101
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, 1997
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 2-53193
COMPUSERVE CORPORATION
(Exact Name of Registrant as specified in its charter)
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)
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 21, 1997 as reported on the NASDAQ Stock Market, was approximately
$211.1 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 21, 1997, the Registrant had outstanding 92,600,000 shares of
common stock.
PART I
ITEMS 1 AND 2. BUSINESS AND PROPERTIES
Overview
CompuServe Corporation ("Company") 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. ("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, Block announced that its Board of Directors had approved
plans to spin-off (the "Spin-off") Block's remaining 80.1% interest in
CompuServe. The Spin-off was subject to, among other things, shareholder
approval at 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.
On August 28, 1996, Block announced that its Board of Directors decided
not to present the proposed Spin-off to shareholders at the Block September 11,
1996 annual meeting. The decision not to present the Spin-off for a
shareholder vote on September 11 was based, in part, on the Company's reported
first quarter and projected second quarter losses, market uncertainties
regarding the online industry and the planned September 1996 introduction of
new interfaces for the CompuServe Interactive Service ("CSi").
On April 3, 1997, it was announced that the Company and Block were engaged
in external discussions regarding possible business combinations involving
CompuServe. There are no assurances that such discussions will result in any
agreement or transaction.
CompuServe operates primarily through two divisions: Interactive Services
and Network Services. Interactive Services offers worldwide online and
Internet access services for consumers, while Network Services provide
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.
Interactive Services
CompuServe Interactive Service
CompuServe Interactive Service ("CSi") is one of the two largest consumer
online services in the world. As of April 30, 1997, the number of CSi
subscribers, exclusive of the subscribers of NIFTY SERVE, CompuServe's Japanese
licensee, was approximately 2.8 million, a decrease of about 12% since
April 30, 1996. CSi targets the more experienced PC user in both the home and
office who values breadth and depth of professional and business-oriented
content. CSi provides over 2,000 content areas such as finance, current events
and online reference; over one thousand 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. CSi has been building its extensive content and
associated relationships for over sixteen years. Management believes CSi
offers the broadest and most comprehensive content in the consumer online
industry, resulting in a service which would be difficult for competitors to
replicate.
CompuServe, its licensee and its distributors provide local access to CSi
in approximately 100 cities outside of the United States, from offices in 21
countries around the world. They offer multilingual interfaces, feature local
content and provide customer service.
CompuServe and its licensee had approximately 3.6 million subscribers
outside of the United States as of April 30, 1997, 1.2 million of which were
supported directly by CSi and the remainder of which were NIFTY SERVE
subscribers. CompuServe has licensed its core technology and network model
relating to its online service to NIFTY, a joint venture of Fujitsu Limited and
Nissho Iwai. NIFTY is licensed to operate its own online service, NIFTY SERVE,
in Japan based on CompuServe technology. In addition, NIFTY has the exclusive
right to distribute CSi in Japan. NIFTY has also been authorized by CompuServe
to license a subdistributor in Taiwan and another in South Korea to distribute
CSi in those countries. NIFTY has a right of first refusal to distribute CSi
in 14 additional Asian countries should CompuServe decide to license a
third-party distributor in those countries.
NIFTY's license with respect to CompuServe technology is perpetual.
NIFTY's license to act as a distributor of CSi is for an unlimited number of
five-year renewable terms, and is next up for renewal in calendar 2001. NIFTY
has the right to terminate its license to distribute CSi at any time, upon one
year's advance notice. CompuServe does not believe that the termination of
this relationship would have a material adverse effect on its financial
condition or results of operations.
NIFTY pays CompuServe a royalty fee on the gross monthly usage revenues of
the NIFTY SERVE online service. During each of the last three years, such
royalties accounted for less than 1% of CompuServe's total Interactive Services
revenues. CompuServe pays NIFTY a royalty for the CSi business that it
generates and the associated support services that it provides to CSi
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 CSi.
CompuServe pays royalties to these distributors for the business that they
generate and the associated support service that they provide to CSi
subscribers in countries in which they operate.
WOW!
In March 1996, CompuServe launched WOW!, a consumer online service
targeted to the mass consumer home market. WOW! complemented the existing CSi
service by targeting the less experienced computer user who, management
believed, were not adequately served by existing online services. The WOW!
service employed a unique, intuitive navigation structure designed to mirror
the manner in which non-computer trained individuals perceive the world. The
underlying technology was transparent to the user. CompuServe applied for a
patent on the WOW! navigation structure.
On November 21, 1996, the Company announced a "Back-to-Basics" strategy
aimed at building on its leadership in the business, professional and technical
market sectors while focusing on profitable segments in the consumer market.
As part of this change in market strategy, the WOW! service was withdrawn
effective January 31, 1997.
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 CSi. As of April 30, 1997, SPRYNET had approximately 280,000
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
lower monthly fee with a competitive hourly rate thereafter.
Network Services
CompuServe Network Services ("CNS") provides virtual private networking,
Internet, Intranet, Extranet services plus groupware application and web
hosting services to corporate clients around the world. In addition to
providing network connectivity and Internet access for CompuServe's CSi and
SPRYNET services, CNS offers dial and dedicated connectivity solutions that
allow corporate customers' dispersed users to gain secure, seamless access to
IP-based applications as well as proprietary systems. Customer applications
supported by CNS include Vital Processing Services LLC (Visa International
Inc.'s point-of-sale network) for credit card authorization, Federal Express
Corp.'s package tracking system, Experian Inc.'s (formerly TRW's credit data
unit) credit data transmission to 200,000 corporate clients, and Charles
Schwab's Street Smart product. At the end of fiscal year 1997 CNS had a client
base of 1,200 corporate customers.
Strategy
CompuServe's goal is to lead in the development and implementation of
personal and commercial applications with computer-based interactive
technology. CompuServe intends to grow its subscriber base for 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:
Refocus the flagship CSi service. In the U.S. consumer market,
CompuServe will continue to provide a distinctive experience in the CSi
online and Internet service, with focused retention and growth efforts in
the business, professional, and technical user markets.
Targeted Service Offerings. CompuServe offers differentiated online
and Internet services to appeal to subscribers' varied interests and
comfort levels with computer technology. Via its wholly-owned
subsidiary, SPRY, CompuServe offers Internet-access-only for the
technically sophisticated PC user who desires only direct access to the
Internet. Additionally, the CSi service is offered for the experienced
computer user who, in addition to direct access to the Internet, wants
the benefits of CSi proprietary services. 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 Internet-access-only service industry continues to
evolve.
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 further 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 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 and profitable growth in the
subscriber base.
Migration to Open Standards CompuServe is 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.
Enhancing CNS' Existing Value-Added Network Services. CNS is
continuing its focus on providing value-added data communication services
that differentiate CNS from its competition. These services include the
integration of best-of-breed technology into its network infrastructure
and customer premise equipment such that CNS can extend its industry-
recognized leadership position in the remote access and host access
markets. CNS' best-of-breed technology partners include Cisco Systems,
Microsoft, AT&T, US Robotics and Citrix. CNS will continue to
aggressively pursue technology partners who deliver products that can be
seamlessly integrated into services that address critical corporate
connectivity needs.
Expand CNS Services Portfolio In High Growth Markets. In addition to
enhancing its position in existing markets, CNS is expanding its services
portfolio in new high growth markets. In areas like application hosting
and premium Internet/Intranet access, CNS is focusing on non-commodity-
based services that provide opportunities for increased operating margins.
In these new high-growth markets, CNS is partnering with key technology
providers like Cisco Systems, Microsoft, Lotus and Netscape.
Enhancement of Network Infrastructure. In addition to continuing its
support for established protocols such as X.25 and SDLC, CNS will proceed
with on-going improvements to its IP ("Internet Protocol") based
infrastructure. This includes expansion of native IP dial and dedicated
POP's and the supporting nationwide ATM ("Asynchronous Transfer Mode")
technology backbone, enhanced Internet peering relationships, movement to
higher dial speeds such as 56kbps and ISDN, and implementation of new
customer provisioning, security and billing systems. Management believes
these network infrastructure enhancements will enable CNS to continue to
offer high-quality value-added differentiated communication solutions.
Management believes that CNS' ability to support both proprietary and open
systems protocols is a competitive advantage, especially with corporate
customers who need to integrate existing systems into Internet and
Intranet environments.
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, SPRYNET. 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
Interactive 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 44 million American households have personal computers and, as of
December 31, 1996, this number was expected to grow to over 63 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 the CSi icon in the
online services folder on the Windows 95 desktop greatly increases
awareness of consumer online services as Windows 95 becomes increasingly
prevalent on home PCs.
The Internet. As of calendar 1996, usage of the Internet, especially
the World Wide Web, was expected to grow at a compounded rate of 31% per
year through the year 2000. By the year 2000, it is estimated that as
many as 250 million people worldwide will have access to the Internet,
through almost 96 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
Management believes that the demand for data communication services will
continue to experience dramatic growth. The key market segments upon which CNS
will focus to capture this demand include virtual private networking (Intranet
and Extranet), premium Internet services, application hosting services,
transaction processing services and broadband communication services.
Key factors driving the need for CNS services include:
Increasing complexity in data communications. Given the rate at
which data communications technology is changing, especially in the
Internet/Intranet environment, it is becoming increasingly difficult for
corporations to maintain their own data communications facilities, while
at the same time such communications are becoming more strategic.
Consequently, the need for outsourcing of data communications is becoming
increasingly necessary for many corporations.
Increasingly mobile workforce. As working from home and traveling
employees become more prevalent among corporate workforces, the need for
integrated remote access solutions will continue to grow.
Increasing need to communicate outside the corporation. An
increasing number of commercial customers are finding it critical to
develop applications that interface with entities outside of the
organization (i.e., Extranets), including business partners, customers and
suppliers.
Increasing desire to leverage the Internet as a strategic tool. As
the desire to utilize the Internet as a corporate communication vehicle
and distribution channel increases, so will the need for secure, cost-
effective and managed Internet solutions.
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
Interactive Services
CompuServe offers an extensive range of communication, information,
entertainment and commerce services to its subscribers.
Communication. Interactive 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 CSi service, an
area which management believes has significant potential for expansion through
creative deployment of technology. Through e-mail, CSi 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 CSi 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 CSi 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 SPRYNET. CSi, 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
databases, extensive reference resources. Management believes CSi 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, interactive forums with financial experts,
and electronic brokerage services.
Entertainment. Interactive services and the Internet are a new form of
media to provide entertainment to consumers. CSi's entertainment news
services, such as Entertainment Drive, Hollywood Hotline and Soap Opera
summaries, are used extensively. Entertainment Drive offers CSi 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. In addition,
CompuServe believes that moderated forums and online chat serve as
entertainment outlets for many CSi subscribers.
Commerce. CompuServe has been a leader in establishing electronic
commerce through its CSi service. CSi subscribers have access to an electronic
mall, which gives them access to approximately 80 merchants who offer or
advertise products online. Businesses utilizing CSi's online merchandising
opportunities include FTD, Shopper's Advantage, American Greetings, and The
Sharper Image. CompuServe also offers subscribers a number of travel related
services. For example, CSi subscribers may check availability and make travel
plans and reservations online via several interactive travel services including
Sabre Interactive, WorldSpan, and Travel, Inc.
Network Services
CNS provides managed business communication solutions to corporate
customers. CNS integrates the best-of-breed Internet, Intranet and Virtual
Private Networking technologies into services that shield its customers from
the business and technology risks associated with managing complex global data
communication environments. Providing highly reliable cost-effective managed
data communication solutions is not a competency of most corporations; it is
however, a CNS core competency.
The CNS network, with more than 500 global points of presence, provides
worldwide remote access, Intranet and Internet solutions to major corporations
throughout the North America, Europe and the Pacific Rim. By integrating
leading data communications technology into its network infrastructure, CNS
provides managed end-to-end solutions that shield customers from the increasing
complexity associated with global wide-area communications. For example, CNS'
remote access solutions utilize CompuServe's network infrastructure in
connection with technology from Microsoft, Cisco and Citrix to provide seamless
multiprotocol host and LAN access. Customers use these remote access solutions
for mission critical corporate applications. CNS also provides dedicated
connectivity services, including Frame Relay, X.25 and high speed Internet
links.
CNS is a leading provider of value-added communication solutions for point
of sale services such as credit card authorizations. Since 1984, CNS has been
providing point of sale authorization to Vital Processing Services LLC (Visa
International Inc.'s point-of-sale network), and in fiscal year 1997 processed
over one billion point of sale transactions.
CNS is also focusing its product development efforts on the application
hosting market. By integrating leading client-server software platforms in its
data centers, CNS provides state-of-the-art groupware application and Web
hosting facilities. To provide these services, CNS works with industry leaders
in client-server platforms such as Microsoft, Lotus and Netscape.
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 1997, in the U.S. CompuServe began to more narrowly
tailor these marketing efforts in conjunction with the "Back-to-Basics"
strategy, as management believes such action will enable CompuServe to better
target appropriate and distinct market segments and help manage the cost of
these programs. As part of CompuServe's efforts to expand its international
subscriber base, marketing in European markets included substantial increases
in distribution of trial software disks through direct mail, publication
inserts and special event promotions, as well as increased general consumer
advertising on television and in periodicals in support of CSi. Also, new CSi
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. At April
30, 1997, CompuServe had retained approximately 54% of new CSi subscribers
after 3 months, 42% after 6 months, 35% after 9 months and 31% after 12 months
of service. There can be no assurance that CompuServe's subscriber retention
rates will not decline below these levels. Since April 30, 1996, CompuServe
has seen a decline in CSi membership.
Microsoft Corp. ("Microsoft") has placed the CSi icon in the online
services folder on the Windows 95 desktop, thus enhancing market awareness and
accessibility of this key service. In addition, CompuServe has co-marketing
agreements with 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 CSi or SPRYNET.
Customer Support
To complement its marketing efforts, CompuServe has invested in customer
service to improve customer retention. 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 service.
Pricing
CSi 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. CSi 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 CSi 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. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
Network Services
CNS has sales offices in over thirty cities in North America and Europe,
and employs over 400 sales associates. These sales associates, unlike many of
CNS' competitors, are focused on selling data communication services
exclusively. Management believes that this direct sales channel is one of the
key strengths of CNS because of the sales associates' ability to build and
maintain strong customer relationships and provide higher levels of response
with direct presence in distributed markets. Management believes that these
strong customer relationships are built on trust in CNS' ability to deliver
highly reliable cost-effective data communication solutions. This trust leads
to new applications in existing accounts and new customer relationships.
Delivery of Interactive 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 CSi the CIM 2.0.1 interface
with an integrated Internet World Wide Web browser and the ability to move
between CSi and related Internet areas. CompuServe makes available at no
additional charge to subscribers of CSi parental control software that assists
parents in controlling their children's access to content. In October 1996,
CompuServe introduced CompuServe 3.0 which has an easier to use graphical
interface, integrated Internet access and upgradable modules. CompuServe 3.0
also features the Internet Explorer browser from Microsoft, which is closely
integrated into CompuServe 3.0 for greatly enhanced ease of use.
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 Internet fee-based services with standard browser
software as well as proprietary services through CSi. 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 Commercial Internet System architecture.
The Company is the first company to license this technology.
Internet Access
CompuServe provides Internet access services through CSi and SPRYNET,
CompuServe's stand-alone Internet-access-only service for both the consumer and
business markets. A CSi subscriber using the current version of the interface
may fully utilize the Internet. In addition, during an online session, a CSi
subscriber using the current software version has seamless access to both CSi's
proprietary content and some of the more popular Internet-based features.
CompuServe believes CSi provides 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 one year duration, with automatic renewal, and usually provide for a
range of fixed or 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 arrangement with Time Warner to
provide the online versions of its Time and Sports Illustrated magazines in the
consumer online market. Due to the increasing competition in the consumer
online industry and the growth of the World Wide Web on the Internet,
CompuServe has seen a decrease in the value and the cost of well-known branded
content.
Whenever possible, CompuServe seeks exclusive arrangements with its
content providers. Many providers are free to make similar data available on
an Internet site they might operate or sponsor. Other providers, and in
particular the managers of forum areas on CSi, 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 CSi 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 16 years, are an important competitive advantage.
As competition in the online services market continues to intensify and
content providers consider the distribution of their content on the Internet
directly rather than through online service providers, the Company will look to
partner with such content providers on the Internet. Such partnering
opportunities may include allowance for CompuServe subscribers to have free
access to subscription-based Internet sites, and content/promotional
programming which in response drives traffic from the Internet to CompuServe
Internet based and proprietary products. While the Company 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 would not have a
material adverse effect on the Company's business. Although the Company
believes the online service providers offer advantages to content providers
that the Internet does not, there can be no assurances that content providers
will continue to distribute their content through online service providers. It
is for this reason that it is critical for the Company to continue to find ways
to partner with content providers on the Internet and generate mutually
beneficial business arrangements.
Other Business
In addition to Interactive 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 98% 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 500 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 8,500 digital switches (nodes) deployed by CompuServe,
and over 85,000 dial-in ports connected to local exchange carriers all
accessible at 33.6 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
CSi, 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 2,500 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
suburban Columbus, Ohio owned by CompuServe. CompuServe also owns and occupies
two other facilities in the Columbus area.
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
had its own engineering and manufacturing capabilities that traditionally had
permitted it to build or buy proprietary hardware for its network. The
manufacturing capability was sold to a third party in fiscal year 1997.
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 implementing 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, 1997, CompuServe had approximately 3,050 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 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 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, would have generally made 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. Although the United Stated Supreme Court recently held that the
Communications Decency Act was unconstitutional, there are indications that
additional legislative action in this area may be forthcoming. The Company
cannot predict the scope of such legislation or the impact on its operations.
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, the German federal prosecutors office in Munich,
Bavaria, began an inquiry into the issue of availability, to CompuServe
members in Germany, of Internet newsgroups alleged to be illegal under
German law. Felix Somm, who was then the general manager of CompuServe
GmbH (Munich), was named as the subject of this inquiry. Based upon the
preliminary inquiry, an official accusation has been filed against
Mr. Somm in the Munich law court. The materials assembled by the federal
prosecutor's office have been turned over to the Munich court. After
reviewing these materials and others, the Munich court will decide whether
the prosecutor's accusations have sufficient merit. As part of this process,
the Company will continue to have the opportunity to submit further
information to the court. Mr. Somm has since resigned from his position as
general manager of CompuServe GmbH to start his own business.
The Company believes that the accusations against Mr. Somm are entirely
groundless and that he will ultimately be vindicated. CompuServe plans to
vigorously oppose this action against Mr. Somm, not withstanding his
resignation.
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,
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 failure to prevent the distribution of material that
infringes on others' copyrights or patents. While CompuServe historically
has generally avoided editing or otherwise monitoring the content accessed
by its customers, industry trends may require it to engage more actively in
the selection, presentation and editing of relevant content in connection
with its information services. 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 have been 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,
and other ramifications, 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.
Subsequent to April 30, 1997, the Company received an assessment from the
German taxing authority related to value-added taxes on the Company's services
provided in Germany. Management is not able to estimate the amount of
potential loss related to this assessment. The Company believes that after
reviewing such matters and consulting with the Company's counsel that the
ultimate resolution of this matter will not have a material adverse effect on
the Company's consolidated financial statements.
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"), Microsoft Network ("MSN"), and
Prodigy Services Company. Among the larger 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, and UUNET Technologies, Inc. CompuServe's
Network Services business competes with local and international
telecommunications companies and other data communications services, including
ANS (a division of AOL), AT&T, MCI, Sprint Corp., Advantis, a joint venture of
IBM and Sears, Roebuck & Co. 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
CSi 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 has 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 the CSi icon in the Windows 95 desktop
folder for online services. These arrangements will help provide simple and
widespread access to CompuServe's CSi 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 CSi and SPRYNET 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 CSi, brand name recognition and
large user base have been its competitive advantages in the consumer online
services 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.
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.
Interactive 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
During fiscal 1997, the Company, certain current and former officers and
directors of the Company and Parent were named as defendants in four purported
class action lawsuits and one lawsuit based on the same allegations in which
the plaintiff does not seek class action status. One purported class action
lawsuit was voluntarily dismissed by the plaintiffs and such plaintiffs have
joined plaintiffs in one of the remaining class action lawsuits. One suit
names the lead underwriters of the Company's initial public offering as
additional defendants and as representatives of a defendant class consisting of
all underwriters who participated in such offering. Each pending suit alleges
similar violations of the Securities Act of 1933 based on assertions of
omissions and misstatements of fact in connection with the Company's public
filings related to its initial public offering. One suit also alleges
violations of the Ohio Securities Code and common law of negligent
misrepresentation. Another suit also alleges violations of Colorado, Florida,
and Ohio statutes and common law of negligent misrepresentation. Relief sought
is unspecified, but includes pleas for rescission and damages. In addition to
the five previously mentioned lawsuits, an action for discovery was filed
during fiscal 1997 solely against the Company. In such action, the plaintiff
seeks factual support for a possible additional claim relating to initial
public offering disclosures. All of these existing lawsuits are before the
State and Federal courts in Columbus, Ohio. The defendants are vigorously
defending these suits.
During fiscal 1997, TeleTech Teleservices, Inc. and TeleTech
Telecommunications, Inc. (collectively, "TeleTech") commenced an action in the
United States District Court, Southern District of Ohio against CompuServe
Incorporated for alleged violations of certain outsourcing contracts between
TeleTech and CompuServe Incorporated related primarily to the WOW! online
service. Teletech seeks recovery under a liquidated damages provision and
other compensatory damages, but has not asserted a specific amount to which it
believes it would be entitled. CompuServe Incorporated has filed counterclaims
alleging multiple breaches by TeleTech of the outsourcing contracts, including
breach of fiduciary duty, breach of confidentiality, and breach of the non-
compete and employee non-solicitation provisions of the outsourcing contracts
by TeleTech. The Company believes it has meritorious defenses and
counterclaims, and is vigorously pursuing this litigation.
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, except for the matters described herein, 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On March 21, 1997, the Company submitted various matters to a vote of its
stockholders at its Annual Meeting of Stockholders. A brief description of
matters voted upon at the Meeting and the results of the voting follows:
1. The election of two Class I directors to serve until the third
succeeding annual meeting of stockholders.
Nominated and accordingly elected to office as Class I directors
were Frank L. Salizzoni and Morton I Sosland:
Frank L. Morton I.
Sallizoni Sosland
-------------- ------------
For 88,362,004 88,354,493
Against or
Withheld 118,687 126,198
Abstentions 0 0
Broker Non-votes 0 0
2. To consider and act upon a proposal to ratify the appointment of
Deloitte & Touche LLP as the Company's independent auditors for the year
ending April 30, 1997
For 88,415,022
Against or
Withheld 65,669
Abstentions 0
Broker Non-votes 0
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:
High Low
------ -----
Fiscal Year 1996
----------------------
Fourth Quarter (April 19-30, $35.50 $27.75
1996)
Fiscal Year 1997
----------------------
First Quarter $29.25 $10.75
Second Quarter $16.75 $8.63
Third Quarter $13.50 $9.25
Fourth Quarter $13.63 $8.88
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 Parent. Any determination as to the payment of dividends
will depend upon the future results of operations, capital requirements 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 21, 1997, there were approximately 1,200 shareholders of record
and approximately 20,000 beneficial holders of CompuServe Common Stock.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
Year Ended April 30,
--------------------------------------------
1997 1996 1995 1994 1993
------ ------ ------ ------ ------
(In thousands, except per share data)
Operating Results:
Revenues:
Interactive Services revenues $556,597 $561,428 $395,954 $266,919 $174,882
Network Services revenues 257,639 198,828 147,673 109,402 81,740
Other revenues (a) 27,651 32,909 39,166 53,565 58,777
-------- -------- -------- -------- --------
Total Revenues 841,887 793,165 582,793 429,886 315,399
Costs and Expenses:
Costs of revenues 546,152 387,470 231,189 179,366 125,642
Marketing (c) 263,126 175,213 104,828 65,591 51,542
General and administrative 47,268 39,634 30,750 32,641 30,199
Depreciation and amort. 113,921 74,708 45,310 31,447 22,198
Equipment leasing 5,276
Product development 27,734 28,304 18,929 16,101 10,403
Purchased research & dev. (b) 83,508
Nonrecurring items (e) 34,754
--------- ------- ------- ------- -------
Total Costs and Expenses 1,038,231 705,329 514,514 325,146 239,984
Operating Earnings (loss) (196,344) 87,836 68,279 104,740 75,415
Interest income 9,842
Interest(expense)-related party (5,555)
--------- ------- ------- ------- -------
Earnings(loss)before taxes (186,502) 82,281 68,279 104,740 75,415
Income tax expense(benefit) (66,668) 33,187 59,481 42,647 29,838
--------- ------- ------- ------- -------
Net earnings (loss)(c) ($119,834) $49,094 $8,798 $62,093 $45,577
========= ======= ======= ======= =======
Earnings (loss) per share ($1.29) $.66 $.12 $.84 $.61
========= ======= ======= ======= =======
As of April 30,
-------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(In thousands)
Balance Sheet Data:
Total assets $802,536 $965,828 $323,557 $330,867 $240,365
Cash, cash equivalents and
investments $161,419 $309,991 $4,913 $3,633 $3,669
Due from Parent $70,228 $17,377
Due to Parent $142,400
Stockholders' equity $651,436 $770,666 $79,858 $241,677 $179,389
Year Ended April 30,
----------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(In thousands, except Network Services customers)
Online/Internet Subscribers:
CSi
U.S. 1,527 2,072 1,737 1,139 780
Europe 892 694 278 119 54
Other international 348 391 177 120 90
------- ------- ------- ------- -------
Total CSi 2,767 3,157 2,192 1,378 924
SPRYNET 280 132 29
WOW! 63
------- ------- ------- ------- -------
Total CompuServe hosted 3,047 3,352 2,221 1,378 924
Licensee 2,326 1,674 809 640 480
------- ------- ------- ------- -------
Total 5,373 5,026 3,030 2,018 1,404
======= ======= ======= ======= =======
CSi subscriber hours 124,973 123,023 50,326 27,271 14,123
SPRYNET subscriber hours 26,124 1,545
Network Services customers 1,200 966 743 586 484
Network Services customer
hours 57,139 45,146 31,539 20,058 14,149
Quarterly Data:
(In thousands, except per
share data) Fiscal 1997 Quarter Ended
------------------------------------------------
July 31, October 31, January 31, April 30,
1996 1996 1997 1997
-------- ----------- ----------- ---------
Revenues $208,642 $214,343 $210,975 $207,927
Costs and Expenses 259,843(e) 308,838(c,e) 234,987 234,563(e)
Net Earnings (Loss) (29,615) (58,035) (14,233) (17,951)
Earnings (Loss) per share ($.32) ($.63) ($.15) ($.19)
Fiscal 1996 Quarter Ended
------------------------------------------------
July 31, October 31, January 31, April 30,
1995 1995 1996 1996
-------- ----------- ----------- ---------
Revenues $186,549 $188,374 $203,032 $215,210
Costs and Expenses 140,944 164,639 185,785 213,961(d)
Net Earnings (Loss)(c) 26,835 13,966 9,398 (1,105)
Earnings (Loss) per share $.36 $.19 $.13 ($.02)
(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, Inc. 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.
In October 1996, the Company changed its rate of amortization of deferred
subscriber acquisition costs to more closely correlate with the recent
trends in subscriber retention rates and member net revenues. The new rate
of amortization is 50% in the first 3 months, 30% in the next 9 months, and
20% in the subsequent year, compared to the previous policy of 60% in the
first 12 months and 40% in the subsequent year. In conjunction with this
change in amortization rates, the Company accelerated amortization of
previously deferred CSi subscriber acquisition costs with a writedown
totaling $34.5 million as of October 31, 1996. Additionally, all
previously deferred subscriber acquisition costs totaling $8.3 million for
WOW! and $2.5 million for SPRYNET were also written off, reflecting the
high costs to service these high usage, flat-priced services. WOW! was
withdrawn from service effective January 31, 1997. See note 2 of notes
to the consolidated financial statements.
(d) During the fourth quarter of fiscal 1996, the Company reduced certain
accruals for incentive compensation and value added taxes totaling
$7,000.
(e) In the first quarter of fiscal 1997, the Company incurred a nonrecurring
pretax charge of $17.7 million relating to the sale of certain assets and
business operations of the corporate computer software group of SPRY,
Inc.; the consolidation of U.S.-based staff functions and office
facilities; the renegotiation of certain third-party customer service
agreements; and the write-off of certain obsolete software costs for
billing and customer service systems. Of the total charge, $9.8 million
required the outlay of cash; the remaining $7.9 million involved no
commitment of funds.
In the second quarter of fiscal 1997, the Company also incurred a
nonrecurring pretax charge of $7.9 million relating to the withdrawal of
the family-oriented WOW! online service. Of the total charge, $5.6
million required the outlay of cash; the remaining $2.3 million involved
no commitment of funds.
In the fourth quarter of fiscal 1997, the Company incurred a nonrecurring
pretax charge of $9.2 million relating to the further consolidation of
office facilities and the write-off of investments in certain content and
technology providers due to their deteriorated financial performance. Of
the total charge, $1.8 million required the outlay of cash; the
remaining $7.4 million involved no commitment of funds.
See note 9 of the notes to consolidated financial statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
CompuServe Corporation ("Company") is a majority owned subsidiary of
Parent, which is a wholly owned subsidiary of H&R Block ("Block"). The
Company's consolidated financial statements include the accounts of SPRY Inc.
("SPRY", a wholly-owned subsidiary of the Company) since the date of
acquisition by Parent. 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, 1996, Block announced that
its Board of Directors had approved plans to spin-off Parent's remaining 80.1%
interest in CompuServe. The Spin-off was subject to, among other things,
shareholder approval at Block's annual meeting in September 1996 and a
favorable ruling from the Internal Revenue Service as to the tax-free nature of
the Spin-off.
On August 28, 1996, Block announced that its Board of Directors decided
not to present the proposed Spin-off to shareholders at the Block September 11,
1996 annual meeting. The decision not to present the CompuServe Spin-off for a
shareholder vote on September 11 was based, in part, on the Company's reported
first quarter and projected second quarter losses, market uncertainties
regarding the online industry and the planned September introduction of new
interfaces for the CompuServe Interactive Service ("CSi").
On April 3, 1997, it was announced that the Company and Block were engaged
in external discussions regarding possible business combinations involving
CompuServe. There are no assurances that such discussions will result in any
agreement or transaction.
The Company's revenues have increased 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. Interactive
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 NIFTY, a licensee of the Company's online technology, represent less than
1% of the Interactive Services revenues. The Company does not expect royalties
received from NIFTY 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 Interactive
Services subscribers have been seasonal from October to March. Historically,
there has been no seasonality in the Company's Network Services business.
Pricing
Competitive dynamics in the online services market have resulted in a
series of price adjustments by the major online service providers over the last
several years. Historically, 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 CSi
intended to encourage subscribers to explore more features of the service, stay
on the service longer and increase CSi's price competitiveness with the other
major consumer online services. The new pricing schedule reduced revenue per
subscriber but contributed to significant increases in subscriber acquisitions
and usage.
Comparison of the current year's revenues, earnings, and revenues per
customer to the prior year are affected by the change in pricing in September
1995. Historically, declines in pricing have been offset by increased usage
and economies of scale. However, increased usage and economies of scale only
partially 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 or declines in revenue per customer. There can be no assurances,
however, that these new revenue sources will be sufficient to offset further
pricing adjustments or a decline in revenue per customer.
The Company also offers fixed pricing for SPRYNET. Because the fixed
monthly prices are above the current average monthly revenue per subscriber
before the change to fixed pricing, revenues have increased. The Company's
costs of providing the service have also increased as subscribers expand their
usage of the service because they experience no marginal cost in doing so.
Management does not expect SPRYNET or its fixed pricing option to materially
impact the Company's results of operations or liquidity.
Subscriber Acquisition and Retention
Prior to fiscal 1997, the Company experienced rapid growth in its
subscriber base. During fiscal 1997, the Company experienced a downturn in
monthly subscriber acquisitions and subscriber retention rates due to several
factors including the emergence of numerous Internet access providers in the
marketplace and competitive pricing issues. One of the key components of
increased subscriber growth is the extent to which those who try an online
service remain customers.
The Company has promoted 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 1997, the Company announced a "Back-to-Basics"
strategy aimed at building on its leadership in the business, professional, and
technical user market while focusing on profitable segments in the consumer
market. As part of this strategy, the Company introduced in the fourth quarter
an enhanced business menu service built on its CSi service with focused content
designed for business people and professionals. In addition in the fourth
quarter, the Company debuted an enhanced version of its flagship online service
for the important U.S. market. The new version organizes thousands of current
content areas -- business, professional, computing and shopping; Forums;
searchable databases; communications capabilities; and select Internet sites --
into 21 easy-to-use, menu-driven CSi Communities. The reorganization
showcases the content and capabilities that have proven most attractive to
CSi's base of sophisticated members, many of whom are business, professional
and technical users. These Communities and the way information is organized
within them are based on extensive research into the wants and needs of
CompuServe's U.S. subscribers and its larger target market of business and
technical professionals -- at work, at home and at play.
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, 1997,
CompuServe had retained approximately 54% of new CSi subscribers after 3
months, 42% after 6 months, 35% after 9 months and 31% after 12 months of
service. There can be no assurance that CompuServe's subscriber retention rates
will not decline below these levels.
Components of Revenues and Costs of Revenues
Revenues from Interactive Services customers are based primarily on online
usage and monthly fees. Revenues from Network Services customers are based
primarily on usage and value-added fees. Revenues per customer for Network
Services customers can vary significantly based upon the individual customer's
requirements.
Variable costs of revenues for Interactive 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 Interactive 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.
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 CSi and
SPRYNET services are the network, content acquisition and customer services
costs as a function of member growth and retention. The SPRYNET service cost
structure does not have a material content component.
Strategic Initiatives
Interactive Services
The Company has announced a "Back-to-Basics" global strategy aimed at
building on its leadership in the business, professional and technical user
market while focusing on profitable segments in the consumer market. The
Company will continue pursuing growth in higher-margin European and other
international consumer markets. In the U. S. consumer market, the Company has
discontinued undifferentiated mass marketing efforts that, with intensified
competition, have produced high attrition rates. The Company will continue to
provide a distinctive experience in the CSi online and Internet service, with
its focus retention and growth efforts on CSi's traditional and loyal base of
users.
As part of this "Back-to-Basics" global strategy, the Company recently
introduced an enhanced version of its flagship online service for the U.S.
market. The new version organizes thousands of current content areas --
business, professional, computing and shopping; Forum areas; searchable
databases; communications capabilities; and select Internet sites into 21
easy-to-use, menu-driven CSi Communities. The reorganization showcases the
content and capabilities that have proven most attractive to CSi's base of
sophisticated members, many of whom are business, professional, and technical
users. These communities and the way information is organized within them are
based on extensive research into the wants and needs of CompuServe's U.S.
subscribers and its larger target market of business and technical
professionals at work, at home, and at play.
Network Services
CNS is continuing its focus on providing value-added data communication
services that differentiate CNS from its competition. These services include
the integration of best-of-breed technology into its network infrastructure and
customer premise equipment such that CNS can extend its industry-recognized
leadership position in the remote access and host access markets. CNS' best-of-
breed technology partners include Cisco Systems, Microsoft, AT&T, US Robotics
and Citrix. CNS will continue to aggressively pursue technology partners who
deliver products that can be seamlessly integrated into services that address
critical corporate connectivity needs.
In addition to enhancing its position in existing markets, CNS is
expanding its services portfolio in new high growth markets. In areas like
application hosting and premium Internet/Intranet access, CNS is focusing on
non-commodity-based services that provide opportunities for increased operating
margins. In these new high-growth markets, CNS is partnering with key
technology providers like Cisco Systems, Microsoft, Lotus and Netscape.
In addition to continuing its support for established protocols such as
X.25 and SDLC, CNS will proceed with on-going improvements to its IP ("Internet
Protocol") based infrastructure. This includes expansion of native IP dial and
dedicated points of presence (POP's) and the supporting nationwide ATM
("Asynchronous Transfer Mode") technology backbone, enhanced Internet peering
relationships, movement to higher dial speeds such as 56kbps and ISDN, and
implementation of new customer provisioning, security and billing systems.
Management believes these network infrastructure enhancements will enable CNS
to continue to offer high-quality value-added differentiated communication
solutions. Management believes that CNS' ability to support both proprietary
and open systems protocols is a competitive advantage, especially with
corporate customers who need to integrate existing systems into Internet and
Intranet environments.
New Accounting Standards
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, "Earnings per Share,"
effective for financial statements for interim and annual periods ending after
December 15, 1997. Earnings per share calculations under this Standard are not
materially different from those disclosed in the consolidated statements of
operations.
Results of Operations
Fiscal Year Ended April 30, 1997 Compared to Fiscal Year Ended April 30,
1996
Interactive Services Revenues. Interactive Services revenues for the year
ended April 30, 1997 decreased 0.9% from the prior year to $556.6 million from
$561.4 million. The decrease in revenues was primarily the result of decreased
usage by subscribers This decrease in usage was partially offset by an
increase in revenue earned from base monthly service fees due to an average
larger subscriber base during fiscal year 1997 as compared to fiscal year 1996.
The average number of CSi subscribers during the fiscal year ended April 30,
1997, exclusive of NIFTY SERVE subscribers, increased 8.4% to 2.97 million from
2.74 million in 1996.
The average monthly CSi revenue per subscriber decreased to $14.90 for
1997 from $17.01 for 1996 primarily due to a new pricing structure introduced
in September 1995. Revenue per subscriber excludes royalties and subscribers
from NIFTY SERVE, SPRYNET and WOW!.
Network Services Revenues. Network Services revenues increased 29.6% to
$257.6 million from $198.8 million for 1996, while the number of Network
Services customers increased 24.2% to 1,200. 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 $27.7 million from
$32.9 million due primarily to decreased usage by the Company's commercial
timeshare customers. Additionally, a one-time $2.4 million gain on the sale of
a minority-interest investment was recognized in 1996. These decreases were
partially offset by an increase in revenues earned for corporate remote
computing services 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 as well as property and other direct costs. Costs of revenues
increased as a percent of total revenues to 64.9% in 1997 from 48.9% in 1996.
The 16.0 percentage point increase is due primarily to lower revenue per member
during the current fiscal year (6.2 percentage points), higher data
communication costs particularly with respect to the buildout and upgrading of
the European network (6.6 percentage points), increased customer service costs
(2.4 percentage points), and increased costs associated with uncollected fees
(1.2 percentage points).
Marketing. Marketing expenses include costs incurred to acquire and
retain subscribers, the Network Services sales organization and other marketing
costs. Effective May 1, 1995, acquisition costs for online subscribers were
deferred and charged to operations over 24 months beginning the month after
such costs were incurred, with 60% amortized in the first twelve months. In
October 1996, the rate of amortization was accelerated to more closely
correlate with the recent trends in subscriber retention rates. See note 2 of
notes to the consolidated financial statements. Marketing expenses as a
percent of total revenues increased in 1997 to 31.3% compared to 22.1% in 1996.
The increase in marketing expenses is primarily attributable to the
amortization of previously deferred CSi subscriber acquisition costs and the
write-off of previously deferred subscriber acquisition costs related to the
SPRYNET and WOW! services which occurred in the second quarter of 1997.
Marketing expenses, exclusive of the amortization of previously deferred costs,
declined as a percent of revenues from 34.3% in 1996 to 25.0% in 1997. The
decrease reflects primarily cutbacks in domestic CSi advertising prior to the
repositioning of CSi for the business, professional, and technical user
communities.
General and Administrative. As a percent of total revenues, general and
administrative expenses increased to 5.6% in 1997 from 4.9% in 1996. This
increase is due primarily to increases in property and other taxes.
Depreciation and Amortization. Depreciation and amortization as a percent
of total revenues increased to 13.5% in 1997 compared to 9.4% in 1996. The
increase reflects the capital expenditures to increase network capacity and
upgrade service in the U.S. and Europe.
Equipment Leasing. During the second quarter of fiscal year 1997, the
Company initiated an equipment leasing program.
Product Development. Product development costs as a percent of total
revenues for 1997 decreased to 3.3% from 3.6% in the prior year. The prior year
included the costs to develop WOW! as well as costs associated with the
software development business of SPRY which was sold in the second quarter of
1997.
Nonrecurring Items. During fiscal year 1997, the Company incurred
nonrecurring pretax charges totaling $34.8 million relating to the sale of
certain assets and business operations of the corporate computer software group
of SPRY; the withdrawal of the family-oriented WOW! online service; the
consolidation of U.S.-based staff functions and office facilities; the
renegotiation of certain third-party customer service agreements; the write-off
of certain obsolete software costs for billing and customer service systems
which are no longer being utilized by the Company and the write-off of
investments in certain content and technology providers due to their
deteriorated financial performance. Of the total charge, $17.2 million required
the outlay of cash; the remaining $17.6 million involved no commitment of
funds.
Taxes on Earnings. The effective tax rate decreased to 36% in 1997
compared to 40% in 1996. The decrease resulted from goodwill amortization in
1997 that is not fully deductible for tax purposes.
Fiscal Year Ended April 30, 1996 Compared to Fiscal Year Ended April 30,
1995
Interactive Services Revenues. Interactive 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 CSi subscribers at
April 30, 1996, exclusive of NIFTY SERVE subscribers, increased 46.7% to 3.2
million from 2.2 million in 1995.
The average monthly CSi 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 NIFTY SERVE and SPRYNET.) During 1996, the average monthly
usage per CSi 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
were 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 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 CSi 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.
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 was owed $17.4 million by Parent. This increased to $70.2 million
at April 30, 1997 reflecting primarily the tax benefits which resulted from the
Parent's ability to reduce U.S. Federal income taxes through utilization of the
Company's tax losses. The tax sharing agreement between the Company and Parent
provides for the remittance of the balance due to the Company within ten days
of the filing of its U.S. Federal income tax return.
The Company's primary source of liquidity has historically been cash flow
from operating activities.
From 1995 through 1997, the Company generated $152.3 million in cash from
operations, primarily net earnings, depreciation and amortization and purchased
research and development. Total cash invested during this period was $491.5
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. In mid-1997, the Company announced its "Back-to-Basics" strategy --
discontinuing its WOW! mass consumer initiative and reducing its domestic
advertising for CSi prior to repositioning the service for the business,
professional, and technical user communities. As a result, subscriber
acquisition and marketing investments declined to approximately $110 million in
1997. The Company expects to spend approximately $100 million for subscriber
acquisition and marketing in 1998.
The Company expects to invest up to $100 million for capital expenditures
in 1998. This will be supplemented by equipment leasing with an estimated cash
purchase value of $25 million. The expenditures for 1997 included $7 million
for deployment of TCP/IP across the Company's network; the planned expenditures
for 1998 include an additional $14 million to bring deployment to a total of 30
major city markets. The cost to fully deploy TCP/IP across the Company's
network will be dependent upon current and future assessments of each
additional market and the associated revenue and profit potential.
The Company's depreciation and amortization expense in future periods will
likely approximate current levels as leasing and other acquisition alternatives
substitute for higher levels of capital expenditures. The Company believes
that cash from operations, the proceeds from the public offering of common
stock coupled with the receipt of tax benefits from Parent will be
sufficient to meet the Company's presently anticipated funding requirements.
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.
In June 1996, the Company agreed to an unsecured $25 million revolving
credit facility with Bank One, Columbus, NA. Management of the Company
determined that, based on the most recent financial information available, this
credit facility was no longer necessary, and accordingly, the facility was
allowed to expire in June 1997.
Approximately 29% of the Company's revenues were generated from sources
outside of the United States, an increase of 9% from the prior year.
Except for the historical information contained herein, the matters
discussed in this report 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 such factors.
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, 1997 and 1996, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended April 30, 1997. 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, 1997 and 1996, and the results of their operations
and their cash flows for each of the three years in the period ended April 30,
1997 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 12, 1997
COMPUSERVE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in Thousands, Except Share Data)
April 30,
------------------
1997 1996
------ ------
ASSETS
Current Assets
Cash and cash equivalents $138,777 $280,646
Investments 22,642 29,345
Receivables, less allowance for doubtful accounts of
$4,884 and $3,429, respectively 118,336 119,186
Due from Parent 70,228 17,377
Prepaid expenses 16,909 14,103
Other current assets 15,924 25,233
--------- ---------
Total current assets 382,816 485,890
INTANGIBLE ASSETS, less accumulated amortization of
$14,587 and $10,610, respectively 8,153 22,809
PROPERTY AND EQUIPMENT, net 355,212 348,059
OTHER ASSETS:
Deferred subscriber acquisition costs, net 43,959 96,636
Other assets 12,396 12,434
--------- ---------
Total other assets 56,355 109,070
--------- ---------
TOTAL $802,536 $965,828
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $54,529 $89,236
Accrued salaries, wages and payroll taxes 15,417 15,475
Accrued taxes 8,016 4,070
Accrued royalties 3,170 6,361
Deferred revenue 5,824 4,077
Other accrued expenses 28,033 19,180
--------- ---------
Total current liabilities 114,989 138,399
DEFERRED INCOME TAXES 36,111 56,763
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common stock, par value $.01 per share: 250,000,000
shares authorized; 92,600,000 shares issued
and outstanding 926 926
Additional paid-in capital 744,288 744,288
Retained earnings (accumulated deficit) (92,713) 27,121
Cumulative translation adjustments (1,065) (1,669)
--------- ---------
Total stockholders' equity 651,436 770,666
--------- ---------
TOTAL $802,536 $965,828
========= =========
See notes to consolidated financial statements.
COMPUSERVE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Amounts in Thousands, Except Share Data
Year Ended April 30,
-----------------------------
1997 1996 1995
------ ------ ------
REVENUES:
Interactive Services revenues $556,597 $561,428 $ 395,954
Network Services revenues 257,639 198,828 147,673
Other revenues 27,651 32,909 39,166
---------- ---------- ----------
Total revenues 841,887 793,165 582,793
COSTS AND EXPENSES:
Costs of revenues 546,152 387,470 231,189
Marketing 263,126 175,213 104,828
General and administrative 47,268 39,634 30,750
Depreciation and amortization 113,921 74,708 45,310
Equipment leasing 5,276
Product development 27,734 28,304 18,929
Purchased research and development 83,508
Nonrecurring items 34,754
----------- ---------- ----------
Total costs and expenses 1,038,231 705,329 514,514
OPERATING EARNINGS (LOSS) (196,344) 87,836 68,279
INTEREST INCOME 9,842
INTEREST (EXPENSE) - related party (5,555)
----------- ---------- ----------
EARNINGS (LOSS) BEFORE TAXES (186,502) 82,281 68,279
INCOME TAX EXPENSE (BENEFIT) (66,668) 33,187 59,481
----------- ---------- ----------
NET EARNINGS (LOSS) ($119,834) $49,094 $8,798
=========== ========== ==========
EARNINGS (LOSS) PER COMMON SHARE ($1.29) $0.66 $0.12
=========== ========== ==========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 92,600,000 74,803,279 74,200,000
See notes to consolidated financial statements.
COMPUSERVE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Amounts in Thousands
Retained
Additional Earnings Cumulative
Common Paid-in (Accumulated Translation
Stock Capital Deficit) Adjustments Total
------ ---------- ----------- ----------- -------
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
Net loss (119,834) (119,834)
Change in foreign currency 604 604
translation adjustment
----- ---------- ---------- -------- ---------
BALANCE AS OF APRIL 30, 1997 $926 $744,288 ($92,713) ($1,065) $651,436
===== ========== ========== ======== =========
See notes to consolidated financial statements.
COMPUSERVE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Amounts in Thousands
Year Ended April 30,
--------------------------------
1997 1996 1995
CASH FLOWS FROM OPERATING ACTIVITIES: -------- -------- --------
Net earnings (loss) ($119,834) $49,094 $8,798
Adjustments to reconcile net earnings
(loss) to net cash provided
(used) by operating activities:
Noncash, nonrecurring items 17,565
Other noncash property writedown 6,500
Depreciation and amortization 113,921 74,708 45,310
Amortization of deferred subscriber
acquisition costs 120,836 22,585
Provision for deferred taxes on earnings (14,840) 46,018 (1,912)
Gain on sale of subsidiary (2,680)
Purchased research and development 83,508
Changes in:
Receivables 650 (38,164) (29,576)
Prepaid expenses (5,091) (9,047) (2,510)
Due from Parent (52,851)
Other current assets 2,936 (11,133) (150)
Deferred subscriber acquisition costs (68,159) (119,221)
Accounts payable (34,707) 46,901 9,018
Accrued salaries, wages and
payroll taxes (58) (3,224) 5,004
Accrued taxes 3,946 (3,559) (2,671)
Accrued royalties (3,191) 27 2,123
Deferred revenue 1,747 2,702 (6,545)
Other accrued expenses 8,853 5,666 3,017
---------- ---------- ---------
Net cash provided (used) by
operating activities (21,777) 63,353 110,734
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (120,590) (219,172) (101,603)
Purchases of short term investments (145,082) (29,345)
Maturities of short term investments 151,785
Proceeds from sale of subsidiary 5,195
Other, net (6,205) (22,919) (3,546)
---------- ---------- ---------
Net cash used by
investing activities (120,092) (271,436) (99,954)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from the sale of common stock,
net of costs of $33,181 518,819
Repayments to Parent (205,000)
Advances from Parent 169,997 (9,500)
--------- ---------- ---------
Net cash provided (used) by
financing activities 483,816 (9,500)
--------- ---------- ---------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS (141,869) 275,733 1,280
CASH AND CASH EQUIVALENTS AT BEGINNING
OF YEAR 280,646 4,913 3,633
--------- ---------- ---------
CASH AND CASH EQUIVALENTS AT END OF YEAR $138,777 $280,646 $4,913
========= ========== =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:
Cash paid to Parent for income taxes $33,187 $59,481
========= ========= =========
Interest paid to Parent $5,555
========= ========= =========
See notes to consolidated financial statements.
COMPUSERVE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED APRIL 30, 1997, 1996 AND 1995
(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, Block 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%. On July 16, 1996, Block
announced that its Board of Directors had approved plans to spin-off (the "Spin-
off") Parent's 80.1% interest in the Company. The Spin-off was subject to,
among other things, shareholder approval at Block's September 1996 annual
meeting, a favorable ruling from the Internal Revenue Service as to the tax-
free nature of the transaction, and the absence of any change in market
conditions or other circumstances that cause Block 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.
On August 28, 1996, Block announced that its Board of Directors decided
not to present the proposed Spin-off to shareholders at the Block September 11,
1996 annual meeting. The decision not to present the Spin-off for a
shareholder vote on September 11 was based, in part, on the Company's reported
first quarter and projected second quarter losses, market uncertainties
regarding the online industry and the planned September introduction of new
interfaces for the CompuServe Interactive Service ("CSi").
The Company provides computer-based information and communication services
to businesses and individual owners of personal computers, and operates
primarily through two business groups: Interactive Services and Network
Services.
Interactive 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.
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.
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
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. 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.
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.
Prior to October 1996, the Company amortized its subscriber acquisition
costs over a 24-month period, on an accelerated basis (60% in the first twelve
months and 40% in the subsequent year), to match subscriber acquisition costs
with associated Interactive Services revenues, beginning in the month
subsequent to the expenditure. In October 1996, the Company changed its rate
of amortization of deferred subscriber acquisition costs to more closely
correlate with the recent trends in subscriber retention rates and member net
revenues. The new rate of amortization is 50% in the first 3 months, 30% in
the next 9 months, and 20% in the subsequent year. In conjunction with this
change in amortization rates, the Company accelerated amortization of
previously deferred CSi subscriber acquisition costs with a writedown totaling
$34.5 million as of October 31, 1996. Additionally, all previously deferred
subscriber acquisition costs totaling $8.3 million for WOW! and $2.5 million
for SPRYNET were also written off, reflecting the high costs to service these
high usage, flat-priced services. WOW! was withdrawn from service effective
January 31, 1997. The total $45.3 million adjustment of deferred subscriber
acquisition costs ($28.6 million after taxes, or $0.31 per share) for the
quarter ended October 31, 1996 is included in marketing expenses. Amortization
of direct response advertising assets was $120,836 (including the $45.3 million
adjustment for deferred subscriber acquisition costs) for the year ended April
30, 1997 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.
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 $2,814 and $4,494 at April 30,
1997 and 1996 are included in intangible assets with amortization expense of
$2,055 and $449 recorded for the years 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.
Unamortized goodwill of $5,339 and $18,315 at April 30, 1997 and 1996 is
included in intangible assets with amortization expense recorded for the years
ended April 30, 1997, 1996 and 1995 was $3,348, $3,123, and $809, respectively.
At each balance sheet date, a determination is made by Management, in
accordance with Statement of Financial Standards No. 121, "Accounting for the
Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of", to
ascertain whether property, plant and equipment, goodwill and other intangible
assets have been impaired based on the sum of expected future undiscounted cash
flows from operating activities. In accordance with this provision, during
fiscal 1997, the Company adjusted the carrying value of certain property assets
due to obsolescence with a write-down of $6.5 million. At year end, the
Company believes that property, deferred subscriber acquisition costs, and
intangible assets at April 30, 1997 and 1996 are realizable and the
depreciation and amortization periods are appropriate.
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.
International Revenues -- The Company received revenues from foreign
sources totaling $242,151, $173,963, and $107,863 for the years ended April
30, 1997, 1996 and 1995, 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 and depreciation. As a
result of the Company filing a consolidated Federal income tax return with its
Parent, the Company has recorded the current income tax receivable as part of
the Due From/To Parent balance in the consolidated balance sheets. The Company
follows the provisions of Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes."
The Company has entered into a Tax Sharing Agreement Plan with its Parent
(see note 12).
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, 1998. 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 February 1997, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 128,
"Earnings per Share," effective for financial statements for interim and annual
periods ending after December 15, 1997. Earnings per share calculations under
this Standard are not materially different from those disclosed in the
consolidated statements of operations.
3. BUSINESS COMBINATION AND DISPOSAL
On April 4, 1995, Block 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 Block's convertible preferred
stock, valued at $5,641. Block subsequently transferred SPRY to Parent. 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 totaling $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 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 operations 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. See note 9
regarding the disposition of certain assets and business operations of the
computer software group of SPRY.
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.
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:
April 30,
------------------------
1997 1996
----------- ----------
Land $4,504 $4,504
Buildings 75,895 69,698
Computer equipment 489,954 407,375
Furniture and equipment 55,914 47,122
Leasehold improvements 18,246 11,641
----------- ----------
644,513 540,340
Less accumulated depreciation and amortization 289,301 192,281
----------- ----------
Total $355,212 $348,059
=========== ==========
Depreciation and amortization of property and equipment for the years
ended April 30, 1997, 1996 and 1995 amounted to $106,055, $69,823, and $43,716,
respectively.
Software license fees with net unamortized values of $11,142 and $7,931
as of April 30, 1997 and 1996 are included in other assets. Amortization
expense for the years ended April 30, 1997, 1996 and 1995 was $2,463, $1,313,
and $784, respectively.
5. TAXES ON EARNINGS
The provision (credit) for taxes on earnings is comprised of the
following:
Year Ended April 30,
-----------------------------------
1997 1996 1995
--------- --------- ---------
Currently payable:
Federal ($46,753) ($11,308) $53,075
State (5,075) (1,523) 8,318
--------- --------- ---------
Total (51,828) (12,831) 61,393
Deferred:
Federal (13,387) 40,557 (1,653)
State (1,453) 5,461 (259)
--------- -------- ---------
Total (14,840) 46,018 (1,912)
--------- -------- ---------
Total ($66,668) $33,187 $59,481
========= ======== =========
The following table reconciles the U.S. Federal income tax rate to the
Company's effective income tax rate:
Year Ended April 30,
-----------------------------------
1997 1996 1995
---------- ---------- ----------
Statutory Rate 35.0% 35.0% 35.0%
Increase in income taxes resulting from:
Purchased research and development 42.8
Goodwill amortization (1.6) 1.3 .4
State income taxes, net of Federal
tax benefit 2.3 3.1 7.7
Other .9 1.2
---------- ---------- ----------
Effective rate 35.7% 40.3% 87.1%
========== ========== ==========
A summary of deferred income taxes follows:
April 30,
----------------------
1997 1996
-------- --------
Gross deferred tax assets:
Difference between accrual and cash
basis accounting ($2,170) ($7,366)
Other (195) (811)
-------- --------
Current (2,365) (8,177)
-------- --------
Deferred Compensation (2,573) (3,213)
State Net Operating Loss Carryforward (2,530)
Impairment of Non-Performing Assets (2,572)
Other (443)
-------- --------
Noncurrent (7,675) (3,656)
-------- --------
Total (10,040) (11,833)
======== ========
Gross deferred tax liabilities:
Depreciation 26,328 22,394
Deferred subscriber acquisition costs 16,172 36,654
Product development costs 1,286 1,371
-------- --------
Noncurrent 43,786 60,419
-------- --------
Net deferred tax liabilities $33,746 $48,586
======== ========
Provision is not made for possible income taxes payable upon distribution
of accumulated earnings of foreign subsidiaries. Such accumulated earnings
aggregated $1,616 at December 31, 1996. Management believes that the taxes
associated with repatriating these earnings would not be material. The state
net operating loss carryforwards included in deferred tax assets expire on
various dates through the year 2011.
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, 1997.
7. COMMITMENTS
A portion of the Company's operations are conducted in leased facilities.
Also, during the second quarter of fiscal 1997, the Company initiated an
equipment leasing program. Total lease expense for the years ended April 30,
1997, 1996 and 1995 was $24,037, $13,283, and $8,397, respectively.
Future minimum lease payments under noncancellable operating leases as of
April 30, 1997 were as follows:
Year Ended April 30,
------------------------
1998 $25,842
1999 23,020
2000 16,819
2001 6,494
2002 3,794
2003 and thereafter 7,076
-----------
Total $83,045
===========
At April 30, 1997, 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 expired in June 1997. There were no borrowings during
1997.
8. CONTINGENCIES
During fiscal 1997, the Company, certain current and former officers and
directors of the Company and Parent were named as defendants in four purported
class action lawsuits and one lawsuit based on the same allegations in which
the plaintiff does not seek class action status. One purported class action
lawsuit was voluntarily dismissed by the plaintiffs and such plaintiffs have
joined plaintiffs in one of the remaining class action lawsuits. One suit
names the lead underwriters of the Company's initial public offering as
additional defendants and as representatives of a defendant class consisting of
all underwriters who participated in such offering. Each pending suit alleges
similar violations of the Securities Act of 1933 based on assertions of
omissions and misstatements of fact in connection with the Company's public
filings related to its initial public offering. One suit also alleges
violations of the Ohio Securities Code and common law of negligent
misrepresentation. Another suit also alleges violations of Colorado, Florida,
and Ohio statutes and common law of negligent misrepresentation. Relief sought
is unspecified, but includes pleas for rescission and damages. In addition to
the five previously mentioned lawsuits, an action for discovery was filed
during fiscal 1997 solely against the Company. In such action, the plaintiff
seeks factual support for a possible additional claim relating to initial
public offering disclosures. All of these existing lawsuits are before the
State and Federal courts in Columbus, Ohio. The defendants are vigorously
defending these suits.
During fiscal 1997, TeleTech Teleservices, Inc. and TeleTech
Telecommunications, Inc. (collectively, "TeleTech") commenced an action in the
United States District Court, Southern District of Ohio against CompuServe
Incorporated for alleged violations of certain outsourcing contracts between
TeleTech and CompuServe Incorporated related to the WOW! online service.
Teletech seeks recovery under a liquidated damages provision and other
compensatory damages, but has not asserted a specific amount to which it
believes it would be entitled. CompuServe Incorporated has filed counterclaims
alleging multiple breaches by TeleTech of the outsourcing contracts, including
breach of fiduciary duty, breach of confidentiality, and breach of the non-
compete and employee non-solicitation provisions of the outsourcing contracts
by TeleTech. The Company believes it has meritorious defenses and
counterclaims, and is vigorously pursuing this litigation.
Subsequent to April 30, 1997, the Company received an assessment from the
German taxing authority related to value-added taxes on the Company's services
provided in Germany. Management is not able to estimate the amount of
potential loss related to this assessment. The Company believes that after
reviewing such matters and consulting with the Company's counsel that the
ultimate resolution of this matter will not have a material adverse effect on
the Company's consolidated financial statements.
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, except for the matters described herein, 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. RESTRUCTURING RESERVES
During fiscal year 1997, the Company incurred nonrecurring pretax charges
totaling $34.8 million relating to the sale of certain assets and business
operations of the corporate computer software group of SPRY; the withdrawal of
the family-oriented WOW! online service; the consolidation of U.S.-based staff
functions and office facilities; the renegotiation of certain third-party
customer service agreements; the write-off of certain obsolete software costs
for billing and customer service systems which are no longer being utilized by
the Company and the write-off of investments in certain content and technology
providers due to their deteriorated financial performance. Of the total charge,
$17.2 million requires the outlay of cash; the remaining $17.6 million
involves no commitment of funds. As of April 30, 1997, substantially all
employees who were included in the employee severance accrual have been
terminated by the Company.
The activity of these special charges is as follows:
1997 Balance at
Provision Activity April 30, 1997
------------ ---------- ---------------
Computer software group sale $9,397 $8,282 $1,115
WOW! discontinuation 8,642 7,301 1,341
Facilities consolidation 4,728 1,120 3,608
Employee severance 2,637 2,167 470
Writedown of assets 9,350 9,350
------------ ---------- ---------------
Total $34,754 $28,220 $6,534
============ ========== ===============
The balances in these restructuring reserves at April 30, 1997 are included in
other accrued expenses. Total revenues and operating losses for the computer
software group of SPRY were immaterial to the 1997 consolidated financial
statements. Total revenues for WOW! during fiscal 1997 totaled $6.5 million.
Direct operating expenses attributable to WOW!, exclusive of allocable network
and host computing costs, totaled $33.9 million for fiscal year 1997.
10. 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, up to 6 percent, with such amounts vesting ratably over five
years of service. Prior to fiscal year 1997, the Company's contributions were
made at management's discretion. Contributions by the Company under the
Investment Plan amounted to $2,829, $0, and $1,126 for the years ended
April 30, 1997, 1996 and 1995, respectively.
11. LONG-TERM INCENTIVE PLANS
Executive Deferred Compensation Plan - In January 1997, the Company
initiated an Executive Deferred Compensation Plan, under which certain key
employees of the Company may elect to defer portions of compensation and earn
interest on the deferred amounts. The Company matches contributions at a rate
of 25%. The Company match in fiscal year 1997 was not material.
Stock Option 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 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 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. Awards under the Plans vest based on terms
established by the Compensation Committee and are exercisable over periods
established by the Compensation Committee not to exceed 10 years. Options to
directors vest on the day preceding the Company's next annual meeting of
stockholders. 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.
The following summarizes the stock option activity for the CompuServe
Corporation Long-Term Incentive Plan from May 1, 1995 to April 30, 1997:
Year Ended Year Ended
April 30, 1996 April 30, 1997
------------------- --------------------
Weighted Weighted
Number Average Number Average
of Exercise of Exercise
Shares Price Shares Price
---------- --------- ---------- -----------
Outstanding at
beginning of period 0 3,677,142 $30.00
Granted 3,677,142 $30.00 548,578 $13.13
Exercised 0 0
Canceled 0 2,385,715 $29.82
---------- --------- --------- ----------
Outstanding at end
of period 3,677,142 $30.00 1,840,005 $25.20
========== =========
Exercisable at end of year 0 0
========== =========
The following table summarizes information about options outstanding at
April 30, 1997:
Options Outstanding
-----------------------------------------------
Weighted Average Weighted
Remaining Average
Range of Exercise Contractual Exercise
Prices Number Life Price
$9.00 - $14.75 524,003 9.40 $13.13
$30.00 1,316,002 8.98 $30.00
----------
1,840,005 $25.20
==========
As of April 30, 1997, there were 56,400 options outstanding under the
Outside Directors Plan of which 33,900 were granted in fiscal year 1997. As of
April 30, 1997, 36,400 options under this plan are exercisable at prices
ranging from $8.81 - $30.00 per share. All options to directors have a
weighted-average remaining contractual life of 9.32 years.
The Company applies APB Opinion No. 25 and related Interpretations in
accounting for its stock option plans. Accordingly, no compensation cost has
been recognized for the plans in 1997 or 1996. All options under the Long-Term
Incentive Plan will expire on October 24, 1997 if the Company has not been spun-
off from Parent. The fair value of options are expected to be of nominal value
based on management's expectations of exercisability given current market
conditions. Accordingly, the options have no compensation cost considerations
under the provisions of FASB Statement No. 123. Subsequent to April 30, 1997,
the Board of Directors eliminated the expiration clause from the option
agreements.
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.
All shares purchased by employees through the Stock Purchase Plan are at fair
market value on the date of purchase. 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. All costs of administering the Stock
Purchase Plan, the fees and expenses of the Agent and other administrative
expenses are paid by the Company.
12. 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 and tax benefits which result from
Block's ability to reduce U.S. Federal income taxes through utilization of the
Company's tax losses. 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, 1997 and 1996, the Company is owed $70,228 and $17,377 by Parent
reflecting primarily the tax benefits which resulted from Block's ability to
reduce U.S. Federal income taxes through utilization of the Company's tax
losses.
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 or, in the event of tax losses, the Company
receives payment equal to the amount by which Block's U.S. Federal income taxes
are reduced..
Executive Deferred Compensation Plan -- Until January 1997, certain key
employees of the Company participated in Block's Executive Deferred
Compensation Plan. This Plan permitted 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 operations. 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. Any contributions made to this Plan prior to
January 1997 were permitted to remain in the Plan and continue to accrue
interest. Subsequent to January 1997, these employees were no longer permitted
to contribute to this plan, however the Company established its own Executive
Deferred Compensation Plan (see note 11).
Stock Option Plans -- The Company's employees participated in several of
Block'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
$9,680, $8,012, and $12,500 for the years ended April 30, 1997, 1996 and 1995,
respectively.
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 1997, 1996 or 1995.
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, 1997:
Name Age Position
- ----------------------- ------- -------------------------
Frank L. Salizzoni 59 Chairman of the Board of Directors
and Acting Chief Executive Officer
Lawrence A. Gyenes 46 Executive Vice President and
Chief Financial Officer
Herbert J. Kahn 57 Executive Vice President,
Corporate Operations
Dennis D. Matteucci 58 President, Interactive Services
Peter F. Van Camp 41 Executive Vice President,
Network Services
Henry F. Frigon 62 Director
Roger W. Hale 54 Director
Morton I. Sosland 72 Director
Edward E. Lucente 57 Director
Frank L. Salizzoni has served as a director of the Company since June 1996
and has served as the Chairman of the Board of the Company since October 1996
and acting Chief Executive Officer since February 1997. Mr. Salizzoni has
served as President and Chief Executive Officer of H&R Block since June 1996.
He 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, Orbital Sciences Corporation and SKF USA Inc.
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, Corporate
Operations 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 Cross
Medical, Inc.
Dennis D. Matteucci has served as President, Interactive 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.
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. Frigon has served as a director of the Company since February 1996 and
served as Chairman of the Board of Directors of the Company from June 1996
until October 1996. Mr. Frigon is a private investor and consultant. He
retired as CEO and President of BATUS, Inc. in March 1990 after serving with
that company for some 10 years. He most recently served as Executive Vice
President-Corporate Development & Strategy and Chief Financial Officer of
Hallmark Cards Incorporated, Kansas City, Missouri, from December 1990 to
December 1994. Mr. Frigon also served on the Board of Directors for BAT
Industries p.l.c., and Hallmark, Inc. during his time there. Mr. Frigon is
presently a director of H&R Block, Group Technologies, Inc., Buckeye Cellulose
Corp. and Dimon, Inc.
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.
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.
Mr. Edward E. Lucente has served as a director of the Company since
October 1996. Mr. Lucente has served as President and CEO of Liant Software
Corporation since 1995; as a marketing consultant from May 1994 to 1995; head
of worldwide sales and marketing of Digital Equipment Corp. from March 1993
until April 1994; Executive Vice-President of Northern Telecom Limited from
January 1992 until March 1993; Member of the Executive Office of Northern
Telecom Limited from February 1991 until March 1993; Senior Vice President of
Marketing for Norther Telecom Limited from February 1991 until January 1992;
Corporate Vice President of International Business Machines Corporation ("IBM")
from 1981 until February 1991. Mr. Lucente is a director of Genicom
Corporation and Information Resources Inc.
Robert J. Massey resigned as President and Chief Executive Officer of the
Company in February 1997 and Steven P. Stanbrook resigned as President,
CompuServe Europe in October 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 terms of Messrs. Frigon and Hale will expire at the
annual meeting of stockholders to be held in 1997, the term of Mr. Lucente will
expire at the annual meeting of stockholders to be held in 1998 and the terms
of Messrs. Salizzoni and Sosland will expire at the annual meeting of
stockholders to be held in 1999.
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, Lucente 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, Lucente 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.
ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table
The following table sets forth the amounts earned during the fiscal years
ended April 30, 1997, 1996 and 1995 by the Company's chief executive officers
and other persons named below (collectively, the "Named Executive Officers").
Long-Term
Compensation
Awards
Annual Shares
Compensation Underlying
Name and Principle Position Year Salary Bonus Options # Other(1)
- --------------------------- ---- -------- ------- ----------- ---------
Robert J. Massey (2) 1997 $223,173 $125,478
Former President and Chief 1996 263,402 $42,340 399,000 783
Executive Officer 90,000(7)
1995 197,358 188,474 135,000(7) 11,348
Frank L. Salizzoni (3) 1997
Chairman of the Board of 1996 6,400
Directors and acting Chief 1995
Executive Officer
Dennis D. Matteucci (4) 1997 300,000 20,000
President, Interactive 1996 11,539 37,383 100,000
Services
Lawrence A. Gyenes (5) 1997 250,000 20,000
Executive Vice President
and Chief Financial Officer 1996 9,615 50,000 100,000
Herbert J. Kahn 1997 198,558 20,000
Executive Vice President,
Corporate Operations 1996 187,598 40,420 188,500 53,598
40,000 (7)
1995 165,673 94,160 65,000 (7) 51,221
Peter Van Camp 1997 177,115 20,000
Executive Vice President, 1996 126,216 107,670 135,334
Network Services 1995 112,000 125,875
Steven P. Stanbrook (6) 1997 167,601 8,939
Former President, 1996 28,346 100,000
CompuServe Europe
Chester Scott 1997 130,962 84,000 7,500
Vice President, 1996 122,621 70,625 70,500
Network Sales 1995 112,000 139,375
(1) Includes severance payments and any payments under the Company's Deferred
Compensation Plan and 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 and resigned in February 1997. Mr. Massey's annual
base salary was $275,000.
(3) Mr. Salizzoni has been a director of the Company since June 1996 and has
served as the Chairman of the Board of the Company since October 1996 and
acting chief executive officer since February 1997. Mr. Salizzoni does not
receive any compensation from the Company.
(4) Mr. Matteucci was hired by the Company in April 1996. Mr. Matteucci's
annual base salary is $300,000.
(5) Mr. Gyenes was hired by the Company in April 1996. Mr. Gyenes's annual
base salary is $250,000.
(6) Mr. Stanbrook was hired by the Company as President, CompuServe Europe in
March 1996 and resigned in October 1996. Mr. Stanbrook's annual base salary
was $275,000.
(7) Represents options to acquire H&R Block common stock granted pursuant to
H&R Block's 1993 Long-Term Executive Compensation Plan.
Stock Option Grants
The following table summarizes options granted during the fiscal year
ended April 30, 1997 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 1997 fiscal year.
Stock Option Grants in Last Fiscal Year
Potential
Realizable Value
at
Assumed Annual
Rates of
Shares Stock Price
Underlying Exercise Appreciation
Options % Total of Base Expiration for Option Term
NAME Granted Granted Price Date 5% 10%
- ------------------ ---------- ------- -------- ---------- -------- --------
Dennis D. Matteucci 20,000(1) 3.6% $295,000 10/24/97 $185,524 $470,154
Lawrence A. Gyenes 20,000(1) 3.6% 295,000 10/24/97 185,524 470,154
Herbert J. Kahn 20,000(1) 3.6% 295,000 10/24/97 185,524 470,154
Peter Van Camp 20,000(1) 3.6% 295,000 10/24/97 185,524 470,154
Chester E. Scott 7,500(1) 1.4% 110,625 10/24/97 69,600 176,325
(1) Represents options to purchase shares of CompuServe common stock awarded
by the CompuServe Compensation Committee. The vesting of such options
are tied to the performance of the Company's stock price.
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, 1997 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,
1997.
FISCAL YEAR END VALUES
Number of Value of
Unexercised Unexcerised
Options In-the-Money
at FY-End (#) Options at FY-End
Exercisable (E) Exercisable (E)
Unexercisable(U) Unexercisable(U)
------------------- ------------------
Frank L. Salizzoni 0 E $0
6,400 U 0
Dennis D. Matteucci 0 E $0
120,000 U 0
Lawrence A. Gyenes 0 E $0
120,000 U 0
Herbert J. Kahn 0 E $0
208,500 U 0
Peter Van Camp 0 E $0
155,334 U 0
Chester Scott 0 E $0
78,000 U 0
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 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 participants, by the Executive Vice President,
Corporate Operations 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 CSi and SPRYNET 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
Beginning on November 1, 1996, the Directors of the Company receive $6,000
per fiscal quarter in cash compensation for their services. This fee is
payable at the first meeting of each fiscal quarter. Prior to this date, the
Directors did not receive any 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, each non-employee Director of the Company (an "Outside
Director") is automatically granted an option to purchase 7,500 shares of
Common Stock upon being elected a new Director. 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. Directors who are
reelected are granted an option for each such additional term, to purchase 5,000
shares of Common Stock, the award being effective on the date of the Annual
Meeting of Stockholders at which they are reelected.
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.
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 Outside Director's Plan.
Shares Underlying
Options Granted(1)
------------------------
Director Group (5 persons) 56,400
(1) The options reported in this column consist of non-qualified options to
acquire Common Stock which have been awarded to the Company's four Outside
Directors. As of April 30, 1997, 36,400 options are exercisable at prices
ranging from $8.81 - $30.00 per share. No options have been exercised.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of April 30, 1997, 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.
Sole Voting Shared Voting
Total Shares and and
Beneficially Investment Investment Percent of
NAME Owned (1) Power Power Class
- -------------------- ------------ ----------- ------------- ----------
Dennis D. Matteucci
Lawrence A. Gyenes 1,000 1,000 .01
Herbert J. Kahn 500 500 .01
Peter F. Van Camp 500 500 .01
Chester E. Scott 10,000 10,000 .11
Henry F. Frigon 9,000 3,000 6,000 .10
Roger W. Hale 500 500 .01
Morton I. Sosland 15,000 15,000 .16
Edward E. Lucente
Frank L. Salizzoni 7,500 7,500 .08
All directors and
executive officers 44,000 38,000 6,000 .48
as a group(10 persons)
H&R Block, Inc. 74,200,000 74,200,000 80.13
4400 Main Street
Kansas City, MO 64111
(1) As of April 30, 1997. 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).
Ownership of H&R Block Stock
The following table sets forth, as of June 1, 1997, 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.
Sole Voting Shared Voting
Total Shares and and
Beneficially Investment Investment
Name Owned(1) Power Power(1)
- ------------------------ ------------ ----------- -------------
Dennis D. Matteucci 260 260
Lawrence A. Gyenes 1,000 1,000
Herbert J. Kahn 10,466(2) 10,466(2)
Peter F. Van Camp 4,216 4,216
Chester E. Scott 3,000 3,000
Henry F. Frigon 13,999(2) 5,999(2) 8,000
Roger W. Hale 13,169(2) 13,169(2)
Morton I. Sosland 282,397(2) 97,809(2) 184,588
Edward E. Lucente
Frank L. Salizzoni 25,333 23,333 2,000
All directors and executive
officers as a group
(10 persons) 346,624 151,776 194,848
(1) As of June 1, 1997. 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, 104,592 shares held by a corporation of which Mr. Sosland is an
officer and a director, and 2,000 shares held by a charitable foundation
of which Mr. Salizzoni is an officer. 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. Mr. Salizzoni has
disclaimed any beneficial ownership of those shares held in the name of
the charitable foundation of which he is an officer.
(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. Kahn -- 10,166; Mr. Frigon -- 5,999;
Mr. Hale -- 11,999; Mr. Salizzoni -- 19,333; and Mr. Sosland -- 19,999.
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 was 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 expected the Spin-off to be completed on or about
November 1, 1996.
On August 28, 1996, Block announced that its Board of Directors decided
not to present the proposed Spin-off to shareholders at the Block September 11,
1996 annual meeting. The decision not to present the CompuServe Spin-off for a
shareholder vote on September 11 was based, in part, on the Company's reported
first quarter and projected second quarter losses, market uncertainties
regarding the online industry and the planned September 1996 introduction of
new interfaces for the CompuServe Interactive Service ("CSi").
The taxable income and losses of the Company and its consolidated
subsidiaries, including SPRY (the "Company Group"), are included in the
consolidated federal income tax returns filed by H&R Block and its consolidated
subsidiaries (the "Parent Group"). 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.
At April 30, 1997, the Company is owed $70.2 million by Parent, due
primarily for income tax benefits resulting from the Company's pretax losses
for the sixteen months ended April 30, 1997.
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. 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 $9.7 million for the year ended
April 30, 1997.
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 1997.
In connection with Robert J. Massey's resignation in February 1997 as the
Company's President and Chief Executive Officer and a director of the Company,
the Company and Mr. Massey entered into an agreement pursuant to which Mr.
Massey is to be paid over a one-year period severance pay in the amount of
$550,000 (equal to twice Mr. Massey's then current annual base pay). Mr.
Massey is also entitled to continuation of certain medical benefits through
August 31, 1997. In the event of the occurrence of a "change in control" of
the Company prior to August 17, 1997 or the execution prior to such date of a
definitive agreement, binding letter of intent or binding letter in principle
regarding a "change in control" of the Company, subject to certain exceptions,
Mr. Massey will become entitled to a bonus equal to $600,000 and, under certain
circumstances, an additional $137,500. Mr. Massey had three months after
February 17, 1997 to exercise any outstanding options to acquire H&R Block
common stock then exercisable. On various dates during these three months, Mr.
Massey exercised a total of 18,001 options. All options to acquire shares of
Common Stock of the Company will expire unexercised. Pursuant to the
agreement, Mr. Massey has agreed not to engage in any activity in the United
States or Europe for a period of 12 months following the date of the agreement
that would compete with the Company's online interactive information services,
Internet access services or network services.
In connection with Alexander B. Trevor's resignation in June 1996 as the
Company's Executive Vice President and Chief Technology Officer, the Company
and Mr. Trevor entered into an agreement pursuant to which, among other things,
Mr. Trevor became entitled to 24 weeks of severance pay and certain earned
incentive compensation. In addition, Mr. Trevor became entitled to 20 weeks of
additional base pay.
The Company has adopted a plan which could apply as a result of a "change
in control" of the Company. The following are the material terms of such plan.
In the event of the termination of an employee in connection with a "change in
control" of the Company, such employee would be entitled to either (i) two
times annual base salary and target bonus for executive vice presidents and
above, (ii) one times annual base salary and target bonus for vice presidents
and director level employees and (iii) two weeks base salary for each year of
service (with a minimum of three months and a maximum of six months base
salary) for all other employees. Such severance will be paid to an employee
terminated (i) without "cause" within two years of a "change in control" or who
resigns with "good reason" or (ii) without "cause" during a "potential change
of control" and a "change of control" in fact occurs within three months after
such person's termination date. In addition, options awarded under the
Company's 1996 Long-Term Incentive Plan would immediately vest upon a "change
of control." The Company's Board of Directors may revoke or materially modify
these severance benefits on 180 days notice. A "change of control" includes,
but is not limited to, (i) the acquisition by any person of more than 25% of
the voting power of the Company's Common Stock, (ii) stockholder approval of a
merger involving the Company unless more than 50% of the successor is owned by
the prior owners of the Company, (iii) a majority of the Company's board of
directors are not nominated by the incumbent board or (iv) if the Company
ceases to own all or substantially all of its Interactive division or Network
division.
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 Auditors' Report
Consolidated Balance Sheets as of April 30, 1997 and 1996
Consolidated Statements of Operations for the Years Ended April 30, 1997, 1996
and 1995
Consolidated Statements of Stockholders' Equity for the Years Ended April 30,
1997, 1996 and 1995
Consolidated Statements of Cash Flows for the Years Ended April 30, 1997, 1996
and 1995
Notes to Consolidated Financial Statements
B. Financial Statement Schedules
Schedule II -- Valuation and Qualifying
Accounts for the Years Ended April 30,
1997, 1996 and 1995
C. Exhibits
Exhibit
Number
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)
Exhibit
Number
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)
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).
Exhibit
Number
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.
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 29th day of
July, 1997.
COMPUSERVE CORPORATION
By: /s/ 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.
Signatures Title Date
*
- ------------------- Chairman of the Board and July 29, 1997
Frank L. Salizzoni Director and Acting Chief
Executive Officer
*
- ------------------- Executive Vice President July 29, 1997
Lawrence A. Gyenes and Chief Financial Officer
(Principle Accounting Officer)
* Director July 29, 1997
- -------------------
Henry F. Frigon
* Director July 29, 1997
- -------------------
Roger W. Hale
* Director July 29, 1997
- -------------------
Morton I. Sosland
* Director July 29, 1997
- -------------------
Edward E. Lucente
*By: Lawrence A. Gyenes
Lawrence A. Gyenes, as
Attorney-In-Fact for each
of the persons indicated
Schedule II -- Valuation and Qualifying Accounts
(Amounts in thousands)
For the Years Ended April 30, 1997, 1996 and 1995
Column A Column B Column C -- Additions Column D Column E
--------------- ----------- ----------------------- ---------- ----------
Balance at Charged to Charged to Balance at
Beginning Costs and Other End of
Description of Period Expenses Accounts Deductions Period
--------------- ----------- ----------------------- ---------- ----------
Year Ended
April 30, 1997
Allowance for
Doubtful Accounts $3,429 $24,269 $22,814 $4,884
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
EXHIBIT INDEX
Exhibit
Number Description
27 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> APR-30-1997
<PERIOD-START> MAY-01-1996
<PERIOD-END> APR-30-1997
<CASH> 138,777
<SECURITIES> 22,642
<RECEIVABLES> 118,336
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 382,816
<PP&E> 355,212
<DEPRECIATION> 289,301
<TOTAL-ASSETS> 802,536
<CURRENT-LIABILITIES> 114,989
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 651,436
<TOTAL-LIABILITY-AND-EQUITY> 802,536
<SALES> 0
<TOTAL-REVENUES> 841,887
<CGS> 0
<TOTAL-COSTS> 1,038,231
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (186,502)
<INCOME-TAX> (66,668)
<INCOME-CONTINUING> (119,834)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (119,834)
<EPS-PRIMARY> (1.29)
<EPS-DILUTED> (1.29)
</TABLE>
