure and employees for the venture
while Lycos will provide the core technology and brand name. The carrying value
of the Company's investment in Lycos Bertelsmann was not material at July 31,
1998 or 1997. The investment is accounted for under the equity method and
accordingly, the Company will recognize 50% of the net profits of Lycos
Bertelsmann when realized.

     On April 13, 1998, the Company entered into a joint venture with Sumitomo
Corporation, a $100 billion dollar company and one of Japan's largest trading
companies, and Internet Initiative Japan (IIJ), the country's largest Internet
Service Provider to create a localized version of the lycos.com Web Site to be
called Lycos Japan which will feature navigation and search capability, and will
soon include news, sports, stocks and other services.  Terms of the deal include
a 40% ownership stake by Lycos in exchange for approximately $992,000, with
Sumitomo Corporation owning 50% of the venture and IIJ maintaining a 10% stake
in the entity. Sumitomo Corporation and Lycos will manage the daily operations
of the site, including aggregation of local content, sales, marketing and
administration from the operations' headquarters in Tokyo, Japan.  For the year
ending July 31, 1998, Lycos' share of operating costs was not material.

Investments

     During 1998 the Company obtained equity interests in two privately held,
internet related companies through the issuance of the Company's common stock
(see Note 2).  Both investments resulted in the Company owning less than 20% of
the respective investees. Accordingly, these investments are accounted for under
the cost method. The Company purchased these investments in March and April,
1998, and their carrying values approximate fair values.  For these non-quoted
investments, the Company regularly reviews the assumptions underlying the
operating performance and cash flow forecasts in assessing the carrying values.

Public Offerings

     On April 2, 1996, the Company completed an initial public offering of its
common stock in which 6,000,000 shares of common stock were issued at a price of
$8.00 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 270,000 shares of its common stock at
a price of $8.00 per share.

                                      41
<PAGE>
 
                                  LYCOS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

     On June 4, 1998, the Company completed a secondary offering of its common
stock in which 4,000,000 shares of common stock were issued at a price of $23.82
per share net of underwriting discounts and commissions. On June 10, 1998,
pursuant to the exercise of an over-allotment option granted to the the
underwriters of the Company's secondary offering, the Company issued an
additional 675,000 shares of its common stock at a price of $25.00 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, 1998 and 1997, the Company had no investments with maturities greater than
three months.

Electronic Commerce and License Fees Receivable

     Electronic commerce and license fees receivable are comprised of fees to be
received in the future on electronic commerce and licensing agreements existing
at the balance sheet date.

Other assets

     Other assets comprise primarily purchased hardware to be sold to joint
venture partners. Purchased hardware will be sold at cost upon completion.

Property and Equipment

     Property and equipment are stated at cost, net of accumulated amortization
and depreciation. Property and equipment are depreciated on a straight-line
basis over the estimated useful lives of the assets (three to five years).
Leasehold improvements are amortized on a straight-line basis over the lesser of
the estimated useful life of the asset or the lease term.

Intangible Assets

     Intangible assets primarily relate to the Company's acquisitions and
include developed technology, licensed technology, trademarks, trade names,
content copyrights, customer base and goodwill. In connection with acquisitions
accounted for under the purchase method of accounting (see Note 4), the Company
recorded these intangible assets based on the excess of the purchase price over
the identifiable tangible net assets of the acquiree on the date of purchase.
Intangible assets are reported at cost, net of accumulated amortization, and are
being amortized over their estimated useful life of five years.

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 to be held and used
or to be disposed of when indicators of impairment are present and the
undiscounted cash flows estimated to be generated by those assets are less than
the asset carrying amount.

Deferred Revenues

     Deferred revenues are comprised of license and electronic commerce fees to
be earned in the future on noncancelable agreements existing at the balance
sheet date.

                                      42
<PAGE>
 
                                  LYCOS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

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.

Revenue Recognition

     The Company's advertising revenues are derived principally from short-term
advertising contracts in which the Company guarantees a number of impressions
for a fixed fee or on a per impression basis with an established minimum fee.
Revenues from advertising are recognized as the services are performed.

     Electronic commerce revenues are derived principally from "slotting fees"
paid for selective positioning and promotion within the Company's suite of
products as well as from royalties from the sale of goods and services from the
Company's websites. The Company's license and product revenues are derived
principally from product licensing fees and fees from maintenance and support of
its products. Eletronic commerce, license and product revenues are generally
recognized upon delivery provided that no significant Company obligations remain
and collection of the receivable is probable. In cases where there are
significant remaining obligations, the Company defers such revenue until those
obligations are satisfied. Fees from maintenance and support of the Company's
products including revenues bundled with the initial licensing fees are deferred
and recognized ratably over the service period.

Cost of Revenues

     Cost of revenues specifically attributable to advertising and electronic
commerce, license and product revenues are not separately identifiable and
therefore are not separately disclosed in the consolidated statements of
operations.

Research and Development Costs

     Research and development expenditures are expensed as incurred. Software
development costs are required to be capitalized when a product's technological
feasibility has been established either by completion of a detail program design
or a working model of the product and ending when a product is available for
general release to consumers. To date, attainment of technological feasibility
of the Company's products and general release to customers have substantially
coincided. As a result, the Company has not capitalized any software development
costs since such costs have not been significant.

Advertising Costs

     The Company expenses advertising production costs as incurred. Advertising
expense was approximately $5,675,000, $4,427,000 and $567,000 for the years
ended July 31, 1998, 1997 and 1996, respectively.

                                      43
<PAGE>
 
                                  LYCOS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

Stock-Based Compensation

     Statement of Financial Accounting Standards No. 123 ("SFAS 123") requires
that companies either recognize compensation expense for grants of stock, stock
options, and other equity instruments based on fair value, or provide pro forma
disclosure of net income (loss) and earnings (loss) per share in the notes to
the financial statements. The Company applies APB Opinion 25 and related
interpretations in accounting for its plans. Accordingly, no compensation cost
has been recognized under SFAS 123 for the Company's stock option plans, and
footnote disclosure is provided in Note 8.

Concentration of Credit Risk

     The Company performs ongoing credit evaluations of its customers' financial
conditions and generally does not require collateral on accounts receivable. The
Company maintains allowances for credit losses and such losses have been within
management's expectations. Direct write-offs of accounts receivable were
$333,000 for the year ended July 31, 1998 and $51,000 for the year ended July
31, 1997. There were no direct write-offs of accounts receivable for the year
ended July 31, 1996. No single customer accounted for greater than 10% of total
revenues during the years ended July 31, 1998, 1997 and 1996.

     The Company's services are provided to customers in several industries
primarily in North America. Sales to foreign customers for the years ended July
31, 1998, 1997 and 1996 were approximately $2,640,000, $1,700,000 and $385,000,
respectively.

Financial Instruments

     The recorded amounts of financial instruments, including cash equivalents,
receivables, accounts payable, accrued expenses and deferred revenues,
approximate their fair market values as of July 31, 1998. The Company has no
investments in derivative financial instruments.

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.

Per Share Amounts

     For the year ended July 31, 1998, the Company adopted the provisions of
Statement of Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings per
Share." SFAS 128 requires the presentation of basic loss per share and diluted
loss per share for all periods presented.  As the Company has been in a net loss
position for the years ended July 31, 1998, 1997 and 1996, common stock
equivalents were excluded from the diluted loss per share calculation as they
would be antidilutive. As a result, diluted loss per share is the same as basic
loss per share, and has not been presented separately.

Stock Split

     In July 1998, the Company's Board of Directors approved a two-for-one
common stock split. Shareholders of record on August 14, 1998 (the record date)
were entitled to one additional share for every share held on August 25, 1998.
The Company has presented loss per share and weighted average shares in the
consolidated statement of operations for all periods presented and all footnote
disclosures reflecting the effect of the stock split.

                                      44
<PAGE>
 
                                  LYCOS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

Treasury Stock

     In connection with a license agreement with Carnegie Mellon University,
CMG@Ventures, Inc. has agreed to sell to the Company the number of shares of
common stock equal to the shares issuable upon exercise of certain options
granted, as defined, at a price equal to the exercise price of the underlying
options exercised (see Note 8).  Under this agreement, the Company issues shares
of Company stock to employees upon exercise of options and subsequently buys an
equivalent number of Company shares at the respective exercise price from
CMG@Ventures, resulting in treasury stock.

Reclassifications

     Certain prior years' balances have been reclassified to conform with the
current year's presentation.

New Accounting Pronouncements

     In June 1997, the Financial Accounting Standards Board issued Statement No.
130 ("SFAS 130") "Reporting Comprehensive Income". This statement
establishes standards for reporting and display of comprehensive income and its
components (revenues, expenses, gains and losses) in a full set of general-
purpose financial statements. This statement is effective for fiscal years
beginning after December 15, 1997. Reclassification of financial statements for
earlier periods provided for comparative purposes is required. The Company
expects to adopt SFAS 130 for the year ending July 31, 1999.  The Company
believes that this pronouncement will not have a material adverse affect on its
results of operations.

     In June 1997, the Financial Accounting Standards Board issued Statement No.
131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and Related
Information". This statement establishes standards for the way that public
business enterprises report information about operating segments in annual
financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
shareholders. This statement is effective for financial statements for periods
beginning after December 15, 1997. The Company expects to adopt SFAS 131 for the
year ending July 31, 1999.  Because the Company operates within a single
operating segment, adoption of this statement is currently not expected to have
a material impact on the Company's consolidated financial statements and
footnote disclosures.

     In October 1997, the American Institute of Certified Public Accountants
issued Statement of Position 97-2 ("SOP 97-2"), "Software Revenue Recognition",
which provides guidance on applying generally accepted accounting principles in
recognizing revenue on software transactions and supersedes SOP 91-1, "Software
Revenue Recognition". The Company expects to adopt SOP 97-2 for its fiscal year
ending July 31, 1999 and does not anticipate any material impact on its revenue
recognition policies.

     In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-1("SOP 98-1"), "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use", which establishes
guidelines for the accounting for the costs of all computer software developed
or obtained for internal use. The Company is required to adopt SOP 98-1
effective August 1, 1999. The adoption of SOP 98-1 is not expected to have a
material impact on the Company's consolidated financial statements.

     In April, 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-5 ("SOP 98-5"), "Reporting on the Costs of
Start-Up Activities." The statement is effective for fiscal years beginning
after December 15, 1998. The statement requires costs of start-up activities and
organization costs to be expensed as incurred. The Company is required to adopt
SOP 98-5 effective August 1, 1999. The adoption of SOP 98-5 is not expected to
have a material impact on the Company's consolidated financial statements.

                                      45
<PAGE>
 
                                  LYCOS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


     In June 1998, the Financial Accounting Standards Board issued Statement No.
133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging
Activities", which requires that all derivative instruments be recorded on the
balance sheet at their fair value. Changes in the fair value of derivatives are
recorded each period in current earnings or other comprehensive income,
depending on whether a derivative is designated as part of a hedge transaction
and, if it is, the type of hedge transaction. For fair-value hedge transactions
in which the Company is hedging changes in an asset's, liability's or firm
commitment's fair value, changes in the fair value of the derivative instrument
will generally be offset in the income statement by changes in the hedged item's
fair value. For cash flow hedge transactions, changes in the fair value of the
derivative instrument will be reported in comprehensive income. The gains and
losses on the derivative instrument that are reported in other comprehensive
income will be reclassified as earnings in the periods in which earnings are
impacted by the variability of the cash flows of the hedged item. The
ineffective portion of all hedges will be recognized in current period earnings.
The Company currently expects to adopt SFAS 133 for the year ending July 31,
1999. Management has determined there will be no impact on its results of
operations or financial position resulting from the adoption of SFAS 133 because
the Company currently does not hold derivative instruments.

2.  INVESTMENTS

     On March 9, 1998, the Company purchased 1,000,000 shares of Class A
Preferred Stock of GlobeComm, Inc. ("GlobeComm") through the issuance of 200,124
shares of Lycos common stock, valued at $4,577,837. The investment, carried at
cost, represents an approximate 9.85% stake in GlobeComm on a fully diluted
basis. GlobeComm is the owner of iName, a leading provider of lifetime
personalized e-mail addresses and advanced e-mail services. Lycos provides free
e-mail services to users based on iName's advanced products.

     On April 13, 1998, the Company purchased 1,915,709 shares of Series B
Convertible Participating Preferred Stock of Sage Enterprises, Inc.
("PlanetAll") through the issuance of 100,904 shares of Lycos common stock,
valued at $3,304,606.  The investment, carried at cost, represents an
approximate 14.1% stake in PlanetAll, on a fully diluted basis.

     Subsequent to July 31, 1998, all of the outstanding common stock of
PlanetAll was acquired by Amazon.com. See Note 7 "Subsequent Events".

3.  PROPERTY AND EQUIPMENT

    Property and equipment, at cost, consisted of the following:

<TABLE>
<CAPTION>
                                                            JULY 31,
                                                 ---------------------------
                                                       1998          1997
                                                 -------------   -----------
     <S>                                           <C>           <C>
     Computers and equipment................       $ 3,623,686   $ 2,234,012
     Furniture and fixtures.................         1,091,726       563,756
     Leasehold improvements.................         1,356,222       585,912
     Purchased software.....................           525,197       141,096
                                                 -------------   -----------
                                                     6,596,831     3,524,776
     Less accumulated depreciation and......        (2,636,772)   (1,127,176)
      amortization..........................     -------------   -----------
                                                   $ 3,960,059   $ 2,397,600
                                                 =============   ===========
</TABLE>

                                      46
<PAGE>
 
                                  LYCOS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


4.  ACQUISITIONS

Tripod, Inc.

     On February 11, 1998, the Company entered into an Agreement and Plan of
Merger (the "Agreement") by and among the Company, Pod Acquisition Corp., a
Delaware corporation and a wholly-owned subsidiary of the Company ("PAC"),
Tripod, Inc., a Delaware corporation ("Tripod"), William Peabody and Richard
Sabot, providing for the merger of PAC with and into Tripod (the "Merger"). On
February 12, 1998,the Company completed the closing of the Merger and Tripod
became a wholly-owned subsidiary of the Company. In accordance with the terms of
the Agreement, Richard Sabot was elected, effective May 1, 1998, to the
Company's Board of Directors for a term expiring at the first Annual Meeting of
the Company's stockholders held after the Company's fiscal year ending July 31,
2000.

     The acquisition was accounted for as a purchase. The purchase price was
allocated to the assets acquired and liabilities assumed based on their
estimated fair values. Results of operations for Tripod have been included with
those of the Company for periods subsequent to the date of acquisition.

     In the Merger, all outstanding shares of Common Stock and Preferred Stock
of Tripod and options and warrants to purchase Common Stock and Preferred Stock
of Tripod were converted into 3,120,826 shares and options and warrants to
purchase Common Stock of the Company. All outstanding options to purchase Common
Stock of Tripod have been assumed by the Company and converted into options to
purchase Common Stock of the Company, and all outstanding warrants to purchase
Preferred Stock of Tripod have been assumed by the Company and converted into
warrants to purchase Common Stock of the Company.

     Under the terms of the Agreement and related Escrow Agreement dated
February 11, 1998, an aggregate of 255,682 shares of Common Stock of the Company
and options and warrants to purchase an additional 56,418 shares of Common Stock
of the Company will be held in escrow for the purpose of indemnifying the
Company against certain liabilities of Tripod and its stockholders. The escrow
will expire on February 11, 1999.

The purchase price was allocated as follows:

<TABLE>
       <S>                                            <C>
       In process research and development...........   $51,600,000
       Developed technology..........................     5,407,138
       Goodwill and other intangible assets..........     2,412,797
       Other assets, principally cash and equipment..     3,633,449
       Liabilities assumed ..........................    (1,603,731)
                                                      -------------
 
                                                        $61,449,653
                                                      =============
</TABLE>

  Accumulated amortization on intangible assets was $627,569 at July 31, 1998.

WiseWire Corporation

     On April 30, 1998, the Company entered into an Agreement and Plan of Merger
(the "Agreement") by and among the Company, Wise Acquisition Corp., a
Pennsylvania corporation and a wholly-owned subsidiary of the Company ("WAC"),
and WiseWire Corporation, a Pennsylvania corporation ("WiseWire"), pursuant to
which WAC was merged with and into WiseWire (the "Merger").  As a result of the
Merger, WiseWire became a wholly-owned subsidiary of the Company.

     The acquisition was accounted for as a purchase.  The purchase price was
allocated to the assets acquired and liabilities assumed based on their
estimated fair values.  Results of operations for WiseWire are included with
those of the Company for periods subsequent to the date of acquisition.


                                      47
<PAGE>
 
                                  LYCOS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


     In the Merger, all outstanding shares of Common Stock and Preferred Stock
of WiseWire and options to purchase Common Stock of WiseWire were converted into
1,648,510 shares and options to purchase Common Stock of the Company. All
outstanding options to purchase Common Stock of WiseWire have been assumed by
the Company.

     Under the terms of the Agreement and related Escrow Agreement dated April
30, 1998, an aggregate of 164,874 shares of Common Stock of the Company will be
held in escrow for the purpose of indemnifying the Company against certain
liabilities of WiseWire and its stockholders.  The escrow will expire on April
30, 1999.

The purchase price was allocated as follows:

<TABLE>
       <S>                                            <C>
       In process research and development...........   $36,000,000
       Developed technology..........................     3,060,189
       Goodwill and other intangible assets..........       127,509
       Other assets, principally cash and equipment..     1,085,290
       Liabilities assumed ..........................      (857,286)
                                                     --------------
                                                                   
                                                        $39,415,702
                                                     ==============
</TABLE>

  Accumulated amortization on intangible assets was $256,330 at July 31, 1998.

GuestWorld, Inc.

     On June 16, 1998, the Company entered into an Agreement and Plan of Merger
(the "Agreement") by and among the Company, VW Acquisition Corp., a Delaware
corporation and a wholly-owned subsidiary of the Company ("VW"), GuestWorld,
Inc., a California corporation ("GuestWorld"), and all of the stockholders of
GuestWorld, acquired all of the outstanding capital stock of GuestWorld through
the merger of VW with and into GuestWorld (the "Merger"). As a result of the
Merger, GuestWorld became a wholly-owned subsidiary of the Company.

     In the Merger, all outstanding shares of Common Stock of GuestWorld were
converted into an aggregate of 126,184 shares of Common  Stock, par value $.01
per share, of the Company.  The acquisition was accounted for as a purchase.
Results of operations for GuestWorld are included with those of the Company for
periods subsequent to the date of acquisition.

     Under the terms of the Agreement and related Escrow Agreement dated June
16, 1998, an aggregate of 12,618 shares of Common Stock of the Company will be
held in escrow for the purpose of indemnifying the Company against certain
liabilities of GuestWorld and its stockholders. The escrow will expire on June
16, 1999.

The purchase price was allocated as follows:

<TABLE>
       <S>                                    <C>
       In process research and development...   $3,639,055
       Developed technology..................      183,868
       Goodwill and other intangible assets..        7,661
       Property and equipment................       50,000
       Liabilities assumed ..................     (300,000)
                                             -------------
                                                          
                                                $3,580,584
                                             ============= 
</TABLE>
 
  Accumulated amortization on intangible assets was $4,597 at July 31, 1998.

                                      48
<PAGE>
 
                                  LYCOS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


In-Process Research and Development

     In connection with the acquisitions of Tripod, WiseWire and GuestWorld, the
Company recorded an in-process research and development charge of $91,239,055,
representing purchased in-process research and development that has not yet
reached technological feasibility and has no alternative future use.  The
Company's management made certain assessments with respect to the determination
of all identifiable assets resulting from, or to be used in, research and
development activities as of the respective acquisition dates. Each of these
activities was evaluated as of the respective acquisition dates so as to
determine their stage of development and related fair value.  The Company's
review, as of the acquisition date, indicated that the in-process research and
development had not reached a state of technological feasibility and evidenced
no alternative future use. In the case of in-process projects, the Company made
estimates to quantify the cost-to-complete for each project, identifying the
project date of introduction, the estimated life of the project, the project's
"fit" within the Company's own in-process research projects, the revenues to be
generated in each future period and the corresponding operating expenses and
other charges to apply to this revenue stream. In order to determine the value
of the earnings stream attributable to the in-process research and development,
the excess earnings from the projects were calculated by deducting the earnings
stream attributable to all other assets including working capital and tangible
assets. Based upon these assumptions, after-tax cash flows attributable to the
in-process project(s) were determined, appropriately discounted back to its
respective net present value, taking into account the uncertainty surrounding
the successful development of the purchased in-process technology.

     In the case of in-process technology, fair values of the corresponding
technologies were determined by the Income Approach which included both a
discounted future earnings methodology and a relief from royalty methodology.
Under these methodologies, the value of the in-process technology is comprised
of the total present value of the future earnings stream attributable to the
technology throughout its anticipated life. An adjustment to the value of
certain in-process research and development projects has been applied based on a
percentage completion formula. The valuation of the acquired in-process research
and development used by the Company in making its determination as to the amount
of in-process research and development expense was supported by valuation
studies prepared by an independent third party appraiser. 
 
  In order to assess the reasonableness of the conclusions reached under the 
Excess Earnings (Discounted Future Earnings) method, the value of the 
technologies was also estimated using a Relief from Royalty approach. Under this
approach, the value of the technologies is estimated to be the present value of
the after tax amounts that the Company would otherwise be required to pay to
third parties to obtain access to the subject technologies, if it did not
already own them. In applying the method, management estimated a royalty rate
and forecasted an estimated royalty stream for the in-process technologies. The
estimated royalty rate used was based on existing Lycos contracts for the
licensing of similar technologies.

  GuestWorld and WiseWire are both development stage companies that had not 
generated significant commercial revenue at their respective acquisition dates 
and were loss making. Neither company had completed development of 
technologically robust or commercially viable products or services. Significant
uncertainty existed in relation to the introduction of such products or 
services.

  Lycos' management has considered the possible existence or value of other 
intangible assets such as patents, copyrights, brand names, customers lists, 
etc. However, management at both companies had been focused on completing the 
development projects underway and they had not undertaken the development of 
other intangible assets. Accordingly, Lycos' management believes that the value 
of any other such assets at the respective acquisition dates to be minimal 
or zero.

  The purchase price paid for GuestWorld and WiseWire reflected payment for 
incomplete technology. Should the in-process projects fail, the value of Lycos' 
investment in these incomplete technologies would be diminimous or zero.

  In the case of Tripod, management does believe that other intangible assets
had been created by management at the acquisition date. As a result, in addition
to valuing in-process research and development, management has also allocated a
proportion of the purchase price, based on their respective fair values, to
existing technology employed in the creation and management of pods as well as
to other intangible assets associated with the existing community members.

                                      49
<PAGE>
 
                                  LYCOS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


     The following unaudited pro forma financial information presents the
combined results of operations of Lycos, Tripod and WiseWire as if the
acquisitions had occurred as of the beginning of 1998, 1997 and 1996,
respectively, after giving effect to certain adjustments, including amortization
of goodwill and other intangible assets. The pro forma financial information
does not necessarily reflect the results of operations that would have occurred
had Lycos, Tripod and WiseWire constituted a single entity during such periods.
Pro forma information for GuestWorld for periods prior to the acquisition have
not been presented because the results of GuestWorld's operations were not
material to the Company's historical results.

<TABLE>
<CAPTION>
                 (UNAUDITED)                        LYCOS         TRIPOD        WISEWIRE        COMBINED
                                               --------------  -------------  -------------  ---------------
<S>                                            <C>             <C>            <C>            <C>
YEAR ENDED JULY 31, 1998
------------------------
Revenues.....................................   $ 56,060,305    $   731,499    $   310,123    $  57,101,927
Operating expenses and interest income, net..    152,976,868      4,690,100      2,625,150      160,292,118
                                             --------------------------------------------------------------
Net loss.....................................   $(96,916,563)   $(3,958,601)   $(2,315,027)   $(103,190,191)
                                             ==============================================================

YEAR ENDED  JULY 31, 1997
-------------------------
Revenues.....................................   $ 22,273,042    $   517,490    $   111,490    $  22,902,022
Operating expenses and interest income, net..     28,892,232      3,506,191      2,463,770       34,862,193
                                             --------------------------------------------------------------
Net loss.....................................   $ (6,619,190)   $(2,988,701)   $(2,352,280)   $ (11,960,171)
                                             ==============================================================

YEAR  ENDED JULY 31, 1996
-------------------------
Revenues.....................................   $  5,257,227    $   239,856    $    79,310    $   5,576,393
Operating expenses and interest income, net..     10,345,065      1,312,799        483,444       12,141,308
                                             --------------------------------------------------------------
Net loss.....................................   $ (5,087,838)   $(1,072,943)   $  (404,134)   $  (6,564,915)
                                             ==============================================================
</TABLE>

WhoWhere?, Inc.

  On August 13, 1998, the Company entered into an Agreement and Plan of merger
to acquire WhoWhere?, Inc. See Note 7 "Subsequent Events".

5.    ACCRUED EXPENSES

      Accrued expenses consist of the following:

<TABLE>
<CAPTION>
                                JULY 31,       JULY 31,  
                                  1998           1997    
                              ------------   ------------
   <S>                        <C>              <C>       
   Compensation and benefits..   2,262,015   $    942,749
   Advertising and promotion..   8,885,178      4,238,361
   Professional fees..........   1,262,351        627,884
   Non-income taxes...........     567,500        407,401
   Other......................   4,612,656      1,171,312
                              ------------   ------------
                                17,589,700   $  7,387,707
                              ============   ============ 
</TABLE>

                                      50
<PAGE>
 
                                  LYCOS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


6.   COMMITMENTS AND CONTINGENCIES

     The Company leases its facilities and certain other equipment under
operating lease agreements expiring through 2004. Future noncancelable minimum
payments as of July 31, 1998 under these leases for each fiscal year end are as
follows:

          1999.................................  $8,557,981
          2000.................................   5,854,175
          2001.................................   3,612,403
          2002.................................   3,402,195
          2003.................................   2,384,660 

     Rent expense under noncancellable operating leases was $5,057,907,
$2,094,774, and $318,500 for the years ended July 31, 1998, 1997 and 1996,
respectively.

     The Company is obligated to make payments totaling approximately $19
million under contracts to provide search and navigation services between June
1998 and September 1999.  No payments had been made under these agreements as of
July 31, 1998.

     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, results of operations or cash flows of the Company.

7.  SUBSEQUENT EVENTS (UNAUDITED)

Acquisition of WhoWhere? Inc.

     On August 7, 1998, the Company entered into an Agreement and Plan of Merger
(the "Agreement") by and among the Company, What Acquisition Corp., a Delaware
corporation and a wholly-owned subsidiary of the Company ("WWAC"), WhoWhere?
Inc., a California corporation ("WhoWhere?"), and certain shareholders of
WhoWhere? providing for the merger of WWAC with and into WhoWhere? (the
"Merger"). On August 13, 1998, the Company completed the closing of the Merger
and WhoWhere? became a wholly-owned subsidiary of the Company.

     The acquisition will be accounted for as a purchase. The purchase price
will be allocated to the assets acquired and liabilities assumed based on their
estimated fair values. Results of operations for WhoWhere? will be included with
those of the Company for periods subsequent to the date of acquisition.

     In the Merger, all outstanding shares of Common Stock and Preferred Stock
of WhoWhere? were converted into an aggregate of 3,770,254 shares of Common
Stock , par value $.01 per share, of the Company (the "Lycos Common Stock"), and
all outstanding options and warrants to purchase Common Stock or Preferred Stock
of WhoWhere? were assumed by the Company and became options or warrants, as the
case may be, to purchase an aggregate of 1,335,244 shares of Lycos Common Stock.

                                      51
<PAGE>
 
                                  LYCOS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


The Company has filed a Registration Statement on Form S-3 with respect to the
resale of the shares of Lycos Common Stock issued in the Merger and the shares
of Lycos Common Stock issuable upon the exercise of warrants assumed in the
Merger and filed a Registration Statement on Form S-8 with respect to the shares
of Lycos Common Stock issuable upon the exercise of options and warrants assumed
in the Merger.

     Under the terms of the Agreement and related Escrow Agreement dated August
13, 1998, an aggregate of 377,038 shares of Lycos Common Stock and options and
warrants to purchase an additional 133,540 shares of Lycos Common Stock will be
held in escrow for the purpose of indemnifying the Company against certain
liabilities of WhoWhere? and its stockholders. The escrow will expire on August
13, 1999.

Acquisition of Wired Ventures, Inc.

     On October 5, 1998, the Company entered into a definitive merger agreement
to acquire Wired Ventures Inc. in a stock-for-stock transaction valued at
approximately $83 million, net of cash to be acquired and the value of shares
issuable to the holders of options to purchase common stock of Wired which are
exercised prior to the closing of the acquisition. The transaction is intended
to be accounted for as a purchase, and accordingly, the purchase price will be
allocated to assets acquired and liabilities assumed based on their respective
fair values. Subject to several conditions, including approval of Wired's
shareholders, the transaction is expected to close in the second quarter of
fiscal 1999.

Acquisition of PlanetAll, Inc.

     In August 1998, pursuant to an Agreement and Plan of Merger, Amazon.com
acquired all of the outstanding capital stock of PlanetAll. Amazon.com issued
approximately 800,000 shares of Amazon.com common stock, par value $.01 per
share valued at approximately $87 million. Of the total of 800,000 shares issued
by Amazon.com, the Company received 107,377 shares valued at approximately $11.6
million at the time of acquisition in exchange for its shares of PlanetAll. See
Note 2.

8.  STOCKHOLDERS' EQUITY

Common Stock

     On June 4, 1998, 4,500,000 of the Company's shares were sold under a
registration statement filed with the Securities Exchange Commission.  Of the
4,500,000 shares sold, 4,000,000 shares were sold by the Company and 500,000
were sold by CMG Information Services, Inc ("CMGI").  The Company did not
receive any proceeds from the sale of shares by CMGI.  Proceeds to the Company
were approximately $95 million, before deduction of expenses payable by the
Company of $350,000.  The Underwriters exercised an option to purchase 675,000
additional shares of Common Stock, resulting in additional proceeds to the
Company of approximately $16 million.

                                      52
<PAGE>
 
                                  LYCOS, INC.

            
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

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
2,000,000 shares of common stock may be granted at an exercise price determined
by the Board of Directors. Options granted under the 1995 Plan are exercisable
in five equal annual 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. The total weighted average contractual life of options
outstanding at July 31, 1998 was 3.5 years.

A summary of option activity under the 1995 Plan is as follows:

<TABLE>
<CAPTION>
                                               WEIGHTED-
                                                AVERAGE          RANGE OF
                                   OPTIONS   EXERCISE PRICE   EXERCISE PRICES
                                 ----------------------------------------------
<S>                              <C>         <C>              <C>
Outstanding at July 31, 1995....  1,120,000         $0.01               $  0.01
  Granted.......................  1,179,552         $2.41     $0.01  -  $  8.00
  Exercised.....................         --            --           ---
  Terminated....................   (390,608)        $0.07     $0.01  -  $  4.80
                                 ----------
 Outstanding at July 31, 1996...  1,908,944         $1.48     $0.01  -  $  8.00
                                 ----------
  Granted.......................    420,000         $7.20     $5.69  -  $  7.94
  Exercised.....................   (101,600)        $0.03     $0.01  -  $  1.16
  Terminated....................   (245,736)        $1.72     $0.01  -  $  8.00
                                 ----------
 Outstanding at July 31, 1997...  1,981,608         $2.73     $0.01  -  $  7.94
                                 ----------
  Granted.......................         --            --           ---
  Exercised.....................   (630,184)        $0.34     $0.01  -  $  7.94
  Terminated....................   (212,080)        $1.25     $0.01  -  $  8.50
                                 ----------
 Outstanding at July 31, 1998...  1,139,344         $3.11     $0.01  -  $  7.94
                                 ==========
 Exercisable at July 31, 1998...    359,368         $3.75     $0.01  -  $  7.75
                                 ========== 
</TABLE>


  The following table summarizes information about the Company's stock options
outstanding at July 31, 1998.

<TABLE>
<CAPTION>
                                   OPTIONS OUTSTANDING               OPTIONS EXERCISABLE         
                          -----------------------------------------------------------------
                                          WEIGHTED-                                             
      1995 STOCK OPTION      NUMBER        AVERAGE     WEIGHTED-                  WEIGHTED-     
        PLAN RANGE OF      OUTSTANDING    REMAINING     AVERAGE       NUMBER       AVERAGE      
          EXERCISE             AT        CONTRACTUAL   EXERCISE   EXERCISABLE AT  EXERCISE      
           PRICES         JULY 31, 1998  LIFE (YEARS)    PRICE    JULY 31, 1998     PRICE       
     --------------------------------------------------------------------------------------     
     <S>                  <C>            <C>           <C>        <C>             <C>           
        $0.01--$1.16            407,696          3.1       $0.02          82,200      $0.01     
        $4.80--$4.80            441,648          3.5       $4.80         269,168      $4.80     
        $5.69--$7.94            290,000          4.7       $7.15           8,000      $6.77     
                          -------------                           --------------
                              1,139,344                                  359,368                
                          =============                           ==============                 
</TABLE>

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.

                                      53
<PAGE>
 
                                  LYCOS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


     The Company has recorded deferred compensation expense of approximately
$610,000 for the difference between the grant price and the estimated fair value
(determined by independent valuations or by reference to third party
transactions) of certain of the Company's stock options granted. This amount is
being amortized over the vesting period of the individual options on a straight-
line basis, determined separately for each portion of the options that vest in
each year. Deferred compensation expense recognized for the year ended July 31,
1998, 1997 and 1996 was approximately $47,000, $142,000 and $234,000,
respectively.

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 2,000,000 shares of common stock
may be issued pursuant to the 1996 Plan upon exercise of options. On June 27,
1997, the Company's Board of Directors voted to authorize an additional 400,000
shares for grant under the 1996 Plan.

     Under the 1996 Plan, incentive stock options may be granted to employees
and officers of the Company and non-qualified stock options may be granted to
consultants, employees and officers of the Company. The exercise price of such
incentive stock options cannot be less than the fair market value of the common
stock on the date of grant, or less than 110% of fair market value in the case
of employees or officers holding 10% or more of the voting stock of the Company.
The Compensation Committee of the Board of Directors has the authority to select
optionees and to determine the terms of the options granted. Options granted
under the 1996 Plan are exercisable in five equal annual installments commencing
on the first anniversary of the date of grant, except that vesting of certain
options are subject to acceleration upon the occurrence of certain events.
Options under the 1996 Plan expire ten years from the date of grant. The total
weighted average contractual life of options outstanding at July 31, 1998, was
9.0 years.

A summary of option activity under the 1996 Plan is as follows:

<TABLE>
<CAPTION>
                                               WEIGHTED-
                                                AVERAGE      RANGE OF EXERCISE
                                  OPTIONS    EXERCISE PRICE        PRICES
                               ------------------------------------------------
<S>                             <C>           <C>          <C>
Outstanding at July 31, 1995...         --          --            --
 Granted.......................    241,500    $   6.52     $ 3.00  -  $  8.88   
 Exercised.....................         --          --            --     
 Terminated....................    (62,000)   $   7.39     $ 6.50  -  $  8.50   
                               -----------                                      
Outstanding at July 31, 1996...    179,500    $   6.21     $ 3.00  -  $  8.88   
                               -----------                                      
 Granted.......................  2,169,844    $   5.82     $ 2.91  -  $  10.75
 Exercised.....................         --          --            --    
 Terminated....................   (298,800)   $   6.56     $ 3.57  -  $  10.75
                               -----------                                      
Outstanding at July 31, 1997...  2,050,544    $   5.72     $ 2.91  -  $  10.75
                               -----------                                      
 Granted.......................  3,593,500    $  22.43     $ 8.38  -  $  49.78
 Exercised.....................   (354,596)   $   5.81     $ 3.00  -  $  10.75
 Terminated....................   (257,200)   $   8.14     $ 3.00  -  $  18.94
                               -----------                                      
Outstanding at July 31, 1998...  5,032,248    $  15.15     $ 2.91  -  $  49.78
                               ===========                                      
Exercisable at July 31, 1998...     96,312    $   6.10     $ 2.91  -  $  10.25
                               ===========
</TABLE>

                                      54
<PAGE>
 
                                  LYCOS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


  The following table summarizes information about the Company's stock options
outstanding at July 31, 1998.

<TABLE>
<CAPTION>
                                      OPTIONS
                                    OUTSTANDING                    OPTIONS EXERCISABLE
                   ----------------------------------------------------------------------
                                      WEIGHTED-
 1996 STOCK OPTION                     AVERAGE     WEIGHTED-                    WEIGHTED-
   PLAN RANGE OF         NUMBER       REMAINING     AVERAGE        NUMBER        AVERAGE
     EXERCISE        OUTSTANDING AT  CONTRACTUAL   EXERCISE     EXERCISABLE     EXERCISE
      PRICES         JULY 31, 1998   LIFE (YEARS)    PRICE    AT JULY 31, 1998    PRICE
                   ----------------------------------------------------------------------
<S>                <C>               <C>           <C>        <C>               <C>
  $ 2.91--$  5.18           545,276      8.1        $   4.31            25,000      $3.79
  $ 5.19--$  5.57           355,812      8.2        $   5.55            15,012      $5.53
  $ 5.67--$  7.88           463,100      8.0        $   6.32            30,700      $6.58
  $ 7.89--$ 10.75         1,219,160      8.9        $   8.62            25,600      $8.14
  $10.76--$ 25.00         1,367,000      9.4        $  19.37                --         --
  $25.01--$ 37.00           965,900      9.8        $  28.73                --         --
  $37.01--$ 53.46           116,000      9.6        $  38.86                --         --
                   ----------------                         ------------------
                          5,032,248                                     96,312
                   ================                         ==================
</TABLE>

     In September 1996, the Company canceled 169,464 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 $4.80 per share. No
compensation expense was recognized by the Company as the exercise price of
these options on the date of grant was at or above fair market value.

1995 Tripod Stock Option Plan

     In connection with the acquisition of Tripod, the Company assumed the 1995
Stock Option Plan under which incentive stock options and nonqualified stock
options to purchase common stock may be granted to officers, key employees and
advisors. Under the Plan, options to purchase 367,926 shares of common stock
were reserved for grants. Options under the 1995 Tripod Stock Option Plan are
generally exercisable in eight semi-annual installments beginning six months
after date of grant.  Options under the 1995 Tripod Stock Option Plan expire ten
years from the date of grant. The total weighted average contractual life of
options outstanding at July 31, 1998 was approximately 10.0 years.

     A summary of option activity under the 1995 Tripod Stock Option Plan is as
follows:

<TABLE>
<CAPTION>
                                                  WEIGHTED-
                                                   AVERAGE      RANGE OF EXERCISE
                                      OPTIONS   EXERCISE PRICE       PRICES
                                   -----------------------------------------------
<S>                                <C>          <C>             <C>
Outstanding at February 12, 1998...   367,926    $  0.65        $ 0.62  -  $  1.54 
 Granted...........................        --         --               --          
 Exercised.........................  (134,492)   $  0.62        $ 0.62  -  $  1.54 
 Terminated........................   (24,820)   $  0.88        $ 0.62  -  $  1.54 
                                   ----------                                      
Outstanding at July 31, 1998.......   208,614    $  0.65        $ 0.62  -  $  1.54 
                                   ==========                                      
Exercisable at July 31, 1998.......    79,995    $  0.62        $ 0.62  -  $  1.54  
                                   ==========
</TABLE>

                                      55
<PAGE>
 
                                  LYCOS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

  The following table summarizes information about stock options outstanding
under the 1995 Tripod Stock Option Plan at July 31, 1998:

<TABLE>
<CAPTION>
                                     OPTIONS
                                   OUTSTANDING                    OPTIONS EXERCISABLE
                   ----------------------------------------------------------------------
                                      WEIGHTED-
 1995 STOCK OPTION                     AVERAGE     WEIGHTED-                    WEIGHTED-
   PLAN RANGE OF         NUMBER       REMAINING     AVERAGE        NUMBER        AVERAGE
     EXERCISE        OUTSTANDING AT  CONTRACTUAL   EXERCISE     EXERCISABLE     EXERCISE
      PRICES         JULY 31, 1998   LIFE (YEARS)    PRICE    AT JULY 31, 1998    PRICE
                   ----------------------------------------------------------------------
  <S>              <C>             <C>             <C>        <C>               <C>
   $0.50--$ 0.75            201,222         10.3       $0.62            79,834      $0.62
   $0.75--$ 2.00              7,392          2.9       $1.54               161      $1.54
                   ----------------                           ----------------
                            208,614                                     79,995
                   ================                           ================
</TABLE>

1995 and 1996 WiseWire Stock Option Plans

  In connection with the acquisition of WiseWire, the Company assumed the 1995
and 1996 Stock Option Plan under which incentive stock options and nonqualified
stock options to purchase common stock may be granted to officers, key employees
and advisors. Under these plans, the Company may grant either incentive stock
options or non-qualified stock options. These  options are fully vested and are
exercisable over a 5 year period from date of grant. The employee plan was
adopted in 1995 and is restricted to Company employees. These options generally
have a term of ten years from the date of grant with 20% vesting after a brief
probationary period and the remainder vest over a four-year period. The non-
employee plan was adopted in 1996 and is intended primarily for directors or
other non-employees. Options granted under the non-employee plan typically vest
immediately. The total weighted average contractual life of options outstanding
under the 1995 and 1996 WiseWire Stock Option Plans at July 31, 1998 was
approximately 8.1 and 8.4 years, respectively.

A summary of option activity under the 1995 WiseWire Stock Option Plan is as
follows:

<TABLE>
<CAPTION>
                                              WEIGHTED-
                                               AVERAGE      RANGE OF EXERCISE
                                  OPTIONS   EXERCISE PRICE        PRICES
                                ----------------------------------------------
<S>                             <C>         <C>             <C>
Outstanding at April 30, 1998...  210,274     $  2.67       $1.34  -  $  53.46
 Granted........................       --          --                       --
 Exercised......................  (63,024)    $  2.02       $1.34  -  $   8.02
 Terminated.....................  (27,096)    $  4.06       $1.34  -  $   8.02
                                ---------                  
Outstanding at July 31, 1998....  120,154     $  2.69       $1.34  -  $  53.46
                                =========
Exercisable at July 31, 1998....   25,960     $  2.83       $1.34  -  $  53.46
                                =========
</TABLE>

  The following table summarizes information about stock options outstanding
under the 1995 WiseWire Stock Option Plan at July 31, 1998:

<TABLE>
<CAPTION>
                                     OPTIONS
                                    OUTSTANDING                    OPTIONS EXERCISABLE
                   ----------------------------------------------------------------------
                                      WEIGHTED-
 1995 STOCK OPTION                     AVERAGE     WEIGHTED-                    WEIGHTED-
   PLAN RANGE OF         NUMBER       REMAINING     AVERAGE        NUMBER        AVERAGE
     EXERCISE        OUTSTANDING AT  CONTRACTUAL   EXERCISE     EXERCISABLE     EXERCISE
      PRICES         JULY 31, 1998   LIFE (YEARS)    PRICE    AT JULY 31, 1998    PRICE
                   ----------------------------------------------------------------------
<S>                <C>               <C>           <C>        <C>               <C>
  $ 1.00--$  2.00            89,224          8.3       $1.34            22,390     $ 1.34
  $ 5.00--$ 53.46            30,930          7.6       $6.61             3,570     $12.18
                   ----------------                         ------------------
                            120,154                                     25,960
                   ================                         ==================
</TABLE>

                                      56
<PAGE>
 
                                  LYCOS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


A summary of option activity under the 1996WiseWire Stock Option Plan is as
follows:

<TABLE>
<CAPTION>
                                              WEIGHTED-
                                               AVERAGE       RANGE OF EXERCISE
                                  OPTIONS   EXERCISE PRICE        PRICES
                                -----------------------------------------------
<S>                             <C>         <C>              <C>
Outstanding at April 30, 1998...   21,034           $13.19    0.14  -  $  53.46
 Granted........................       --               --         --
 Exercised......................       --               --         --
 Terminated.....................  (13,466)          $13.10    0.14  -  $  53.46
                                ---------
Outstanding at July 31, 1998....    7,568           $13.37   13.37  -  $  13.37
                                =========
Exercisable at July 31, 1998....    7,568           $13.37   13.37  -  $  13.37
                                =========
</TABLE>

  The following table summarizes information about stock options outstanding
under the 1996 WiseWire Stock Option Plan at July 31, 1998:

<TABLE>
<CAPTION>
                                      OPTIONS
                                    OUTSTANDING                   OPTIONS EXERCISABLE
                     ---------------------------------------- -----------------------------   
                                      WEIGHTED-
 1996 STOCK OPTION                     AVERAGE     WEIGHTED-                    WEIGHTED-
   PLAN RANGE OF         NUMBER       REMAINING     AVERAGE        NUMBER        AVERAGE
     EXERCISE        OUTSTANDING AT  CONTRACTUAL   EXERCISE     EXERCISABLE     EXERCISE
      PRICES         JULY 31, 1998   LIFE (YEARS)    PRICE    AT JULY 31, 1998    PRICE
                     ---------------------------------------- -----------------------------   
<S>                  <C>            <C>            <C>        <C>               <C>
 $ 10.69--$ 16.04         7,568          8.4        $13.37          7,568         $13.37
                     ==========                               ===========                      
</TABLE>

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 200,000 shares of common stock. The
Director Plan is administered by the Board of Directors. Under the Director Plan
each non-employee director first elected to the Board of Directors after the
completion of the initial public offering will receive an option for 20,000
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, 1998, 40,000 options had been granted at exercise prices of between
$5.75 and $8.69 per share and remained outstanding under the Director Plan, of
which 13,333 were exercisable.

1996 Employee Stock Purchase Plan

  On February 2, 1996, the 1996 Employee Stock Purchase Plan ("1996 Purchase
Plan") was adopted by the Company's Board of Directors. The 1996 Purchase Plan
authorizes the issuance of a maximum of 500,000 shares of common stock and is
administered by the Compensation Committee of the Board of Directors. All
employees of the Company who have completed six months of service with the
Company are eligible to participate in the 1996 Purchase Plan with the exception
of those employees who own 5% or more of the Company's stock and directors who
are not employees of the Company may not participate in this plan. Employees
elect to have deducted from 1%-10% of their base compensation. The exercise
price for the option is 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.

                                      57
<PAGE>
 
                                  LYCOS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


Stock-Based Compensation

     The Company has granted options to purchase shares of common stock to key
employees and directors. These options vest over periods of up to five years and
expire at various dates through 2007. The Company has adopted the disclosure
provisions of SFAS No. 123 with respect to its stock-based compensation. The
effects of applying SFAS No. 123 in this pro forma disclosure may not be
representative of the effects on reported income or loss for future years. SFAS
123 does not apply to awards prior to 1995. The Company anticipates additional
awards in future years. Had compensation cost for the Company's stock-based
compensation plans been determined based on the grant date fair value in
accordance with SFAS 123, the Company's net loss and net loss per share for the
years ended July 31, 1998, 1997 and 1996 would have been increased to the pro
forma amounts indicated below:

<TABLE>
<CAPTION>
                                            AS REPORTED                       PRO FORMA            
                                --------------------------------- -------------------------------- 
                                     NET LOSS     LOSS PER SHARE      NET LOSS      LOSS PER SHARE 
                                --------------------------------- -------------------------------- 
<S>                             <C>               <C>             <C>               <C>            
Year ended July 31, 1998.......    $(96,916,563)          $(3.13)   $(103,919,264)          $(3.36)
Year ended July 31, 1997.......    $ (6,619,190)          $(0.24)   $  (7,548,626)          $(0.28)
Year ended July 31, 1996.......    $ (5,087,838)          $(0.21)   $  (5,191,133)          $(0.22) 
</TABLE>

     The grant date fair value of each stock option is estimated using the 
Black-Scholes option-pricing model with the following assumptions: an expected
life of four years for both the 1996 plan and the 1995 plan for all three years,
expected volatility of 100% for both Plans in 1998 and 70% for both plans for
1997 and 1996, a dividend yield of 0% for both plans and a weighted average 
risk-free interest rate of 5.48% for both Plans in 1998 and 6.50% for the 1996
plan and 5.75% for the 1995 plan in 1997 and 1996. The weighted average grant
date fair values of options granted in 1998, 1997 and 1996 were $16.47, $4.87
and $1.62, respectively. The weighted-average remaining contractual life of
options outstanding at July 31, 1998 was 9.0 years.

9.   INCOME TAXES

     The company did not record any provision for federal and state income taxes
through July 31, 1998.  The actual tax expense for 1998, 1997 and 1996 differs
from "expected" tax expense (computed by applying the statutory U.S. federal
corporate tax rate of 34% to earnings before income taxes) as follows:

<TABLE>
<CAPTION>
                                                          YEAR ENDED JULY 31,
                                                  -----------------------------------
                                                       1998       1997        1996
                                                  ----------- ------------ ---------- 
                                                             (In thousands)  
<S>                                               <C>        <C>           <C>
Computed "expected" tax benefit                      $(32,952)   $(2,251)   $(2,035)
Nondeductible amounts and other differences:
        In Process Research and Development            31,459         --        154
        Other                                              85       (326)        --
Change in valuation allowance for deferred taxes
        allocated to income tax expense                 1,408      2,577      1,881
                                                  ----------- ------------ ---------- 
                                                     $     --    $    --    $    --
                                                  =========== ============ ========== 
</TABLE>

                                      58
<PAGE>
 
                                  LYCOS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


  At July 31, 1998 and 1997 deferred income tax assets and liabilities result
from temporary differences in the recognition of income and expense for tax and
financial reporting purposes.  The sources and tax effects of these temporary
differences are presented below:

<TABLE>
<CAPTION>
                                                                                 JULY 31,
                                                                          ---------------------
(In thousands)                                                               1998       1997
                                                                          ---------   ---------
<S>                                                                       <C>          <C>
Deferred tax liabilities:
 Book over tax basis of developed technology                                $  2,806   $   250
                                                                          ----------  ---------
Total deferred liabilities                                                     2,806       250
                                                                          ----------  ---------
Deferred tax assets:
       Deferred Revenue                                                        2,169     1,823
       Reserves                                                                2,307       867
       Tax in excess of book basis for differences in equity investments       2,164     1,923
       Net operating losses and credit carryforwards                          15,979       311
       Other                                                                     594       103
                                                                          ----------  ---------
Total gross deferred tax assets                                               23,213     5,027
Less valuation allowance                                                     (20,407)   (4,777)
Net deferred tax asset                                                         2,806       250
                                                                          ----------  ---------
Net deferred income taxes                                                   $     --   $    --
                                                                          ==========  =========
</TABLE>

  In assessing the realizability of deferred tax assets, the Company considers
whether it is more likely than not that some or all of the deferred tax asset
will not be realized.  The Company believes that sufficient uncertainty exist
regarding the realizability of the deferred tax assets such that valuation
allowances of $20,407,000 and $4,777,000 for July 31, 1998 and 1997
respectively, have been established for deferred tax assets.

  At July 31, 1998, the Company had approximately $38,000,000 of federal and
state net operating loss carryforwards which will begin to expire in 2007 for
federal purposes and 1998 for state purposes.  Utilization of the net operating
losses may be subject to an annual limitation imposed by change in ownership
provisions of Section 382 of the Internal Revenue Code and similar state
provisions.

  In accordance with FAS 109, the accounting for the tax benefits of acquired
deductible temporary differences, which are not recognized at the acquisition
date because a valuation allowance is established, and recognized subsequent to
the acquisitions will be applied first to reduce to zero, any goodwill and other
noncurrent intangible assets related to the acquisitions.  Any remaining
benefits would be recognized as reduction of income tax expense.  As of July 31,
1998, $5,460,000 of the Company's deferred asset pertains to acquired companies,
the future benefits of which will be applied first to reduce to zero any
goodwill and other noncurrent intangible related to the acquisitions prior to
reducing the Company's income tax expense.  Deferred tax assets and related
valuation allowance of approximately $10,519,000 relate to certain operating
loss carryforwards resulting from the exercise of employee stock options, the
tax benefit of which, when recognized, will be accounted for as a credit to
additional paid-in capital rather than a reduction of income tax.

  The Company's deferred tax liability relates solely to the difference in bases
of acquired assets. 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.

                                      59
<PAGE>
 
                                  LYCOS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


10.  SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

  The following table sets forth selected quarterly financial and stock price
information for the years ended July 31, 1998 and 1997. The operating results
for any given quarter are not necessarily indicative of results for any future
period. The Company's common stock is traded on the NASDAQ National Market
System ("NASDAQ/NMS") under the symbol LCOS. Included below are the high and
low sales prices (adjusted for a 2-for-1 stock split effected as of August 1,
1995) during each quarterly period for the shares of common stock as reported by
NASDAQ/NMS.

<TABLE>
<CAPTION>
                                                      (IN THOUSANDS, EXCEPT PER SHARE DATA)
                              ----------------------------------------------------------------------------------
                                        FISCAL 1998 QUARTER ENDED                FISCAL 1997 QUARTER ENDED
                              ----------------------------------------------------------------------------------
                                OCT. 31    JAN. 31    APR. 30    JUL. 31   OCT. 31   JAN. 31   APR. 30   JUL. 31
                              ----------------------------------------------------------------------------------
<S>                           <C>          <C>       <C>         <C>       <C>       <C>       <C>       <C>
Total revenues................   $9,303    $12,603   $ 15,129    $19,025   $ 3,663   $ 5,004   $ 5,853   $ 7,753
Cost of revenues..............    1,779      2,719      4,747      3,268       741       993     1,116     1,487
Gross profit..................    7,524      9,884     10,382     15,757     2,922     4,011     4,737     6,266
Research & development
     expense..................    1,435      1,734      2,704      3,605       974       976     1,158     1,192
In-process research &
     development expense......       --         --     87,600      3,639        --        --        --        --
Sales and marketing...........    5,477      7,310     10,172     12,077     4,627     4,754     4,526     5,218
General and administrative
     expenses.................      932        990      1,508      2,200       545       693       645       836
Amortization of intangibles...      113        113        444      1,462       117       141       161       122
Operating loss................     (433)      (263)   (92,046)    (7,226)   (3,341)   (2,553)   (1,753)   (1,102)
Interest income...............      540        564        524      1,423       582       541       480       527
Net income (loss).............      107        301    (91,522)    (5,803)   (2,759)   (2,012)   (1,273)     (575)
Basic and diluted net income
(loss) per share..............   $ 0.00    $  0.00   $  (2.95)   $ (0.16)  $ (0.10)  $ (0.08)  $ (0.05)  $ (0.02)
Market Price:
 High.........................    21.00      21.00      39.57      53.63      6.38      9.38     11.38      9.63
 Low..........................     8.13      12.63      17.60      24.16      2.88      4.75      6.00      5.60
</TABLE>

11.  RELATED PARTY TRANSACTIONS

  In connection with the formation of the Company, the Company, CMU,
CMG@Ventures and CMG Information Services, Inc. ("CMGI") entered into a
license agreement ("License Agreement") pursuant to which CMU granted the
Company a perpetual, exclusive (with certain limited exceptions), worldwide
license to use the Lycos Internet search and indexing technology and the Lycos
Catalog. The Company paid licensing fees and additional payments equal to 50% of
certain cash receipts, as defined, totaling approximately $1,250,000. All
amounts due under the License Agreement were paid as of July 31, 1996. The
Company also issued 2,000,000 shares of common stock in connection with this
Agreement. Accumulated amortization under the License Agreement at July 31, 1997
and 1996 was $726,000 and $337,000, respectively.

  On February 9, 1996, the Company sold 183,160 shares and 80,000 shares of
common stock and options to acquire 119,452 shares and 52,172 shares of Common
Stock to CMU and Dr. Michael Mauldin, respectively, for an aggregate purchase
price of $328,950, pursuant to the exercise of preemptive rights granted to
these parties in the License Agreement. These preemptive rights were exercised
in connection with the issuance of shares of common stock pertaining to the
Company's acquistion of Point Communications on October 12, 1995 (see Note 4).
The options granted to Dr. Mauldin and CMU have an exercise price of $1.00 per
share and became fully vested upon completion of the Company's initial public
offering in April 1996.

                                      60
<PAGE>
 
                                  LYCOS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

  In addition to amounts paid to CMU in connection with the License Agreement,
the Company was also required to pay to CMU an additional $525,000 pursuant to
two licenses granted by CMU which were assigned to the Company. As of July 31,
1998, the Company had paid an aggregate of $400,000 to CMU pursuant to these
licenses.

  In April 1998 the remaining carrying value of the License Agreement of
approximately $831,000 was written off as it was not considered to have any
remaining future economic benefit.

                                      61
<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 16, 1998. 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

       The following reports on Form 8-K were filed during the quarter ended
       July 31, 1998:

       On May 1, 1998, the Company filed a Form 8-K (as amended by Form 8-K/A
       filed on May 15, 1998) pursuant to Items 2 and 7 of such Form regarding
       its acquisition of WiseWire, Inc.

       On June 30, 1998, the Company filed a Form 8-K pursuant to Item 2 and 7
       of such Form regarding its acquisition of GuestWorld, Inc.

  (c)  List of Exhibits


 EXHIBIT
 NUMBER                         DESCRIPTION OF EXHIBIT
 -------  ----------------------------------------------------------------------
    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*  Restated Certificate of Incorporation of the Company.
    3.2*  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.
  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.

                                      62
<PAGE>
 
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K
(CONTINUED)

 EXHIBIT
 NUMBER                           DESCRIPTION OF EXHIBIT
--------   ---------------------------------------------------------------------
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
           dated as of March 29, 1996.
10.30***+  Agreement between the Company and Netscape Communications Corporation
           dated as of April 1, 1997.
10.31***+  Agreement between the Company and Bertelsmann Internet Services GmbH
           dated as of May 1, 1997.
10.32***+  Agreement between the Company and GTE New Media Services dated as of
           November 18, 1996.
10.33***   Office sublease between Praxis International and the Company dated
           December 4, 1996.
10.34+     Agreement between the Company and BarnesandNoble.com, Inc. dated July
           31, 1997.
10.35****  Leggat McCall Properties Lease, dated January 30, 1998.
10.36****+ Agreement between the Company and Netscape Communications Corporation
           dated as of May 19, 1998.
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.
27         Financial Data Schedule.

*    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.
***  Incorporated by reference from the Company's Quarterly Report on Form 
     10-Q for the quarterly period ended April 30, 1997.
**** Incorporated by reference from the Company's Quarterly Report on Form 10-Q 
     for the quarterly period ended April 30, 1998.
+    Confidential material omitted and filed separately with the Securities and
     Exchange Commission.

                                      63
<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.


                                        By:   /s/ Robert J. Davis


                                                   Robert J. Davis
                                        President and Chief Executive Officer
                                            (Principal Executive Officer)

Date: October 26, 1998

  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.


<TABLE> 
<CAPTION> 
         SIGNATURE                         TITLE                       DATE
---------------------------  ----------------------------------  ----------------
<S>                          <C>                                 <C>
/s/ Robert J. Davis          President, Chief Executive Officer  October 26, 1998
--------------------------   (Principal Executive Officer) and
       Robert J. Davis       Director
 
/s/ Edward M. Philip         Chief Operating Officer, Chief      October 26, 1998
--------------------------   Financial Officer (Principal
     Edward M. Philip        Financial Officer), Accounting
                             Officer and Secretary
 
/s/ David S. Wetherell       Director                            October 26, 1998
--------------------------
       David S. Wetherell
 
/s/ Daniel J. Nova           Director                            October 26, 1998
--------------------------
     Daniel J. Nova
 
/s/ John M. Connors, Jr.     Director                            October 26, 1998
--------------------------          
     John M. Connors, Jr.            

/s/ Richard Sabot            Director                            October 26, 1998
--------------------------          
      Richard Sabot 
</TABLE>

                                      64