<PAGE> 1
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------------
FORM 10-K/A
------------------------------
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED APRIL 30, 1996
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 2-53193
COMPUSERVE CORPORATION
<TABLE>
<S> <C>
Delaware 31-1459598
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5000 Arlington Centre Boulevard
Columbus, Ohio 43220
(Address of principal executive offices) (Zip Code)
</TABLE>
Registrant's Telephone Number including area code: (614) 457-8600
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act: Common Stock, par
value $0.01 per share
------------------------------
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 requirement for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. Yes /X/ No / /
The aggregate market value of the common stock held by non-affiliates of
the Registrant, based upon the closing sale price of the common stock on July
26, 1996 as reported on the NASDAQ Stock Market, was approximately $234 million.
Shares of common stock held by each officer and director and by each person who
owns 5% or more of the outstanding common stock have been excluded in that such
persons may be deemed to be affiliates. This determination of affiliate status
is not necessarily a conclusive determination for other purposes.
As of July 24, 1996, the Registrant had outstanding 92,600,000 shares of
common stock.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 2
PART I
ITEMS 1 AND 2. BUSINESS AND PROPERTIES
OVERVIEW
CompuServe Corporation was incorporated in Delaware on February 16, 1996
and holds all of the outstanding capital stock of CompuServe Incorporated.
CompuServe Incorporated was founded in 1969 as a computer timesharing service
and introduced its first online service in 1979. CompuServe Incorporated holds
all of the outstanding capital stock of SPRY, Inc. ("SPRY"). Until April 1996,
CompuServe Corporation was a wholly-owned subsidiary of H&R Block Group, Inc.
("Parent"). Parent is a wholly-owned subsidiary of H&R Block, Inc. ("H&R
Block"). CompuServe Corporation and its consolidated subsidiaries are
collectively referred to as the "Company" or "CompuServe."
In April, 1996, CompuServe Corporation completed an initial public offering
of 18,400,000 shares of its common stock. CompuServe Corporation's shares are
quoted on the Nasdaq stock market under the symbol "CSRV."
On July 16, 1996, H&R Block announced that its Board of Directors had
approved plans to spin-off (the "Spin-off") H&R Block's remaining 80.1% interest
in CompuServe. The Spin-off is subject to, among other things, shareholder
approval at H&R Block's annual meeting expected to take place in September 1996
and a favorable ruling from the Internal Revenue Service as to the tax-free
nature of the transaction. H&R Block announced that it expects the Spin-off to
be completed on or about November 1, 1996.
CompuServe operates primarily through two divisions: Online Services and
Network Services. Online Services offers worldwide online and Internet access
services for consumers, while Network Services provides worldwide network
access, management and applications, and Internet services to businesses.
For convenience, a glossary of certain technical terms used in this
document has been set forth at the end of this section.
ONLINE SERVICES
COMPUSERVE INFORMATION SERVICE
CompuServe Information Service ("CIS") is one of the two largest consumer
online services in the world. As of April 30, 1996, the number of CIS
subscribers, exclusive of the subscribers of NiftyServe, CompuServe's Japanese
licensee, was approximately 3.2 million subscribers, an increase of
approximately 43.9% over April 30, 1995. CIS targets the more experienced PC
user in both the home and office who values breadth and depth of professional
and business oriented content. CIS provides over 2,000 content areas such as
finance, current events and online reference; approximately 900 managed forums
where subscribers with similar interests can meet to exchange information, hold
online discussions and download files and programs; e-mail; integrated Internet
access; and electronic commercial services. CIS has been building its extensive
content and associated relationships for over fifteen years. Management believes
CIS offers the broadest and most comprehensive content in the consumer online
industry, resulting in a service which would be difficult for any competitor to
replicate.
CompuServe, its licensee and its distributors provide local access to CIS
in approximately 75 cities outside of the United States, from offices in 17
countries around the world. They offer multilingual interfaces, feature local
content and provide customer service.
CompuServe and its licensee had approximately 2.7 million subscribers
outside of the United States as of April 30, 1996, 1.0 million of which were
supported directly by CIS and the remainder of which were NiftyServe
subscribers. CompuServe has licensed its core technology and network model
relating to its online service to NiftyServe, a joint venture of Fujitsu Limited
and Nissho Iwai. NiftyServe is licensed to operate its own online service in
Japan based on CompuServe technology. In addition, NiftyServe has the exclusive
right to distribute CIS in Japan. NiftyServe has also been authorized by
CompuServe to license a subdistributor in Taiwan and another in Korea to
distribute CIS in those countries. NiftyServe also has a right of first refusal
to distribute CIS in 16 additional Asian countries should CompuServe decide to
license a third-party distributor in those countries.
NiftyServe's license with respect to CompuServe technology is perpetual.
NiftyServe's license to act as a distributor of CIS is for an unlimited number
of five-year renewable terms, and is next up for renewal in calendar 2001.
NiftyServe has the right to terminate its license to distribute CIS at any time,
upon one year's advance notice. CompuServe does not believe that the termination
of this relationship would have an adverse effect on its financial condition or
results of operations.
<PAGE> 3
NiftyServe pays CompuServe a royalty fee on the gross monthly usage
revenues of the NiftyServe online service. During each of the last three years,
such royalties accounted for less than 1% of CompuServe's total Online Services
revenues. CompuServe pays NiftyServe a royalty for the CIS business that it
generates and the associated support services that it provides to CIS
subscribers.
In addition, CompuServe has arrangements with various distributors in
Australia, New Zealand, Hong Kong, Mexico, Argentina, Chile, Venezuela, Israel
and South Africa, whose main function is to generate customers for CIS.
CompuServe pays royalties to these distributors for the business that they
generate and the associated support service that they provide to CIS subscribers
in countries in which they operate.
WOW!
In March 1996, CompuServe launched WOW!, a new consumer online service
targeted to the home market. As of April 30, 1996, there were approximately
63,000 WOW! subscribers. WOW! complements the existing CIS service by targeting
the less experienced computer user who, management believes, is not adequately
served by existing online services. The WOW! service employs a unique, intuitive
navigation structure designed to mirror the manner in which non-computer trained
individuals perceive the world. The underlying technology is transparent to the
user. CompuServe has applied for a patent on the WOW! navigation structure.
Focusing on the family, WOW! accommodates up to six individual users per
household, providing different interfaces for children and adults. WOW! offers
carefully selected and relevant content and emphasizes "communities of interest"
that draw people together. Within each of the communities, content managers are
responsible for maximizing subscriber satisfaction by representing the interests
of the subscribers when making content decisions. Subscribers are able to
perform any of six WOW! functions at the community level: Chat, Reference,
Messaging, News, Internet and Shopping. Additional features include e-mail, a
24-hour news room in which content is compiled and rapidly deployed, seamless
Internet browsing capabilities, electronic news clippings, context-sensitive
online help and the ability of parents to restrict access by their children to
certain content areas designated by the parents.
The success of WOW! will depend upon CompuServe's ability to sustain it in
the market in a cost-effective manner, the acceptance of this new product by the
target audience, and CompuServe's ability to improve initial problems
encountered with WOW! regarding software bugs and other technical difficulties,
connections reliability and network speed, ease of use and customer service.
There can be no assurance that WOW! will be generally accepted and used, or that
it will fill the strategic role that CompuServe intends for it. Furthermore,
WOW! currently is available only for computers using Microsoft Corp.'s Windows
95 operating system and in CD-ROM format. While CompuServe believes that most
new computers are being sold with Windows 95 operating systems and CD-ROM
drives, a substantial number of existing PCs are not so equipped.
SPRYNET
SPRY, CompuServe's Internet subsidiary, provides Internet-access-only
services through SPRYNET to those more technically sophisticated users who
choose to access the Internet directly without availing themselves of services
offered through CIS or WOW!. As of April 30, 1996, SPRYNET had approximately
130,000 subscribers. SPRYNET offers subscribers a choice of unlimited access to
the Internet for a competitive fixed monthly fee, or a fixed amount of access
for a monthly fee with a competitive hourly rate thereafter.
NETWORK SERVICES
Network Services provides wide area network connectivity, applications and
systems management to business clients needing to reach dispersed audiences
around the world. CompuServe also provides Internet access and services to
businesses. Examples of network services include supplying the point of sale
network to Visa International Inc. for credit card authorizations, transmitting
credit data for TRW Inc. to approximately 200,000 corporate clients and
providing package tracking information to customers of Federal Express Corp.
CompuServe has particular expertise in supporting groupware applications, such
as Lotus Notes, in which a customer can replicate and provide access to
important and often proprietary data to a large number of widely dispersed users
without compromising the integrity of the original data. CompuServe's network
supports both proprietary protocols for secure transmissions and open protocols
for Internet access.
2
<PAGE> 4
STRATEGY
CompuServe's goal is to continue to lead in the development and
implementation of personal and commercial applications with computer-based
interactive technology. CompuServe intends to continue to grow its subscriber
base for consumer online and Internet services, expand its market position in
the corporate networking sector and continue to seek opportunities to increase
the value of the new medium of computer-based interactive technology to
individuals and businesses.
CompuServe intends to accomplish these strategic goals through the
following initiatives:
FOCUSED INVESTMENTS IN SUBSCRIBER ACQUISITION AND
RETENTION. Commencing in the summer of 1995, CompuServe began
implementation of a strategy to provide the platform for significant
long-term growth in its Online Services subscriber base. Initiatives
included a substantial increase in investments in marketing, distribution,
customer support and services to attract and retain subscribers. In
addition, significant investments have been made in the development of a
new CIS interface and WOW!. Most of these initiatives are continuing; in
fiscal 1997, however, CompuServe plans to more narrowly focus its marketing
for CIS on key market segments, improve its proprietary interface and
improve its technical infrastructure by migrating from its existing
proprietary platform to an open-standards, Internet-based platform.
TARGETED SERVICE OFFERINGS. CompuServe offers differentiated online
and Internet services to appeal to subscribers' varied interests and
comfort levels with computer technology. CompuServe offers
Internet-access-only for the technically sophisticated PC user who desires
only direct access to the Internet, CIS for the experienced computer user
who in addition to direct access to the Internet wants the benefits of CIS
services and WOW!, targeted to the new and less experienced PC user. All
services are further customized through content and pricing to better match
the preferences of distinct subscriber segments. CompuServe will continue
to review this mix, however, as the Interest-access-only service industry
continues to change rapidly.
ACCELERATED INTERNATIONAL EXPANSION. CompuServe is focusing its
international efforts on Western Europe where it has a leading market
position and existing infrastructure and where it believes the potential
exists for significant international growth. Efforts abroad will include
expanding local content offerings and continuing to examine new
opportunities for synergistic marketing and distribution efforts.
CompuServe is also continuing to upgrade its network by installing POPs
(points of presence) in various European cities, including ISDN connections
in some of these cities. Outside of Europe, CompuServe is focusing on
specific countries or regions where it believes there is potential for
significant growth in the subscriber base.
INCREASE VALUE-ADDED NETWORK SERVICES. In addition to providing data
networking services, CompuServe is expanding its offering of value-added
networking services such as server maintenance, customized software and
groupware solutions, and billing services with the goal of providing
comprehensive solutions to corporations wishing to outsource their private
networks. This strategy is intended to differentiate CompuServe from more
commodity-oriented pure network providers, enhancing customer acquisition
and providing an opportunity to expand operating margins.
EXPANSION AND ENHANCEMENT OF NETWORK INFRASTRUCTURE. Over time,
CompuServe intends to migrate to a full Internet TCP/IP transit network
which will utilize ATM technology. ATM is a method of sending data at
"broadband" speeds (T3, 45 mbps and above) which will offer CompuServe
enhanced scalability of its network because as network traffic grows,
CompuServe will be able to move to higher-speed carrier services without
changing to a new technology. Management believes that as the market fully
develops for commercial Internet applications, an ATM-based TCP/IP network
will position CompuServe to provide to end users a new generation
network-centric application and data hosting environment. CompuServe is in
the process of migrating its servers to the Windows NT environment.
Finally, CompuServe is expanding its network infrastructure by
significantly increasing the number of access ports, all of which will
support speeds of 28.8 kbps in order to permit subscribers high quality
access to both CompuServe's proprietary content and the Internet.
Consistent with this action, CompuServe is also migrating from its legacy,
proprietary back-end technical platform for building, maintaining and
delivering content and online services to a new platform based on
Internet-compliant open standards. Among other things, this will ease
product maintenance as well as help speed time-to-market for new products,
and it will broaden the methods by which both present and future customers
can access CompuServe's information services.
3
<PAGE> 5
BUSINESS SYNERGIES. CompuServe leverages its network and host server
infrastructure across all of its businesses to reduce time to market and
exploit cost advantages. For example, CompuServe's extensive existing
network enabled it to more rapidly roll out its Internet-access-only
service. In addition, CompuServe's strong consumer and business presence
allows CompuServe's sales force to cross-sell services and positions
CompuServe to assume a leadership role in the commercialization of the
Internet. Management believes that CompuServe's secure proprietary network
for financial transactions and sensitive communications is a valuable
complement to its growing emphasis on the Internet and open protocol
systems.
THE MARKET
ONLINE SERVICES MARKET
Management believes that consumer online and Internet services are the
first stage in the evolution of a fully-integrated new medium that will embrace
online services, the Internet, multimedia and other interactive technologies.
This new medium has the potential to provide, in a more appealing and cost- and
time-efficient manner, many of the functions now provided by mail, telephone,
television and written materials. The evolution of this new medium has enormous
implications for the way individuals communicate, work, learn and relax.
Key factors driving the demand for online and Internet services include:
PC PENETRATION IN THE HOME AND OFFICE. The network-connected,
multimedia PC has become the platform of choice for meeting a wide range of
information, entertainment, and communication needs. Currently, more than
37 million American households have personal computers and, as of December
31, 1995, this number was expected to grow to over 50 million households by
the year 2000. Almost all new PCs are being acquired with high speed modems
and CD-ROM drives and with online/Internet access software included. As PC
penetration increases, not only does the universe of potential subscribers
increase, but an increased subscriber base substantially enhances the
utility of the service as a vehicle for communication.
EASE OF USE AND ENGAGING CONTENT. Graphical user interfaces combined
with multimedia presentation have made PCs and applications running on them
far easier to use. As the size of the online services market grows, more
content is being produced for this market.
INCREASED AWARENESS. Awareness of consumer online services has
dramatically increased because of the combination of media publicity about
the Internet and the significant amount of advertising being done by larger
companies in the market promoting the concept of online interactivity.
Additionally, there are now millions of subscribers to consumer online
services worldwide who are likely to communicate the advantages of online
services to non-users. Also, arrangements such as Microsoft Corp.'s
agreement with CompuServe to place CIS and WOW! icons in the online
services folder on the Windows 95 desktop will greatly increase awareness
of consumer online services as Windows 95 becomes increasingly prevalent on
home PCs.
THE INTERNET. As of calendar 1995, usage of the Internet, especially
the World Wide Web, was expected to grow at a compounded rate of 70% per
year through 2000. There are now about 10 million computers permanently
attached to the Internet running on some 70,000 networks providing access.
Management believes that value-added content aggregation, billing and
support services represent a significant opportunity for qualified
companies providing Internet access, such as CompuServe.
NETWORK SERVICES MARKET
Many of the factors driving growth in the Online Services market are
directly or indirectly contributing to growth in demand for network services.
Key market segments served by CompuServe are dial packet services, broadband
data communication services, transaction processing services, international
corporate connectivity and groupware applications.
Key factors driving the demand for CompuServe's Network Services include:
AVAILABILITY OF BROADBAND TELECOMMUNICATIONS. The availability of
broadband telecommunications which permit large amounts of data to be
transmitted to remote locations rapidly at a reasonable cost is increasing
the attractiveness of network computing as an information disseminating
tool.
4
<PAGE> 6
EXPECTATION OF CONNECTIVITY. The concept of network computing has been
firmly established in most corporations, and businesses are seeking to
expand connectivity beyond the local area network to a wide area network,
not only within their enterprise, but also with customers and suppliers.
EVOLVING TECHNOLOGY. Software tools which make shared access to and
use of information readily accessible are dramatically increasing network
usage. Examples of this type of software include groupware, such as Lotus
Notes, which permits multiple users to collaborate and use information, and
World Wide Web server and browser software, which permits linking to
various databases of information through a World Wide Web home page.
MOBILE COMPUTING. The prevalence of mobile computing has increased
businesses' demands for widely deployed local access dial networks to
connect business travellers to their home offices.
POPULARITY OF CORPORATE OUTSOURCING. The computer networking market is
rapidly evolving, and many corporations are finding it more cost-effective
to turn to third-party suppliers such as CompuServe which, with its
superior expertise and experience, can more effectively manage hardware and
software needs for data communications.
RAPIDLY CHANGING MARKETS AND TECHNOLOGY
The markets served by CompuServe are characterized by rapid technological
change resulting in dynamic customer demands and frequent new product and
service introductions. CompuServe's markets can change rapidly as a result of
innovation in computer hardware, software and communication technology.
CompuServe's future results will depend in part on its ability to make timely
and cost-effective enhancements and additions to its technology and introduce
new services that meet customer demands. Maintaining flexibility to respond to
technological and market dynamics may require substantial expenditures.
An integral part of CompuServe's technology has been its proprietary
software. Early releases of software often contain errors or defects. There can
be no assurance that, despite extensive testing by CompuServe, errors will not
be found in CompuServe's new product releases and services prior to or after
commencement of commercial deployment, resulting in product redevelopment costs
and loss of, or delay in, market acceptance. Similar experiences could occur
with CompuServe's recently announced initiative to use an Internet-based,
open-standard architecture for delivery and support of its online information
services. Furthermore, any of these possibilities could result from CompuServe's
own activities or those of its suppliers. Once these products, processes and
initiatives are introduced, no assurance can be given that they will be
generally accepted and used, or that they will fill the strategic role that
CompuServe intends for them.
ACQUISITIONS AND INVESTMENTS
To stay at the forefront of the rapidly changing business and technological
environment in which CompuServe operates, CompuServe may need to acquire
technology, products or services, through acquisitions or take majority or
minority equity positions in software, hardware or content providers. Such
acquisitions may not be available to CompuServe, or may not be available at the
times or on terms acceptable to CompuServe. In order for the Spin-off to qualify
as a tax-free distribution under the Internal Revenue Code of 1986, as amended,
H&R Block must control 80% of the total voting power of CompuServe's outstanding
voting stock at the time of the Spin-off. As a result, CompuServe's ability to
effect acquisitions and mergers using CompuServe's Common Stock will be severely
limited until after the Spin-off.
In addition, many of the acquisitions which CompuServe might make could
involve risks, including the successful integration and management of acquired
technology, operations and personnel. The integration of acquired businesses may
also lead to the loss of key employees of the acquired companies and diversion
of management attention from other ongoing business concerns. In addition,
acquisitions may result in significant charges for in-process research and
development or other matters.
PRODUCTS AND SERVICES
ONLINE SERVICES
CompuServe offers an extensive range of communication, information,
entertainment and commerce services to its subscribers.
COMMUNICATION. Online services and the Internet are revolutionizing
communication by linking together individuals around the globe at modest cost
through e-mail, electronic bulletin boards and online discussions. These
communication applications are the single greatest use of the CIS service, an
area which management
5
<PAGE> 7
believes has significant potential for expansion through creative deployment of
technology. Through e-mail, CIS subscribers can send messages to other
subscribers or to non-subscribers through a variety of means, including the
Internet. Online chat enables subscribers to hold virtual discussions with
individuals or groups or merely monitor discussions taking place. Managed forums
provide a location for people of similar interests to share information, ranging
from expression of opinion to downloading computer programs.
INFORMATION. CompuServe makes available to the mass market a vast universe
of information available on CIS, WOW! and the Internet. Because of the medium's
unique characteristics, online information is capable of being updated and
expanded on a real-time basis. Management believes that CIS offers the broadest
and deepest array of content in the consumer online industry, which is augmented
by information available on the Internet; Internet-sourced information is also
available through either WOW! or SPRYNET. CIS, as CompuServe's most
comprehensive information service offering, provides subscribers local and
worldwide news, sports and financial information, North American and
international newspapers and periodicals and, via gateways to hundreds of other
data bases, extensive reference resources. Management believes CIS is the
preferred source for computing information and support among online and Internet
users. CompuServe provides extensive databases of computer oriented information
and offers the largest number of support areas dealing with computer hardware
and software of any online service.
CompuServe views its role as a content aggregator to be one of its
principal value-added functions. In this role, CompuServe not only identifies
information of interest to its subscribers, but also develops software
applications to facilitate manipulation of that information and communication
applications that facilitate the exchange and understanding of information.
CompuServe believes these tools dramatically increase the utility of the
information to its customers. For example, CompuServe Executive News Service
enables subscribers to establish a personalized electronic "clipping folder" to
automatically identify and store information from news wires such as AP and
Reuters that will be of particular interest to the subscriber. In the financial
area, CompuServe augments its financial market and economic news and analysis
with portfolio tracking and financial planning software, interactive forums with
financial experts, and electronic brokerage services.
ENTERTAINMENT. Online services and the Internet are a new form of media to
provide entertainment to consumers. CIS's entertainment news services, such as
Entertainment Drive, Hollywood Hotline and Soap Opera summaries, are used
extensively. Entertainment Drive offers CIS subscribers moderated chat sessions
with celebrities and other content focused on the entertainment industry.
Subscribers can also access movie reviews, restaurant ratings and a variety of
interactive and multi-player games. Important relationships with content
providers such as Time Warner provide CIS subscribers with a variety of other
entertainment-oriented offerings. In addition, CompuServe believes that
moderated forums and online chat serve as entertainment outlets for many CIS
subscribers. Yet additional entertainment opportunities are offered through
CompuServe's WOW! service.
COMMERCE. CompuServe has been a leader in establishing electronic commerce
through its CIS service. CIS subscribers have access to an electronic mall,
which gives them access (at no connect-time charge) to approximately 170
merchants who offer or advertise products online. Businesses utilizing CIS's
online merchandising opportunities include Land's End, J.C. Penney and Brooks
Brothers. CompuServe also offers subscribers a number of travel related
services. For example, CIS subscribers may check availability and make travel
plans and reservations online via several interactive travel services including
EasySabre, WorldSpan, Travel Shopper, and OAG Electronic Edition.
NETWORK SERVICES
CompuServe's Network Services offers its customers a fast and reliable data
communication system that can be customized to meet their particular
requirements. At its most basic level, Network Services provides data transport
services across CompuServe's network. In addition, CompuServe also provides its
customers with value-added services such as managed data network services,
whereby equipment is procured, configured, installed and managed by CompuServe
at the customer's location, and integrated communications solutions for its
customers which incorporate client software with CompuServe's network services.
CompuServe's value-added services enable customers to provide their
employees with remote dial and private line access to central LAN or host
servers. For example, CompuServe offers a crew scheduling service that allows
pilots and flight attendants to access flight schedules from their home PCs and
to submit requests for specific flights. This service is now used for crew
scheduling by all of the top U.S. carriers as well as British Airways and
Lufthansa. Other corporate customers using CompuServe's dial or leased line
services include Charles Schwab, TRW Inc., United Stationers and Federal Express
Corp. Other corporate customers utilize
6
<PAGE> 8
CompuServe's network to establish LAN to LAN connectivity as a high-speed
alternative to leased long distance lines. CompuServe provides LAN to LAN
connectivity and manages network equipment on the customer's premises for major
businesses such as Burger King and Charles Schwab. An emerging market exists for
CompuServe's Internet-based network services and expertise. Customers in this
growing field include Amdahl, Informix, Oracle UK and Southwest Airlines.
CompuServe is a leading provider of value-added data communication services
for point of sale authorization of credit card purchases. Since 1984, Network
Services has been providing point of sale authorization to Visa International,
Inc. Other transaction processing customers of CompuServe include National
Processing, Michigan National Bank and Harris Bank. In 1995, over 1.1 billion
credit card transactions were processed over CompuServe's network.
Network Services is also active in promoting and providing groupware
services for its customer base. CompuServe's groupware services permit a
customer to replicate and provide access to important and often proprietary data
to a large number of widely-dispersed users without compromising the integrity
of the original data. In this regard, Network Services is especially active in
providing Lotus Notes replication services to its customers such as
International Business Machines Corporation ("IBM"), Boston Chicken, Inc. and
the Arthur Andersen worldwide organization.
MARKETING AND DISTRIBUTION
SUBSCRIBER ACQUISITION AND RETENTION
CompuServe employs a number of approaches to position and strengthen its
brands in the consumer market place. The goal of these programs is to promote
subscriber acquisition and build long-term loyalty and increased usage by
providing the right combination of content and utility, customer support and
pricing for the targeted market segments.
MARKETING AND PROMOTION
CompuServe promotes its online services through a variety of marketing
efforts such as direct mail, publication inserts, national television
advertising and print advertisements in general business and specialty
periodicals. During fiscal 1996, CompuServe began a major new marketing and
distribution effort to capitalize on the growing interest in online services and
the Internet, spending approximately $160 million in 1996 for marketing and
distribution, an increase of nearly fourfold over 1995. The goals of the new
programs were to increase market awareness of the CompuServe name, communicate
targeted messages to different consumer audiences, and make it easier for
consumers to sample and subscribe to CompuServe's services. Major aspects of the
new programs included substantial increases in distribution of trial software
disks through direct mail, publication inserts and special event promotions,
increased general consumer advertising on television and in periodicals in
support of CIS and the WOW! introduction, and expanded international marketing
efforts. CompuServe plans to more narrowly tailor these efforts for fiscal year
1997, as management believes such action will enable CompuServe to better target
appropriate and distinct market segments and help manage the cost of these
programs. Also, new CIS subscribers receive ten free hours of access in their
first month. CompuServe believes that this industry-wide practice has been a
significant factor in encouraging new signups.
In common with other companies with which CompuServe competes, CompuServe
expects subscriber turnover as subscribers cancel for various reasons. Some
industry analysts believe that both existing and prospective online users will
examine the World Wide Web and the Internet as an alternative to online service
providers. Management of CompuServe believes this could be a cause of high
online turnover, as well as a cause of slowing new subscriber growth. Also,
while offering free access during an introductory period has significantly
encouraged new signups, it has also resulted in a higher percentage of
subscribers canceling in the first 90 days. Similarly, the types of marketing
and promotion recently undertaken by CompuServe can also have an impact on
subscriber retention rates. At April 30, 1996, CompuServe had retained
approximately six out of ten customers that had subscribed in the previous 90
days, five out of ten customers that had subscribed in the previous year and two
years, and four out of ten customers that had subscribed in the previous three
and four years. There can be no assurance that CompuServe's subscriber retention
rates will not decline below these levels.
CompuServe also cross-sells its online service through its Network Services
salesforce to corporate network customers. Microsoft Corp. ("Microsoft") has
agreed with CompuServe to place the CIS and WOW! icons in the online services
folder on the Windows 95 desktop, thus further enhancing market awareness and
accessibility of these key services. In addition, CompuServe has co-marketing
agreements with
7
<PAGE> 9
most major personal computer hardware and peripheral device manufacturers. For
example, CompuServe bundles its online access software with the hardware shipped
by PC manufacturers, which gives the new PC owner an easy and immediate
opportunity to sign up for CompuServe service. CompuServe also has co-marketing
agreements with a number of its content providers.
CompuServe is also pursuing co-branding opportunities with, among others, a
number of airline and hotel affinity programs. Under this strategy, CompuServe
assists the program partner in establishing access to member accounts through
CIS, and the affinity program partner assists CompuServe in marketing and
distributing CIS access software to its members. CompuServe has entered into
similar co-branding opportunities through SPRYNET with such companies as
Marriott and PC World magazine.
Most of the marketing initiatives begun in fiscal 1996 are continuing in
fiscal 1997. However, CompuServe plans to delay certain advertising and
marketing programs until the release of CompuServe Information Manager ("CIM")
3.0, currently scheduled for the late summer of 1996, and also plans to more
narrowly focus its fiscal 1997 marketing for CIS on key market segments. In
addition to the improvements expected from CIM 3.0, its proprietary interface,
CompuServe also plans on continued improvements in its technical infrastructure.
CompuServe expects to see developments to enhance the effectiveness of its
overall marketing and distribution efforts, and technical infrastructure as
described elsewhere herein.
CUSTOMER SUPPORT
To complement its marketing efforts, CompuServe has invested in customer
service to improve customer retention. During 1996, CompuServe more than doubled
its customer service personnel worldwide (including outsourced personnel),
increased incoming telephone lines in the United States by 100% and introduced
an improved automated call handling system. These efforts have reduced busy
signals when customers call for assistance and enhanced response time to
customer questions. CompuServe plans to continue to monitor its customer service
function to optimize staffing in light of costs, benefits and the effects of
improvements the Company is able to achieve in the quality of its online
services and network and overall ease-of-use of its information services.
Related to this customer service focus, the new CIS interface, CIM 3.0, will
incorporate enhanced orientation and assistance features to facilitate use by
new subscribers.
PRICING
CIS subscribers currently pay a membership fee of $9.95 per month entitling
them to five hours of service with additional hours costing $2.95 per hour. CIS
also offers a pricing package for more frequent users, charging $24.95 per month
for 20 hours of service with additional hours costing $1.95 per hour. Certain
CIS services are subject to surcharges in both pricing packages. SPRYNET offers
three pricing packages: $19.95 per month for unlimited usage, $4.95 per month
for three hours of service with additional hours costing $1.95, and $9.95 per
month for seven hours of service with additional hours costing $1.95 per hour.
WOW! is available for $17.95 per month for unlimited usage. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Pricing."
NETWORK SERVICES
Network Services employs approximately 390 sales associates. CompuServe
maintains 33 offices in North America and Europe, and has sales and support
capabilities in each of its offices. CompuServe believes that its sales and
support personnel are a key competitive advantage in the network services
market. Unlike some of CompuServe's competitors, CompuServe's personnel are
exclusively data communication oriented. CompuServe believes that this focus
results in more rapid and effective customer support. Network Services' sales
associates also afford CompuServe immediate contacts for potential cross-selling
opportunities with Online Services.
DELIVERY OF ONLINE SERVICES
INTERFACES TO COMPUSERVE'S SERVICES
A major factor affecting subscriber satisfaction with an online service is
the appearance and utility of the user interface which controls how a subscriber
can navigate the service. Subscribers navigate within a service by clicking on
icons or words, or by entering text-based instructions via a keyboard.
In November 1995, CompuServe introduced for CIS the CIM 2.0.1 interface
with an integrated Internet World Wide Web browser and the ability to move
between CIS and related Internet areas. CompuServe makes available at no
additional charge to subscribers of CIS and WOW! parental control software that
assists
8
<PAGE> 10
parents in controlling their children's access to content. In late summer 1996,
CompuServe expects to introduce CIM 3.0 which will have an easier to use
graphical interface, integrated Internet access and upgradable modules. CIM 3.0
will also feature the Internet Explorer browser from Microsoft, which will be
closely integrated into CIM 3.0 for greatly enhanced ease of use.
WOW!'s interface features two "views," one for adults and one for children.
Each view is a simple and appealing graphical interface that permits the user to
navigate the service in a minimum of steps without getting lost. While the views
present different content and functions (e.g., the children's view does not
permit users to conduct electronic commerce or engage in online chat, and
Internet access is limited to sites deemed appropriate for children), both are
built on a simple grid that identifies a "place" on WOW! as the intersection of
content and function. Parents are able to enjoy the full power of an online
service while providing their children with a safe interactive experience.
WOW! currently is available only for computers using Microsoft's Windows 95
operating system and only in CD-ROM format which, management believes, represent
the majority of PCs currently being sold for home use. WOW! also features
Microsoft's Internet Explorer browser.
SPRYNET permits CompuServe's Internet-access-only customers to utilize
CompuServe's Mosaic World Wide Web browser as well as any other browser the
customer prefers, including the industry leaders, Microsoft's Internet Explorer
and Netscape's Navigator.
The Company supports open standards, and believes that access to the
Company's proprietary online services will eventually be available through
Internet browser software. Recently, the Company announced that its services
would adopt Internet-based open standards. Ultimately, this will allow users who
are subscribers to enter the fee-based service with standard browser software as
well as the proprietary CompuServe Information Manager software (CIM). The open
standards approach also will allow developers to more easily create and provide
content that can be offered by the Company. The Company and Microsoft jointly
unveiled their alliance to deploy Microsoft's new Normandy platform for
commercial Internet services. The Company is the first company to license the
Normandy technologies, the most advanced Internet platform solution designed
specifically for online/Internet service providers and commercial Web
publishers.
MULTIMEDIA AND CD-ROM
CompuServe views CD-ROM as an opportunity to enhance the online experience
of its subscribers. In 1994, CompuServe introduced its own subscription CD-ROM.
This product allows CompuServe to present information with text, graphics, video
and sound enabling the user to sample music, items for purchase online and
software that would take considerable time to download. Links on the CD-ROM can
be activated so that additional and more current information on the subject
becomes available to the user. CompuServe has also entered into a series of
arrangements with producers of CD-ROM products such as encyclopedias to include
links to CIS to provide the latest updates on the subject, thereby keeping the
purchaser's investment current.
INTERNET ACCESS
CompuServe provides Internet access services through WOW! and CIS and also
through SPRYNET, CompuServe's stand-alone Internet-access-only service for both
the consumer and business markets. A CIS subscriber using the current version of
CIM (and a WOW! subscriber using the adult "VIEW") may fully utilize the
Internet. In addition, during an online session, a CIS subscriber using the
current CIM version has seamless access to both CIS's proprietary content and
some of the more popular Internet-based features. CompuServe believes CIS and
WOW! provide subscribers a value-added approach to the Internet through its
content direction, which makes finding useful material on the Internet easier.
CONTENT PROVIDERS AND ALLIANCES
CompuServe actively recruits new information providers to expand and
enhance the appeal of its consumer online service offerings. CompuServe
currently has content agreements with more than 200 providers. While each
agreement may contain its own unique terms, these contracts generally provide
for a duration of one to two years, with automatic renewal, and usually provide
for a range of fixed and variable fees, which depend upon subscriber usage of
the content.
CompuServe believes it is a leader in providing high quality branded
content. For example, CompuServe has an exclusive arrangement with Time Warner
to provide the online versions of its Time, Fortune, Money, People and Sports
Illustrated magazines in the consumer online market. Due to the increasing
competition in
9
<PAGE> 11
the consumer online industry and the growth of the World Wide Web on the
Internet, CompuServe has seen an increase in the cost of well-known branded
content.
Whenever possible, CompuServe seeks exclusive arrangements with its content
providers. Many providers are free to make the same or similar data available on
an Internet site they might operate or sponsor. Other providers, and in
particular the managers of forum areas on CIS, are contractually restricted from
providing similar information in a manner competitive with CompuServe, often
expressly including the Internet. Because CompuServe is a major Internet access
provider, however, it can be beneficial to CompuServe even if a provider places
similar content on the Internet since CompuServe often can arrange to be the
Internet access provider of choice in such cases and is able to enter into other
advantageous arrangements with these content providers, such as cross-marketing.
CompuServe also has arrangements with AT&T by which AT&T's WorldNet
subscribers can access CIS on a discounted basis, and an alliance with Time,
Inc. by which CompuServe subscribers can access -- at no additional charge --
Time's new Power Pathfinder service. These are examples of how CompuServe plans
to integrate the increasing popularity of the World Wide Web and the entire
Internet with its proprietary online services to produce a synergistic,
value-added experience for both existing and new users worldwide.
CompuServe believes that its relationships with content providers, which
have been developed over 15 years, are an important competitive advantage.
As competition in the online services market continues to intensify, it is
becoming more difficult and expensive to secure and retain content and content
providers. CompuServe generally pays royalties to its content providers under
short-term renewable agreements. While CompuServe does not believe that any
single content provider is material to its operations, there can be no assurance
that the loss of a number of content providers or significantly increased costs
to maintain certain content providers would not have a material adverse effect
on CompuServe's business. In addition, with the increasing popularity of the
Internet and the ease of establishing a presence thereon, content providers may
choose to distribute or otherwise make available their content on the Internet
directly rather than through OSPs. Although CompuServe believes that OSPs offer
advantages to content providers that the Internet does not, there can be no
assurance that content providers will continue to distribute their content
through OSPs and that current and prospective online customers will not look to
Internet access alone to satisfy their electronic information and interactive
demands.
OTHER BUSINESS
In addition to Online Services and Network Services, CompuServe continues
to provide certain computer hosting services to certain corporate customers.
CompuServe's other businesses contribute a small percentage of its revenues and
are expected to decline in importance in the future.
NETWORK, HOST SERVER INFRASTRUCTURE AND PROPERTIES
CompuServe's customers connect to its network through their PCs -- the
"client" computer. These connections are established through local access, or
toll-free or long distance services where local access is unavailable.
CompuServe has the capability to provide local access to over 90% of the U.S.
population living in metropolitan areas of 25,000 people or more. CompuServe's
network connects clients to computers that act as "servers" to store data to be
accessed by clients. Servers comprise an array of computers owned by CompuServe,
its corporate customers or entities connected to the Internet. Network
connection is made through a variety of communications hardware, such as
telephone lines, switches and routers, which serve to direct data and enable
communication over a variety of computer operating systems. All other customers
can access the network through toll-free numbers. On average, CompuServe's
customers are able to connect to the network on their first attempt between
95.5% and 96.5% of the time, with the lower success rate being during peak
usage. Depending on the type of connection, customers may also experience a
failure to successfully negotiate a connection an additional approximately two
percent of the time. The network is deployed in over 460 POPs worldwide. The
POPs are located throughout the world in leased office space. A number of these
POPs are in H&R Block tax offices and are subject to arms-length leases,
typically terminable upon 90 days notice by either party. CompuServe believes
that any or all of these lease agreements could easily be replaced upon similar
terms within the 90 days notice of termination required by the leases. The
network consists of a backbone comprised of broadband lines leased from common
carriers, approximately 7,500 digital switches (nodes) manufactured and deployed
by CompuServe, and over 60,000 dial-in ports connected to local exchange
carriers. Based on currently projected demand from more users wanting greater
bandwidth,
10
<PAGE> 12
CompuServe expects to have approximately 85,000 dial-in ports by the end of
fiscal year 1997, all accessible at 28.8 kbps access speeds. Via point-to-point
protocol conversion, CompuServe enables its users to access the Internet from
any of its dial-in ports.
On average, the measured throughput of CompuServe's network, including CIS,
is 90% of modem speed. However, customers may experience decreased throughput
depending on the time of day, the area of the network accessed and temporary
hardware or software problems. CompuServe continually monitors network
throughput and makes necessary hardware and software adjustments to maximize
network throughput.
CompuServe maintains three physically distinct and remote data centers in
the Columbus, Ohio vicinity, each one supplied with two independent sources of
commercial power as well as diesel generators to provide emergency back-up
power. Telecommunications connectivity for each center is from a separate
Ameritech central office and all three centers are connected by a fiber optic
ring for redundancy. Three types of host server technologies are currently
employed: Systems Concepts SC-30/SC-40 36 bit servers run under a proprietary
operating system; DEC Vax servers run VMS; and Intel 32 bit machines run Windows
NT. In total, CompuServe operates approximately 1,575 servers and maintains
approximately one terrabyte of storage. CompuServe is in the process of
migrating its servers to the Windows NT environment.
CompuServe's executive offices are located in an office complex in
Columbus, Ohio owned by CompuServe. CompuServe also owns and occupies two other
facilities in the Columbus area, one of which is a multi-building facility that,
although currently under construction, is nearing completion and is already
significantly populated. CompuServe plans to take occupancy of the remainder
during calendar 1996. CompuServe leases office space in other buildings in the
Columbus area and in a number of locations in the United States and Europe.
Management of the software and hardware which comprise CompuServe's
technology is a complex undertaking. CompuServe has generally released new
software and deployed new computer and data communications hardware on a timely
basis. When delays have been encountered, they have not been material to
CompuServe's operations. Unlike its major OSP and ISP competitors, CompuServe
has its own engineering and manufacturing capabilities that traditionally have
permitted it to create proprietary hardware for its network. Examples include
company developed communications switches. Although CompuServe believes that
this expertise has in the past permitted it to more quickly implement a more
reliable and cost-effective infrastructure, this has been challenged by
CompuServe's new open standards initiative which recognizes that advances in
architecture technology have been difficult to keep pace with while CompuServe
is simultaneously competing in its core online services business. This has led
CompuServe to adopt a buy-versus-build bias to its infrastructure, an approach
that has been carried over to CompuServe's network and hardware, as well as to
its operating system and protocol decisions.
CompuServe is also investigating acquisition and implementation of a new
customer billing and information management system to upgrade or replace its
current proprietary system which has become difficult to use and maintain.
EMPLOYEES
As of April 30, 1996, CompuServe had approximately 3,650 full-time
employees. None of CompuServe's employees are covered by collective bargaining
agreements. CompuServe believes that its relations with its employees are good.
INTELLECTUAL PROPERTY
CompuServe holds a variety of trademark, copyright, patent and other
intellectual property rights. For example, CompuServe has registered the name
CompuServe and has made application to register the name WOW! with the United
States Patent and Trademark Office. CompuServe has developed proprietary
hardware solutions, such as telecommunications switches and modems, and software
which CompuServe believes have given it a competitive advantage. CompuServe has
filed several patent applications covering certain elements of its technology.
All of CompuServe's software is under the protection of the copyright laws and
other laws.
In addition to copyright and patent protection, CompuServe attempts to
protect its proprietary technology under trade secret laws, employee and
third-party non-disclosure agreements and other methods of protection.
CompuServe grants its customers a license to use CompuServe's products and
services under agreements that contain terms and conditions prohibiting the
unauthorized reproduction of CompuServe's products. Despite these precautions,
it may be possible for unauthorized third parties to copy certain portions of
CompuServe's
11
<PAGE> 13
products or reverse engineer or obtain and use information CompuServe regards as
proprietary. While CompuServe's competitive position may be affected by its
ability to protect its proprietary information, due to the technological
innovation within CompuServe's industry, CompuServe believes that patent and
copyright protections are less significant to CompuServe's success than other
factors, such as the knowledge, ability and experience of CompuServe's
personnel, name recognition and on-going product development and customer
support.
CompuServe believes that its software, products, and services do not
infringe on the proprietary rights of third parties. From time to time, however,
CompuServe has received communications from third parties asserting that
features or content of certain of its services may infringe copyrights and other
rights of such party. To date, no such claims have had a material adverse effect
on CompuServe's ability to develop, market and sell its products or operate its
services. There can be no assurance that third parties will not assert
infringement claims against CompuServe in the future with respect to current or
future products or services. In fact, management believes there may be an
increase in claims of this sort as the importance of software patents grows and
as lucrative means of leveraging inventions, as applied to this still-developing
interactive information industry, are sought. These kinds of assertions could
require CompuServe to enter into royalty arrangements or result in costly
litigation.
GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES
In the United States, CompuServe is not currently subject to direct
regulation other than federal and state regulation applicable to businesses
generally. However, changes in the regulatory environment relating to the
telecommunications and media industry, including the areas of privacy and
regulation of content deemed to be inappropriate for children, indecent or in
other ways improper, could affect CompuServe's business. A portion of the
recently adopted telecommunications reform legislation in the United States, the
Communications Decency Act, generally makes it illegal for persons to knowingly
use an interactive computer service to send or display "indecent" communications
to minors or to knowingly and intentionally permit a telecommunications facility
controlled by such persons to be used for such purposes. A number of defenses
are expressly provided in the Communications Decency Act that may be available
to OSPs and ISPs. Soon after its enactment on February 8, 1996, the
Communications Decency Act was challenged in federal court on constitutional
grounds. Such challenge has caused its enforcement to be halted, although it is
not certain that such cessation will continue throughout the entire litigation
process. A special three-judge panel in June, 1996, found that the
Communications Decency Act was in large part unconstitutional; that decision is
currently under appeal to the United States Supreme Court. CompuServe cannot
predict whether the Communications Decency Act will ultimately be upheld or how
a court would interpret the Communications Decency Act, including its defenses.
There also are laws that make it illegal to traffic in obscene or child
pornographic materials, including by computer. While CompuServe does not believe
that its activities will violate these laws, it cannot predict how a court would
interpret any of these laws in the online or Internet context or whether a court
would hold that there is a duty on CompuServe to monitor material being
transmitted or, if notified that illegal material is being transmitted, to
attempt to stop or restrict such transmissions.
In November 1995, CompuServe was presented by local authorities in Munich,
Germany with a list of more than 200 Internet newsgroups that they asserted
contained material that was illegal to make available to minors or was otherwise
illegal to disseminate in Germany. In response, CompuServe temporarily suspended
access to most of the newsgroups on the list pending further investigation. In
addition, CompuServe has been advised that a prosecutor in Mannheim, Germany is
investigating CompuServe and other providers of Internet access in Germany
because of a World Wide Web home page containing neo-Nazi material. The
prosecutor is investigating to determine whether providing access to this home
page violates German laws prohibiting dissemination of certain neo-Nazi and
other ethnically offensive material.
In response to market needs and CompuServe's desire to place greater access
control in the hands of adults, and in contemplation of content regulation
initiatives under way both in the United States and abroad, including the
Communications Decency Act, CompuServe makes available at no additional charge
to subscribers parental control tools that assist parents in controlling their
children's access to content. CompuServe cannot predict whether providing
parental control capabilities will satisfy present or future laws regulating
access to indecent communications or other types of content.
Additionally, the applicability to OSPs and ISPs of existing laws governing
issues such as intellectual property ownership, defamation and personal privacy
is uncertain. Courts have indicated that, under certain circumstances, OSPs and
ISPs could be held responsible for the publication of defamatory material or for
12
<PAGE> 14
failure to prevent the distribution of material that infringes on others'
copyrights. While CompuServe historically has generally avoided editing or
otherwise monitoring the content accessed by its customers, it intends to engage
more actively in the selection, presentation and editing of relevant content in
connection with its information services, especially WOW!. The future
interpretation by the courts relating to online defamation, privacy, copyright
infringement and other legal issues is uncertain.
CompuServe is aware of certain industry requests of the FCC to review the
impact of Internet usage on U.S. telecommunications service including the
generally lower cost structure for local connections regarding data versus voice
transmission. FCC regulatory review and rulemaking could result in new
regulation of the Internet and online industry, changes in current rules
governing telecommunications or both. In turn, this could result in increased
telecommunications costs for the Internet and online industry, including
CompuServe. CompuServe cannot predict whether or to what extent any such new
rulemaking will occur.
The online and Internet industry currently is under close scrutiny and
inquiry by the Federal Trade Commission, taxing authorities and a number of
state attorneys general. Additional federal, state and local government agencies
may also scrutinize such industry or initiate inquiries. Costs incurred as a
result of government inquiries, initiatives, investigations or lawsuits relating
to any of the foregoing (as well as process or business changes resulting
therefrom) could have a material adverse effect on CompuServe's business,
financial condition or results of operations.
COMPETITION
CompuServe competes in the online services industry as well as in the
Internet and networking services industries. Each of these industries is highly
competitive and includes a number of significant participants. CompuServe's
primary direct competitors in the proprietary online services industry are
America Online, Inc. ("AOL") and Prodigy Services Company. In the Internet-based
online services industry, CompuServe has several competitors, principally
Microsoft Network ("MSN"), a venture led by Microsoft. Among the larger Internet
service providers ("ISPs") competing with CompuServe in the Internet-access-only
business are AT&T Corp. ("AT&T"), MCI Telecommunications Corporation ("MCI"),
NETCOM On-Line Communications Services, Inc., Earthlink, BBN Corporation, AOL's
GNN service, PSINet Inc. and UUNET Technologies, Inc. CompuServe's Network
Services business competes with local and international telecommunications
companies and other data communications services, including AT&T, MCI, Sprint
Corp., Advantis, a joint venture of IBM and Sears, Roebuck & Co., Electronic
Data Systems, Inc. and British Telecom plc. An increasing number of publishing,
broadcasting and other media and technology companies are expected to enter the
online services market, either directly or through alliances, in order to
enhance distribution of their content and programming. Regional telephone
operating companies, long distance carriers and cable companies may also enter
the markets served by CompuServe. Many of the competitors and possible future
competitors referred to above have significantly greater financial, technical,
marketing and personnel resources than CompuServe.
Microsoft's position as the leading personal computer operating system
software company may continue to give MSN certain competitive advantages,
including distribution and marketing synergies. Management believes that MSN may
yet enjoy a cost advantage relative to other online services, including
CompuServe's, in terms of distribution through OEMs, as the MSN software is
included with Microsoft's Windows 95 operating system. Other online services,
including CompuServe, traditionally have needed to make payments to OEMs to have
their software pre-loaded onto new PCs. It is unclear whether Microsoft incurs
any costs for the distribution of MSN through the OEM channel. Microsoft has
agreed to bundle CompuServe's icons and interface software for CIS and WOW! with
Windows 95. CompuServe cannot predict the extent to which technical, economic,
competitive or other pressures will arise to affect the relative benefits of
this development.
CompuServe recently entered into a non-exclusive agreement with AT&T
pursuant to which AT&T's WorldNet subscribers will be offered discounted access
to CompuServe. CompuServe also signed license and marketing agreements with
Microsoft and Netscape Communications, Inc. ("Netscape") under which CompuServe
will license the Microsoft and Netscape browsers. Under the Microsoft
arrangements, CompuServe will place two icons in the Windows 95 desktop folder
for online services -- one for CIS and one for WOW! These arrangements will help
provide simple and widespread access to CompuServe's CIS and WOW! services.
CompuServe has also recently entered into an agreement with Time Inc. New Media,
an affiliate of Time Warner Inc., whereby CompuServe will begin offering to CIS,
SPRYNET and WOW!
13
<PAGE> 15
subscribers, at no charge, access to two new Time Inc. New Media services that
will be available to non-members on a paid subscription basis.
CompuServe believes that the principal competitive factors in the consumer
online services industry include the ability to aggregate engaging content, ease
of use, established user base, brand name awareness, competitive pricing,
customer service, and a low cost and reliable network infrastructure. CompuServe
believes that its extensive existing network infrastructure and reliability,
breadth and depth of content for CIS, brand name recognition and large user base
have been its competitive advantages in the consumer online services industry.
Recent changes to CompuServe's pricing structure, the introduction of WOW! and
CIM 3.0, customer care initiatives and infrastructure improvements are expected
to enhance CompuServe's position as a leader in the consumer online industry.
The main competitive factors in the Network Services business are the number and
location of POPs, speed, bandwidth and reliability of the network, sales and
support able to meet the needs of customers and competitive pricing. CompuServe
believes that its ability to meet the needs of its customers with respect to
these factors, as well as its ability to differentiate itself by providing
value-added services to its customers, have been its competitive advantages in
the Network Services business.
In addition to competing against other OSPs and ISPs to attract
subscribers, CompuServe also competes to retain subscribers once they have
signed with one of CompuServe's services. Industry subscriber attrition rates,
or the rates at which subscribers leave an online service, continue to be high.
CompuServe is introducing a number of initiatives to reduce attrition and
increase usage. There can be no assurance that these initiatives will be
successful. Sustained high rates of attrition would materially and adversely
affect CompuServe's business, financial condition and results of operations.
Management believes that competitive pressures on pricing will continue as
current and new Internet and online providers seek to increase market share.
Price changes and possible increased spending in areas, such as marketing and
product development, could limit CompuServe's opportunities to enter into and
renew agreements with content providers and distribution partners, develop new
products and services, and continue to grow its subscriber base, all of which
could result in increased attrition of CompuServe's subscribers. Any of these
events could have a material adverse effect on CompuServe's business, financial
condition and results of operations.
GLOSSARY
ATM Asynchronous Transfer Mode. An information transfer
standard for routing traffic based on an address
contained within the first five bytes of a fifty-three
byte-long, fixed length data packet.
Backbone A centralized high-speed network that interconnects
smaller, independent networks.
Bandwidth The number of bits of information which can move through
a communications medium in a given amount of time.
Broadband A telecommunications transmission facility that has a
bandwidth greater than a voice grade line, for example
T-1 and T-3 lines.
Data packet A data transmission technique whereby information is
segmented and routed in discrete data envelopes called
packets, each with its own appended control information
for routing, sequencing and error checking.
Frame-relay An information transfer standard for relaying traffic
based on an address contained in the header of a variable
length data packet that is up to 2,106 bytes long.
Frame-relay has less overhead than ATM but may be
difficult to operate at speeds greater than 45 Mbps.
Graphical user
interface A means of communicating with a computer by manipulating
icons, menus and windows rather than using text commands.
Groupware Software which permits multiple users of data to
retrieve, use and manipulate information within a
controlled environment over a network.
Home page An entry point for a collection of information presented
through the World Wide Web.
14
<PAGE> 16
Internet A global collection of interconnected data communications
networks which use TCP/IP, a common communications
protocol.
ISDN Integrated Services Digital Network. An information
transfer standard for transmitting digital voice and data
over telephone lines at speeds up at 128 kbps.
ISP Internet service provider.
Kbps Kilobits per second. A data transmission rate. One
Kilobit equals 1,024 bits of information.
LAN Local Area Network. A data communications network
designed to interconnect personal computers,
workstations, minicomputers, file servers and other
communications and computing devices within a localized
environment.
Mbps Megabits per second. A data transmission rate. One
megabit equals 1,024 kilobits.
Modem A device for transmitting digital information over an
analog telephone line.
Node The point in a network which connects a single computer
to the network.
Online services Commercial information services that offer a computer
user access to a specified slate of information,
entertainment and communications menus on what appears to
be a single system.
OSP Online service provider.
PC Personal computer.
POPs Points-of-presence. Geographic areas within which OSPs
and ISPs provide local access.
Port The interface through which data is transmitted into or
out of a computer.
PPP Point-to-Point Protocol. An information transfer standard
for transmitting data packets over network connections
between two points.
Router A system placed between networks that relays data to
those networks based upon a destination address contained
in the data packets being routed.
Shareware Software that is uploaded by its owner to an online
service or the Internet for use by others, and usually
paid for after a trial period.
TCP/IP Transmission Control Protocol/Internet Protocol. A suite
of network protocols that allow computers with different
architectures and operating system software to
communicate with other computers on the Internet.
T-1 A data communications circuit capable of transmitting
data at 1.5 mbps (sometimes called DS-1).
T-3 A data communications circuit capable of transmitting
data at 45 mbps (sometimes called DS- 3).
Unix A computer operating system frequently found on work
stations and PCs and noted for its portability and
communications functionality.
Wide area network A data communications network designed to interconnect
personal computers, workstations, microcomputers, file
servers and other communications and computing devices
that covers an area larger than a single building or
campus.
World Wide Web or
Web A collection of computer systems supporting a
communications protocol that permits multi-media
presentation of information over the Internet.
ITEM 3. LEGAL PROCEEDINGS
In July 1996, the Company and H&R Block were each served with a Summons and
Class Action Complaint in a case entitled Greenfield v. CompuServe Corporation,
et al. and filed in the Court of Common Pleas, Franklin County, Ohio. Also in
July 1996, a second suit was filed against the Company and H&R Block, in federal
district court for the Southern District of Ohio, entitled Romine v. CompuServe
Corporation, et al.. These complaints (the "Complaints") also name the directors
and certain officers of CompuServe at
15
<PAGE> 17
the time of the IPO and allege violations of the Securities Act of 1933, the
Ohio Securities Code and common law. The Company intends to vigorously defend
the litigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
CompuServe Corporation common stock began trading on April 19, 1996 on the
Nasdaq Stock Market, under the symbol "CSRV". As reported by the NASDAQ Stock
Market, the high and low sales prices were as shown below:
<TABLE>
<CAPTION>
FOR THE QUARTER ENDED HIGH LOW
--------------------------------------------------- ------- ------
<S> <C> <C>
April 30, 1996..................................... $ 35.50 $27.75
</TABLE>
CompuServe Corporation has never declared, nor has it paid, any cash
dividends on its Common Stock. The Company currently intends to retain its
earnings to finance future growth and, therefore, does not anticipate paying any
cash dividends on its Common Stock in the foreseeable future. During the year
ended April 30, 1995, CompuServe Incorporated declared a non-cash dividend of
$272.4 million to H&R Block Group, Inc. Any determination as to the payment of
dividends will depend upon the future results of operations, capital requirement
and financial condition of the Company and its subsidiaries and such other
factors as the Board of Directors of the Company may consider, including any
contractual or statutory restrictions on the Company's ability to pay dividends.
As of July 12, 1996, there were approximately 1,000 shareholders of record
and approximately 20,000 beneficial holders of CompuServe Common Stock.
16
<PAGE> 18
ITEM 6. SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
<TABLE>
<CAPTION>
YEAR ENDED APRIL 30,
--------------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
OPERATING RESULTS:
Revenues:
Online Services revenues................ $561,428 $395,954 $266,919 $174,882 $124,559
Network Services revenues............... 198,828 147,673 109,402 81,740 63,097
Other revenues(a)....................... 32,909 39,166 53,565 58,777 78,808
--------- --------- --------- --------- ---------
Total Revenues............................ 793,165 582,793 429,886 315,399 266,464
Costs and Expenses:
Costs of revenues....................... 387,470 231,189 179,366 125,642 122,974
Marketing(c)............................ 175,213 104,828 65,591 51,542 41,763
General and administrative.............. 39,634 30,750 32,641 30,199 24,972
Depreciation and amortization........... 74,708 45,310 31,447 22,198 13,679
Product development..................... 28,304 18,929 16,101 10,403 8,499
Purchased research and development(b)... 83,508
--------- --------- --------- --------- ---------
Total Costs and Expenses.................. 705,329 514,514 325,146 239,984 211,887
--------- --------- --------- --------- ---------
Operating earnings........................ 87,836 68,279 104,740 75,415 54,577
Interest expense to Parent................ 5,555 -- -- -- --
--------- --------- --------- --------- ---------
Earnings before taxes..................... 82,281 68,279 104,740 75,415 54,577
Taxes on earnings......................... 33,187 59,481 42,647 29,838 21,591
--------- --------- --------- --------- ---------
Net earnings(c)........................... $ 49,094 $ 8,798 $ 62,093 $ 45,577 $ 32,986
========= ========= ========= ========= =========
Earnings per share........................ $ .66 $ .12 $ .84 $ .61 $ .44
========= ========= ========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
AS OF APRIL 30,
--------------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Total assets.............................. $965,828 $323,557 $330,867 $240,365 $174,173
Cash, cash equivalents and investments.... $310,991 $ 4,913 $ 3,633 $ 3,669 $ 5,158
Due to Parent............................. $142,400
Stockholders' equity...................... $770,666 $ 79,858 $241,677 $179,389 $133,780
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED APRIL 30,
--------------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT NETWORK SERVICES CUSTOMERS)
<S> <C> <C> <C> <C> <C>
OTHER DATA:
Online subscribers:
North America........................... 2,336 1,765 1,139 780 612
International........................... 1,016 456 239 144 114
-------- -------- -------- -------- --------
Total USA hosted........................ 3,352 2,221 1,378 924 726
Licensee................................ 1,674 809 640 480 350
-------- -------- -------- -------- --------
Total online subscribers.................. 5,026 3,030 2,018 1,404 1,076
Total online subscriber hours............. 123,023 50,326 27,271 14,123 8,646
Network Services customers................ 966 743 586 484 377
Total network customer hours.............. 45,146 31,539 20,058 14,149 10,283
</TABLE>
17
<PAGE> 19
QUARTERLY DATA:
<TABLE>
<CAPTION>
FISCAL 1996 QUARTER ENDED FISCAL 1995 QUARTER ENDED
--------------------------------------------- -----------------------------------------------
JULY 31 OCTOBER 31 JANUARY 31 APRIL 30 JULY 31 OCTOBER 31 JANUARY 31 APRIL 30
1995 1995 1996 1996 1994 1994 1995 1995
-------- ---------- ---------- -------- -------- ---------- ---------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues......... $186,549 $188,374 $203,032 $215,210 $127,896(a) $136,631 $154,172 $ 164,094
Costs and
Expenses......... 140,944 164,639 185,785 213,961(d) 93,855 101,771 112,500 206,388
Net Earnings
(Loss)(c)...... 26,835 13,966 9,398 (1,105) 20,699 21,196 25,320 (58,417)(b)
Earnings (Loss)
per Share...... $ .36 $ .19 $ .13 $ (.02) $ .28 $ .29 $ .34 $ (.79)
</TABLE>
- ---------------
(a) Other revenues include the operations of, and the gain of $2,680 on the sale
of, Collier-Jackson, Inc. sold in June 1994, and the operations of other
businesses sold in 1993 and 1994 which are not considered significant.
(b) The Company recorded a charge for purchased research and development of
$83,508 in connection with the acquisition of SPRY in April 1995, which is
not deductible for income tax purposes. See note 3 of notes to the
consolidated financial statements.
(c) On May 1, 1995, the Company changed its method of accounting for direct
response advertising costs to conform with the American Institute of
Certified Public Accountants Statement of Position 93-7, "Reporting on
Advertising Costs." Effective February 1, 1996, the Company changed further
the method of accounting for these costs. The net effect of these changes in
accounting was to increase assets by $96,636 as of April 30, 1996. Net
earnings increased $6,271, $9,310, $23,587, and $18,524 for the quarters
ended July 31, 1995, October 31, 1995, January 31, 1996 and April 30, 1996,
respectively and $57,692 for the year ended April 30, 1996. See note 2 of
notes to the consolidated financial statements and "New Accounting
Standards" in "Item. 7 -- Management's Discussion and Analysis of Financial
Condition and Results of Operations".
(d) During the fourth quarter of fiscal 1996, the Company reduced certain
accruals for incentive compensation and value added taxes totalling $7,000.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
CompuServe Corporation is a majority owned subsidiary of Parent, which is a
wholly owned subsidiary of H&R Block. On April 4, 1995, H&R Block acquired SPRY
for $101.6 million. On January 30, 1996, H&R Block contributed its interest in
SPRY to the Company. The Company's consolidated financial statements include the
accounts of SPRY since the date of acquisition by H&R Block. For additional
information relating to this acquisition, see note 3 of notes to the
consolidated financial statements.
On April 19, 1996, the Company completed an initial public offering of
18,400,000 shares of its common stock at $30 per share. This transaction reduced
Parent's ownership to 80.1%. On July 16, H&R Block announced that its Board of
Directors had approved plans to Spin-off H&R Block's remaining 80.1% interest in
CompuServe. The Spin-off is subject to, among other things, shareholder approval
at H&R Block's annual meeting expected to take place in September 1996 and a
favorable ruling from the Internal Revenue Service as to the tax-free nature of
the Spin-off. H&R Block announced that it expects the Spin-off to be completed
on or about November 1, 1996.
The Company's revenues have increased significantly over the last three
years, primarily because of the growth in subscriber count driven by the rapidly
expanding market for consumer online and Internet services, and because of
Network Services revenue growth due to market and market share increases. Online
Services revenues are generated principally from subscribers paying a monthly
membership fee and charges based on usage. Since these members pay a monthly
fee, the Company considers them to be active. The usage of the service by
members who have a complimentary account is not material. Royalties received
from NiftyServe, a licensee of the Company's online technology, represent less
than 1% of the Online Services revenues. The Company does not expect royalties
received from NiftyServe to materially change in the future. Network Services
revenues are generated based upon terms negotiated as to price and duration.
Other revenues consist primarily of computer hosting services to certain
corporate customers and network services to H&R Block.
Traditionally both the acquisition and usage patterns of Online Services
subscribers were seasonal from October to March. However, because of the
increase in acquisition rates due to both the Company's continuing promotional
activities throughout the year and the overall growth in the industry, the
effects of this seasonality in the last year was offset somewhat as a
significant factor in the business. Historically, there has been no seasonality
in the Company's Network Services business.
18
<PAGE> 20
PRICING
Competitive dynamics in the online services market have resulted in a
series of price decreases by the major online service providers over the last
three years. Historically, CompuServe has made these price adjustments in
February and the adverse impact of such price reductions on earnings has been
more than offset by increased volume and economies of scale.
In September 1995, CompuServe introduced a new pricing schedule for CIS
intended to encourage subscribers to explore more features of the service, stay
on the service longer and increase CIS's price competitiveness with the other
major consumer online services. The new pricing schedule has reduced revenue per
subscriber but has contributed to significant increases in subscriber
acquisitions and usage.
The change in pricing in September 1995 followed a change in pricing the
preceding February, the month in which the Company had typically reviewed and
adjusted pricing in previous years. The two price changes in less than 12 months
affect the comparison of revenues, earnings and revenues per customer compared
to the preceding year. Historically, declines in pricing have been offset by
increased usage and economies of scale. However, increased usage and economies
of scale have not yet fully offset the impact of the September 1995 price
change. Management believes that competitive pressures on pricing will continue
as current and new Internet and online providers seek to increase market share.
Management believes that potential new sources of revenues such as advertising
and transaction processing will help offset the effects of potential future
price decreases and declines in revenue per customer.
In addition, the Company has recently begun offering fixed pricing for
SPRYNET and for WOW!, but does not yet have sufficient data available to
determine the impact of such pricing on results of operations or liquidity.
Because the new fixed monthly prices are above the current average monthly
revenue per subscriber before the change to fixed pricing, management believes
that revenues may increase. The Company's costs of providing the service may
also increase as subscribers expand their usage of the service because they
experience no marginal cost in doing so. Management believes that fixed pricing
may increase both revenues and expenses, but does not currently expect this
change to have a material impact on the Company's results of operations or
liquidity. There can be no assurance, however, that revenues and expenses will
respond to fixed pricing in the manner in which management anticipates.
GROWTH IN SUBSCRIBER BASE AND SUBSCRIBER RETENTION
The Company has experienced rapid growth in its subscriber base. During
1995, the net number of the Company's and its licensee's subscribers grew by an
average of 84,000 per month, and at an average of 166,000 per month for 1996.
See also "-- Projected Results for Fiscal Quarter Ending July 31, 1996." One of
the key components of increased subscriber growth is the extent to which those
who try an online service remain customers.
The Company promotes its services through a variety of marketing efforts
such as direct mail, publication inserts, national television advertising and
print advertisements in general interest, business and specialty periodicals.
During 1996, the Company began a major new marketing and distribution effort to
capitalize on the growing interest in online services and the Internet,
investing over $160 million in 1996 for marketing and distribution, an increase
of nearly fourfold over 1995. Major aspects of the new programs included
substantial increases in distribution of trial software disks through direct
mail and publication inserts. New CIS subscribers receive ten free hours of
access in their first month. The Company believes that this industry-wide
practice has been a significant factor in encouraging new signups.
Similar to its competitors, the Company expects subscriber turnover as
subscribers cancel for various reasons. While offering free access during an
introductory period has significantly encouraged new signups, it has also
resulted in a higher percentage of subscribers canceling in the first 90 days.
Similarly, the types of marketing and promotion undertaken by the Company can
also have an impact on subscriber retention rates. At April 30, 1996, the
Company had retained approximately six out of ten customers that had subscribed
in the previous 90 days, five out of ten customers that had subscribed in the
previous year and two years and four out of ten customers that had subscribed in
the previous three and four years. There can be no assurance that the Company's
subscriber retention rates will not decline below these levels.
COMPONENTS OF REVENUES AND COSTS OF REVENUES
Revenues from Online Services customers are based primarily on online usage
and monthly fees. There are no material differences in revenues per customer
between the identified Online Services subscriber groups (other than NiftyServe
subscribers). Revenues from Network Services customers are based primarily on
19
<PAGE> 21
usage and value-added fees. Revenues per customer for Network Services customers
can vary significantly based upon the individual customer's requirements.
Management expects that the decline in revenue per customer in 1996 will
continue next fiscal year, consistent with its goal to attract more customers
and encourage more online usage through pricing and targeted service offerings.
Variable costs of revenues for Online Services increase with usage due to
royalty payments to information providers, bankcard costs based upon the number
of customers, customer service costs, and data communication costs shared by
Online and Network Services. While a significant portion of data communications
costs is fixed in the short term, data communications costs are variable in the
long term due to the significant growth in number of customers. Economies of
scale and productivity improvements related to data communications and
infrastructure mitigate the rate of increase in other categories included in
costs of revenue.
The major component of the costs of revenue for Network Services is the
cost of network links. The ratios of these costs to revenue have not materially
changed. The major components of the costs of revenue for CIS and SPRYNET and
the recently launched WOW! services are the network, content acquisition and
customer services costs as a function of member growth and retention. The CIS
and WOW! services have the same basic cost structure, and the primary change in
this structure has been an increase in content acquisition costs for CIS and an
increase in customer service costs for WOW!. The SPRYNET service cost structure
does not have a material content component.
STRATEGIC INITIATIVES
On August 1, 1995, the Company announced a series of investment initiatives
designed to enhance long-term competitiveness, take advantage of accelerating
growth opportunities and enhance market share for its online services. They
include: the launch of WOW!; a simplified and less expensive pricing structure;
a new CIS interface; increased expenditures for marketing and infrastructure
expansion; and the expansion of Internet access through CIS, WOW! and SPRYNET.
These initiatives, which have been underway since early fall of 1995, are
expected to reduce profitability over a twelve-to-eighteen-month period.
Management anticipates that the expenses associated with these initiatives will
be partially offset by a one-time benefit in 1996 from a change in accounting
for direct response advertising costs.
NEW ACCOUNTING STANDARDS
On May 1, 1995, the Company changed its method of accounting for direct
response advertising costs to conform with the American Institute of Certified
Public Accountants Statement of Position 93-7, "Reporting on Advertising Costs"
("SOP 93-7"). Under SOP 93-7, direct response advertising costs that meet
certain criteria are recorded as assets and are amortized on a
cost-pool-by-cost-pool basis over the period during which the future benefits
are expected to be received. (See note 2 of notes to the consolidated financial
statements.) Effective May 1, 1995, in compliance with SOP 93-7, acquisition
costs for online subscribers are being deferred and charged to operations over
24 months beginning the month after such costs are incurred, with 60% amortized
in the first twelve months.
Effective February 1, 1996, the Company changed its policy of capitalizing
subscriber acquisition costs related to magazine and newspaper advertisements
and broadcast costs to expensing those costs which do not necessarily result in
a direct revenue-generating response. Additionally, the Company began to
capitalize related payroll, outsourcing, disk and CD-ROM costs for activities
directly associated with direct-response advertising. All costs capitalized
before this change will continue to be amortized. The net effect of these two
changes increased marketing costs by $9 million for the fourth quarter ended
April 30, 1996, and would have increased marketing costs by approximately $7
million for the nine months ended January 31, 1996. The launch of the new WOW!
service in March 1996 resulted in most of the increase during the fourth
quarter. This change will have a greater impact on the Company's marketing costs
in 1997, as the Company expects to increase subscriber acquisition activity,
including those subscriber acquisition expenditures which the Company will be
expensing as incurred.
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," effective for transactions entered into after December 15, 1995.
This Statement requires the disclosure of the estimated fair value of
stock-based compensation arrangements with employees and encourages, but does
not require, the recognition of such expense. Certain Company employees
participate in the Company's long-term incentive plan. The Company
20
<PAGE> 22
does not intend to adopt the recognition provisions of this Statement;
therefore, the adoption of this Statement will have no effect on the Company's
financial statements.
PROJECTED RESULTS FOR FISCAL QUARTER ENDING JULY 31, 1996
On July 16, 1996, the Company announced that flat subscriber growth within
its CIS online service, coupled with continued investments in the introduction
of WOW! and infrastructure improvements, will result in a projected net loss
from operations for the quarter ending July 31, 1996. The flat CIS online
service subscriber growth reflects the planned delay in advertising and
marketing programs until the release of CIM 3.0 (currently scheduled for late
summer 1996), traditional industry-wide summer slowdown in signups, and a higher
level of cancellations of subscribers acquired through the Company's recently
expanded marketing effort. Revenue performance from Network Services and Online
Services for WOW! and SPRYNET is consistent with management expectations.
The Company is also in the process of taking action to reduce costs and to
dispose of certain underperforming assets. These actions, after consideration of
one-time costs and charges to implement such actions, are expected to further
negatively impact first quarter and full year results for the fiscal year ending
April 30, 1997, but benefit earnings of subsequent periods.
Except for the historical information contained herein, the matters
discussed in this Form 10-K are forward-looking statements which involve risks
and uncertainties including, but not limited to, economic, competitive,
governmental and technological factors affecting the Company's operations,
markets, products, services and prices and other factors discussed in the
Company's filings with the Securities and Exchange Commission.
RESULTS OF OPERATIONS
FISCAL YEAR ENDED APRIL 30, 1996 COMPARED TO FISCAL YEAR ENDED APRIL 30,
1995
ONLINE SERVICES REVENUES. Online Services revenues for the year ended April
30, 1996 increased 41.8% over the prior year to $561.4 million from $396.0
million. The increase in revenues was primarily the result of the increase in
the Company's subscriber base. The number of CIS subscribers at April 30, 1996,
exclusive of NiftyServe subscribers, increased 43.9% to 3.2 million from 2.2
million in 1995.
The average monthly CIS revenue per subscriber decreased to $17.01 for 1996
(an average of $16.45 for the fourth quarter) from $19.17 for 1995 due to a
price reduction implemented in February 1995 and a new pricing structure
introduced in September 1995. (Revenue per subscriber excludes royalties and
subscribers from NiftyServe and SPRYNET.) During 1996, the average monthly usage
per CIS subscriber increased 51.4% compared to 1995.
NETWORK SERVICES REVENUES. Network Services revenues increased 34.6% to
$198.8 million from $147.7 million for 1995, while the number of Network
Services customers increased 30.0% to 966. The increase in revenues was due to
the increase in the number of network customers and higher usage by existing
customers.
OTHER REVENUES. Other revenues decreased 16.0% to $32.9 million from $39.2
million due primarily to the sale of Collier-Jackson, Inc. in 1995 ($2.0 million
revenue from this divested business and a $2.7 million pretax gain on sale), and
$1.5 million from H&R Block Tax Services for development of tax preparation
software in 1995. These amounts were partially offset by a $2.4 million gain on
the sale of a minority-interest investment in 1996. Other revenues also include
corporate remote computing services and fees from H&R Block Tax Services, Inc.
for electronic tax filing support.
COSTS OF REVENUES. Costs of revenues consist primarily of data
communication costs, royalties paid to information and service providers,
salaries associated with providing customer support and operating the data
centers and property and other direct costs. Costs of revenues increased as a
percent of total revenues to 48.9% in 1996 from 39.7% in 1995. Of the 9.2
percentage point increase, 5.8 percentage points reflect costs associated with
increased network hours, and 2.1 percentage points reflect increased customer
service costs.
MARKETING. Marketing expenses include costs incurred to acquire and retain
subscribers, other marketing expenses and the Network Services sales
organization. Effective May 1, 1995, acquisition costs for online subscribers
are being deferred and charged to operations over 24 months beginning the month
after such costs are incurred, with 60% amortized in the first twelve months.
See note 2 of notes to the consolidated financial statements. Marketing expenses
as a percent of total revenues increased in 1996 to 22.1% (34.3% before deferral
of subscriber acquisition costs) compared to 18.0% in 1995. The increase in
marketing expenses is primarily attributable to increased general consumer
advertising on television and in periodicals, a greater use
21
<PAGE> 23
of publication inserts, expanded international marketing efforts, distribution
of trial software disks through direct mail, the launch of WOW!, and special
event promotions and advertising expenses incurred by SPRY.
GENERAL AND ADMINISTRATIVE. As a percent of total revenues, general and
administrative expenses decreased to 4.9% in 1996 from 5.3% in 1995. This
decrease primarily reflected the favorable outcome of certain legal matters,
sales tax audits and VAT issues which had been provided for in prior periods.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization as a percent
of total revenues increased to 9.4% in 1996 compared to 7.8% in 1995. The
increase was due to increased capital expenditures to double network capacity
during 1996 to support the Company's rapid growth, and the amortization of
goodwill related to the SPRY acquisition which is being amortized over five
years.
PRODUCT DEVELOPMENT. Product development costs as a percent of total
revenues for 1996 increased to 3.6% from 3.2% in the prior year. The increase
was due primarily to the acquisition of SPRY in April 1995 and increases in
software development and personnel costs for the new WOW! online service as well
as enhancements to the CIS interface.
TAXES ON EARNINGS. The effective tax rate decreased to 40.3% in 1996
compared to 87.1% in 1995. The decrease resulted from a charge for purchased
research and development in 1995 that was not deductible for income tax
purposes.
FISCAL YEAR ENDED APRIL 30, 1995 COMPARED TO FISCAL YEAR ENDED APRIL 30,
1994
ONLINE SERVICES REVENUES. Online Services revenues increased 48.3% to
$396.0 million in 1995 from $266.9 million in 1994. The increase in Online
Services revenues was due primarily to the increase in the number of
subscribers. The number of CIS subscribers, exclusive of NiftyServe, increased
61.2% to 2.2 million from 1.4 million in 1994. The average monthly revenue per
subscriber in 1995 was $19.17 compared to $19.35 in 1994, reflecting the impact
of a price reduction in February 1994, partially offset by higher usage.
NETWORK SERVICES REVENUES. Network Services revenues increased 35.0% to
$147.7 million from $109.4 million in the prior year. The number of Network
Services customers increased 26.8% over the prior year to 743 from 586. The
increase in revenues was due to the increase in network customers and greater
usage by existing customers.
OTHER REVENUES. Other revenues decreased 26.9% as compared to the prior
year to $39.2 million from $53.6 million, primarily due to the sale of
Collier-Jackson, Inc. in June 1994.
COSTS OF REVENUES. Costs of revenues as a percent of total revenues was
39.7% in 1995 compared to 41.7% in 1994. This decrease was due primarily to the
sale of Collier-Jackson, Inc., partially offset by an increase in data
communication costs from higher wide area network and online subscriber usage,
royalties paid to information and content providers and customer support
activities.
MARKETING. Marketing expenses as a percent of total revenues increased to
18.0% from 15.3% in 1994. The increase in marketing expenses was due to an
increase in expenditures to increase the online subscriber and network customer
base.
GENERAL AND ADMINISTRATIVE. General and administrative expenses as a
percent of total revenues decreased to 5.3% in 1995 from 7.6% in 1994. The
decrease was due primarily to lower business taxes due to favorable resolution
of various sales tax issues and legal matters.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense as a
percent of total revenues increased to 7.8% in 1995 from 7.3% in 1994.
Depreciation expense increased as a result of capital additions of computers,
servers, network nodes and modems.
PRODUCT DEVELOPMENT. Product development costs as a percent of total
revenues decreased to 3.2% in 1995 from 3.7% in 1994. The decrease was due
primarily to the completion of software that was developed for H&R Block Tax
Services, Inc. in 1994.
PURCHASED RESEARCH AND DEVELOPMENT. During 1995, the Company recorded a
charge for purchased research and development in connection with the acquisition
of SPRY. See note 3 of notes to the consolidated financial statements.
TAXES ON EARNINGS. The effective tax rate increased to 87.1% in 1995 from
40.7% in 1994 as a result of the charge for purchased research and development
that was not deductible for income tax purposes.
22
<PAGE> 24
LIQUIDITY AND CAPITAL RESOURCES
In April 1996, the Company sold 18.4 million shares of its common stock in
a public offering and received $518.8 million net of underwriting fees and
expenses.
Historically, the Company had participated in H&R Block's centralized cash
management system whereby cash received from operations was transferred to H&R
Block's centralized cash accounts and cash disbursements were funded from the
centralized cash accounts on a daily basis. Accordingly, cash requirements for
operating purposes and for capital expenditures were met from this source. The
Company began utilizing its own centralized cash management system following the
public offering of its common stock in April 1996.
In March 1995, the Company declared a non-cash dividend of $272.4 million
to H&R Block Group which reduced "Due From Parent" by the same amount. At
October 31, 1995, the Company's "Due to Parent" (which constituted payables to
HRB Management) was $199.8 million. Interest income (expense) was not calculated
prior to October 31, 1995 due to H&R Block Group's prior policy of not crediting
(charging) interest with respect to intercompany accounts. Interest income
(expense) related to intercompany accounts is not appropriate because it was not
credited or charged, and management believes that it would not have been
material in periods prior to October 31, 1995. Effective October 31, 1995, this
intercompany balance was replaced with a $124.8 million contribution to capital
and a $75.0 million intercompany payable. In April 1996, the Company repaid $205
million in intercompany accounts, which reflected the Company's continued
investment in capital expenditures and marketing, and which included $5.6
million for interest from November 1, 1995. All outstanding intercompany
balances were evidenced by an intercompany credit facility between the Company
and HRB Management. Intercompany borrowings bear interest at the applicable
prime rate, adjusted monthly. At April 30, 1996, the Company is owed $17.4
million by Parent.
The Company's primary source of liquidity has historically been cash flow
from operating activities. At April 30, 1996, the Company had cash, cash
equivalents and investments totaling $310.0 million.
In each of the years 1994 and 1995, the Company generated positive cash
flow and advanced these funds to H&R Block. From 1994 through 1996, the Company
generated $278.2 million in cash from operations, primarily net earnings,
depreciation and amortization. Total cash invested during this period was $448.7
million, mainly reflecting capital expenditures for computers, network nodes and
modems.
Beginning in 1996, the Company significantly accelerated its expenditures
to grow its subscriber base and to expand its infrastructure to support
substantial increases in system usage. The Company invested approximately $160
million in 1996 for subscriber acquisition and marketing, a fourfold increase
over 1995. The Company expects to spend approximately $175 million for
subscriber acquisition and marketing in 1997.
The Company also invested $219 million for capital expenditures in 1996 and
expects to invest up to $190 million for capital expenditures in 1997. The
planned expenditures for 1997 include approximately $50 million for deployment
of TCP/IP across the Company's network. In addition, the Company estimates that
the full deployment of TCP/IP across its network will cost approximately $200
million over the three years beginning in 1997. Management anticipates that
capital expenditures will continue to increase in the near term due to equipment
replacements and purchases of additional equipment to support an increased base
of online subscribers, growth in corporate network customers and additional
facilities.
The Company's depreciation and amortization expense in future periods will
increase due to the substantial capital investment and marketing initiatives
described above. Management believes that these initiatives will result in
higher revenues and improved cash flows in future periods. The Company believes
that the proceeds from the public offering of common stock in April 1996 will be
sufficient to meet the Company's presently anticipated funding requirements for
approximately eighteen months to two years. Thereafter, if internally generated
cash is insufficient to meet the Company's capital needs, the Company may be
required to seek additional sources of funds.
The Company agreed to an unsecured $25 million revolving credit facility
with Bank One, Columbus, NA, in June 1996. Borrowings under the credit facility
will bear interest at a floating rate equal to either the bank's prime rate or
0.25% over LIBOR. The Company is required to pay an unused commitment fee of
0.08% per annum for this facility. Borrowings under the credit facility may be
used for general corporate purposes. The facility expires in June 1997, subject
to renewal. There can be no assurance as to the availability of other external
sources of financing or the terms under which it would be available.
Approximately 20% of the Company's revenues were generated from sources
outside of the United States and future growth potential for the Company's
services is located outside of the United States. In the normal course of its
business, the Company enters into hedging transactions to mitigate its exposure
to exchange rate fluctuations.
23
<PAGE> 25
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEPENDENT AUDITORS' REPORT
To the Stockholders and Directors
of CompuServe Corporation:
We have audited the accompanying consolidated balance sheets of CompuServe
Corporation (a majority-owned subsidiary of H&R Block Group, Inc.) and
subsidiaries as of April 30, 1996 and 1995, and the related consolidated
statements of earnings, stockholders' equity and cash flows for each of the
three years in the period ended April 30, 1996. Our audits also included the
consolidated financial statement schedule listed in Item 14. These financial
statements and financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and financial statement schedule 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, such consolidated financial statements present fairly, in
all material respects, the financial position of CompuServe Corporation and
subsidiaries at April 30, 1996 and 1995, and the results of their operations and
their cash flows for each of the three years in the period ended April 30, 1996
in conformity with generally accepted accounting principles. Also, in our
opinion, the financial statement schedule, when considered in relation to the
basic consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
As discussed in Note 2 to the consolidated financial statements, the
Company changed its method of accounting for direct response advertising during
the year ended April 30, 1996.
Deloitte & Touche LLP
Columbus, Ohio
June 14, 1996
24
<PAGE> 26
COMPUSERVE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA
<TABLE>
<CAPTION>
APRIL 30,
--------------------
1996 1995
-------- --------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents............................................. $280,646 $ 4,913
Investments........................................................... 29,345
Receivables, less allowance for doubtful accounts of $3,429 and
$3,986, respectively............................................... 119,186 81,022
Due from parent....................................................... 17,377
Prepaid expenses...................................................... 14,103 5,056
Other current assets.................................................. 25,233 14,768
-------- --------
Total current assets............................................. 485,890 105,759
INTANGIBLE ASSETS, less accumulated amortization of $10,610 and $7,006,
respectively.......................................................... 22,809 14,353
PROPERTY AND EQUIPMENT, net............................................. 348,059 198,710
OTHER ASSETS:
Deferred subscriber acquisition costs, net............................ 96,636
Other assets.......................................................... 12,434 4,735
-------- --------
Total other assets............................................... 109,070 4,735
-------- --------
TOTAL................................................................... $965,828 $323,557
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable...................................................... $ 89,236 $ 42,335
Accrued salaries, wages and payroll taxes............................. 15,475 18,699
Accrued taxes......................................................... 4,070 7,629
Accrued royalties..................................................... 6,361 6,334
Deferred revenue...................................................... 4,077 1,375
Other accrued expenses................................................ 19,180 13,514
-------- --------
Total current liabilities........................................ 138,399 89,886
DEFERRED INCOME TAXES................................................... 56,763 11,413
DUE TO PARENT........................................................... 142,400
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, par value $.01 per share: 250,000,000 shares authorized;
shares issued and outstanding of 92,600,000 and 74,200,000,
respectively....................................................... 926 742
Additional paid-in capital............................................ 744,288 100,879
Retained earnings (accumulated deficit)............................... 27,121 (21,973)
Cumulative translation adjustments.................................... (1,669) 210
-------- --------
Total stockholders' equity....................................... 770,666 79,858
-------- --------
TOTAL................................................................... $965,828 $323,557
======== ========
</TABLE>
See notes to consolidated financial statements.
25
<PAGE> 27
COMPUSERVE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA
<TABLE>
<CAPTION>
YEAR ENDED APRIL 30,
-----------------------------------------
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
REVENUES:
Online Services revenues............................ $ 561,428 $ 395,954 $ 266,919
Network Services revenues........................... 198,828 147,673 109,402
Other revenues...................................... 32,909 39,166 53,565
----------- ----------- -----------
Total revenues................................. 793,165 582,793 429,886
COSTS AND EXPENSES:
Costs of revenues................................... 387,470 231,189 179,366
Marketing........................................... 175,213 104,828 65,591
General and administrative.......................... 39,634 30,750 32,641
Depreciation and amortization....................... 74,708 45,310 31,447
Product development................................. 28,304 18,929 16,101
Purchased research and development.................. 83,508
----------- ----------- -----------
Total costs and expenses....................... 705,329 514,514 325,146
----------- ----------- -----------
OPERATING EARNINGS.................................... 87,836 68,279 104,740
INTEREST EXPENSE TO PARENT............................ 5,555
----------- ----------- -----------
EARNINGS BEFORE TAXES................................. 82,281 68,279 104,740
TAXES ON EARNINGS..................................... 33,187 59,481 42,647
----------- ----------- -----------
NET EARNINGS.......................................... $ 49,094 $ 8,798 $ 62,093
=========== =========== ===========
EARNINGS PER COMMON SHARE............................. $ 0.66 $ 0.12 $ 0.84
=========== =========== ===========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING............ 74,803,279 74,200,000 74,200,000
</TABLE>
See notes to consolidated financial statements.
26
<PAGE> 28
COMPUSERVE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
AMOUNTS IN THOUSANDS
<TABLE>
<CAPTION>
RETAINED
ADDITIONAL EARNINGS CUMULATIVE
COMMON PAID-IN (ACCUMULATED TRANSLATION
STOCK CAPITAL DEFICIT) ADJUSTMENTS TOTAL
------ ---------- ------------ ----------- --------
<S> <C> <C> <C> <C> <C>
BALANCE AS OF APRIL 30, 1993............ $742 $ (741) $ 179,528 $ (140) $179,389
Net earnings............................ 62,093 62,093
Change in foreign currency translation
adjustment............................ 195 195
---- --------- ---------- ------- --------
BALANCE AS OF APRIL 30, 1994............ 742 (741) 241,621 55 241,677
Net earnings............................ 8,798 8,798
Dividends to Parent..................... (272,392) (272,392)
Change in foreign currency translation
adjustment............................ 155 155
Parent contribution to capital.......... 101,620 101,620
---- --------- ---------- ------- --------
BALANCE AS OF APRIL 30, 1995............ 742 100,879 (21,973) 210 79,858
Net earnings............................ 49,094 49,094
Sale of common stock.................... 184 518,635 518,819
Change in foreign currency translation
adjustment............................ (1,879) (1,879)
Parent contribution to capital.......... 124,774 124,774
---- --------- ---------- ------- --------
BALANCE AS OF APRIL 30, 1996............ $926 $ 744,288 $ 27,121 $(1,669) $770,666
==== ========= ========== ======= ========
</TABLE>
See notes to consolidated financial statements.
27
<PAGE> 29
COMPUSERVE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
AMOUNTS IN THOUSANDS
<TABLE>
<CAPTION>
YEAR ENDED APRIL 30,
----------------------------------
1996 1995 1994
--------- --------- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings.............................................. $ 49,094 $ 8,798 $ 62,093
Adjustments to reconcile net earnings to net cash provided
by operating activities:
Depreciation and amortization.......................... 74,708 45,310 31,447
Amortization of deferred subscriber acquisition
costs................................................ 22,585
Provision for deferred taxes on earnings............... 46,018 (1,912) 1,401
Gain on sale of subsidiary............................. (2,680)
Purchased research and development..................... 83,508
Changes in:
Receivables.......................................... (38,164) (29,576) (16,368)
Prepaid expenses..................................... (9,047) (2,510) (8)
Other current assets (11,133) (150) (1,051)
Deferred subscriber acquisition costs................ (119,221)
Accounts payable..................................... 46,901 9,018 14,769
Accrued salaries, wages and payroll taxes............ (3,224) 5,004 4,897
Accrued taxes........................................ (3,559) (2,671) 4,699
Accrued royalties.................................... 27 2,123 1,912
Deferred revenue..................................... 2,702 (6,545) 174
Other accrued expenses............................... 5,666 3,017 162
---------- ---------- ---------
Net cash provided by operating activities......... 63,353 110,734 104,127
---------- ---------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment....................... (219,172) (101,603) (76,526)
Purchase of short term investments........................ (29,345)
Proceeds from sale of subsidiary.......................... 5,195
Other, net................................................ (22,919) (3,546) (754)
---------- ---------- ---------
Net cash used by investing activities............. (271,436) (99,954) (77,280)
---------- ---------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock, net of costs of
$33,181................................................ 518,819
Repayments to Parent...................................... (205,000)
Advances from Parent...................................... 169,997 (9,500) (26,883)
---------- ---------- ---------
Net cash provided (used) by financing
activities...................................... 483,816 (9,500) (26,883)
---------- ---------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........ 275,733 1,280 (36)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR.............. 4,913 3,633 3,669
---------- ---------- ---------
CASH AND CASH EQUIVALENTS AT END OF YEAR.................... $ 280,646 $ 4,913 $ 3,633
========== ========== =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid to Parent for income taxes...................... $ 33,187 $ 59,481 $ 42,647
========== ========== =========
Interest paid to Parent................................... $ 5,555
==========
</TABLE>
See notes to consolidated financial statements.
28
<PAGE> 30
COMPUSERVE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED APRIL 30, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
1. ORGANIZATION
CompuServe Corporation ("Company") is a majority-owned subsidiary of H&R
Block Group, Inc. ("Parent"). Parent is a wholly-owned subsidiary of H&R Block,
Inc. ("Block").
On April 19, 1996, the Company entered into an agreement with Parent
whereby Parent contributed all of its shares of CompuServe Incorporated ("Inc.")
(at the time a wholly-owned subsidiary of Parent) to the Company in exchange for
74,199,000 shares of Company common stock. This transaction has been accounted
for similar to a pooling of interests, and accordingly, the accompanying
financial statements have been restated to include the accounts and operations
of the combined companies for all periods prior to the transaction.
In April 1995, Parent acquired SPRY, Inc. ("SPRY"), as described in Note 3.
On January 30, 1996, Parent contributed its investment in SPRY to Inc. The
accompanying consolidated financial statements include the accounts of SPRY
since the date of acquisition by Parent.
On April 19, 1996, the Company completed an initial public offering of
18,400,000 shares of its common stock at $30.00 per share. This transaction
reduced the Parent's ownership in the Company to 80.1%. The Parent intends to
distribute its remaining ownership interest in the Company by means of a
split-off or spin-off within approximately twelve months of the initial public
offering. The distribution will be subject to the receipt of a favorable ruling
from the Internal Revenue Service or an opinion of counsel as to the tax-free
nature of the transaction, certain other conditions and the absence of any
change in market conditions or other circumstances that cause the Parent to
conclude that the distribution is not in the best interests of its stockholders.
Prior to the initial public offering, the Parent owned all 1,000 shares
outstanding.
The Company provides computer-based information and communication services
to businesses and individual owners of personal computers, and operates
primarily through two business groups: Online Services and Network Services.
Online Services revenues are generated primarily from subscribers paying a
monthly membership fee and charges based on usage as well as from fees received
from a licensee and distributors of the Company's online service technology.
Network Services revenues are generated by providing secure turnkey, value added
global network interconnectivity and access services to individuals and major
corporate customers internationally. Network revenues are generated based upon
terms negotiated as to price and duration. Other revenues consist primarily of
computer time sharing services to certain corporate customers and network
services to Block.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION -- The consolidated financial statements
include the accounts of the Company and its wholly-owned subsidiaries. All
material intercompany transactions and balances have been eliminated.
MANAGEMENT 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 periods. Actual results could differ from those estimates.
During the fourth quarter of fiscal 1996, the Company reduced certain accruals
for incentive compensation and value added taxes totalling $7,000.
REVENUE RECOGNITION -- Revenues are recorded in the period in which the
service is provided or the product is shipped.
PROPERTY AND EQUIPMENT -- Buildings, computer hardware, furniture and
equipment are recorded at cost and depreciated over the estimated useful lives
of the assets, ranging from 3 to 10 years for computer hardware, furniture and
equipment and 45 years for buildings, using the straight-line method. Leasehold
improvements are amortized over the period of the respective lease using the
straight-line method. Maintenance and repairs are expensed as incurred.
Expenditures which significantly increase the value of the assets or extend
useful lives are capitalized.
29
<PAGE> 31
DEFERRED SUBSCRIBER ACQUISITION COSTS -- Effective May 1, 1995, the Company
prospectively changed its method of accounting for direct response advertising
costs to conform with the American Institute of Certified Public Accountants
Statement of Position 93-7, "Reporting on Advertising Costs," which specifies
the accounting for direct response advertising. Under this accounting method,
direct response advertising costs that meet certain criteria are reported as
assets and are amortized on a cost-pool-by-cost-pool basis over the period
during which the future benefits are expected to be received. The Company
amortizes its subscriber acquisition costs over a 24-month period, on an
accelerated basis (60% in the first twelve months), in order to match subscriber
acquisition costs with associated Online Services revenues, beginning in the
month subsequent to the expenditure. Subscriber acquisition costs include
primarily magazine and newspaper advertisements, broadcast costs, direct mail
costs including mailing lists and postage, payments to OEMs, and disk and CD-ROM
costs related directly to new subscriber solicitations. These costs consist of
incremental direct costs paid to independent third parties. No indirect costs
are included in deferred subscriber acquisition costs. The net effect of the
change in accounting increased assets by $96,636 at April 30, 1996 and increased
net earnings by $57,692 for the year then ended. Amortization of direct response
advertising assets was $22,585 for the year ended April 30, 1996 and is included
in marketing costs. Direct response advertising costs incurred to obtain new
online service subscribers are recoverable from monthly revenues generated from
those subscribers within a short period of time after the related costs are
incurred.
The Company expenses advertising costs not classified as direct response
the first time the advertising takes place.
Effective February 1, 1996, the Company changed its policy of capitalizing
subscriber acquisition costs related to magazine and newspaper advertisements
and broadcast costs to expensing those costs which do not result in a direct
revenue-generating response. Additionally, the Company began to capitalize
related payroll, outsourcing and disk and CD-ROM costs for activities directly
associated with direct-response advertising. All costs capitalized before this
change will continue to be amortized.
PRODUCT DEVELOPMENT COSTS -- The Company capitalizes costs incurred for the
development of computer software when the project has reached technological
feasibility, and continues to capitalize such costs until the product is
available for release to the general public. Capitalized costs include direct
labor and related fringe benefits for software produced by the Company and the
costs of software purchased from third parties. Research and development costs
incurred prior to technological feasibility are expensed as incurred. The
Company amortizes product development costs based upon the greater of the amount
using (a) the rates that current gross revenues for a product bears to the total
of current and anticipated future gross revenues for that product or (b) the
straight-line method over the remaining estimated life of the product commencing
the month after the date of product release.
Unamortized product development costs of $4,494 at April 30, 1996 are
included in intangible assets with amortization expense of $449 recorded for the
year then ended. Amounts of capitalizable product development costs were not
material in previous years.
INTANGIBLE ASSETS -- The excess cost of purchased subsidiaries over the
fair value of net tangible assets acquired and other intangibles is being
amortized over periods ranging from 5 to 20 years on a straight-line basis. The
amortization expense recorded for the years ended April 30, 1996, 1995 and 1994
was $3,123, $809 and $1,706, respectively.
At each balance sheet date, a determination is made by management to
ascertain whether intangibles have been impaired based on several criteria,
including, but not limited to, revenue trends, undiscounted operating cash flows
and other operating factors.
Effective May 1, 1995, the Company early adopted Statement of Financial
Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived
Assets and Long-Lived Assets to Be Disposed Of." This Statement establishes
accounting standards for the impairment of long-lived assets, certain
identifiable intangibles and goodwill related to those assets. The adoption of
this Statement had no effect on the Company's financial condition or results
from operations.
FOREIGN CURRENCY TRANSLATION -- Assets and liabilities of the Company's
foreign operations are translated into U.S. dollars at exchange rates prevailing
at the end of the period. Substantially all revenues from foreign sources are
billed and collected in U.S. dollars. Expense transactions conducted in foreign
currency are translated at the average of exchange rates in effect during the
period. Translation gains and losses are recorded directly to stockholders'
equity.
30
<PAGE> 32
INTERNATIONAL REVENUES -- The Company received revenues from foreign
sources totalling $173,963, $107,863 and $65,461 for the years ended April 30,
1996, 1995 and 1994, respectively.
TAXES ON EARNINGS -- The Company files a consolidated Federal income tax
return with its Parent on a calendar year basis. Therefore, the current
liability for taxes on earnings recorded in the consolidated balance sheet at
year end consists principally of taxes on earnings for the period January 1 to
the end of each financial reporting period. The Company provides for taxes on
earnings on a separate-company basis. Deferred taxes on earnings are provided
for temporary differences between financial and tax reporting, which consist
principally of deferred subscriber acquisition costs, depreciation, and
differences between accrual and cash basis accounting. As a result of the
Company filing a consolidated Federal income tax return with its Parent, the
Company has recorded the current income tax payable as part of the Due From/To
Parent balance in the consolidated balance sheets.
Prior to May 1, 1993, taxes on earnings were determined under Accounting
Principles Board Opinion Number 11, whereby the income tax provision was
calculated using the deferred method. Effective May 1, 1993, the Company adopted
the provisions of Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes," which provides for the recognition of deferred
tax assets and liabilities for the tax consequences of temporary differences
between the financial statement carrying amounts and the tax bases of existing
assets and liabilities. The cumulative effect of the change in method as of May
1, 1993 was not material.
The Company has entered into a Tax Sharing Agreement Plan with its Parent
(see Note 11).
CASH AND CASH EQUIVALENTS -- The Company considers all highly liquid debt
instruments with an original maturity of three months or less to be cash
equivalents. Substantially all cash and cash equivalents are held in one
financial institution.
INVESTMENTS -- Investments consist of corporate debt securities and U.S.
government agency obligations, maturing prior to April 30, 1997. The Company
classifies these investments as available for sale in accordance with Statement
of Financial Accounting Standards No. 115, "Accounting for Certain Investments
in Debt and Equity Securities." Accordingly, such investments are carried at
market value, which approximates cost.
DISCLOSURES REGARDING FINANCIAL INSTRUMENTS -- For all financial
instruments, including cash and cash equivalents, investments, receivables,
accrued liabilities and accounts payable, the carrying value is considered to
approximate fair value due to the relatively short maturity of the respective
instruments.
EARNINGS PER SHARE -- Net earnings per common share is based on the
weighted average number of shares outstanding during the periods presented. All
share and per share information have been retroactively adjusted for the
74,199,000 common shares issued to Parent in exchange for all of the common
shares of Inc. as described in Note 1.
NEW ACCOUNTING STANDARD -- In October 1995, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation", effective for transactions entered
into after December 15, 1995. This Statement requires the disclosure of the
estimated fair value of stock-based compensation arrangements with employees and
encourages, but does not require, the recognition of such expense. The Company's
employees participate in Company's and Parent's stock option plans. Within 90
days after Parent distributes its remaining interest in the Company, the
employees will cease to participate in the Parent's plans. The Company does not
intend to adopt the recognition provisions of this Statement; therefore, the
adoption of this Statement will have no effect on the Company's financial
condition or results from operations.
RECLASSIFICATIONS -- Reclassifications have been made to the 1995 financial
statements to conform to the presentation used in 1996.
3. BUSINESS COMBINATION AND DISPOSAL
On April 4, 1995, Parent acquired SPRY for $41,785 in cash and convertible
preferred stock valued at $54,194. In addition, outstanding options for SPRY
common stock were converted into options for Parent's convertible preferred
stock, valued at $5,641. In January 1996, Parent contributed its investment in
SPRY to Inc. This transaction has been accounted for at Parent's historical cost
and, accordingly, the consolidated financial statements include the accounts of
SPRY since the date of Parent's acquisition. In connection with the purchase,
certain intangible assets, including software technology, tradenames and an
assembled workforce totalling $11,656 were acquired. These intangibles are being
amortized on a straight-line basis over five years. Research and development
projects related to SPRY's next product generation were also acquired. These
31
<PAGE> 33
projects represent SPRY's research and development efforts prior to the merger,
which had not yet reached the stage of technological feasibility and had no
alternative future use; thus, the ultimate revenue generating capability of
these projects was uncertain. The purchased research and development was valued
at $83,508 using a discounted, risk-adjusted future income approach. The fiscal
1995 consolidated statement of earnings includes a charge for purchased research
and development which is not deductible for income tax purposes. The fair value
of assets acquired, including intangibles, was $106,371; liabilities assumed
were $4,751. Liabilities assumed are non-cash items excluded from the
consolidated statements of cash flows. Had the acquisition occurred at the
beginning of fiscal 1994, operating results on a pro forma basis would not have
been significantly different.
In accordance with the terms of the merger agreement, certain SPRY
employees are entitled to additional consideration of up to $3,100 if financial
and operational goals set forth therein are achieved. The incentive compensation
ultimately paid, if any, will increase the excess of cost of fair value over net
intangible assets acquired related to SPRY. Subsequent to April 30, 1996,
approximately $674 in incentive compensation was paid and increased intangible
assets. A final payout, if any, is due in January 1997.
On June 30, 1994, Inc. sold the stock of its wholly-owned subsidiary,
Collier-Jackson, Inc., for $5,195 in cash. The operating results of
Collier-Jackson are reflected in the consolidated statements of earnings through
the date of disposition, and the gain on the sale of $2,680 is included in other
revenues.
4. PROPERTY AND EQUIPMENT
A summary of property and equipment follows:
<TABLE>
<CAPTION>
APRIL 30,
--------------------
1996 1995
-------- --------
<S> <C> <C>
Land.................................................................... $ 4,504 $ 4,504
Buildings............................................................... 69,698 47,211
Computer equipment...................................................... 407,375 241,385
Furniture and equipment................................................. 47,122 27,419
Leasehold improvements.................................................. 11,641 4,507
-------- --------
540,340 325,026
Less accumulated depreciation and amortization.......................... 192,281 126,316
-------- --------
Total.............................................................. $348,059 $198,710
======== ========
</TABLE>
Depreciation and amortization of property and equipment for the years ended
April 30, 1996, 1995 and 1994 amounted to $69,823, $43,716 and $29,285,
respectively.
Software license fees with net unamortized values of $7,931 and $3,495 as
of April 30, 1996 and 1995 are included in other assets. Amortization expense
for the years ended April 30, 1996, 1995 and 1994 was $1,313, $784 and $456,
respectively.
5. TAXES ON EARNINGS
The provision for taxes on earnings is comprised of the following:
<TABLE>
<CAPTION>
YEAR ENDED APRIL 30,
------------------------------
1996 1995 1994
-------- ------- -------
<S> <C> <C> <C>
Currently payable (credit):
Federal....................................................... $(11,308) $53,075 $34,132
State......................................................... (1,523) 8,318 7,114
-------- ------- -------
Total...................................................... (12,831) 61,393 41,246
Deferred:
Federal....................................................... 40,557 (1,653) 1,159
State......................................................... 5,461 (259) 242
-------- ------- -------
Total...................................................... 46,018 (1,912) 1,401
-------- ------- -------
Total........................................................... $ 33,187 $59,481 $42,647
======== ======= =======
</TABLE>
32
<PAGE> 34
The following table reconciles the U.S. Federal income tax rate to the
Company's effective income tax rate:
<TABLE>
<CAPTION>
YEAR ENDED APRIL 30,
--------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Statutory rate......................................................... 35.0% 35.0% 35.0%
Increase in income taxes resulting from:
Purchased research and development................................... 42.8
Goodwill amortization................................................ 1.3 .4 .6
State income taxes, net of Federal tax benefit....................... 3.1 7.7 4.6
Other................................................................ .9 1.2 .5
---- ---- ----
Effective rate......................................................... 40.3% 87.1% 40.7%
==== ==== ====
</TABLE>
A summary of deferred income taxes follows:
<TABLE>
<CAPTION>
APRIL 30,
-------------------------------
1996 1995 1994
-------- -------- -------
<S> <C> <C> <C>
Gross deferred tax assets:
Difference between accrual and cash basis accounting......... $ (7,366) $ (8,074) $(4,134)
Other........................................................ (811) (771) (636)
-------- -------- -------
Current................................................... (8,177) (8,845) (4,770)
-------- -------- -------
Deferred compensation........................................ (3,213) (2,894) (2,351)
Other........................................................ (443) (36) (67)
-------- -------- -------
Noncurrent................................................ (3,656) (2,930) (2,418)
======== ======== =======
(11,833) (11,775) (7,188)
-------- -------- -------
Gross deferred tax liabilities:
Depreciation................................................. 22,394 14,343 11,668
Deferred subscriber acquisition costs........................ 36,654
Product development costs.................................... 1,371
-------- -------- -------
Noncurrent................................................ 60,419 14,343 11,668
-------- -------- -------
Net deferred tax liabilities................................... $ 48,586 $ 2,568 $ 4,480
======== ======== =======
</TABLE>
Provision is not made for possible income taxes payable upon distribution
of accumulated earnings of foreign subsidiaries. Such accumulated earnings
aggregated $1,117 at December 31, 1995. Management believes that the taxes
associated with repatriating these earnings would not be material.
6. FOREIGN EXCHANGE RISK MANAGEMENT
During fiscal years 1994 and 1996, the Company purchased forward foreign
exchange contracts to hedge currency fluctuations for expenses payable in
selected currencies in fiscal years 1995 and 1996. No maturities extend beyond
the fiscal year for which the expenses are hedged. Gains and losses from forward
contracts are recognized in earnings upon maturity, and directly offset the
currency fluctuation for expenses paid. There are no open forward contract
commitments at April 30, 1996.
7. COMMITMENTS
A portion of the Company's operations are conducted in leased premises.
Total lease expense for the years ended April 30, 1996, 1995 and 1994 was
$13,283, $8,397 and $6,429, respectively.
33
<PAGE> 35
Future minimum lease payments under noncancellable operating leases as of
April 30, 1996 were as follows:
<TABLE>
<CAPTION>
YEAR ENDED APRIL 30,
--------------------
<S> <C>
1997............................................................ $ 8,774
1998............................................................ 7,423
1999............................................................ 4,587
2000............................................................ 3,075
2001............................................................ 2,643
2002 and thereafter............................................. 5,457
-------
Total......................................................... $31,959
=======
</TABLE>
In fiscal 1994, the Company began construction of a major multi-phased
building facility in Hilliard, Ohio. The buildings are expected to be completed
in fiscal 1997. At April 30, 1996, the Company had commitments for expenditures
of approximately $9.6 million related to the completion of the buildings.
At April 30, 1996, the Company had a commitment for an unsecured $25
million revolving line of credit with a bank. The line of credit bears interest
at either the bank's prime rate or the London Interbank Offered Rate ("LIBOR")
plus .25% and expires in June 1997.
8. CONTINGENCIES
The Company in the ordinary course of business is threatened with or named
as a defendant in various lawsuits. It is not possible to determine the ultimate
disposition of these matters; however, management is of the opinion that the
final resolution of any threatened or pending litigation is not likely to have a
material adverse effect on the financial statements of the Company.
9. EMPLOYEE BENEFIT PLAN
The Company sponsors a 401(k) Investment Plan for all U.S. based employees.
The Investment Plan allows for employees to defer up to 10 percent of their
compensation. The Company matches 50 percent of employee contributions at
management's discretion, up to 6 percent, with such amounts vesting ratably over
five years of service. Contributions by the Company under the Investment Plan
amounted to $1,126 and $1,239 for the years ended April 30, 1995 and 1994,
respectively. There was no contribution for the year ended April 30, 1996.
10. LONG-TERM INCENTIVE PLANS
In March 1996, the Company adopted the CompuServe Corporation Long-Term
Incentive Plan and Outside Directors Plan (the "Plans") which authorize the
grant of options or stock appreciation rights to key employees, officers and
directors. The number of shares which may be awarded under the Plans shall not
exceed 4,090,000 shares in the aggregate, and no more than 500,000 shares for
stock options or stock appreciation rights may be awarded to any one individual
in any one-year period.
Under the terms of the Plans, options and stock appreciation rights are to
be granted at exercise prices equal to the fair market value of such stock as of
the date of grant. In 1996, the Compensation Committee of the Board of Directors
granted to employees and directors options to purchase an aggregate of 3,677,142
and 30,000 shares of common stock, respectively, at $30 per share, none of which
were exercisable at April 30, 1996. Options to employees vest ratably over a
three year period commencing on April 19, 1998. Options to directors vest on the
day preceding the Company's next annual meeting of stockholders.
11. RELATED PARTY TRANSACTIONS
DUE FROM/TO PARENT -- Amounts due to Parent consist of cash advances for
purchases of property and equipment, acquisitions, current income tax
liabilities and fluctuating working capital needs, offset by payments made by
the Company from its operating bank accounts. Effective November 1, 1995, the
Company was charged interest at the prime rate of Commerce Bank of Kansas City,
adjusted monthly. Prior to this date, Parent did not charge (credit) the Company
interest expense (income) on the balance. Following the sale of common stock as
described in Note 1, the Company paid Parent $205,000 to satisfy the balance
owed, including interest of $5,555. The supplemental earnings per share for the
year ended April 30, 1996 would have been $0.64 assuming this balance and
related interest expense would have been eliminated at the beginning of the
period. At April 30, 1996, the Company is owed $17,377 by Parent.
34
<PAGE> 36
The fiscal 1995 financial statements include a dividend to Parent for
$272,392, and Parent's contribution of its investment in SPRY of $101,620 to
Inc. In October 1995, Parent made an additional contribution to Inc. of
$124,774. These transactions were recorded in the Due To/From Parent account;
accordingly, they are considered non-cash items excluded from the consolidated
statements of cash flows.
Prior to the Company's public offering of common stock in April 1996, the
Parent provided various services to Inc., including certain tax, treasury and
internal audit functions. The estimated costs of these services, which are not
material, have not been reflected in the consolidated statements of earnings.
TAX SHARING AGREEMENT -- The Company and Block have entered into an Income
Tax Sharing Agreement, pursuant to which the Company generally is obligated to
pay Block the Company's liability for federal, state and local income taxes
incurred during any taxable period.
EXECUTIVE DEFERRED COMPENSATION PLAN -- Certain key employees of the
Company participate in Parent's Executive Deferred Compensation Plan until the
expected split-off or spin-off date by the Parent. This Plan permits its
participants to defer portions of compensation and earn interest on the deferred
amounts. The salaries and the Company's matching of deferred salaries are
included in the consolidated statements of earnings. Since Block is liable for
all distributions made or to be made under the Plan, the Company has recorded
the deferred compensation and the matching thereon as part of the Due From/To
Parent balance in the consolidated balance sheets.
STOCK OPTION PLANS -- The Company's employees participated in several of
the Parent's stock option plans for its common stock. Any remaining options not
exercised by 90 days after the expected split-off or spin-off date by the Parent
will expire. Under these plans, options were granted to selected employees to
purchase Block's common stock for periods not exceeding ten years at a price not
less than 100 percent of fair market value on the date of the grant.
In connection with the acquisition of SPRY, outstanding options to purchase
SPRY common stock under an employee stock option plan were converted on April 5,
1995 to purchase shares of Block's convertible preferred stock.
COMPUTER PROGRAMMING AND PROCESSING SERVICES -- The Company provides
certain programming and electronic processing services related to tax return
filings with the Internal Revenue Service and in various state jurisdictions for
an affiliate of Parent. The terms of this arrangement are renegotiated annually.
Revenues generated in connection with this arrangement amounted to $8,012,
$12,500 and $13,101 for the years ended April 30, 1996, 1995 and 1994,
respectively.
SERVICE PROVIDER AGREEMENT -- An affiliate of Parent utilizes the Company's
online service to offer its information and communication service products.
Under the terms of a three-year agreement, the Company will receive royalties on
certain revenues earned by the affiliate through the Company's online service.
Conversely, the Company will pay royalties to the affiliate for revenues earned
from connect time charges related to the affiliate's products.
CORPORATE SERVICES AGREEMENT -- The Company and HRB Management, Inc., a
wholly-owned subsidiary of Parent, entered into a corporate services agreement
pursuant to which HRB Management, Inc. will provide to the Company from time to
time, upon request of the Company, certain routine and ordinary corporate
services, including financial, accounting, tax and legal services. For these
services, Parent will be reimbursed for its costs (including the pro rata costs
of Parent employees performing such services and allocable overhead). The
initial term of this agreement is one year. Thereafter, unless either party
provides the other with at least 60 days' prior written notice to the contrary,
the agreement will be automatically renewed for successive one year terms until
terminated. No amounts were paid in 1996.
12. SUBSEQUENT EVENTS (UNAUDITED)
In July 1996, the Company and H&R Block were each served with a Summons and
Class Action Complaint in a case entitled Greenfield v. CompuServe Corporation,
et al. and filed in the Court of Common Pleas, Franklin County, Ohio. Also in
July 1996, a second suit was filed against the Company and H&R Block, in federal
district court for the Southern District of Ohio, entitled Romine v. CompuServe
Corporation, et al.. These complaints (the "Complaints") also name the directors
and certain officers of CompuServe at the time of the IPO and allege violations
of the Securities Act of 1933, the Ohio Securities Code and common law. The
Company intends to vigorously defend the litigation.
35
<PAGE> 37
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The Board of Directors of the Company is divided into three classes of
directors, with each class elected to a three-year term every third year and
holding office until their successors are elected and qualified. The following
table sets forth information with respect to directors and executive officers of
the Company for the fiscal year ended April 30, 1996:
<TABLE>
<CAPTION>
NAME AGE POSITION
- --------------------------------------- --- ------------------------------------------------
<S> <C> <C>
Henry F. Frigon........................ 61 Chairman of the Board of Directors
Robert J. Massey....................... 51 President and Chief Executive Officer and
Director
Lawrence A. Gyenes..................... 45 Executive Vice President and Chief Financial
Officer
Herbert J. Kahn........................ 56 Executive Vice President, Administration
Dennis D. Matteucci.................... 57 President, Online Services
Steven P. Stanbrook.................... 39 President, CompuServe Europe
Peter F. Van Camp...................... 40 Executive Vice President, Network Services
Division
Roger W. Hale.......................... 53 Director
Frank L. Salizzoni..................... 58 Director
Morton I. Sosland...................... 71 Director
</TABLE>
Mr. Frigon has served as Chairman of the Board of Directors of the Company
since June 1996 and as a director of the Company since February 1996. Mr. Frigon
served as Executive Vice President-Corporate Development & Strategy and Chief
Financial Officer of Hallmark Cards Incorporated, Kansas City, Missouri,
greeting card company, from January 1991 until his retirement in December 1994.
He had previously served as President and Chief Executive Officer of BATUS
Incorporated, Louisville, Kentucky. Mr. Frigon is a director of Circle K
Corporation, Dimon Inc., Group Technologies Corp., H&R Block and Buckeye
Cellulose Corporation.
Robert J. Massey has served as President and Chief Executive Officer of the
Company since June 1995 and as a director of the Company since February 1996. He
was Executive Vice President of Network Services from December 1990 to June
1995, and has held various other positions since joining the Company in 1976.
Lawrence A. Gyenes has served as Executive Vice President and Chief
Financial Officer of the Company since May 1, 1996. Prior to joining the
Company, he was Corporate Vice President, Finance and Chief Financial Officer of
Helene Curtis, Inc. since July 1994. Mr. Gyenes was Corporate Vice President,
Finance of G.D. Searle & Co. from October 1992 to July 1994, and was Corporate
Controller for such company from July 1991 to September 1992. He was Vice
President, Commercial Operations of Lorex Pharmaceuticals from 1988 to June
1991.
Herbert J. Kahn has served as Executive Vice President, Administration of
the Company since March 1995. He was Senior Vice President, Administration from
May 1992 to March 1995, and was Vice President, Administration from the time he
joined the Company in September 1991 to May 1992. Prior to joining the Company,
Mr. Kahn was Executive Vice President of Operations for ABB Process Automation,
Inc. Mr. Kahn is a director of Danninger Medical Technologies, Inc.
Dennis D. Matteucci has served as President, Online Services of the Company
since May 1, 1996. Mr. Matteucci served as Group Executive for Transmission and
Components, Sales and Marketing of Northern Telecom from January 1994 until his
retirement in September 1994. From June 1993 to January 1994 he served as Chief
Operating Officer of such company, from February 1993 to June 1993 he served as
Executive Vice President, Sales of an operating company of Northern Telecom, and
from September 1991 to February 1993 he held various other positions at Northern
Telecom. Prior to that, Mr. Matteucci held various positions with IBM.
Steven P. Stanbrook has served as President, CompuServe Europe since May 1,
1996. Mr. Stanbrook served as President and Chief Executive Officer of Sara Lee
Bakery from October 1994 to January 1996. From February 1994 to October 1994 he
served as Vice President, Corporate Development of Sara Lee
36
<PAGE> 38
Corporation, from 1993 to February 1994 he served as Regional President,
Europe/Africa of Sara Lee/Douwe Egberts and from 1992 to 1993 he served as
President/Managing Director, UK/Eire of Sara Lee Household and Personal Care.
From 1990 to 1992 Mr. Stanbrook served as Executive Vice President of Kiwi
Brands Inc.
Peter F. Van Camp has served as Executive Vice President of Network
Services since August 1995. He was Vice President Sales for Network Services,
including the management of that division's European operations from January
1991 to August 1995. He joined the Company in 1982 and has held various field
management positions in the Company throughout the United States.
Mr. Hale has served as a director of the Company since February 1996. Mr.
Hale has served as Chairman, President and Chief Executive Officer of LG&E
Energy Corporation, Louisville, Kentucky, since August 1990. He has also served
as Chairman of the Board of Louisville Gas & Electric Company since February
1990 and Chief Executive Officer of such company since June 1989. Mr. Hale is a
director of H&R Block and PNC Bank Corp.
Frank L. Salizzoni has served as a director of the Company since June 1996.
Mr. Salizzoni has served as Interim President and Chief Executive Officer of H&R
Block since June 1996. Mr. Salizzoni served as President and Chief Operating
Officer of USAir, Inc. from March 1994 until April 1996. From November 1990 to
March 1994, he served as Executive Vice President-Finance of USAir, Inc. Mr.
Salizzoni is a director of H&R Block and SKF USA Inc.
Mr. Sosland has served as a director of the Company since February 1996.
Mr. Sosland has served as Chairman of Sosland Companies, Inc., Kansas City,
Missouri, since January 1993 and as Chairman of Sosland Publishing Company since
1984. He was President of such company from July 1968 to December 1992. Mr.
Sosland is a director of H&R Block and Kansas City Southern Industries, Inc.
Richard H. Brown resigned as Chairman of the Board of Directors of the
Company and Alexander B. Trevor resigned as Executive Vice President and Chief
Technology Officer of the Company in June 1996.
INFORMATION REGARDING THE BOARD OF DIRECTORS AND COMMITTEES
The Company's By-laws provide for a minimum of two directors and a maximum
of fifteen directors and empower the Company's Board of Directors to fix the
exact number of directors and to fill any vacancies on the Board of Directors.
The Company's Board of Directors currently consists of five directors. Under the
Company's Certificate of Incorporation, the Company's Board of Directors is
divided into three classes with each class of directors serving a staggered
three-year term. The term of Mr. Sosland will expire at the annual meeting of
stockholders to be held in October 1996, the terms of Messrs. Frigon and Hale
will expire at the annual meeting of stockholders to be held in 1997 and the
terms of Messrs. Massey and Salizzoni will expire at the annual meeting of
stockholders to be held in 1998.
Under the Company's By-laws, the Board of Directors may establish one or
more committees, appoint one or more members of the Board of Directors to serve
on each committee, fix the exact number of committee members, fill vacancies,
change the composition of the committee, impose or change the duties of the
committee and terminate the committee. The Board of Directors has established
Audit and Compensation Committees. The members of the Audit Committee are
currently Messrs. Hale (Chairman), Frigon and Sosland. The Audit Committee is
empowered by the Board of Directors to review the financial books and records of
the Company in consultation with the Company's accounting staff and its
independent auditors and to review with the accounting staff and independent
auditors any questions raised with respect to accounting and auditing policy and
procedure. The members of the Compensation Committee are currently Messrs.
Frigon (Chairman), Hale and Sosland. The Compensation Committee makes
recommendations to the Board of Directors as to general levels of compensation
for all employees of the Company, the annual salary of each of the executive
officers of the Company, and awards to employees under the Company's Incentive
Plan described in Item 11 and reviews and approves compensation and benefit
plans of the Company.
37
<PAGE> 39
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth the amounts earned during the fiscal years
ended April 30, 1995 and 1996 by the Company's chief executive officers and
other persons named below (collectively, the "Named Executive Officers").
<TABLE>
<CAPTION>
LONG-TERM
-----------------
COMPENSATION
ANNUAL AWARDS
COMPENSATION -----------------
------------------ SHARES UNDERLYING ALL OTHER
NAMES AND PRINCIPAL POSITION YEAR SALARY BONUS OPTIONS # COMPENSATION(1)
- ------------------------------------------- ---- -------- -------- ----------------- ---------------
<S> <C> <C> <C> <C> <C>
Robert J. Massey(2)........................ 1996 $263,402 $ 42,340 399,000 $ 783
President and Chief Executive Officer 90,000(3)
1995 197,358 188,474 135,000(3) 11,348
Dennis D. Matteucci(4)..................... 1996 11,539 37,383 100,000 --
President, Online Services
Steven P. Stanbrook(5)..................... 1996 28,346 0 100,000 --
President, CompuServe Europe
Lawrence A. Gyenes(6)...................... 1996 9,615 50,000 100,000 --
Executive Vice President and Chief
Financial Officer
Herbert J. Kahn............................ 1996 187,598 40,420 188,500 53,598
Executive Vice President, Administration 40,000(3)
1995 165,673 94,160 65,000(3) 51,221
Alexander B. Trevor(7)..................... 1996 210,000 33,670 206,000 807
Former Executive Vice President and Chief 10,000(3)
Technology Officer 1995 203,462 182,974 135,000(3) 4,724
Maurice A. Cox............................. 1996 46,154 -- -- --
Former President and Chief Executive 1995 282,692 338,297 215,000(3) 66,834
Officer
</TABLE>
- ---------------
(1) Includes payments under H&R Block's Executive Survivor Plan and Deferred
Compensation Plan.
(2) Mr. Massey was promoted to President and Chief Executive Officer of the
Company in June 1995.
(3) Represents options to acquire H&R Block common stock granted pursuant to H&R
Block's 1993 Long-Term Executive Compensation Plan.
(4) Mr. Matteucci was hired by the Company in April 1996. Mr. Matteucci's annual
base salary is $300,000.
(5) Mr. Stanbrook was hired by the Company in March 1996. Mr. Stanbrook's annual
base salary is $275,000.
(6) Mr. Gyenes was hired by the Company in April 1996. Mr. Gyenes's annual base
salary is $250,000.
(7) Mr. Trevor resigned from the Company in June 1996.
STOCK OPTION GRANTS
The following table summarizes options granted during the fiscal year ended
April 30, 1996 to the Named Executive Officers. The amounts shown as potential
realizable values on the options identified in the table are based on assumed
annualized rates of appreciation in the price of the common stock underlying the
options of five percent and ten percent over the term of the options, as set
forth in the rules of the Securities and Exchange Commission. Actual gains, if
any, on stock option exercises are dependent upon the future performance of the
common stock underlying the options. There can be no assurance that the
potential realizable values reflected in this table will be achieved. No stock
appreciation rights of the Company were granted during the Company's 1996 fiscal
year.
38
<PAGE> 40
STOCK OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT
ASSUMED ANNUAL RATES OF
STOCK PRICE APPRECIATION
SHARES EXERCISE FOR
UNDERLYING % OF OPTION TERM
OPTIONS TOTAL BASE EXPIRATION -------------------------
NAME GRANTED GRANTED PRICE DATE 5% 10%
- -------------------------- ---------- ------- -------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Robert J. Massey.......... 150,000(1) 10.55% $30.00 4/24/2006 $2,830,500 $ 7,171,500
249,000(2) 12.48% $30.00 4/24/2006 $4,698,630 $11,904,690
90,000(3) 2.54% $41.00 6/30/2005 $2,320,200 $ 5,880,000
Dennis D. Matteucci....... 100,000 7.03% $30.00 4/24/2006 $1,887,000 $ 4,781,000
Steven P. Stanbrook....... 100,000 7.03% $30.00 4/24/2006 $1,887,000 $ 4,781,000
Lawrence A. Gyenes........ 100,000 7.03% $30.00 4/24/2006 $1,887,000 $ 4,781,000
Herbert J. Kahn........... 80,000(1) 5.62% $30.00 4/24/2006 $1,509,600 $ 3,824,800
108,500(2) 5.44% $30.00 4/24/2006 $2,047,395 $ 5,187,385
40,000(3) 1.13% $41.00 6/30/2005 $1,031,200 $ 2,613,600
Alexander B. Trevor....... 55,000(1) 3.86% $30.00 4/24/2006 $1,037,850 $ 2,629,550
151,000(2) 7.57% $30.00 4/24/2006 $2,849,370 $ 7,219,310
10,000(3) (4) $41.00 6/30/2005 $ 257,800 $ 653,400
</TABLE>
- ---------------
(1) Represents options to purchase shares of CompuServe common stock awarded by
the CompuServe Compensation Committee as of the completion of the initial
public offering. Such options vest ratably over a three-year period
commencing on the second anniversary of the grant date and shall
automatically be cancelled if H&R Block does not distribute its ownership
interest in the Company to its stockholders within 12 months of the
completion of the initial public offering.
(2) Represents nonqualified options to purchase shares of CompuServe common
stock awarded by the CompuServe Compensation Committee in respect of options
to purchase shares of H&R Block common stock ("Block Options"). Each
employee of the Company and its subsidiaries who held outstanding Block
Options prior to the initial public offering of the Company's Common Stock
was awarded an option under the Incentive Plan to purchase a number of
shares of the Company's Common Stock equal to the number of shares subject
to the outstanding Block Options. Such options vest ratably over a
three-year period commencing on the second anniversary of the grant date and
shall automatically be cancelled if H&R Block does not distribute its
ownership interest in the Company to its stockholders within 12 months of
the completion of the initial public offering.
(3) Represents options to acquire H&R Block common stock granted pursuant to H&R
Block's 1993 Long-Term Executive Compensation Plan. "% Total Granted" is
based upon the total number of options to acquire H&R Block common stock
granted by H&R Block.
(4) Represents less than one percent of the total number of options to acquire
H&R Block common stock granted by H&R Block.
OPTION EXERCISES AND FISCAL YEAR-END VALUES
The following table presents the number and value of unexercised options to
acquire shares of the Company's common stock as of April 30, 1996 for the Named
Executive Officers. No options to acquire the Company's common stock were
exercised by the Named Executive Officers during the year ended April 30, 1996.
FISCAL YEAR END VALUES
<TABLE>
<CAPTION>
VALUE OF
NUMBER OF UNEXERCISED
UNEXERCISED IN-THE-MONEY
OPTIONS AT OPTIONS AT
FY-END(#) FY-END
EXERCISABLE(E) EXERCISABLE(E)
NAMES UNEXERCISABLE(U) UNEXERCISABLE(U)
- -------------------------------------------------------------- ---------------- ----------------
<S> <C> <C>
Robert J. Massey.............................................. O E $ -E
399,000 U O U
Dennis D. Matteucci........................................... O E -E
100,000 U O U
Steven P. Stanbrook........................................... O E -E
100,000 U O U
Lawrence A. Gyenes............................................ O E -E
100,000 U O U
Herbert J. Kahn............................................... O E -E
188,500 U O U
Alexander B. Trevor........................................... O E -E
206,000 U O U
</TABLE>
39
<PAGE> 41
EMPLOYEE BENEFIT PLANS
The Board of Directors of the Company has adopted the following employee
benefit plans to provide incentives to attract and retain qualified employees.
LONG-TERM INCENTIVE PLAN
On March 12, 1996, the Company adopted the CompuServe Corporation Long-Term
Incentive Plan (the "Incentive Plan") which was approved by Parent in March
1996. The number of shares which may be awarded under the Incentive Plan shall
not exceed 4,000,000 shares in the aggregate, and no more than 500,000 shares
for stock options or stock appreciation rights may be awarded to any one
individual in any one-year period. Shares issued under the Incentive Plan may be
authorized and unissued shares or treasury shares. In the event of certain
transactions affecting the type or number of outstanding shares, the number of
shares subject to the Incentive Plan, the number or type of shares subject to
outstanding awards, and the exercise price thereof, shall be appropriately
adjusted. The Incentive Plan authorizes the award of stock options, stock
appreciation rights ("SARs"), stock grants (which may be subject to
restrictions), performance stock and performance units, and authorizes the
establishment of one or more stock purchase programs. The Compensation Committee
of the Board of Directors has been appointed to administer the Incentive Plan.
Subject to the terms of the Incentive Plan, the Compensation Committee
determines which employees or other individuals providing services to the
Company shall be eligible to receive awards under the Incentive Plan, and the
amount, price, timing and other terms and conditions applicable to such awards.
Options awarded under the Incentive Plan may be either incentive stock
options which are intended to satisfy the requirements of Section 422 of the
Internal Revenue Code of 1986 (the "Code"), or non-qualified stock options which
are not intended to satisfy Section 422 of the Code. SARs may be granted in
tandem or otherwise in connection with options, or may be granted as
free-standing awards. Exercise of an option will result in the corresponding
surrender of any tandem SAR. Under the terms of the Incentive Plan, options will
have an exercise price that is not less than the greater of the fair market
value of a share of Common Stock at the time the option is granted, or par
value. SARs are the right to receive, in cash or stock, the excess of the fair
market value of a specified number of shares of Common Stock at the time of
exercise over a specified price not less than 100% of the fair market value of
the Common Stock when the SAR is granted or, if granted in tandem with an
option, the option exercise price. Options and SARs become exercisable in
accordance with the terms established by the Compensation Committee, which may
include conditions relating to completion of a specified period of service or
achievement of performance standards. Options and SARs shall expire on the date
determined by the Compensation Committee which shall not be later than the
earliest to occur of (i) the tenth anniversary of the grant date, (ii) the first
anniversary of the participant's termination of employment by reason of death or
disability, (iii) the third anniversary of the participant's termination of
employment by reason of retirement, or (iv) the three month anniversary of the
participant's termination of employment for any other reason. Shares transferred
to a participant pursuant to the exercise of an option or SAR may be subject to
such additional restrictions or limitations as the Compensation Committee may
determine.
Under the Incentive Plan, the Compensation Committee may grant awards of
Common Stock to participants, which shall be subject to such conditions and
restrictions, if any, as the Compensation Committee may determine. During the
period a stock award is subject to restrictions or limitations, the Compensation
Committee may award the participant dividend rights with respect to such shares.
The Incentive Plan also provides that the Compensation Committee may establish
one or more stock programs which may permit purchases of Common Stock at up to a
50% discount, or provide for the award of matching Common Stock at a matching
rate which is not greater than one matching share for each share of Common Stock
purchased by the participant. Matching awards may not be made in connection with
discount purchases of stock.
The Compensation Committee may award performance stock to participants, the
distribution of which is subject to achievement of performance objectives, or
performance units which entitle the participant to receive value for the units
at the end of a performance period to the extent provided under the award. In
either case, the number of shares or units and the performance measures and
periods shall be established by the Compensation Committee at the time the award
is made.
In the event that the holder of an option pays all or a portion of the
exercise price in shares of Common Stock, the Compensation Committee may award
an option (a "Reload Option") to purchase the number of shares surrendered in
payment of the exercise price. The exercise price of the Reload Option shall be
fair
40
<PAGE> 42
market value of a share of Common Stock on the date of grant, the Reload Option
shall not be exercisable for a period of six months, and shall expire on the
same date as the original option with respect to which it was granted.
A participant who is granted a stock option will not be subject to federal
income tax at the time of grant, and the Company will not be entitled to a tax
deduction by reason of such grant. Upon exercise of a nonqualified option,
generally the difference between the option price and the fair market value of
the Common Stock on the date of exercise will be considered ordinary income to
the participant, and generally the Company will be entitled to a corresponding
tax deduction.
Upon exercise of an incentive stock option, no taxable income will be
recognized by the participant and the Company is not entitled to a tax deduction
by reason of such exercise. If the participant makes no disposition of shares
acquired pursuant to an incentive stock option within two years from the date of
grant of such option, or within one year of the transfer of the shares to the
participant, any gain or loss realized on a subsequent disposition of such
shares will be treated as a long-term capital gain or loss. Under such
circumstances, the Company will not be entitled to any deduction for Federal
income tax purposes. If the foregoing holding period requirements are not
satisfied, then the difference, with certain adjustments, between the fair
market value of the Common Stock at the date of exercise and the option price
will be considered ordinary income to the participant, and generally the Company
will be entitled to a corresponding tax deduction.
Upon the exercise of an SAR, the amount paid to the participant will be
considered ordinary income to the participant, and generally the Company will be
entitled to a corresponding tax deduction. Stock awards, Common Stock purchased
by participants under the Incentive Plan, and matching shares awarded with
respect to such purchased shares, are considered ordinary income to the
participant in an amount equal to the fair market value of the shares granted or
purchased (less any amount paid for the Common Stock by the participant), at the
later of the grant date or the date the shares are no longer subject to a
substantial risk of forfeiture, unless the participant elects to be taxed at the
grant date. Generally, the Company will be entitled to a corresponding tax
deduction at the time and in the amount the participant recognizes ordinary
income.
EMPLOYEE STOCK PURCHASE PLAN
The Company has established the CompuServe Corporation 1996 Employee Stock
Purchase Plan (the "Stock Purchase Plan") which is intended to facilitate open
market purchases of Common Stock by employees after the completion of the
Offerings. Generally, all regular employees who work at least 20 hours per week
are eligible to participate in the Stock Purchase Plan after 90 consecutive days
of employment. Participants may authorize payroll deductions of between 2% and
6% of their pay to be used for purchases under the Stock Purchase Plan. The
Company remits the accumulated payroll deductions to an independent agent who
then makes purchases in the open market on behalf of the participants on a
monthly or more frequent basis. The agent may not purchase shares from the
Company or its affiliates.
The shares acquired by the agent are allocated to participants' accounts
monthly, based on the average price paid for shares during the month. Cash
dividends received by the agent for shares held in participants' accounts are
automatically reinvested in shares of Common Stock, unless the participant
elects otherwise. When the participant terminates employment or otherwise
withdraws from the Stock Purchase Plan, the participant receives a certificate
for the whole shares held in the participant's account, and receives cash in
lieu of fractional shares.
Generally, the agent is responsible for the administration of the Stock
Purchase Plan in accordance with its terms, although the Compensation Committee
may assist the Agent with respect to issues which arise under the Plan. All
costs of administering the Stock Purchase Plan, the fees and expenses of the
Agent and other administrative expenses are paid by the Company.
ANNUAL INCENTIVE PLAN
The Company has established the CompuServe 1996 Short-Term Incentive Plan
for employees of the Company and its subsidiaries. The plan consists of two
parts, the Key Executive Incentive Plan ("KEIP") Program and the MBO Program.
Under the KEIP Program, employees selected by the Compensation Committee
will have the opportunity to receive a cash incentive award based on the
attainment of KEIP Program Goals established by the Compensation Committee for a
Performance Period (which shall be the fiscal year of the Company). The KEIP
Program also permits participants to be selected, and KEIP Program Goals to be
established for those
41
<PAGE> 43
participants, by the Executive Vice President, Administration and the Chief
Executive Officer of the Company. The KEIP Program Goals are based on one or
more of the following elements, as determined by the Compensation Committee: (i)
Company income, (ii) Company revenue, (iii) net new CIS, SPRYNET, and WOW!
customers, and (iv) net new Network Services customers. The KEIP Program Goals
are to be established, and may be revised, by the Compensation Committee,
provided that such establishment or revision may occur not later than 90 days
after the beginning of the Performance Period (but in no event after 25% of the
Performance Period has elapsed), and while the outcome as to the goals is
substantially uncertain. If actual performance exceeds the established goals,
participants may earn up to 150% of the target amount. (However, in no event may
the amount payable to any participant under the KEIP Program for any Performance
Period exceed $500,000.) If actual results fall short of the KEIP Program Goals,
awards will be less than the target amount. Awards for the KEIP Program for any
Performance Period will be paid as soon as practicable after the end of the
Performance Period, and after the Compensation Committee has approved the report
of the performance results.
Employees selected by the Compensation Committee, or selected by the Chief
Executive Officer of the Company (or by such officer's designees) from among
groups designated by the Compensation Committee, will participate in the MBO
Program. Each MBO Program participant will have the opportunity to receive a
cash incentive award based on the attainment of MBO Program Goals established by
the participant's direct supervisor in consultation with the participant. The
MBO Program Goals for any participant may be revised by the participant's
supervisor to take into account changes that render achievement moot,
inconsistent with applicable objectives, unreasonable or undesirable, or to take
account of circumstances not within the control of or area of responsibility of
the participant. The amount of the incentive award which may be paid to a
participant under the MBO Program will be established by the Compensation
Committee, or by the Chief Executive Officer of the Company (or by such
officer's designees) from within a range established by the Compensation
Committee. Under the MBO Program, a participant shall be entitled to up to 100%
of the designated bonus amount, based on the extent to which the MBO Program
Goals are met, as determined by the participant's direct supervisor in
consultation with the participant.
The KEIP Program may be amended or terminated by the Board of Directors of
the Company at any time.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Compensation information with respect to the Named Executive Officers for
1996 reflects compensation earned in part while the Company was a wholly owned
subsidiary of H&R Block. Until April 1996, the Company had no compensation
committee. Executive compensation levels during 1996 were established by the
Company's Chief Executive Officer, except that the compensation level of the
Chief Executive Officer was established by the Compensation Committee and the
Chief Executive Officer of H&R Block.
COMPENSATION OF DIRECTORS
Directors of the Company do not receive annual cash retainers or cash fees
for attendance at board or committee meetings.
On March 12, 1996, the Company adopted the CompuServe Corporation 1996
Outside Directors Plan (the "Directors Plan") which was approved by the
Company's sole stockholder, H&R Block Group, in March 1996. Under the Directors
Plan, on the date of each annual meeting of stockholders, each non-employee
Director of the Company (an "Outside Director") is automatically granted an
option to purchase 7,500 shares of Common Stock. Individuals who first become
Outside Directors on other than an annual meeting date are eligible for an
option award, subject to a pro rata reduction to reflect the period during which
they were not an Outside Director.
The exercise price of the shares subject to the option shall be the greater
of the fair market value of a share of Common Stock on the date that the option
is granted or par value. Options become exercisable on the day immediately
preceding the next annual stockholders meeting and remain exercisable until the
earlier of the ten-year anniversary of the grant date, or the first anniversary
of the Outside Director's termination of service on the Board. If the Outside
Director terminates service on the Board for reasons other than death or
disability prior to the vesting date, such option is forfeited. All options
become immediately exercisable in the event of the Outside Director's death or
disability. Options are not transferable except as designated by the holder by
will or the laws of descent and distribution. The option purchase price shall be
payable in cash or in shares of Common Stock.
42
<PAGE> 44
The number of shares which may be awarded under the Directors Plan shall
not exceed 90,000 shares. Shares issued under the Plan may be authorized and
unissued shares or treasury shares. In the event of certain transactions
affecting the type or number of outstanding shares, the number of shares subject
to the Directors Plan, the number or type of shares subject to outstanding
options, and the exercise price thereof, shall be adjusted to reflect the
transaction.
An Outside Director who is granted a stock option will not be subject to
federal income tax at the time of grant, and the Company will not be entitled to
a tax deduction by reason of such grant. Upon exercise of the option, the
difference between the option price and the fair market value of the Common
Stock on the date of exercise will be considered ordinary income to the Outside
Director, and generally the Company will be entitled to a corresponding tax
deduction.
The following table sets forth the number of options to purchase shares of
Common Stock which have been awarded under the Director's Plan.
<TABLE>
<CAPTION>
SHARES UNDERLYING
OPTIONS GRANTED(1)
------------------
<S> <C>
Non-Executive Director Group (4 persons).................................... 30,000
</TABLE>
- ---------------
(1) The options reported in this column consist of non-qualified options to
acquire Common Stock which were awarded to the Company's four Outside
Directors at the time of the Company's initial public offering exercise
price per share of $30.00. The options will become exercisable on the day
preceding the Company's annual meeting of stockholders to be held in October
1996.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of April 30, 1996, the ownership of the
Company's common stock by beneficial owners of more than five percent (5%) of
the outstanding shares of the Company, the directors of the Company, the Named
Executive Officers, and all directors and executive officers as a group.
<TABLE>
<CAPTION>
TOTAL SHARES SOLE VOTING SHARED VOTING
BENEFICIALLY AND AND
NAME OWNED(1) INVESTMENT POWER INVESTMENT POWER
- ---------------------------------------------------- ------------ ---------------- ----------------
<S> <C> <C> <C>
Robert J. Massey.................................... 1,000 1,000 --
Dennis D. Matteucci................................. -- -- --
Steven P. Stanbrook................................. 1,000 1,000 --
Lawrence A. Gyenes.................................. 1,000 1,000 --
Herbert J. Kahn..................................... 500 500 --
Henry F. Frigon..................................... 9,000 3,000 6,000
Roger W. Hale....................................... 500 500 --
Morton I. Sosland................................... 15,000 15,000 --
Frank L. Salizzoni.................................. 7,500 7,500
Alexander B. Trevor................................. -- -- --
All directors and executive officers
as a group (10 persons)........................... 36,000 30,000 6,000
H&R Block, Inc...................................... 74,200,000 74,200,000 --
4400 Main Street
Kansas City, MO 64111
</TABLE>
- ---------------
(1) As of April 30, 1996. For purposes of this disclosure, the Securities and
Exchange Commission has defined "beneficial ownership" to include securities
over which the individual has sole or shared investment or voting power
regardless of the economic incidents of ownership. The shares reported in
the table include shares held by certain family members of the directors or
in trusts or custodianships for such members (directly or through nominees).
43
<PAGE> 45
OWNERSHIP OF H&R BLOCK STOCK
The following table sets forth, as of July 26, 1996, the ownership of H&R
Block common stock by the Company's directors, the Named Executive Officers, and
all directors and executive officers as a group.
<TABLE>
<CAPTION>
TOTAL SHARES SOLE VOTING SHARED VOTING
BENEFICIALLY AND AND
NAME OWNED(1) INVESTMENT POWER INVESTMENT POWER
- ---------------------------------------------------- ------------ ---------------- ----------------
<S> <C> <C> <C>
Robert J. Massey.................................... 35,666(2) 35,666(2) --
Dennis D. Matteucci................................. 260(1) -- 260(1)
Steven P. Stanbrook................................. -- -- --
Lawrence A. Gyenes.................................. 1,000 1,000 --
Herbert J. Kahn..................................... 10,466(2) 10,466(2)
Henry F. Frigon..................................... 11,999(2) 3,999(2) 8,000
Roger W. Hale....................................... 11,130(2) 11,130(2) 58
Morton I. Sosland................................... 280,397(2) 95,809(2) 184,588
Frank L. Salizzoni.................................. 23,999 23,999 --
Alexander B. Trevor................................. 20,791(2) 20,791(2) --
All directors and executive officers
as a group (10 persons)........................... 381,300 188,452 192,906
</TABLE>
- ---------------
(1) As of April 30, 1996. For purposes of this disclosure, the Securities and
Exchange Commission has defined "beneficial ownership" to include securities
over which the individual has sole or shared investment or voting power
regardless of the economic incidents of ownership. The shares reported in
the table include shares held by certain family members of the directors or
in trusts or custodianships for such members (directly or through nominees).
The reported shares also include 260 shares owned by Mr. Matteucci's wife,
8,000 shares held by a charitable foundation of which Mr. Frigon is a
director, 9,000 shares held by a charitable foundation of which Mr. Sosland
is an officer and a director and 104,592 shares held by a corporation of
which Mr. Sosland is an officer and a director. The respective directors
have disclaimed any beneficial ownership of those shares held by or for
their family members, Mr. Frigon has disclaimed any beneficial ownership of
those shares held in the name of the charitable foundation of which he is a
director, and Mr. Sosland has disclaimed any beneficial ownership of those
shares held by said corporation or in the name of the charitable foundation
of which he is an officer and director.
(2) Includes shares which the specified person has the right to purchase within
60 days pursuant to options granted in connection with H&R Block's stock
option plans, as follows: Mr. Massey -- 35,666; Mr. Kahn -- 10,166; Mr.
Trevor -- 15,999; Mr. Frigon -- 3,999; Mr. Hale -- 9,999; Mr. Salizzoni --
17,999; and Mr. Sosland -- 17,999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company is controlled by H&R Block, which beneficially owns not less
than 80.1% of the outstanding Common Stock of the Company. On July 16, 1996, H&R
Block announced that its Board of Directors had approved plans to spin-off H&R
Block's remaining 80.1% interest in CompuServe. The Spin-off is subject to,
among other things, shareholder approval at H&R Block's annual meeting expected
to take place in September 1996 and a favorable ruling from the Internal Revenue
Service as to the tax-free nature of the transaction. H&R Block announced that
it expects the Spin-off to be completed on or about November 1, 1996.
The taxable income and losses of the Company and its consolidated
subsidiaries, including SPRY (the "Company Group"), will be included in the
consolidated federal income tax returns filed by H&R Block and its consolidated
subsidiaries (the "Parent Group") prior to the Distribution. The Company and H&R
Block entered into a Tax Sharing Agreement (the "Tax Sharing Agreement") which
requires the Company to pay H&R Block an amount in respect of federal income
taxes equal to the amount of the federal income taxes that the Company Group
would be required to pay if the Company Group were to file its own consolidated
federal income tax return and was never part of the Parent Group. Effectively,
this results in the Company's annual income tax provision being computed as if
the Company filed a separate tax return, except that items such as net operating
losses, capital losses, foreign tax credits, investment tax credits or similar
items which might not be immediately recognizable in a separate return, are
allocated according to the Tax Sharing Agreement and reflected in the Company's
annual income tax provision to the extent that such items reduce the current or
future Parent Group federal income tax liability.
The Company and H&R Block executed a Registration Rights Agreement pursuant
to which H&R Block may demand registration under the Securities Act of shares of
the Company's capital stock held by it at any time, subject to its agreement not
to sell any shares prior to the expiration of 180 days, subject to waiver by the
Company, from the date of the Prospectus filed in connection with the initial
public offering.
44
<PAGE> 46
The Company may postpone such a demand under certain circumstances. In addition,
H&R Block may request the Company to include shares of the Company's capital
stock held by H&R Block in any registration proposed by the Company of such
capital stock under the Securities Act.
CompuServe has entered into a number of agreements whereby CompuServe
leases space to house telephone accessible points of presence in some of the
local offices of H&R Block and its franchisees in cities throughout the country.
CompuServe makes annual aggregate rental payments of approximately $148,000 in
connection with such agreements.
The Company has entered into a Credit Card Program Agreement with Block
Financial Corporation ("Block Financial"), an affiliate of H&R Block, for the
issuance by Block Financial of a CompuServe Visa or Mastercard credit card to
employees and subscribers of the Company. CompuServe does not receive royalties
in respect of this agreement.
The Company provides certain programming and electronic processing services
related to tax return filings with the Internal Revenue Service and in various
state jurisdictions for an affiliate of H&R Block. The terms of this arrangement
may be renegotiated annually. Revenues generated in connection with this
arrangement amounted to approximately $8.0 million for the year ended April 30,
1996.
An affiliate of H&R Block utilizes the Company's online service to offer
its information and communication service products. Under the terms of a
three-year agreement, the Company will receive royalties on certain revenues
earned by the affiliate through the Company's online service. Conversely, the
Company will pay royalties to the affiliate for revenues earned from connect
time charges related to the affiliate's products. Revenues generated in
connection with this arrangement amounted to approximately $21,000, and
royalties paid in connection with this arrangement amounted to approximately
$1,000, for the year ended April 30, 1996.
Prior to the initial public offering, the Company incurred intercompany
payables to HRB Management (reflected in the Operating Company's financial
statements as "Due to Parent") in connection with the receipt of cash advances
for purchases of property and equipment, acquisitions, current income tax
liabilities and fluctuating working capital needs, offset by payments made by
the Company from its operating bank accounts. HRB Management did not charge the
Operating Company interest expense on the balance due. At October 31, 1995, the
Operating Company's payable to HRB Management was approximately $199.8 million.
Effective October 31, 1995, this intercompany balance was reduced by a
contribution to capital of approximately $124.8 million. Since October 31, 1995,
the remaining balance has borne interest at the prime rate at Commerce Bank of
Kansas City, adjusted monthly. Following the sale of common stock in the initial
public offering, the company paid HRB Management $205 million to satisfy the
balance owed, including interest of $5.6 million. The supplemental earnings per
share for the year ended April 30, 1996 would have been $0.64 assuming this
balance and related interest expense would have been eliminated at the beginning
of the period. At April 30, 1996, the Company is owed $17.4 million by H&R
Block.
In April 1996, the Company and HRB Management, a wholly-owned subsidiary of
the H&R Block Group, entered into a Corporate Services Agreement pursuant to
which HRB Management will provide to the Company from time to time, upon request
of the Company, certain routine and ordinary corporate services, including
financial, accounting, tax, legal and internal audit services. For these
services, HRB Management will be reimbursed for its costs (including the pro
rata costs of the HRB Management employees performing such services and
allocable overhead). The initial term of this agreement is one year. Thereafter,
unless either party provides the other with at least 60 days' prior written
notice to the contrary, the agreement will be automatically renewed for
successive one year terms until terminated. No amounts were paid in 1996.
45
<PAGE> 47
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
A. Consolidated Financial Statements
The following consolidated financial statements of CompuServe Corporation
and the Report of Independent Auditors thereon are included in Item 8, above.
DESCRIPTION
Independent Auditor's Report
Consolidated Balance Sheets as of April 30, 1996 and 1995
Consolidated Statements of Earnings for the Years Ended April 30, 1996,
1995 and 1994
Consolidated Statements of Stockholders' Equity for the Years Ended April 30,
1996, 1995 and 1994
Consolidated Statements of Cash Flows for the Years Ended April 30, 1996, 1995
and 1994
Notes to Consolidated Financial Statements
B. Financial Statement Schedules
Schedule II -- Valuation and Qualifying
Accounts for the Years Ended April 30,
1996, 1995 and 1994
C. Exhibits
<TABLE>
<CAPTION>
EXHIBIT NUMBER
- --------------
<C> <S>
3.1 Certificate of Incorporation (incorporated by reference to similarly numbered
exhibit to Registration Statement on Form S-1 (No. 333-1498) of CompuServe
Corporation)
3.2 By-laws (incorporated by reference to similarly numbered exhibit to
Registration Statement on Form S-1 (No. 333-1498) of CompuServe Corporation)
4.1 Form of Certificate for Common Stock (incorporated by reference to Exhibit 5 to
Registrant's Registration Statement on Form 8-A (No. 2-53193) of CompuServe
Corporation)
4.2 Form of Rights Agreement between CompuServe Corporation and Rights Agent
(including the Form of Certificate of Designation, Preferences and Rights of
Series A Junior Preferred Stock and Form of Rights Certificate) (incorporated
by reference to Exhibit 4.3 to Registrant's Registration Statement on Form 8-A
(No. 2-53193) of CompuServe Corporation)
10.1 Network Services Agreement dated June 5, 1992 between CompuServe Incorporated
and VISA U.S.A. Inc., as amended by Amendment to Network Services Agreement
dated November 14, 1994 (incorporated by reference to similarly numbered
exhibit to Registration Statement on Form S-1 (No. 333-1498) of CompuServe
Corporation)
10.2 Form of License and Distributorship Agreement between CompuServe Incorporated
and its international distributors (incorporated by reference to similarly
numbered exhibit to Registration Statement on Form S-1 (No. 333-1498) of
CompuServe Corporation)
10.3 Special Customer Arrangement Agreement dated July 5, 1994 between CompuServe
Incorporated and MCI Telecommunications Corporation, as amended by First
Amendment to MCI Special Customer Arrangement dated November 20, 1995 and Third
Amendment to MCI Special Customer Arrangement dated February 5, 1996
Arrangement dated November 20, 1995 and Third Amendment to MCI Special Customer
Arrangement dated February 5, 1996 (incorporated by reference to similarly
numbered exhibit to Registration Statement on Form S-1 (No. 333-1489) of
CompuServe Corporation)
10.4 Form of Credit Card Program Agreement dated October 1, 1994 between CompuServe
Incorporated and Block Financial Corporation (incorporated by reference to
similarly numbered exhibit to Registration Statement on Form S-1 (No. 333-1498)
of CompuServe Corporation)
10.5 Form of Rapid Refund Agreement between CompuServe Incorporated and H&R Block
Tax Services, Inc. (incorporated by reference to similarly numbered exhibit to
Registration Statement on Form S-1 (No. 333-1498) of CompuServe Corporation)
</TABLE>
46
<PAGE> 48
<TABLE>
<CAPTION>
EXHIBIT NUMBER
- --------------
<C> <S>
10.6 Tax Sharing Agreement among CompuServe Corporation, H&R Block, Inc. and certain
subsidiaries of CompuServe Corporation (incorporated by reference to similarly
numbered exhibit to Registration Statement on Form S-1 (No. 333-1498) of
CompuServe Corporation)
10.7 Form of Registration Rights Agreement between CompuServe Corporation and H&R
Block, Inc. (incorporated by reference to similarly numbered exhibit to
Registration Statement on Form S-1 (No. 333-1498) of CompuServe Corporation)
10.8 Form of Sub-Lease Agreement between CompuServe Incorporated and H&R Block, Inc.
for POP equipment (incorporated by reference to similarly numbered exhibit to
Registration Statement on Form S-1 (No. 333-1498) of CompuServe Corporation)
10.9 Contract dated August 13, 1983 between CompuServe Incorporated and American
Telephone and Telegraph Company, as amended by Amendment to Contract between
AT&T Corp. and CompuServe Incorporated dated September 16, 1994, Amendment No.
2 dated October 27, 1995 and Amendment No. 3 dated February 16, 1996
(incorporated by reference to similarly numbered exhibit to Registration
Statement on Form S-1 (No. 333-1498) of CompuServe Corporation)
10.10 Form of Corporate Services Agreement between the Company and HRB Management,
Inc. (incorporated by reference to similarly numbered exhibit to Registration
Statement on Form S-1 (No. 333-1498) of CompuServe Corporation).
10.11 CompuServe Corporation 1996 Long-Term Incentive Plan (incorporated by reference
to similarly numbered exhibit to Registration Statement on Form S-1 (No.
333-1498) of CompuServe Corporation). S-1 (No. 333-1498) of CompuServe
Corporation).
10.12 CompuServe Corporation 1996 Outside Directors Plan (incorporated by reference
to similarly numbered exhibit to Registration Statement on Form S-1 (No.
333-1498) of CompuServe Corporation).
10.13 CompuServe Corporation 1996 Employee Stock Purchase Plan (incorporated by
reference to similarly numbered exhibit to Registration Statement on Form S-1
(No. 333-1498) of CompuServe Corporation).
10.14 CompuServe 1996 Short-Term Incentive Plan (incorporated by reference to
similarly numbered exhibit to Registration Statement on Form S-1 (No. 333-1498)
of CompuServe Corporation).
10.15 Form of Intercompany Credit Facility (incorporated by reference to similarly
numbered exhibit to Registration Statement on Form S-1 (No. 333-1498) of
CompuServe Corporation).
21.1 Subsidiaries of the Company (incorporated by reference to similarly numbered
exhibit to Registration Statement on Form S-1 (No. 333-1498) of CompuServe
Corporation).
27 Financial Data Schedule.
</TABLE>
47
<PAGE> 49
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, on the 30th day of
July, 1996.
COMPUSERVE CORPORATION
By: Lawrence A. Gyenes
------------------------------------
Lawrence A. Gyenes
Executive Vice President
and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934 this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated.
<TABLE>
<CAPTION>
SIGNATURES TITLE DATE
- ------------------------------------- ---------------------------------------- -------------
<S> <C> <C>
* Chairman of the Board and Director July 30, 1996
- -------------------------------------
Henry F. Frigon
* President, Chief Executive Officer and July 30, 1996
- ------------------------------------- Director
Robert J. Massey
* Executive Vice President and Chief July 30, 1996
- ------------------------------------- Financial Officer
Lawrence A. Gyenes
* Treasurer and Corporate Controller July 30, 1996
- ------------------------------------- (Principal Accounting Officer)
Kenneth M. Marinik
* Director July 30, 1996
- -------------------------------------
Roger W. Hale
* Director July 30, 1996
- -------------------------------------
Frank L. Salizzoni
* Director July 30, 1996
- -------------------------------------
Morton I. Sosland
*By: Lawrence A. Gyenes
---------------------------------
Lawrence A. Gyenes, as
Attorney-In-Fact for each
of the persons indicated
</TABLE>
48
<PAGE> 50
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(AMOUNTS IN THOUSANDS)
FOR THE YEARS ENDED APRIL 30, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
COLUMN B COLUMN C -- ADDITIONS COLUMN E
---------- ------------------------ ----------
COLUMN A BALANCE AT CHARGED TO CHARGED TO COLUMN D BALANCE AT
- ------------------------------------------ BEGINNING COSTS AND OTHER ---------- END OF
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD
- ------------------------------------------ ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Year Ended April 30, 1996
Allowance for Doubtful Accounts......... $3,986 $ 11,505 $ 12,062 $3,429
Year Ended April 30, 1995
Allowance for Doubtful Accounts......... 3,283 4,223 3,520 3,986
Year Ended April 30, 1994
Allowance for Doubtful Accounts......... 1,095 5,361 3,173 3,283
</TABLE>
49
<PAGE> 51
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------------------------------------------------------------------------------
<S> <C>
27 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> APR-30-1996
<PERIOD-START> MAY-01-1995
<PERIOD-END> APR-30-1996
<CASH> 280,646
<SECURITIES> 29,345
<RECEIVABLES> 119,186
<ALLOWANCES> 3,429
<INVENTORY> 0
<CURRENT-ASSETS> 25,233
<PP&E> 348,059
<DEPRECIATION> 192,281
<TOTAL-ASSETS> 965,828
<CURRENT-LIABILITIES> 138,399
<BONDS> 0
0
0
<COMMON> 926
<OTHER-SE> 769,740
<TOTAL-LIABILITY-AND-EQUITY> 965,828
<SALES> 0
<TOTAL-REVENUES> 793,165
<CGS> 0
<TOTAL-COSTS> 705,329
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 5,555
<INCOME-PRETAX> 82,281
<INCOME-TAX> 33,187
<INCOME-CONTINUING> 49,094
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 49,094
<EPS-PRIMARY> .66
<EPS-DILUTED> .66
</TABLE>
