UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
_________________________
FORM 10-Q
_________________________
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended May 31, 2001
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 0-17932
_________________________
Micron Electronics, Inc.
------------------------
(Exact name of registrant as specified in its charter)
State or other jurisdiction of incorporation or organization: Minnesota
_________________________
Internal Revenue Service - Employer Identification No. 41-1404301
_________________________
1450 Eagle Flight Way, Boise, ID 83709
(Address, including zip code of principal executive offices)
(208) 898-3434
(Registrant's telephone number, including area code)
_________________________
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No ____
----
The number of outstanding shares of the registrant's common stock as of July
9, 2001 was 96,856,165.
1
PART I. Financial Information
------------------------------
Item 1. Financial Statements
Micron Electronics, Inc.
Consolidated Statements of Operations
(In thousands, except per share amounts)
(Unaudited)
For the quarter ended For the nine months ended
May 31, June 1, May 31, June 1,
2001 2000 2001 2000
-------------------------------------------------------------------------------------------------------------------------------
Revenues $ 15,395 $ 10,155 $ 43,386 $ 21,465
Cost of revenues 9,715 7,860 28,438 15,638
----------- ----------- ----------- -----------
Gross margin 5,680 2,295 14,948 5,827
----------- ----------- ----------- -----------
Operating expenses:
Sales, marketing and technical support 9,509 9,220 27,760 16,947
General and administrative 8,384 5,682 27,479 10,855
Goodwill amortization 1,540 1,841 5,102 3,338
Other expense (income), net 29 (72) 565 753
----------- ----------- ----------- -----------
Total operating expenses 19,462 16,671 60,906 31,893
----------- ----------- ----------- -----------
Operating loss (13,782) (14,376) (45,958) (26,066)
Loss on equity investment (2,037) - (4,919) -
Gain on sale of investment - - 4,500 -
Interest income, net 2,082 3,005 6,489 9,420
----------- ----------- ----------- -----------
Loss from continuing operations before taxes (13,737) (11,371) (39,888) (16,646)
Income tax benefit 4,625 3,084 12,694 4,634
----------- ----------- ----------- -----------
Loss from continuing operations (9,112) (8,287) (27,194) (12,012)
----------- ----------- ----------- -----------
Discontinued operations, net of tax:
Income (loss) from discontinued operations - 6,421 (1,784) 30,490
Loss on disposal of discontinued operations (31,442) - (178,942) -
----------- ----------- ----------- -
Total income (loss) from discontinued operations (31,442) 6,421 (180,726) 30,490
----------- ----------- ----------- -----------
Net income (loss) $ (40,554) $ (1,866) $ (207,920) $ 18,478
=========== ============ =========== ===========
Net income (loss) per share, basic and diluted:
Continuing operations $ (0.09) $ (0.09) $ (0.28) $ (0.12)
Discontinued operations (0.33) 0.07 (1.87) 0.31
----------- ----------- ----------- -----------
$ (0.42) $ (0.02) $ (2.15) $ 0.19
=========== =========== =========== ===========
Number of shares used in per share calculations:
Basic and diluted 96,856 96,535 96,775 96,390
Fiscal 2000 amounts have been reclassified to reflect separately the results of
discontinued operations.
The accompanying notes are an integral part of the financial statements.
2
Micron Electronics, Inc.
Consolidated Balance Sheets
(In thousands, except par value and share data)
(Unaudited)
As of May 31, 2001 August 31, 2000
------------------------------------------------------------------------------------------------------------------
Assets
Cash and cash equivalents $ 114,397 $ 200,002
Liquid investments 70,784 126,032
Receivables, net 23,250 4,404
Income taxes recoverable 23,466 -
Deferred income taxes - 13,152
Other current assets 1,816 2,847
----------- -----------
Total current assets 233,713 346,437
Property, plant and equipment, net 48,906 37,673
Goodwill and intangibles, net 72,331 81,821
Investments - held to maturity 7,250 1,250
Equity investment 5,000 6,408
Other assets 509 2,103
Net assets of discontinued operations - 88,228
----------- -----------
Total assets $ 367,709 $ 563,920
=========== ===========
Liabilities And Shareholders' Equity
Accounts payable and accrued expenses $ 35,886 $ 28,004
Current debt 23 1,971
----------- -----------
Total current liabilities 35,909 29,975
Deferred income taxes 9,325 16,082
Other liabilities 8,078 11,283
----------- -----------
Total liabilities 53,312 57,340
----------- -----------
Commitments and contingencies
Common stock, $.01 par value, authorized 150 million shares; issued
and outstanding 96.9 million and 96.7 million, respectively 969 967
Additional capital 150,221 134,485
Retained earnings 163,207 371,128
----------- -----------
Total shareholders' equity 314,397 506,580
----------- -----------
Total liabilities and shareholders' equity $ 367,709 $ 563,920
=========== ===========
Fiscal 2000 amounts have been reclassified to reflect separately the results of
discontinued operations.
The accompanying notes are an integral part of the financial statements.
3
Micron Electronics, Inc.
Consolidated Statements of Cash Flows
(Amounts in thousands)
(Unaudited)
Nine months ended May 31, 2001 June 1, 2000
----------------------------------------------------------------------------------------------------------------------------------
Cash Flows From Operating Activities
Net (loss) income $ (207,920) $ 18,478
Adjustments to reconcile net (loss) income to net cash (used in) provided
by operating activities from continuing operations:
Loss (income) from discontinued operations 180,726 (30,490)
Depreciation and amortization 17,106 7,687
Gain on sale of MCMS common stock (4,500) -
Loss on equity investment 4,919 -
Provision for doubtful accounts 1,619 65
Other (1,103) (2,372)
Changes in operating assets and liabilities, net of acquisitions:
Receivables (24,603) (2,973)
Other current assets 1,029 (562)
Accounts payable and accrued expenses (3,367) 13,933
Deferred income taxes (101) 631
Other (769) (2,025)
------------- --------------
Net cash (used in) provided by operating activities of continuing operations (36,964) 2,372
------------- --------------
Cash Flows From Investing Activities
Expenditures for property, plant and equipment (18,176) (19,344)
Purchases of held to maturity investments (116,344) (158,169)
Proceeds from maturities of investment securities 167,500 212,500
Proceeds from sale of MCMS common stock 4,500 -
Proceeds from disposal of equity investment 1,489 -
Acquisitions, net of cash acquired - (58,297)
Equity investment (5,000) (7,000)
Other (483) (2,415)
------------- --------------
Net cash provided by (used for) investing activities of continuing operations 33,486 (32,725)
------------- --------------
Cash Flows From Financing Activities
Repayments of debt (1,948) (9,289)
Proceeds from issuance of common stock 915 3,395
------------- --------------
Net cash used for financing activities of continuing operations (1,033) (5,894)
------------- --------------
Net cash used in continuing operations (4,511) (36,247)
Net cash provided by (used in) discontinued operations (81,094) 17,409
------------- --------------
Net decrease in cash and cash equivalents (85,605) (18,838)
Cash and cash equivalents at beginning of period 200,002 200,950
------------- --------------
Cash and cash equivalents at end of period $ 114,397 $ 182,112
============= ==============
Fiscal 2000 amounts have been reclassified to reflect separately the results of
discontinued operations. The accompanying notes are an integral part of the
financial statements.
4
Micron Electronics, Inc.
Notes to Financial Statements
(Tabular amounts in thousands, except per share amounts)
(Unaudited)
1. Nature of Business
General
Micron Electronics, Inc., through its HostPro subsidiary, is a leading Web
hosting company that offers a broad range of business-to-business Internet
products and services, including managed dedicated hosting services, co-location
and connectivity services, electronic commerce services, application hosting,
and other Web hosting products.
Historically, Micron Electronics, Inc. and its subsidiaries (collectively the
"Company") provided a variety of computer products and related services through
its PC Systems, SpecTek, and HostPro business segments. The Company has disposed
of its PC Systems and SpecTek business segments, which are reported separately
as discontinued operations - See Footnote 3 "Discontinued Operations." The
Company's Web hosting business ("HostPro") will remain as the Company's sole
continuing operations. Prior to its disposal, the PC Systems business consisted
of developing, marketing, manufacturing, selling and supporting a wide range of
desktop and notebook systems and network servers under the micronpc.com brand
name and selling, reselling, and supporting a variety of additional peripherals,
software and services. Prior to its disposal, the SpecTek business consisted of
processing and marketing various grades of memory products in either component
or module form for specific applications.
History of Operating Losses
HostPro has incurred net losses and losses from operations for each period from
inception through the first nine months of 2001, and anticipates incurring
losses for at least the next two years. The Company does not expect HostPro to
generate positive cash flow from operations for at least one year.
The Company's future success is dependent upon its ability to achieve
profitability prior to the depletion of cash reserves and to raise funds,
thereafter, if needed. While the Company believes that it has adequate resources
to maintain planned operations for at least one year from the balance sheet
date, there is no assurance that HostPro will be profitable in the future under
its current Web and application hosting model or that adequate funding will be
available to allow the Company to continue operations subsequent to the one-year
time period. However, the Company's current financial forecast indicates that
there are sufficient cash reserves on hand until the Company reaches positive
cash flows.
Anticipated Business Combination
On March 23, 2001, the Company, Interland, and Imagine Acquisition Corporation
("Merger Sub"), a wholly owned subsidiary of the Company, entered into an
Agreement and Plan of Merger dated as of March 22, 2001 (the "Merger
Agreement"). Subject to the terms and conditions of the Merger Agreement, Merger
Sub will merge with and into Interland, with Interland to survive and become a
wholly owned subsidiary of the Company (the "Merger"). Each outstanding share of
Interland common stock will be exchanged for 0.861 (the "Exchange Ratio") shares
of Micron Electronics common stock, and options and warrants to purchase
Interland common stock will be exchanged for options or warrants, respectively,
to purchase shares of the Company's common stock according to the Exchange
Ratio. Based on provisions of the Merger Agreement, the Exchange Ratio may be
subject to change. After the closing of the Merger, Interland shareholders and
Micron Technology, Inc. ("MTI") are expected to own approximately 30% and 43%,
respectively, of the Company's outstanding common shares. In connection with the
planned combination with Interland, the Company converted all the outstanding
stock options under the HostPro Stock Plans to stock options of the Company and
adopted and consolidated the HostPro stock plans as the Micron Electronics, Inc.
2001 Equity Incentive Plan.
Interland provides a broad range of Web hosting, applications hosting and other
related Web-based business solutions specifically designed to meet the needs of
small- and medium-sized businesses. Interland had net sales of $10.9 million and
a net loss of $16.9 million for the quarter ended March 31, 2001, and net sales
of $34.3 million and a net loss of $67.0 million for the year ended December 31,
2000.
2. Summary of Significant Accounting Policies
Interim Unaudited Financial Information
The accompanying unaudited financial information as of May 31, 2001 and June 1,
2000 and for the three and nine month periods then ended, has been prepared in
accordance with generally accepted accounting principles for interim financial
information.
5
Micron Electronics, Inc.
Notes to Financial Statements--Continued
(Tabular Amounts in thousands, except per share amounts)
(Unaudited)
Preparing the Company's financial statements in accordance 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 revenue and expenses during the reporting
period. Actual results could differ from those estimates. Certain
reclassifications, none of which affects net income or loss, have been made to
present the financial statements on a consistent basis.
The accompanying consolidated financial statements include the accounts of the
Company and its majority owned subsidiaries. All intercompany balances and
transactions have been eliminated in consolidation. In the opinion of
management, the accompanying unaudited financial statements contain all
adjustments (consisting solely of normal recurring adjustments) necessary to
present fairly the financial position of the Company and its results of
operations and cash flows. Operating results for the nine-month period ended May
31, 2001 are not necessarily indicative of the results that may be expected for
the full year.
Basis of Presentation
This report on Form 10-Q ("10-Q") for the third quarter ended May 31, 2001,
should be read in conjunction with the Company's Annual Report on Form 10-K
("10-K") for the fiscal year ended August 31, 2000 and the Company's current
report on Form 8-K ("8-K") filed June 13, 2001, which presents the historical
financial results of the PC Systems and SpecTek businesses as discontinued
operations. Portions of the accompanying financial statements are derived from
the audited year-end financial statements contained in the 8-K. The Company's
operations are reported on a fiscal basis, which is a 52 or 53-week period
ending on the Thursday closest to August 31. The years ending August 30, 2001
and August 31, 2000 contain 52 weeks. All references to periods, including
annual and quarterly, are on a fiscal basis unless otherwise indicated. As of
May 31, 2001 MTI owned 61% of the Company's outstanding common stock.
Revenue Recognition
Revenue from continuing operations is primarily generated by providing shared
and dedicated hosting, application hosting, and connectivity services. Revenue
is recognized as the services are provided. Hosting contracts generally are for
service periods ranging from 1 to 12 months and typically require up-front fees.
Such fees, including set-up fees for hosting services, are deferred and
recognized ratably over the customers' expected service period.
Basic and Diluted Income (Loss) Per Share
The Company follows Statement of Financial Accounting Standards ("SFAS") No.
128, "Earnings Per Share." That statement requires the disclosure of basic net
income (loss) per share and diluted net income (loss) per share. Basic net
income (loss) per share is computed by dividing net income (loss) by the
weighted-average number of common shares outstanding during the period and does
not include any other potentially dilutive securities.
In addition to net income (loss) per share, the Company has also reported per
share amounts on the separate income statement components required by Accounting
Principles Board Opinion No. 30 ("APB No. 30") "Reporting the Results of
Operations -- Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions."
Because the Company has reported a loss from continuing operations during each
period being reported, the effect of dilutive securities is excluded from the
calculation of per share amounts. Earnings per share exclude the effect of
antidilutive stock options, aggregating 13.7 million for the quarter and nine
months ended May 31, 2001 and 8.6 million in the quarter and nine months ended
June 1, 2000.
Recently Issued Accounting Standards
In June 1998, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 requires that all
derivatives be recorded as either assets or liabilities in the balance sheet and
marked-to-market on an ongoing basis. SFAS No. 133 applies to all derivatives
including stand-alone instruments, such as forward currency exchange contracts
and interest rate swaps, or embedded derivatives, such as call options contained
in convertible debt instruments. The Company implemented SFAS No. 133 in the
first quarter of 2001 and the implementation did not have a material impact on
the Company's results of operations, financial condition or cash flows. In
December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin ("SAB") No. 101 "Revenue Recognition in Financial Statements". SAB No.
101 summarizes certain staff views in applying generally accepted accounting
principles to revenue recognition in financial statements. Adoption is currently
required by the end of fiscal 2001, and early adoption
6
Micron Electronics, Inc.
Notes to Financial Statements--Continued
(Tabular Amounts in thousands, except per share amounts)
(Unaudited)
is permitted. The Company does not expect the effect SAB No. 101 to have a
material effect on its results of operations, financial condition or cash flows.
In April 2000, the Financial Accounting Standards Board issued Interpretation
No. 44 ("FIN 44"), "Accounting for Certain Transactions Involving Stock
Compensation--an Interpretation of APB Opinion No. 25." FIN 44 clarifies and
modifies APB Opinion No. 25 "Accounting for Stock Issued to Employees". The
provisions of FIN 44 became effective in 2000 and did not have a material effect
on the Company's results of operations, financial condition or cash flows.
3. Discontinued Operations
The Company has discontinued the operations of its PC Systems and SpecTek
business segments. These segments are accounted for as discontinued operations
in accordance with APB No. 30. Amounts in the financial statements and related
notes for all periods shown have been reclassified to reflect the discontinued
operations.
Operating results for the discontinued operations are reported, net of tax,
under "Income (loss) from discontinued operations" on the accompanying
Statements of Operations. In addition, the loss for the disposal of the
discontinued operations has been recorded, net of tax, under "Loss on disposal
of discontinued operations" on the accompanying Statements of Operations.
For financial reporting purposes, the assets and liabilities of the discontinued
operations are combined and classified in the accompanying Balance Sheet as of
August 31, 2000, under "Net assets of discontinued operations." Cash flows from
the discontinued operations are also stated separately on the accompanying
Statements of Cash Flows, under "Net cash provided by (used in) discontinued
operations."
PC Systems
On May 31, 2001, the Company sold its PC Systems business to GTG PC Holdings,
LLC ("GTG PC"), an affiliate of the Gores Technology Group. Under the terms of
the agreement, GTG PC received assets, which included $76.5 million in cash, and
assumed specified liabilities of the PC Systems business. When the Company
announced its planned sale of the PC Systems business to GTG PC, the Company had
anticipated that the cash transfer to GTG PC would be $70.0 million. The
difference consists primarily of reimbursements made for liabilities assumed by
GTG PC that, in accordance with the original terms, were to be retained by the
Company. The Company is required to meet certain working capital requirements
based on the net assets and liabilities transferred to GTG PC. The final
determination of the working capital transferred to GTG PC is subject to audit.
Any adjustment to the working capital transferred could result in an additional
cash payment by the Company to GTG PC and a corresponding increase to the loss
on disposal.
The Company retained all liabilities of the PC Systems business not assumed by
GTG PC, including, for example, liabilities for taxes arising prior to the
closing of the transaction, employee termination and related expenses, and any
contingent liabilities arising prior to the closing date. In addition, the
Company has agreed for a period of three years not to compete with the PC
Systems business, and for two years, not to solicit or hire prior employees of
the PC Systems business. For a transition period after the closing of the
purchase, GTG PC agreed to provide certain information technology, financial,
telecommunications and human resources services to the Company at GTG PC's cost
plus 10% during the first four months after the closing, and at its cost plus
25% for the following two months.
Through May 31, 2003, or for the applicable statute of limitations with respect
to taxes and government contracts, the Company is obligated to indemnify the
purchaser and affiliated entities for any breaches of the representations and
warranties contained in the agreement. In addition, the Company is obligated for
an indefinite period of time to indemnify the purchaser and affiliated entities
for any breaches in covenants. The agreement provides that the maximum aggregate
liability of the Company for indemnification under the agreement is $10.0
million, or, in some limited circumstances, $30.0 million.
The agreement also provides that the Company would potentially be entitled to
receive a percentage of any proceeds in the event the PC Systems business is
sold or has an initial public offering of its securities within three years of
the closing of the purchase. The Company would receive a payment only after the
repayment of transaction costs, repayment of debt and capital contributions,
payment of a specified amount of cash to GTG PC and obligations under employee
incentive programs.
7
Micron Electronics, Inc.
Notes to Financial Statements--Continued
(Tabular Amounts in thousands, except per share amounts)
(Unaudited)
At the end of its second fiscal quarter of 2001, consistent with accounting for
discontinued operations, the Company recorded an estimate of future operating
losses from the discontinued operation between March 2, 2001 and May 31, 2001,
the expected completion date of the sale, and an estimate of the loss on
disposal of the discontinued operation. This estimated after tax loss recorded
in the second fiscal quarter of 2001 was $147.5 million. Based on the final
terms of the agreement to sell the PC Systems business and actual operating
results, we recorded an additional loss of $34.4 million in the third fiscal
quarter of 2001, resulting in a revised estimated loss of $181.9 million.
Management believes that the estimated loss is reasonable, however it is based
on preliminary data and is subject to revision. Included in the loss on disposal
are employee termination costs of approximately $9.8 million, of which $8.0
million is included in the accompanying Balance Sheets under "Accounts payable
and accrued liabilities" at May 31, 2001. The Company expects that all remaining
severance liabilities will be settled by the first fiscal quarter of 2002.
Summarized below are the operating results for PC Systems business, which are
included together with SpecTek's operating results in the accompanying
Statements of Operations under "Income (loss) from discontinued operations."
Also included below is the loss on the disposal of the PC Systems business that
is reported in the accompanying Statements of Operations under "Loss on disposal
of discontinued operations."
For the quarter ended For the nine months ended
May 31, June 1, May 31, June 1,
2001 2000 2001 2000
-------------------------------------------------------------------------------------------------------------------------------
Net sales $ 128,361 $ 246,273 $ 602,818 $ 748,174
----------- ----------- ----------- -----------
Loss before income taxes (35,973) (65,075) (83,598)
Income tax benefit 10,474 19,307 24,780
----------- ----------- -----------
Loss from discontinued operations, net of tax (25,499) (45,768) (58,818)
Loss on disposal of discontinued operations, net of tax (34,368) - (181,868) -
----------- ----------- ----------- -----------
Loss from discontinued operations, net of tax $ (34,368) $ (25,499) $ (227,636) $ (58,818)
=========== =========== =========== ===========
Summarized below are the assets and liabilities of the PC Systems business,
which are included together with the assets and liabilities of SpecTek in the
accompanying Balance Sheets under "Net assets of discontinued operations."
As of August 31, 2000
--------------------------------------------------------------------------------
Assets
Cash and equivalents $ -
Receivables 175,496
Inventories 17,138
Other current assets 7,524
Property, plant and equipment, net 138,134
Other assets 6,437
-----------
Total assets 344,729
-----------
Liabilities
Accounts payable and accrued expenses 214,071
Other liabilities 18,999
-----------
Total liabilities 233,070
-----------
Net assets of discontinued operations $ 111,659
===========
8
Micron Electronics, Inc.
Notes to Financial Statements--Continued
(Tabular amounts in thousands, except per share amounts)
(Unaudited)
The Company has discontinued the operations of its SpecTek business segment,
which is accounted for as discontinued operations in accordance with APB No. 30.
Pursuant to the Amended and Restated Component Recovery Agreement (as amended,
the "Component Recovery Agreement"), dated effective September 2, 1999, MTI
exercised its rights to purchase the assets of the SpecTek business. On March
22, 2001, the Company entered into a Purchase Agreement (the "Purchase
Agreement") to sell all assets primarily used by SpecTek and certain land,
buildings and intellectual property to MTI. Pursuant to the terms of the
Purchase Agreement, the Company transferred the land, buildings and intellectual
property to MTI on March 22, 2001, and received $18 million of cash in excess of
the historical cost from MTI. This amount has been recorded, net of tax, as an
increase in additional paid in capital. The Company has leased back a portion of
the land and buildings from MTI and has also been granted a license to use
certain components of the intellectual property. In addition, MTI agreed to pay
the Company for the March 1, 2001 net book value of the assets used by SpecTek,
less any outstanding intercompany payables. The proceeds from this transaction,
net of intercompany payables, were approximately $43.2 million, not including
certain land, buildings and intellectual property. Pursuant to the Purchase
Agreement, the assets used by SpecTek were transferred to MTI on April 5, 2001.
The valuation of the assets transferred was subject to audit by MTI. Upon
completion of the audit, net proceeds were adjusted downward to $39.6 million.
This adjustment was included in the accompanying Statement of Operations under
"Loss on disposal of discontinued operations," during the third quarter of 2001.
Summarized below are the operating results for SpecTek, which are included
together with the PC Systems business' operating results in the accompanying
Statements of Operations under "Income (loss) from discontinued operations."
For the quarter ended For the nine months ended
May 31, June 1, May 31, June 1,
2001 2000 2001 2000
-------------------------------------------------------------------------------------------------------------------------------
Net sales $ 34,203 $ 113,115 $ 248,309 $ 286,616
----------- ----------- ----------- -----------
Income before income taxes 44,655 62,836 126,639
Income tax provision (12,735) (18,852) (37,331)
----------- ----------- -----------
Income from discontinued operations, net of tax 31,920 43,984 89,308
Gain on disposal of discontinued operations, net of tax 2,926 - 2,926 -
----------- ----------- ----------- -----------
Income from discontinued operations, net of tax $ 2,926 $ 31,920 $ 46,910 $ 89,308
=========== =========== =========== ===========
Summarized below are the assets and liabilities of SpecTek, which are included
with the assets and liabilities of the PC Systems business in the accompanying
Balance Sheets under "Net assets of discontinued operations."
As of August 31, 2000
--------------------------------------------------------------------------------
Assets
Receivables $ 53,968
Inventories 13,620
Property, plant and equipment, net 35,619
Other assets 411
-----------
Total assets $ 103,618
===========
Liabilities
Accounts payable and accrued expenses $ 126,626
Other liabilities 423
-----------
Total liabilities 127,049
-----------
Net liabilities of discontinued operations $ (23,431)
===========
4. Receivables
As of May 31, 2001 August 31, 2000
--------------------------------------------------------------------------------
9
Micron Electronics, Inc.
Notes to Financial Statements--Continued
(Tabular amounts in thousands, except per share amounts)
(Unaudited)
Trade receivables $ 9,012 $ 3,639
Service contract refund 9,700 -
Other 5,536 1,070
Allowance for doubtful accounts (998) (305)
----------- -----------
$ 23,250 $ 4,404
=========== ===========
5. Property, Plant and Equipment
As Of May 31, 2001 August 31, 2000
-------------------------------------------------------------------------------
Computer equipment and software $ 28,081 $ 16,429
Leasehold improvements 19,032 10,550
Assets in progress 14,485 14,990
Less accumulated depreciation and amortization (12,692) (4,296)
----------- -----------
$ 48,906 $ 37,673
=========== ===========
6. Acquired Intangibles and Goodwill
As Of May 31, 2001 August 31, 2000
-------------------------------------------------------------------------------
Goodwill $ 64,312 $ 65,375
Acquired intangibles 24,700 24,700
----------- -----------
89,012 90,075
Less accumulated amortization (16,681) (8,254)
----------- -----------
$ 72,331 $ 81,821
=========== ===========
Amortization expense related to goodwill and acquired intangible assets amounted
to $2.8 million and $2.9 million for the quarters ended May 31, 2001 and June 1,
2000 and $8.4 million and $5.4 million for the first nine months of 2001 and
2000, respectively.
7. Equity Investment
On April 7, 2000, the Company invested $7 million in Bird on a Wire, Inc.
("BOAW"), a dedicated Web hosting start-up company in exchange for a
non-interest bearing convertible debenture. The Company has accounted for this
investment using the equity method of accounting. Correspondingly, losses
incurred by BOAW have been treated as a reduction in its equity investment. On
May 28, 2001, BOAW entered into a definitive agreement to sell its assets. After
settling BOAW liabilities, the Company received net proceeds of $1.5 million and
has recorded a loss on disposal of approximately $1.7 million, which is included
in the Statements of Operations under "Loss on equity investments."
8. Accounts Payable and Accrued Expenses
As Of May 31, 2001 August 31, 2000
-------------------------------------------------------------------------------
Trade payable $ 11,557 $ 7,670
Deferred revenue 3,385 3,198
Taxes payable 795 7,268
Accrued payroll and related liabilities 13,608 3,442
Other accrued expenses 6,541 6,426
----------- -----------
$ 35,886 $ 28,004
=========== ===========
9. Other Liabilities
10
Micron Electronics, Inc.
Notes to Financial Statements--Continued
(Tabular amounts in thousands, except per share amounts)
(Unaudited)
As Of May 31, 2001 August 31, 2000
----------------------------------------------------------------------------------------------------------------------------------
Accrued stock compensation $ 2,373 $ 5,340
Other 5,705 5,943
----------- -----------
$ 8,078 $ 11,283
=========== ===========
10. Debt
As Of May 31, 2001 August 31, 2000
----------------------------------------------------------------------------------------------------------------------------------
Notes payable $ - $ 1,854
Capitalized lease obligations payable in monthly installments through
October 2002, interest rate of 10.04% 23 117
----------- -----------
Current debt $ 23 $ 1,971
=========== ===========
On March 28, 2001, the Company terminated its unsecured credit agreement with a
group of financial institutions, which provided borrowings up to $100.0 million.
11. Transactions with Affiliates - Discontinued Operations
For the quarter ended For the nine months ended
May 31, June 1, May 31, June 1,
2001 2000 2001 2000
-------------------------------------------------------------------------------------------------------------------------------
Net sales $ 8,552 $ 1,506 $ 23,561 $ 4,257
Inventory purchases 16,755 22,974 103,808 62,161
Component recovery agreement expenses 9,845 49,566 99,483 106,119
Administrative services and other expenses (income) (285) 201 (206) 432
Lease from MTI 1,165 - 1,165 -
Property, plant and equipment purchases 608 3,025 14,186 8,164
Property, plant and equipment sales 5,313 20,441 32,649 26,564
The transactions noted above were primarily between the Company's discontinued
operations and MTI. On March 22, 2001, the Company entered into a Purchase
Agreement to sell all assets primarily used by SpecTek and certain land,
buildings and intellectual property assets to MTI (see Footnote 3, "Discontinued
Operations - SpecTek").
12. Operating Segment and Geographic Information
The Company adopted Statement of Financial Accounting Standards (SFAS) 131,
"Disclosures about Segments of an Enterprise and Related Information" in 1999.
SFAS 131 supersedes SFAS 14, "Financial Reporting for Segments of a Business
Enterprise," replacing the "industry segment" approach with the "management"
approach. The management approach designates the internal organization that is
used by management for making operating decisions and assessing performance as
the source of its reportable segments. SFAS 131 also requires disclosures about
products and services, geographic areas, and major customers.
The Company had three business segments, PC Systems, SpecTek, and HostPro. As
discussed in Footnote 3 "Discontinued Operations", the PC Systems and SpecTek
business units are being reported as discontinued operations. HostPro, the
remaining business segment, is reported as the Company's continuing operation.
13. Income Taxes
11
Micron Electronics, Inc.
Notes to Financial Statements--Continued
(Tabular amounts in thousands, except per share amounts)
(Unaudited)
The effective income tax rate on continuing operations was approximately 34% and
27% for the third quarter of 2001 and 2000, respectively. The effective income
tax rate on continuing operations was approximately 32% and 28% for the first
nine months of 2001 and 2000, respectively. These rates principally reflect the
federal statutory rate, net of the effect of state taxes, tax-exempt securities
and non-deductible goodwill amortization. The change in the effective income tax
rates primarily reflect tax benefits and tax sharing arrangements that are no
longer available due to the disposal of the discontinued operations.
14. Gain on Sale of Investment
On September 29, 2000, the Company sold its remaining 10% interest in MCMS, Inc.
("MCMS") for a net gain of $4.5 million which is reported in the Statements of
Operations under "Gain on sale of investment". MCMS was formerly the Company's
wholly owned subsidiary, of which 90% was sold in September 1998.
15. Commitments and Contingencies
The Company is defending a consumer class action lawsuit filed in the Federal
District Court of Minnesota based on the alleged sale of defective computers. No
class has been certified in the case. The case involves a claim that the Company
sold computer products with a defect that may cause errors when information is
written to a floppy disk. Substantially similar lawsuits have been filed against
other major computer manufacturers. The case is currently in the early stages of
discovery, and we are therefore unable to estimate total expenses, possible loss
or range of loss that may ultimately be connected with the matter.
During the third quarter of 1997, the Company began to collect and remit
applicable sales or use taxes in nearly all states. In association therewith,
the Company is party to agreements with nearly all states, which generally limit
its liability, if any, for non-remittance of sales and use taxes prior to such
agreements' effective dates. The Company believes the resolution of any matters
relating to the non-remittance of sales or use taxes prior to the balance sheet
date will not have a material adverse effect on its business, financial
position, and results of operations and cash flows.
Periodically, the Company is made aware that technology it uses may infringe on
intellectual property rights held by others. The Company has accrued a liability
and charged operations for the estimated costs of settlement or adjudication of
certain asserted and unasserted claims for alleged infringement prior to the
balance sheet date. Resolution of these claims could have a material adverse
effect on future results of operations.
The Company is currently a party to various other legal actions arising out of
the normal course of business, none of which is expected to have a material
adverse effect on the Company's business, financial position, results of
operations and cash flows.
Pursuant to the Merger Agreement (see Footnote 1, "Nature of Business -
Anticipate Business Combination"), the Company has entered into a Bridge Loan
Agreement (the "Loan Agreement") with Interland, Inc. ("Interland"). Under the
terms of the Loan Agreement, the Company has agreed to advance up to an
aggregate principal amount of $10 million to Interland between June 30, 2001 and
August 31, 2001. If the closing of the Merger Agreement has not occurred prior
to August 31, 2001, the Company has agreed to advance up to $20 million. No
advances have been made under the Loan Agreement.
The Company is a party to agreements with Computer Associates ("CA") for certain
Network Operations Center ("NOC") software and related maintenance and
professional services. The agreements contemplate significant minimum
expenditures by the Company until March 2003.
At May 31, 2001, the Company had commitments of $0.8 million for the expansion
and upgrading of facilities and equipment and $9.9 million for infrastructure
software projects.
16. Sale of Connectivity Accounts
On March 26, 2001 the Company entered into an agreement to sell substantially
all of its consumer dial-up accounts for between $4 and $5 million. The final
proceeds from the sale are subject to adjustment based upon the number of
accounts which cancel during a specified time period following the transfer.
Revenue from these accounts was approximately 11.8% and 17.6% of total revenues
for the third quarter of 2001 and 2000, respectively, and 12.4% and 20.4% of
total revenues for the nine months of 2001 and 2000,
12
Micron Electronics, Inc.
Notes to Financial Statements--Continued
(Tabular amounts in thousands, except per share amounts)
(Unaudited)
respectively. The sale of these accounts is not expected to have a substantial
impact on operating income. These accounts were transferred in June 2001.
13
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-------------------------------------------------------------------------------
of Operations
-------------
Statements contained in this Form 10-Q that are not purely historical are
forward-looking statements and are being provided in reliance upon the "safe
harbor" provisions of the Private Securities Litigation Reform Act of 1995.
Words such as "anticipates," "expects," "intends," "plans," "believes," "seeks,"
"estimates," and similar expressions identify forward-looking statements. These
forward-looking statements include but are not limited to statements regarding
our expectations of our future liquidity needs, our plans to merge with
Interland and expectations regarding the business and financial results of the
combined company, our expectations regarding our future operating results
including our planned expansion of HostPro's customer base and increase in
HostPro's revenue levels, and the actions we expect to take in order to maintain
HostPro's existing customers and expand HostPro's operations and customer base.
All forward-looking statements are made as of the date hereof and are based on
current management expectations and information available to the Company as of
such date. The Company assumes no obligation to update any forward-looking
statement. It is important to note that actual results could differ materially
from historical results or those contemplated in the forward-looking statements.
Forward-looking statements involve a number of risks and uncertainties, and
include trend information. Factors that could cause actual results to differ
materially include, but are not limited to, those identified in "Certain
Factors" and in other Company filings with the Securities and Exchange
Commission. All quarterly references are to the Company's fiscal periods ended
May 31, 2001, August 31, 2000 or June 1, 2000, unless otherwise indicated. All
annual references are also on a fiscal basis, unless otherwise indicated. All
tabular dollar amounts are stated in thousands.
Overview
Micron Electronics, Inc. and its subsidiaries (collectively the "Company") have
historically provided a variety of computer products and related services
through the Company's PC Systems, SpecTek, and HostPro business segments. We
have discontinued PC Systems, our computer manufacturing business, and SpecTek,
our memory products business. See Footnote 3 "Discontinued Operations" to the
accompanying financial statements. As a result we are now exclusively a Web
hosting company (HostPro).
The Company was originally established April 7, 1995 through the merger of three
businesses: Micron Computer, Inc., Micron Custom Manufacturing Services, Inc.
and ZEOS International, LTD. As of May 31, 2001, Micron Technology, Inc. ("MTI")
owned 61% of our outstanding common stock. HostPro, our continuing operation,
was formed through the integration of four companies purchased during 1999 and
2000. These include Los Angeles-based NetLimited, Inc., (d.b.a. "HostPro"),
Seattle-based LightRealm, Florida-based Worldwide Internet Publishing Company,
and Boise-based Micron Internet Services.
On March 23, 2001, Micron Electronics, Interland, Inc. ("Interland"), and
Imagine Acquisition Corporation ("Merger Sub"), our wholly owned subsidiary,
entered into an Agreement and Plan of Merger dated as of March 22, 2001 (the
"Merger Agreement"). Subject to the terms and conditions of the Merger
Agreement, Merger Sub will merge with and into Interland, with Interland to
survive and become our wholly owned subsidiary (the "Merger"). Each outstanding
share of Interland common stock will be exchanged for 0.861 (the "Exchange
Ratio") shares of our common stock, and options and warrants to purchase
Interland common stock will be exchanged for options or warrants, respectively,
to purchase shares of our common stock according to the Exchange Ratio. Based on
provisions of the Merger Agreement, the Exchange Ratio may be subject to change.
After the closing of the Merger, Interland shareholders and MTI are expected to
own approximately 30% and 43%, respectively, of our outstanding common shares.
Interland provides a broad range of Web hosting, applications hosting and other
related Web-based business solutions specifically designed to meet the needs of
small- and medium-sized businesses. Interland had net sales of $34.3 million and
a net loss of $67.0 million for the year ended December 31, 2000 and net sales
of $10.9 million and a net loss of $16.9 million for the quarter ended March 31,
2001.
HostPro offers a broad range of business-to-business Internet products and
services including managed dedicated hosting solutions, co-location and
connectivity services, electronic commerce, application hosting and other Web
hosting products. With data centers in Los Angeles, California; Seattle,
Washington; Moses Lake, Washington; Boca Raton, Florida; and Boise, Idaho, we
provide these services primarily to small- and medium-sized businesses. Our
business is rapidly evolving and we have a limited operating history. As a
result, we believe that period-to-period comparisons of our revenue and
operating results, including our cost of revenue and other operating expenses as
a percentage of total revenue, are not meaningful and should not be relied upon
as indicators of future performance. We do not believe that our historical
growth rates are an indication of our future results.
Revenues are primarily generated by providing shared, dedicated, co-located and
applications hosting services, connectivity and equipment sales to customers.
Revenues are recognized as the services are provided. Hosting contracts
generally are for service periods ranging from 1 to 12 months and typically
require up-front fees. These fees, including set-up fees for hosting services,
are deferred and recognized ratably over the customers' expected service period.
14
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-------------------------------------------------------------------------------
of Operations--Continued
------------------------
Cost of revenue is mainly comprised of compensation and related expenses for
data center and provisioning operations, Internet connectivity and other related
telecommunications expense, and depreciation and amortization of capital and
intangibles related to data center equipment and operations.
Our operating expenses consist of:
. Sales, marketing and technical support, which is mainly
comprised of compensation costs and costs associated with
technical support and marketing our products and services.
Compensation costs include salaries and related benefits,
commissions and bonuses. Our marketing expenses include the
costs of direct mail, advertising and other mass market
programs; and
. General and administrative, which is mainly comprised of
compensation and related expenses, occupancy costs, and
depreciation and amortization of capital and intangible assets
related to the engineering, development and administrative
functions.
We intend to invest heavily in sales and marketing, the continued development of
our network infrastructure and technology, and engineering and development for
future product expansion. We expect to expand our operations and workforce,
including our network operations, technical support, and administrative
resources. In addition, we intend to continue to expand and develop new sales
channels and relationships. Our future success is dependent upon our ability to
achieve profitability prior to depletion of cash reserves and to raise funds,
thereafter, if needed. While we currently believe that we have adequate
resources to maintain planned operations for at least one year from the balance
sheet date, we cannot assure you that HostPro will be profitable in the future
under its current Web and application hosting model or that adequate funding
will be available to allow us to continue operations subsequent to the one-year
time period. We do not expect to generate positive cash flows from operations
for at least one year. However, the Company's current financial forecast
indicates that there are sufficient cash reserves on hand until the Company
reaches positive cash flows.
Discontinued Operations
PC Systems
We have discontinued the operations of our PC Systems business segment, which is
being accounted for as discontinued operations in accordance with Accounting
Principles Board Opinion No. 30 ("APB No. 30") "Reporting the Results of
Operations -- Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions." On
May 31, 2001, the Company sold its PC Systems business to GTG PC Holdings, LLC,
("GTG PC") an affiliate of the Gores Technology Group. Under the terms of the
agreement, GTG PC received assets, which included $76.5 million in cash, and
assumed specified liabilities of the PC Systems business. When the Company
announced its planned sale of the PC Systems business to GTG PC, the Company had
anticipated that the cash transfer to GTG PC would be $70.0 million. The
difference consists primarily of reimbursements made for liabilities assumed by
GTG PC that, in accordance with the original terms, were to be retained by the
Company. The Company is required to meet certain working capital requirements
based on the net assets and liabilities transferred to GTG PC. The final
determination of the working capital transferred to GTG PC is subject to audit.
Any adjustment to the working capital transferred could result in an additional
cash payment by the Company to GTG PC and a corresponding increase to the loss
on disposal of discontinued operations.
The Company retained all liabilities of the PC Systems business not assumed by
GTG PC, including, for example, liabilities for taxes arising prior to the
closing of the transaction, employee termination and related expenses, and any
contingent liabilities arising prior to the closing date. In addition, the
Company has agreed for a period of three years not to compete with the PC
Systems business, and for two years, to not solicit or hire prior employees of
the PC Systems business. For a transition period after the closing of the
purchase, the purchaser agreed to provide certain information technology,
financial, telecommunications and human resources services to the Company at GTG
PC's cost plus 10% during the first four months after the closing, and at its
cost plus 25% for the following two months.
Through May 31, 2003, or for the applicable statute of limitations with respect
to taxes and government contracts, the Company is obligated to indemnify the
purchaser and affiliated entities for any breaches of the representations and
warranties contained in the agreement. In addition, the Company is obligated for
an indefinite period of time to
15
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-------------------------------------------------------------------------------
of Operations--Continued
------------------------
indemnify the purchaser and affiliated entities for any breaches in covenants.
The agreement provides that the maximum aggregate liability of the Company for
indemnification under the agreement is $10.0 million, or, in some limited
circumstances, $30.0 million.
The agreement also provides that the Company would potentially be entitled to
receive a percentage of any proceeds in the event the PC Systems business is
sold or has an initial public offering of its securities within three years of
the closing of the purchase. The Company would receive a payment only after the
repayment of transaction costs, repayment of debt and capital contributions,
payment of specified amount of cash to GTG PC and obligations under employee
incentive programs.
At the end of its second fiscal quarter of 2001, consistent with accounting for
discontinued operations, the Company recorded an estimate of future operating
losses from the discontinued operation between March 2, 2001 and May 31, 2001,
the expected completion date of the sale, and an estimate of the loss on
disposal of the discontinued operation. This estimated after tax loss recorded
in the second fiscal quarter of 2001 was $147.5 million. Based on the final
terms of the agreement to sell the PC Systems business and actual operating
results, we recorded an additional loss of $34.4 million in the third fiscal
quarter of 2001, resulting in a revised estimated loss of $181.9 million.
Management believes that the estimated loss is reasonable, however, it is based
on preliminary data and is subject to revision. Included in the loss on disposal
are employee termination costs of approximately $9.8 million, of which $8.0
million is included in the accompanying Balance Sheets under "Accounts payable
and accrued liabilities" at May 31, 2001. The Company expects that all remaining
severance liabilities will be settled by the end of the first fiscal quarter of
2002.
SpecTek
The Company has discontinued the operations of its SpecTek business segment,
which is accounted for as discontinued operations in accordance with APB No. 30.
Pursuant to the Amended and Restated Component Recovery Agreement (as amended,
the "Component Recovery Agreement"), dated effective September 2, 1999, MTI
exercised its rights to purchase the assets of the SpecTek business. On March
22, 2001, the Company entered into a Purchase Agreement (the "Purchase
Agreement") to sell all assets primarily used by SpecTek and certain land,
buildings and intellectual property assets to MTI. Pursuant to the terms of the
Purchase Agreement, the Company transferred the land, buildings and intellectual
property to MTI on March 22, 2001, and received $18 million of cash in excess of
the historical cost from MTI. This amount has been recorded, net of tax, as an
increase in additional paid in capital. The Company has leased back a portion of
the land and buildings from MTI and has also been granted a license to use
certain components of the intellectual property. In addition, MTI agreed to pay
the Company for the March 1, 2001 net book value of the assets used by SpecTek,
less any outstanding intercompany payables. Net proceeds from the sale of the
SpecTek assets under the Purchase Agreement were $43.2 million. Pursuant to the
Purchase Agreement, the assets used by SpecTek were transferred to MTI on April
5, 2001. The valuation of the assets transferred was subject to audit by MTI.
Upon completion of the audit, net proceeds were adjusted downward to $39.6
million. This adjustment was included in the accompanying Statement of
Operations under "Loss on disposal of discontinued operations," during the third
quarter of 2001.
Results of Continuing Operations
Our consolidated financial information presents the net effect of discontinued
operations separate from the results of the Company's continuing operations.
Historical financial information has been reclassified to present consistently
the discontinued operations, and the discussion and analysis that follows
generally focuses on continuing operations.
The loss from continuing operations for the third quarter of 2001 was $9.1
million, or $ (0.09) per basic and diluted share, on net sales of $15.4 million,
compared to loss from continuing operations of $8.3 million, or $ (0.09) per
basic and diluted share, on net sales of $10.2 million for the third quarter of
2000. For the nine months ending May 31, 2001, the loss from continuing
operations was $27.2 million, or $(0.28) per basic and diluted share, on net
sales of $43.4 million, compared to loss from continuing operations of $12.0
million, or $(0.12) per basic and diluted share, on net sales of $21.5 million
for the same period of the prior year. The following table sets forth, for the
periods indicated, certain data derived from our consolidated statements of
operations:
For the quarter ended For the nine months ended
May 31, June 1, May 31, June 1,
2001 2000 2001 2000
------------------------------------------------------------------------------------------------------------------------------------
Revenues 100.0% 100.0 % 100.0% 100.0%
Cost of revenues 63.1 77.4 65.5 72.9
------ ------ ------ ------
Gross margin 36.9 22.6 34.5 27.1
------ ------ ------ ------
16
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-------------------------------------------------------------------------------
of Operations--Continued
------------------------
Operating expenses:
Sales, marketing and technical support 61.8 90.8 64.0 79.0
General and administrative 54.4 56.0 63.3 50.6
Goodwill amortization 10.0 18.1 11.8 15.5
Other expense (income), net 0.2 (0.7) 1.3 3.5
------ ------ ------ ------
Total operating expenses 126.4 164.2 140.4 148.6
Operating loss (89.5) (141.6) (105.9) (121.5)
Loss on equity investment (13.2) - (11.3) -
Gain on sale of investment - - 10.4
Interest income, net 13.5 29.6 14.9 43.9
------ ------ ------ ------
Loss from continuing operations before taxes (89.2) (112.0) (91.9) (77.6)
Income tax benefit 30.0 30.4 29.2 21.6
------ ------ ------ ------
Loss from continuing operations (59.2)% (81.6)% (62.7)% (56.0)%
======= ====== ====== ======
Revenues
For the quarter ended For the nine months ended
May 31, June 1, May 31, June 1,
2001 2000 2001 2000
------------------------------------------------------------------------------------------------------------------------------------
(Amounts in 1000's)
Hosting revenue $ 10,998 $ 6,060 $ 29,607 $ 11,444
Connectivity revenue 2,692 2,346 8,251 6,389
Other revenue 1,705 1,749 5,528 3,632
----------- ---------- --------- ---------
Total Revenues $ 15,395 $ 10,155 $ 43,386 $ 21,465
=========== ========== ========= =========
Revenues increased $5.2 million, or 51.6%, and $21.9 million or 102.1%,
respectively, for the quarter and for the nine months ended May 31, 2001 when
compared to the same periods from the prior year.
Hosting revenues increased $4.9 million or 81.5% and $18.2 million or 158.7%,
respectively, for the quarter and for the nine months ended May 31, 2001 when
compared to the same periods from the prior year. The growth in hosting revenues
has been driven by new customer growth, fiscal 2000 acquisitions and upgrading
existing customers. Excluding the effect of the acquisitions in 2000, hosting
growth was 78% and 98%, respectively, for the quarter and the nine months ended
May 31, 2001, when compared to the same periods from the prior year. Sequential
quarterly hosting revenue growth from the second to the third quarter of 2001
was 10.2%. Shared hosting revenues were 73.4% and 72.2% of hosting revenues for
the quarter and nine months ending May 31, 2001, respectively, compared to 83.9%
and 87.3%, respectively, for the same periods from the prior year. Dedicated
hosting revenues were 20.3% and 20.9% of hosting revenues for the quarter and
nine months ending May 31, 2001, respectively, compared to 12.9% and 9.6%,
respectively, for the same periods from the prior year. We have continued to
focus on increasing our higher-end hosting services and ended the third quarter
of 2001 with the number of dedicated, managed and unmanaged servers in excess of
1,240, compared to 577 from the same period a year ago.
Connectivity revenues increased $0.3 million or 15% and $1.9 million or 29%,
respectively, for the quarter and for the nine months ended May 31, 2001 when
compared to the same period from the prior year. The growth in connectivity
revenues has been driven primarily by new customer growth. On March 26, 2001 the
Company entered into an agreement to sell substantially all of its consumer
dial-up accounts for between $4 and $5 million. Revenue from consumer dial-up
accounts was approximately 11.8% and 17.6% of total revenues for the third
quarter of 2001 and 2000, respectively, and 12.4% and 20.4% of total revenues
for the nine months of 2001 and 2000, respectively. The sale of these accounts
is not expected to have a substantial impact on operating income. These accounts
were transferred in June 2001.
Other revenue is primarily comprised of equipment sales to customers.
17
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-------------------------------------------------------------------------------
of Operations---continued
-------------------------
We maintained over 147,000 paid hosted Web sites, 79,700 paid hosting accounts
and 38,800 Internet access accounts at the end of the third quarter of 2001.
These numbers compare to 100,300 paid hosted Web sites, 51,300 paid hosting
accounts and 37,900 Internet access accounts at the end of the third quarter of
2000.
Cost of Revenues
Cost of revenues increased 23.6% and 81.9% to $9.7 million and $28.4 million,
respectively, for the quarter and nine-month periods ended May 31, 2001 from
$7.9 million and $15.6 million in the same periods of the prior year. In the
third quarter of 2001, the increases in cost of revenues were related to
supporting our larger customer base and revenue levels and were primarily
related to increased depreciation relating to data center build-outs and
equipment purchases, the cost of equipment sold to customers, rent, and
telecommunications and Internet access costs. For the nine-month period ended
May 31, 2001, the increase in cost of revenues was primarily related to
depreciation relating to data center build-outs and equipment purchases,
telecommunications and Internet access costs, the cost of equipment sold to
customers, technical personnel costs and rent. Our cost of revenues as a
percentage of revenues decreased to 63.1% and 65.5%, respectively, for the
quarter and nine-month periods ended May 31, 2001 from 77.4% and 72.9% for the
same periods of the prior year. We anticipate that costs of revenues will
increase in absolute dollars, but decline as a percentage of revenues as we
continue to grow, and achieve a more cost-effective scale of operations.
Sales, Marketing and Technical Support
Sales, marketing and technical support expenses increased 3.1% and 63.8% to $9.5
million and $27.8 million, respectively, for the quarter and nine-month periods
ended May 31, 2001 from $9.2 million and $16.9 million in the same periods of
the prior year. The increase in sales, marketing and technical support expenses
during the quarter and nine months ended May 31, 2001 was primarily related to
increased outsourced telemarketing costs and sales and technical support
personnel costs, offset partially by a reduction in advertising costs. Technical
support costs were $2.4 million and $7.3 million, respectively, for the quarter
and the nine-month period ended May 31, 2001, compared to $1.3 million and $2.8
million from the same periods of the prior year.
General and Administrative
General and administrative expenses increased 47.6% and 153.1% to $8.4 million
and $27.5 million, respectively, for the quarter and nine-month periods ended
May 31, 2001 from $5.7 million and $10.9 million in the same periods of the
prior year. The increase in general and administrative expenses during the
quarter ended May 31, 2001, was primarily related to increased engineering,
development, general and administrative personnel costs, depreciation and bad
debt expenses. For the nine-month period ended May 31, 2001, the increase was
primarily related to engineering, development, general and administrative
personnel costs, depreciation, bad debt expenses, consulting fees, rent and
intangible amortization.
Goodwill Amortization
Goodwill amortization increased for the nine month period ended May 31, 2001, as
a result of the acquisitions of the Web and applications hosting companies that
occurred between August 1999 and March 2000.
Earnings Before Income Taxes, Depreciation and Amortization ("EBITDA")
Our earnings before net interest, income taxes, depreciation, amortization,
including amortization of acquisition compensation costs, loss on equity
investment and gain on sale of investment and was a loss of $8.1 million and
$28.0 million, respectively, for the quarter and nine-month periods ended May
31, 2001 compared to a loss of $9.7 million and $17.4 million in the same
periods of the prior year. The increases in the level of EBITDA losses were
primarily due to increased expenditures needed to support our growth in
operations, including salaries and benefits for additional employees, network
costs, rent, and other costs related to the increase in the number of our data
centers as well as increased sales, technical support, and general and
administrative expenses. Although EBITDA should not be used as an alternative to
operating loss or net cash provided by (used for) operating activities,
investing activities or financing activities, each as measured under generally
accepted accounting principles, our management believes that EBITDA is an
additional meaningful measure of performance.
Loss on Equity Investment
The loss on equity investments includes the Company's equity share of the losses
of Bird on a Wire, Inc. ("BOAW"), as well as the Company's loss on disposal of
its investment therein. On May 28, 2001, BOAW entered into a definitive
agreement to sell its assets.
18
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-------------------------------------------------------------------------------
of Operations---continued
-------------------------
After settling BOAW liabilities, the Company received net proceeds of $1.5
million. Included in loss on equity investments is approximately $1.7 million
loss on disposal of BOAW in the third quarter of 2001.
Gain on Sale of Investment
On September 29, 2000, the Company sold its remaining 10% interest in MCMS, Inc.
("MCMS") for a net gain of $4.5 million. MCMS was formerly the Company's wholly
owned subsidiary, of which 90% was sold in February 1998.
Interest Income
Interest income, net consists of interest income earned on the Company's
invested cash and liquid investments. Interest income, net decreased 30.7% and
31.1% to $2.1 million and $6.5 million for the quarter and nine-month periods
ended May 31, 2001, respectively from $6.5 million and $9.4 million in the same
periods of the prior year. The reduction in interest income is primarily due to
the lower levels of cash and liquid investments that were available for
investment during the quarter and nine months ended May 31, 2001.
Income Tax Provision
The effective income tax rate on continuing operations was approximately 34% and
27% for the third quarter of 2001 and 2000, respectively. The effective income
tax rate on continuing operations was approximately 32% and 27% for the first
nine months of 2001 and 2000, respectively. These rates principally reflect the
federal statutory rate, net of the effect of state taxes, tax-exempt securities
and non-deductible goodwill amortization. The change in the effective income tax
rates primarily reflect tax benefits and tax sharing arrangements that are no
longer available due to the disposal of the discontinued operations.
Liquidity and Capital Resources
As of May 31, 2001, we had $185.2 million in cash, cash equivalents and liquid
investments. This represents a decrease of $140.9 million compared to August 31,
2000. In addition, as of May 31, 2001, there were also $7.3 million of held to
maturity investments, with original maturities in excess of one year.
Principal sources of liquidity in the first nine months of 2001 were $33.5
million from investing activities, including $167.5 million of proceeds from
maturing investments and $4.5 million of proceeds from the sale MCMS common
stock, offset by $116.3 million of purchases of held to maturity investments,
$81.1 used in the Company's discontinued operations, $18.2 million for purchases
of property, plant and equipment and $5.0 million for the purchase of an equity
investment. We used $37.0 million of cash in operating activities primarily due
to increased operating expenses to position HostPro for future growth.
The SpecTek and PC Systems dispositions had a material impact on our liquidity
in the third quarter of 2001. Pursuant to the Component Recovery Agreement, on
March 22, 2001, MTI exercised its rights to purchase the assets of the SpecTek
business. In addition, the Company agreed to sell to MTI certain land, buildings
and intellectual property assets. The proceeds from this transaction, net of
existing intercompany payables, were approximately $43.2 million. SpecTek has
been our only profitable segment and our only source of positive cash flows,
excluding interest income. The discontinuance of the SpecTek segment will have a
material adverse effect on our financial position, results of operations and
cash flows.
On May 31, 2001, the Company sold its PC Systems business to GTG PC Holdings,
LLC, ("GTG PC") an affiliate of the Gores Technology Group. Under the terms of
the agreement, GTG PC received assets, which included $76.5 million in cash, and
assumed specified liabilities of the PC Systems business. The Company is
required to meet certain working capital requirements based on the net assets
and liabilities transferred to GTG PC. The final determination of the working
capital transferred to GTG PC is subject to audit. Any adjustment to the working
capital transferred could result in an additional cash payment by the Company to
GTG PC and a corresponding increase to the loss on disposal of discontinued
operations.
On March 28, 2001, we terminated our unsecured credit agreement with a group of
financial institutions, which provided borrowings up to $100.0 million.
At May 31, 2001, we had commitments of $0.8 million for the expansion and
upgrading of facilities and equipment and $9.9 million for infrastructure
software projects. We anticipate making capital expenditures in excess of $3.7
million during the remainder of 2001.
19
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-------------------------------------------------------------------------------
of Operations---Continued
-------------------------
HostPro does not expect to generate positive cash flow from its operations for
at least one year. However, we expect to have adequate cash reserves to fund
operations during this period. Our future success is dependent upon our ability
to achieve profitability prior to the depletion of cash reserves and to raise
funds, thereafter, if needed. We cannot assure that HostPro will be profitable
in the future under its current Web and application hosting model or that
adequate funding will be available to allow us to continue operations subsequent
to the one-year time period. However, the Company's current financial forecast
indicates that there are sufficient cash reserves on hand until the Company
reaches positive cash flows.
Certain Factors
You should carefully consider the following factors and all other information
contained in this Form 10-Q before you make any investment decisions with
respect to our securities. The risks and uncertainties we describe below are not
the only risks we face. If any of the adverse events described in the following
factors actually occur or we do not accomplish necessary events or objectives
described in the factors, our business, financial condition and operating
results could be materially and adversely affected, the trading price of our
common stock could decline and you could lose all or part of your investment.
HostPro has incurred losses since inception, and we expect it to incur losses
for at least the next two years. HostPro has incurred net losses and losses from
operations for each period from inception through the first nine months of 2001.
We do not expect HostPro, or the combined company if the Interland merger is
consummated, to generate positive cash flow from operations for at least one
year. Operating expenses could increase as a result of expanding and adapting
network infrastructure, increasing sales and marketing efforts, broadening
customer support capabilities, integrating the Interland and HostPro businesses
and expanding administrative resources in anticipation of future growth. To the
extent that increases in expenses are not offset by increased revenues, the
results of operations and financial condition of the combined businesses would
be materially affected. Even if the combined company achieves profitability, it
may not be able to sustain or increase profitability on a quarterly or annual
basis in the future.
Our historical financial information will not be representative of our future
results. Since we have sold our non-hosting businesses, our historical financial
information, contained in previous filings with the Securities and Exchange
Commission, will not be representative of our future operating results.
Including the operations of the non-hosting businesses--which are now classified
as discontinued operations in our financial statements--HostPro's revenues
represented less than 3% for fiscal 2000, and less than 5% for the nine months
ending May 31, 2001, of the Company's total revenues. HostPro's costs and
expenses, which are reflected in our financial statements as continuing
operations, include infrastructure costs associated with HostPro's use of or
benefit from centralized corporate services provided by Micron Electronics,
including:
. information technology;
. telecommunications;
. accounting, tax and treasury;
. human resources;
. legal; and
. insurance.
The historical financial information of the Web hosting business has been
adjusted to take into account the estimated impact of the discontinued
operations. These estimates could change in periods subsequent to the
disposition of the non-hosting businesses and, therefore, the historical
information is not necessarily indicative of the future financial results of the
Web hosting business.
HostPro has a limited operating history and its business model is still
evolving, which makes it difficult to evaluate its prospects. HostPro's limited
operating history makes evaluating its business operations and prospects
difficult. HostPro was grown, in part, through the acquisition of four separate
hosting and Internet service provider companies during the period from August
1999 through March 2000. HostPro's range of service offerings has changed since
its inception and its business model is still new and developing. Because some
of HostPro's services are new, the market for them is uncertain. As a result,
the revenue and income potential of its business, as well as the potential
benefits of its proposed merger with Interland, may be difficult to evaluate.
20
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-------------------------------------------------------------------------------
of Operations---Continued
-------------------------
Our quarterly operating results may fluctuate and our future revenues and
profitability are uncertain. HostPro's past operating results have been subject
to fluctuations, on a quarterly and an annual basis. HostPro may also experience
significant fluctuations in quarterly and annual operating results due to a wide
variety of factors. Because of these fluctuations, comparisons of operating
results from period to period are not necessarily meaningful and should not be
relied upon as an indicator of future performance. Factors that may cause
operating results to fluctuate include, but are not limited to:
. demand for and market acceptance of our services;
. introductions of new products or services or enhancements by us and
our competitors;
. technical difficulties or system downtime affecting the Internet
generally or our hosting operations specifically;
. the mix of products and services sold by us or our competitors;
. customer retention;
. the timing and success of our advertising and marketing efforts and
introductions of new services to customers and the timing and success
of the marketing efforts and introductions of new services to
customers of our resellers;
. the timing and magnitude of capital expenditures, including
construction costs relating to the expansion of operations;
. increased competition in the Web hosting and applications hosting
markets;
. changes in our pricing policies and the pricing policies of our
competitors;
. gains or losses of key strategic relationships; and
. other general and industry-specific economic factors.
We cannot provide any assurances about the extent to which we will be successful
in achieving any plans to increase the size our customer base, the amount of
services we offer or the amount, if any, of increase in revenues we will
experience during the next fiscal year, or beyond. In addition, relatively large
portions of our expenses are fixed in the short-term, and therefore our results
of operations are particularly sensitive to fluctuations in revenues. Also, if
we were unable to continue using third-party products in our service offerings,
our service development costs could increase significantly.
We operate in a new and evolving market with uncertain prospects for growth and
may not be able to sustain growth in our customer base. The market for Web
hosting and applications hosting services for small- and medium-sized businesses
has only recently begun to develop and is evolving rapidly. Our future growth,
if any, will depend upon the willingness of small- and medium-sized businesses
to outsource Web hosting and applications hosting services, our ability to
increase our average revenue per customer, and our ability to retain customers.
The market for our services may not develop further, consumers may not widely
adopt our services and significant numbers of businesses or organizations may
not use the Internet for commerce and communication. If this market fails to
develop further or develops more slowly than expected, or if our services do not
achieve broader market acceptance, we will not be able to grow our customer
base. In addition, we must be able to differentiate ourselves from our
competition through our service offerings and brand recognition. These
activities may be more expensive than we anticipate, and we may not be
successful in differentiating ourselves, achieving market acceptance of our
services or selling additional services to our existing customer base.
Micron Electronics' stock price may be volatile. The market price of our common
stock has experienced a significant decline in recent months. The price has been
and is likely to continue to be highly volatile due to several factors, such as:
. the failure of the combined company (if the merger with Interland is
consummated) to experience the benefits of the merger as quickly as
anticipated, or at all, or an increase over estimates of the costs of
or operational difficulties arising from the merger;
. if the merger with Interland is consummated, the failure of the impact
of the merger on the combined company's financial results to be in
line with the expectations of financial analysts;
. variations in actual and anticipated operating results;
. changes in earnings estimates by analysts;
. variations in actual and anticipated operating results of customers or
competitors;
. material reductions in spending by customers;
21
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-------------------------------------------------------------------------------
of Operations---Continued
-------------------------
. announcements by us or our competitors regarding new products and
service introductions;
. the volatility inherent in stock within the sectors within which we
conduct business;
. general decline in economic conditions; and
. reductions in the volume of trading in our common stock.
Our customer base includes a significant number of businesses that currently
face increasing difficulty in obtaining funding to support their operations.
Many of our customers are businesses, including Internet-based businesses, that
have traditionally been initially funded by venture capital firms and then
through public securities offerings. Funding alternatives for these businesses
have become more limited than in the past. Many of these customers have ceased
or reduced their operations, and it has become increasingly difficult for the
Company to collect revenues from these businesses. If the market for technology
and Internet-based businesses is not supported by the private and public
investors who have funded these customers, the Company faces the risk that these
customers may cease, curtail or limit Web site operations. If this continues to
occur, the Company could experience a loss of revenue associated with these
customers and will then have to increase sales to other businesses using the
Internet in order to preserve and grow revenue. If the Company is successful in
increasing sales to other businesses, it will incur the expenses associated with
these new customers, such as sales and marketing expenses, including
commissions, and implementation costs. As a result, to preserve and grow
revenue, the Company will have to increase sales by substantially more than the
amount of lost revenue.
Our transition to a company focused solely on Web hosting represents a
significant transition from our historical business, and our disposal of our
non-hosting businesses could adversely affect our operating results. On March
23, 2001, we announced plans to sell our non-hosting businesses and plans to
acquire Interland. Our plans to become a company focused solely on the Web
hosting industry represent a significant transition from the business we have
conducted to date. This transition has resulted in an approximate reduction of
82% in the number of our employees and a significant reduction in the levels of
revenues and operating income historically experienced by the Company. We cannot
assure you that we will be able to complete this transition successfully.
Efforts to fulfill this planned transition have placed, and are expected to
continue to place, a significant strain on our management team and have
diverted, and are expected to continue to divert, the attention of management
from the day-to-day operations of our business.
We could incur liabilities in the future relating to our PC Systems business. We
could incur liabilities relating to our PC Systems business under the terms of
our agreement to sell that business to GTG PC Holdings. We will retain specified
liabilities, including liabilities for taxes arising prior to the closing of the
transaction, contingent liabilities arising prior to the closing date, some
which are described above, as well as liabilities for some accounts payable and
other agreements. We are also obligated to indemnify the purchaser and its
affiliated entities for any breaches of our representations and warranties
contained in the agreement for a period of two years, or the applicable statute
of limitations for some liabilities. This indemnification obligation could be as
high as $10.0 million or, in some limited circumstances, $30.0 million. In
addition, the Company is required to meet specified working capital requirements
based on the net assets and liabilities transferred to GTG PC. The final
determination of the working capital transferred to GTG PC Holdings is subject
to audit. Accordingly, in the future, the combined company could be required to
make payments with respect to the PC Systems business, which could adversely
affect our future results of operations.
We may have additional liabilities for sales and use taxes. During the third
quarter of 1997, Micron Electronics began to collect and remit applicable sales
or use taxes in nearly all states. We are a party to agreements with nearly all
states, which generally limit our liability, if any, for non-remittance of sales
and use taxes prior to such agreements' effective dates. Micron Electronics
previously accrued a liability for the estimated settlement cost of issues
related to sales and use taxes not covered by such agreements. Our management
believes the resolution of any matters relating to the non-remittance of sales
or use taxes will not materially affect our business, financial position,
results of operations and cash flows. This potential liability will remain with
us even though we have sold the PC Systems business.
HostPro's reliance on GTG PC Holdings for transition services. HostPro has
historically relied on the PC Systems business to provide some of its internal
operating systems, such as internal network and telephone support, payroll
systems and accounting systems. A portion of the costs of operating these
systems has been allocated to HostPro for financial reporting purposes. These
systems have been transferred in connection with the sale of the PC Systems
business, and, as a result, HostPro will be required to obtain alternative
sources for these systems, following a transition period during which GTG PC
Holdings will continue to provide support. If these transition services do not
extend until HostPro is able to integrate its systems with Interland, or if
HostPro is otherwise required to obtain comparable services at higher costs, its
operating results could be adversely affected.
We may not effectively execute our Web hosting strategy and as a result, others
may seize the market opportunity that we have identified. If we fail to execute
our Web hosting strategy in a timely or effective manner, our competitors may be
able to seize the
22
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-------------------------------------------------------------------------------
of Operations---Continued
------------------------
opportunity we have identified to address the Web hosting needs of small- and
medium-sized businesses. Our business strategy is complex and requires that we
successfully and simultaneously complete many tasks, and the failure to complete
any one of these may jeopardize our strategy as a whole. Execution of our
strategy may be more difficult in light of our planned merger with Interland
because the management team for the combined company will not have worked
together as a team prior to the merger closing. In order to be successful, we
will need to:
. market our services and build our brand name effectively;
. provide reliable and cost-effective services that can be
expanded to meet the demands of our customers;
. develop new Internet applications products and services;
. continue to grow our infrastructure to accommodate additional
customers and increased use of our network bandwidth;
. expand our channels of distribution and our international operations;
. continue to respond to competitive developments;
. influence and respond to emerging industry standards and other
changes; and
. attract, retain and motivate qualified personnel.
Micron Technology is our majority shareholder and is therefore able to control
matters requiring shareholder approval. As of July 9, 2001, Micron Technology
owned approximately 61% of Micron Electronics' outstanding common stock. After
the completion of the planned merger with Interland, Micron Technology is
expected to own approximately 43% of the outstanding common stock of Micron
Electronics. In addition, two of Micron Electronics' current directors are also
directors of Micron Technology, including Steven R. Appleton, Chairman and Chief
Executive Officer of Micron Technology. Under the terms of the agreements with
Micron Electronics, Micron Technology has agreed, among other things, not to
sell any of its shares for a period of nine months following the merger. In
addition, Micron Electronics has rights to repurchase shares owned by Micron
Technology up to the number that would reduce Micron Technology's ownership to
25% of Micron Electronics' outstanding shares. So long as Micron Technology
continues to own a substantial portion of Micron Electronics' outstanding common
stock, Micron Technology will have the ability to exert significant influence
over matters requiring shareholder approval, including the election of
directors, and potentially could control the management and corporate policies
of the combined company. The level of Micron Technology's ownership of Micron
Electronics' common stock may limit our ability to complete future equity
financing.
HostPro faces intense competition. The Web hosting and applications hosting
markets are highly competitive and are becoming more so. There are few
substantial barriers to entry, and we expect that we will face additional
competition from existing competitors and new market entrants in the future. We
may not have the resources, expertise or other competitive factors to compete
successfully in the future. Many of our competitors have substantially greater
financial, technical and marketing resources, larger customer bases, longer
operating histories, greater name recognition and more established relationships
in the industry than we do. As a result, these competitors may be able to:
. develop and expand their network infrastructures and service offerings
more rapidly;
. adapt to new or emerging technologies and changes in customer
requirements more quickly;
. take advantage of acquisition and other opportunities more readily;
and
. devote greater resources to the marketing and sale of their services
and adopt more aggressive pricing policies than we can.
In an effort to gain market share, some of our competitors have offered, and may
in the future offer, Web hosting services similar to ours at lower prices or
with incentives not matched by us, including free start-up and domain name
registration, periods of free service, low-priced Internet access or free
software. In addition, some of our competitors may be able to provide customers
with additional benefits, including reduced communications costs, which could
reduce the overall costs of their services relative to ours. We may not be able
to reduce the pricing of our services or offer incentives in response to the
actions of our competitors without harming our business. Because of the fierce
competition in the Web hosting and applications hosting industry, the number of
competitors could lead to a surplus in service providers, leading to further
reductions in the prices of services. We also believe that the market in which
we compete is likely to consolidate further in the near future, which could
result in increased price and other competition that could damage our business.
Current and potential competitors in the market include Web hosting service
providers, applications hosting providers, Internet service providers,
telecommunications companies, large information technology firms that provide a
wide array of information
23
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-------------------------------------------------------------------------------
of Operations---Continued
-------------------------
technology services and computer hardware suppliers. Our competitors may operate
in one or more of these areas and include companies such as Concentric Network
Corporation, an XO Communications, Inc. company, Data Return Corp., Digex
Corporation, Digital Island, EarthLink, Inc., Exodus Communications, Inc.,
Interliant, NTT Verio Inc., and Navisite, Inc. In addition, large diversified
companies such as Intel Corporation, Dell Computer Corporation, International
Business Machines Corporation and AT&T Corporation have entered or indicated
their intent to enter into some of these markets, which will intensify the
competition.
Our ability to successfully market our services could be substantially impaired
if we are unable to deploy new Internet applications or if new Internet
applications deployed by us prove to be unreliable, defective or incompatible.
We cannot assure you that we will not experience difficulties that could delay
or prevent the successful development, introduction or marketing of Internet
application services in the future. If any newly introduced Internet
applications suffer from reliability, quality or compatibility problems, market
acceptance of our services could be greatly hindered and our ability to attract
new customers could be adversely affected. We cannot assure you that new
applications deployed by us will be free from any reliability, quality or
compatibility problems. If we incur increased costs or are unable, for technical
or other reasons, to host and manage new Internet applications or enhancements
of existing applications, our ability to successfully market our services could
be substantially impaired. In addition, we cannot assure you that any new
services or applications will be accepted by customers.
Impairment of our intellectual property rights could negatively affect our
business or could allow competitors to minimize any advantage that our
proprietary technology may give us. We rely on a combination of patent,
copyright, trademark, service mark and trade secret laws and contractual
restrictions to establish and protect proprietary rights in our services. At
this point, we have no patented technology that would preclude or inhibit
competitors from entering the Web hosting market that we serve. While we may
file patent applications on particular aspects of our technology, we cannot be
sure that we will receive any patents. We have entered into confidentiality and
other agreements with our employees and contractors, including agreements in
which the employees and contractors assign their rights in inventions to us. We
have also entered into nondisclosure agreements with our suppliers, distributors
and some customers in order to limit access to and disclosure of their
proprietary information. These contractual arrangements or the other steps they
have taken to protect our intellectual property may not prove sufficient to
prevent illegal use of their technology or to deter independent third-party
development of similar technologies.
Policing unauthorized use of products or methods of operation and fully
protecting our proprietary rights is difficult, and we cannot guarantee that the
steps we have taken to protect our proprietary rights will be adequate. In
addition, effective copyright, trademark, trade secret and patent protection may
not be available in every country in which our products and services are
distributed. Further, Micron Electronics is currently, and may in the future, be
involved in legal disputes relating to the validity or alleged infringement of
our, or of a third party's, intellectual property rights. We expect that
participants in the Web hosting market will be increasingly subject to
infringement claims as the number of services and competitors in the combined
company's industry segment grows. Intellectual property litigation is typically
extremely costly and can be disruptive to our business operations by diverting
the attention and energies of management and key technical personnel. In
addition, any adverse decisions could subject us to significant liabilities,
require us to seek licenses from others, prevent us from manufacturing, using,
licensing or selling certain of our products and services, or cause severe
disruptions to our operations or the markets in which we compete, any one of
which could dramatically impact our business and results of operations.
Periodically, Micron Electronics is made aware that technology it uses may
infringe on intellectual property rights held by others. Micron Electronics has
accrued a liability and charged operations for the estimated costs of settlement
or adjudication of certain asserted and unasserted claims for alleged
infringement prior to the balance sheet date. Resolution of these claims could
have a material adverse effect on future results of operations and cash flows,
and could require changes in the products or processes of the combined company.
We face risks relating to existing litigation. We are defending a consumer class
action lawsuit filed in the Federal District Court of Minnesota based on the
alleged sale of defective computers. No class has been certified in the case.
The case involves a claim that Micron Electronics sold computer products with a
defect that may cause errors when information is written to a floppy disk.
Substantially similar lawsuits have been filed against other major computer
manufacturers. The case is currently in the early stages of discovery, and we
are therefore unable to estimate total expenses, possible loss or range of loss
that may ultimately be connected with the matter. This potential liability will
remain with Micron Electronics even though it has sold the PC Systems business.
Periodically, we are made aware that technology we use may infringe on
intellectual property rights held by others. Resolution of these claims could
have a material adverse effect on future results of operations and cash flows.
24
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-------------------------------------------------------------------------------
of Operations---Continued
-------------------------
If we acquire additional companies, products or technologies, we may face risks
similar to those we currently face in connection with the merger with Interland.
As part of our strategy to grow our HostPro business, we have made a number of
acquisitions and investments, and we may continue to pursue acquisitions of
businesses or assets that we believe are complementary to our business. We will
be required to record material goodwill and other intangible assets in the
likely event the purchase price of the acquired businesses exceeds the fair
value of the net assets acquired. In the past, this has resulted in significant
amortization charges, and these charges may increase in future periods as we
continue our acquisition strategy. The acquired businesses may not achieve the
revenues and earnings anticipated to be achieved by us. If we acquire another
company, we will likely race the same risks, uncertainties and disruptions as
discussed above with respect to our merger with Interland. For example, we may
not be able to successfully assimilate the additional personnel, operations,
acquired technology and products into our business. Furthermore, we may have to
incur debt or issue equity securities to pay for any additional future
acquisitions or investments, the issuance of which could be dilutive to existing
shareholders. As a result, there could be a material adverse effect on our
future financial condition and results of operations. We cannot assure you of
the timing or size of future acquisitions, or the effect future acquisitions may
have on our operating results.
We will rely heavily on our key personnel. Our future success will depend, in
part, on our ability to attract and retain key management, technical and sales
and marketing personnel. We attempt to enhance our management and technical
expertise by recruiting qualified individuals who possess desired skills and
experience in certain targeted areas. We experience strong competition for such
personnel in the Web hosting industry. Our inability to retain employees and
attract and retain sufficient additional employees, and information technology,
engineering and technical support resources, could have a material adverse
effect on our business, financial condition, results of operations and cash
flows. We cannot assure you that we will not lose key personnel or that the loss
of any key personnel will not have a material adverse effect on our business,
financial position, results of operations and cash flows.
If our recent Web hosting acquisitions are not perceived as successful, this
might cause a decline in our stock price. We recently acquired several companies
in order to develop and expand our Web hosting business, including LightRealm,
Worldwide International Publishing Corporation, NetLimited, Inc. and Micron
Internet Services. Many of these companies are in the early stages of their
development and have unproven business models. We might not realize the
anticipated benefits of these or other acquisitions to the extent that we
anticipate, or at all. If the anticipated benefits from these acquisitions are
not achieved, our stock price could decline.
If we are unable to expand our network infrastructure capacity, we may not be
able to meet increasing demand, and could lose customers and may unable to
sustain or increase our revenues. We must continue to expand and adapt our
network infrastructure to meet the increase in the number of users and the
amount of information they wish to transport and to meet changing customer
requirements. The expansion and adaptation of our telecommunications and hosting
facility infrastructure will require substantial financial, operational and
management resources as we negotiate for access to telecommunications systems
with existing and other network infrastructure suppliers. Significant and rapid
expansion of our network due to increased usage will place additional stress
upon our network hardware, traffic management systems and hosting facilities.
The ability of our network to connect and manage a substantially larger number
of customers at high transmission speeds is as yet unknown. In addition, our
ability to expand our network while maintaining superior performance is unknown.
As customers' bandwidth usage increases, we will need to make additional
investments in our infrastructure to maintain adequate data transmissions
speeds, the availability of which may be limited and the cost of which may be
significant. Additional network capacity may not be available from third-party
suppliers as it is needed by us. As a result, our network may not be able to
achieve or maintain a sufficiently high capacity of data transmission,
especially if customer usage increases. Any failure on our part to achieve or
maintain high-capacity data transmission could significantly reduce consumer
demand for our services and adversely affect our business.
If we are unable to obtain sufficient telecommunications network capacity at
reasonable costs, we may not be able to provide services at prices acceptable to
our customers, thereby reducing demand for our services. Our success will depend
upon the capacity, ease of expansion, reliability and security of our network
infrastructure, including the capacity leased from our telecommunications
network suppliers. Our network currently delivers service through Cable &
Wireless, McLeod, Qwest, Electric Lightwave, Genuity, Worldcom, Level 3, XO,
Sprint and Touch America. Some of these suppliers are also competitors. Our
operating results depend, in part, upon the pricing and availability of
telecommunications network capacity from a limited number of providers. If
capacity is not available to us as our customers' usage increases, our network
may not be able to achieve or maintain sufficiently high data transmission
capacity, reliability or performance. In addition, our business would suffer if
our network suppliers increased the prices for their services and we were unable
to pass along any increased costs to our customers. Any failure on our part or
the part of our third-party suppliers to achieve or maintain high data
transmission capacity, reliability or performance could significantly reduce
customer demand for our services, damage our business reputation and increase
our costs.
25
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-------------------------------------------------------------------------------
of Operations--Continued
------------------------
We depend on our reseller sales channel to market and sell many of our services.
We will not control our resellers, and if we fail to develop or maintain good
relations with resellers, we may not achieve the growth in customers and
revenues that we expect. An element of the strategy for our growth is to further
develop the use of third parties that resell our services. Many of these
resellers are Web development or Web consulting companies that also sell our Web
hosting services, but that generally do not have established customer bases to
which they can market our services. We are not currently dependent on any one
reseller to generate a significant level of business, but we have benefited from
business generated by the reseller channel. Although we attempt to provide our
resellers with incentives such as price discounts on our services that the
resellers seek to resell at a profit, the failure of our services to be
commercially accepted in some markets, whether as a result of a reseller's
performance or otherwise, could cause our current resellers to discontinue their
relationships with us, and we may not be successful in establishing additional
reseller relationships as needed.
HostPro will be subject to changes in technology and industry standards. In the
Web and applications hosting industry, service providers must keep pace with
evolving technologies in order to offer relevant, sophisticated services on a
timely basis to meet rapidly changing customer demands. Our future success will
depend, in part, upon our ability to offer services that incorporate leading
technologies, address the increasingly sophisticated and varied needs of our
current and prospective Web and applications hosting customers and respond to
technological advances and emerging industry standards and practices on a timely
and cost-effective basis. The market for Web hosting services is characterized
by rapidly changing and unproven technologies, evolving industry standards,
changes in customer needs, emerging competition and frequent introductions of
new services. To be successful, we must continually improve the performance,
features and reliability of our services, including our proprietary
technologies, and modify our business strategies accordingly. We could also
incur substantial costs if we need to modify our services or infrastructure in
order to adapt to these changes. Technological advances may have the effect of
encouraging some of our current or future customers to rely on in-house
personnel and equipment to furnish the services that we currently provide. If we
are unable to maintain the compatibility of our services with products offered
by our vendors, we could lose or fail to attract customers.
We believe that our ability to compete successfully also depends upon the
continued compatibility of our services with products offered by various
vendors. Enhanced or newly developed third-party products may not be compatible
with our infrastructure, and such products may not adequately address the needs
of our customers. Although we currently intend to support emerging standards,
industry standards may not be established, and, even if they are established, we
may not be able to conform to these new standards in a timely fashion in order
to maintain a competitive position in the market. Our failure to conform to the
prevailing standard, or the failure of a common standard to emerge, could cause
us to lose customers or fail to attract new customers. In addition, products,
services or technologies developed by others could render our services
noncompetitive or obsolete.
HostPro's ability to attract customers is dependent on the reliable performance
and growth of use of the Internet. Use of the Internet for retrieving, sharing
and transferring information among businesses, consumers, suppliers and partners
has recently begun to increase rapidly. The adoption of the Internet for
information retrieval and exchange, commerce and communication, particularly by
those enterprises that have historically relied upon alternative means of
information gathering, commerce and communications generally requires the
adoption of a new medium of conducting business and exchanging information. If
the Internet as a commercial or business medium fails to develop further or
develops more slowly than expected, we would not be able to grow our customer
base as quickly as desired and our customers would be less likely to require
more complex, higher services from us.
As a Web and applications hosting company, our success will depend in large part
on continued growth in the use of the Internet. The lack of continued growth in
the usage of the Internet would adversely affect our business because we would
not gain additional customers and our existing customers might not have any
further use for our services. Internet usage and growth may be inhibited for a
number of reasons, such as:
. inadequate network infrastructure;
. security concerns;
. uncertainty of legal and regulatory issues concerning the use of the
Internet;
. inconsistent quality of service;
. lack of availability of cost-effective, reliable, high-speed service;
and
. failure of Internet use to expand internationally.
26
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-------------------------------------------------------------------------------
of Operations--Continued
------------------------
If Internet usage grows, the Internet infrastructure may not be able to support
the demands placed on it by this growth, or its performance and reliability may
decline. For example, Web sites have experienced interruptions in service as a
result of outages and other delays occurring throughout the Internet network
infrastructure. If these outages or delays occur frequently, use of the Internet
as a commercial or business medium could in the future grow more slowly or
decline.
HostPro is vulnerable to system failures, which could harm its reputation, cause
its customers to seek reimbursement for services, and cause its customers to
seek another provider for services. HostPro must be able to operate the systems
that manage our network around the clock without interruption. Our operations
will depend upon our ability to protect our network infrastructure, equipment
and customer files against damage from human error, fire, earthquakes,
hurricanes, floods, power loss, telecommunications failures, sabotage,
intentional acts of vandalism and similar events. Although we have attempted to
build redundancy into our networks, our networks are currently subject to
various points of failure. For example, a problem with one of our routers
(devices that move information from one computer network to another) or switches
could cause an interruption in the services we provide to a portion of our
customers. In the past, we have experienced periodic interruptions in service.
In addition, failure of any of our telecommunications providers to provide the
data communications capacity we require, as a result of human error, a natural
disaster or other operational disruption, could result in interruptions in
services. Any future interruptions could:
. cause customers or end users to seek damages for losses incurred;
. require us to replace existing equipment or add redundant facilities;
. damage our reputation for reliable service;
. cause existing customers to cancel their contracts; or
. make it more difficult for us to attract new customers.
We offer some customers a 99.9% service level warranty. Under these policies, we
guarantee that those customers' Web sites will be available at least 99.9% of
the time in each calendar month for as long as the customer is using its Web
hosting services. If we were to experience widespread system failure, we could
incur significant costs under those warranties.
Our data centers and networks may be vulnerable to security breaches. A
significant barrier to electronic commerce and communications is the need for
secure transmission of confidential information over public networks. Some of
our services rely on security technology licensed from third parties that
provides the encryption and authentication necessary to effect the secure
transmission of confidential information. Despite the design and implementation
of a variety of network security measures by us, unauthorized access, computer
viruses, accidental or intentional actions and other disruptions could occur. In
the past, we have experienced, and in the future we may experience, delays or
interruptions in service as a result of the accidental or intentional actions of
Internet users, current and former employees or others. In addition,
inappropriate use of the network by third parties could also potentially
jeopardize the security of confidential information, such as credit card and
bank account numbers stored in our computer systems. These security problems
could result in our liability and could also cause the loss of existing
customers and potential customers. In addition, third parties could interfere
with the operation of our customers' Web sites through intentional attacks
including causing an overload of traffic to these Web sites.
Although we intend to continue to implement industry-standard security measures,
third parties may be able to overcome any measures that we implement. The costs
required to eliminate computer viruses and alleviate other security problems
could be prohibitively expensive and the efforts to address such problems could
result in interruptions, delays or cessation of service to our customers, and
harm our reputation and growth. Concerns over the security of Internet
transactions and the privacy of users may also inhibit the growth of the
Internet, especially as a means of conducting commercial transactions.
Disruption of our services caused by unknown software defects could harm our
business and reputation. Our service offerings depend on complex software,
including proprietary software tools and software licensed from third parties.
Complex software often contains defects, particularly when first introduced or
when new versions are released. We may not discover software defects that affect
our new or current services or enhancements until after they are deployed.
Although we have not experienced any material software defects to date, it is
possible that defects may occur in the software. These defects could cause
service interruptions, which could damage our reputation or increase our service
costs, cause us to lose revenue, delay market acceptance or divert our
development resources.
Providing services to customers with critical Web sites and Web-based
applications could potentially expose HostPro to lawsuits for customers' lost
profits or other damages. Because the Web hosting and applications hosting
services of HostPro are critical to many of our customers' businesses, any
significant interruption in the services provided by us could result in lost
profits or other indirect or consequential damages to our customers as well as
negative publicity and additional expenditures for us to correct the problem.
27
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-------------------------------------------------------------------------------
of Operations--Continued
------------------------
Although the standard terms and conditions of our customer contracts disclaim
liability for any such damages, a customer could still bring a lawsuit against
us claiming lost profits or other consequential damages as the result of a
service interruption or other Web site or application problems that the customer
may ascribe to us. A court might not enforce any limitations on HostPro's
liability, and the outcome of any lawsuit would depend on the specific facts of
the case and legal and policy considerations even if we believe we would have
meritorious defenses to any such claims. In such cases, we could be liable for
substantial damage awards. Such damage awards might exceed our liability
insurance by unknown but significant amounts, which would seriously harm our
business.
We could face liability for information distributed through our network. The law
relating to the liability of on-line services companies for information carried
on or distributed through their networks is currently unsettled. On-line
services companies could be subject to claims under both United States and
foreign law for defamation, negligence, copyright or trademark infringement,
violation of securities laws or other theories based on the nature and content
of the materials distributed through their networks. Several private lawsuits
seeking to impose such liability upon other entities are currently pending
against other companies. In addition, organizations and individuals have sent
unsolicited commercial e-mails from servers hosted by service providers to
massive numbers of people, typically to advertise products or services. This
practice, known as "spamming," can lead to complaints against service providers
that enable such activities, particularly where recipients view the materials
received as offensive. We may, in the future, receive letters from recipients of
information transmitted by our customers objecting to such transmission.
Although we prohibit our customers by contract from spamming, we cannot assure
you that our customers will not engage in this practice, which could subject us
to claims for damages.
In addition, we may become subject to proposed legislation that would impose
liability for or prohibit the transmission over the Internet of some types of
information. Other countries may also enact legislation or take action that
could impose liability on us or cause us not to be able to operate in those
countries. The imposition upon us and other on-line services of potential
liability for information carried on or distributed through our systems could
require us to implement measures to reduce our exposure to this liability, which
may require us to expend substantial resources, or to discontinue service
offerings. The increased attention focused upon liability issues as a result of
these lawsuits and legislative proposals also could affect the growth of
Internet use.
Our business may be impacted by government regulation and legal uncertainties.
Only a small body of laws and regulations currently applies specifically to
access to, or commerce on, the Internet. Due to the increasing popularity and
use of the Internet, however, laws and regulations with respect to the Internet
may be adopted at federal, state and local levels, covering issues such as user
privacy, freedom of expression, pricing, characteristics and quality of products
and services, taxation, advertising, intellectual property rights, information
security and the convergence of traditional telecommunications services with
Internet communications. We cannot fully predict the nature of future
legislation and the manner in which government authorities may interpret and
enforce. As a result, we and our customers could be subject to potential
liability under future legislation, which in turn could have a material adverse
effect on our business. For example, if legislation were adopted in the U.S. or
internationally that makes transacting business over the Internet less favorable
or otherwise curtails the growth of the Internet, our business would suffer. The
adoption of any such laws or regulations might decrease the growth of the
Internet, which in turn could decrease the demand for our services or increase
the cost of doing business or in some other manner harm our business.
In addition, applicability to the Internet of existing laws governing issues
such as property ownership, copyright and other intellectual property issues,
taxation, libel, obscenity and personal privacy is uncertain. These laws
generally pre-date the advent of the Internet and related technologies and, as a
result, do not consider or address the unique issues of the Internet and related
technologies. Changes to laws intended to address these issues could create
uncertainty in the marketplace that could reduce demand for our services or
increase the cost of doing business as a result of costs of litigation or
increased service delivery costs, or could in some other manner have a material
adverse effect on our business.
In addition, because our services are available over the Internet virtually
worldwide, and because we facilitate sales by our customers to end users located
in multiple states and foreign countries, such jurisdictions may claim that we
are required to qualify to do business as a foreign corporation in those states
or that we have a permanent establishment in the foreign country.
Our international operations are subject to risks. We derived approximately 18%
of our revenues from international sales for the quarter ended May 31, 2001.
International business is subject to a number of special risks, including:
. different regulatory requirements;
. different privacy, censorship and liability standards and regulations;
. less protective intellectual property laws ;
. different technology standards;
28
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-------------------------------------------------------------------------------
of Operations--Continued
------------------------
. unexpected changes in, or imposition of, regulatory requirements;
. tariffs and other barriers and restrictions ;
. general geopolitical risks such as political and economic instability ;
. hostilities among countries and changes in diplomatic and trade
relationships; and
. other factors beyond our control.
Substantial future sales of shares by shareholders could negatively affect our
stock price. If our shareholders sell substantial amounts of Micron Electronics
common stock in the public market after the merger with Interland, the market
price of Micron Electronics common stock could decline. Under a shareholder
agreement, Mr. Kocher and some Interland shareholders have agreed not to sell
their shares of Micron Electronics common stock, representing approximately 12%
of the outstanding common stock of the combined company, assuming an exchange
ratio of 0.8610, for a period of nine months after the closing of the merger,
subject to limited exceptions. Additionally, Micron Technology, who will own
approximately 43% of the outstanding common stock of the combined company,
assuming an exchange ratio of 0.8610, agreed not to sell any shares of Micron
Electronics common stock beneficially held by it for a period of nine months
after the closing of the merger with Interland, subject to limited exceptions.
As a result, after these lockup provisions expire, approximately 55% of the
outstanding common stock of the combined company, assuming an exchange ratio of
0.8610, will be eligible for sale in the public market subject to volume
limitations under Rule 144 of the Securities Act. Furthermore, these
shareholders will have the right to require the combined company to register
their shares for sale pursuant to an existing registration rights agreement.
Risks Associated With The Merger
If we do not maintain specified cash balances, the exchange ratio for the shares
of Interland to be exchanged in the merger will be adjusted or the merger could
be terminated. The exchange ratio of 0.861 shares of Micron Electronics common
stock for each outstanding share of Interland common stock will be adjusted if
the cash and cash equivalents of Micron Electronics less any reserves related to
Micron Electronics' PC Systems or SpecTek businesses - the Net Available Cash -
are less than $200 million at the time of the merger closing. The exchange ratio
could increase to as high as 2.3676 shares of Micron Electronics common stock
for each share of Interland common stock, if the Net Available Cash balance
drops below $10.0 million. If the exchange ratio is increased, the holders of
Interland stock would receive more shares of Micron Electronics stock in the
merger, which would dilute the current holders of Micron Electronics stock.
However, the exchange ratio will not be adjusted for fluctuations in the trading
price of Micron Electronics common stock or Interland common stock. Based on our
current projections, there is a possibility that the Net Available Cash at the
time of closing could be less than $200 million, which would result in a small
adjustment to the exchange ratio.
In addition, if the Net Available Cash amount is less than $100.0 million at the
merger closing, then Interland will have the right to terminate the merger
agreement. However, this termination right may not be exercised by Interland if
it has been advanced more than $10.0 million by Micron Electronics under a
bridge loan and security agreement entered into in connection with the merger
agreement.
We do not currently expect that our shareholders will receive a distribution of
cash. The merger agreement with Interland provides that to the extent that we
have cash and cash equivalents greater than $200.0 million, less specified
liabilities at the time of the closing of the merger, the record holders of our
common stock as of the close of trading on the closing date of the merger may be
entitled to receive pro rata payments of that cash. We do not currently expect
that any distribution will be made. In addition, the merger agreement provides
that those holders may also be entitled to receive distributions of any net
proceeds to the Company from the sale of our PC Systems business. We may under
specified circumstances share in proceeds received, if any, after payment of
specified liabilities or reserves by GTG PC if GTG PC sells or liquidates that
business within three years of the closing of the sale to GTG PC. We cannot
assure you that any distribution to our shareholders will be made from these
proceeds. Even if we have excess cash or if there are any proceeds from the sale
of the PC Systems business, the distribution of these funds is subject to a
number of restrictions.
If we do not successfully integrate the operations and personnel of Interland in
a timely manner, this will disrupt the combined company's business and could
negatively affect our operating results. Our acquisition of Interland involves
risks related to the integration and management of Interland's operations and
personnel with those of HostPro. The integration of Micron Electronics and
Interland will be a complex, time consuming and expensive process and may
disrupt the businesses of both companies if not completed in a timely and
efficient manner. After the merger, the combined company must operate as a
combined organization utilizing common information and telecommunications
systems, operating procedures, financial controls and human resources practices.
29
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-------------------------------------------------------------------------------
of Operations--Continued
------------------------
Micron Electronics and Interland may encounter substantial difficulties, costs
and delays involved in integrating their operations, including:
. potential incompatibility of business cultures;
. perceived adverse changes in business focus;
. potential conflicts in marketing or other important relationships;
. potential operating inefficiencies and increased costs associated with
having and integrating different information and telecommunictions
systems currently used by each of HostPro and Interland;
. potential decline in the level of customer service and customer
satisfaction; and
. the loss of key employees and diversion of the attention of management
from other ongoing business concerns.
Our headquarters are located in Boise, Idaho, while Interland's headquarters are
located in Atlanta, Georgia. The combined company will be headquartered in
Atlanta, Georgia. Our integration of Interland's operations and personnel may be
difficult due to the geographic distance between the two companies. In addition,
we have completed a number of acquisitions of hosting companies and are still in
the process of completing the integration of these businesses. This could make
the integration of Interland more difficult. If this integration effort is not
successful, then results of operations could be adversely affected, employee
morale could decline, key employees could leave and customers could cancel
existing orders or choose not to place new ones. In addition, the attention and
effort devoted to the integration of the two companies will significantly divert
management's attention from other important issues, such as expansion of the
combined customer base, which could negatively affect the business and operating
results of the combined company.
The benefits of the merger may be lower than expected and the costs associated
with the merger could be higher than expected, which could harm the financial
results of the combined company and cause a decline in the value of our common
stock. We expect to realize cost reductions due to synergies created by merging
with Interland in areas such as integration and expansion of nationwide
technical support capabilities over a larger customer base, integration of
information and telecommunications systems, marketing the larger combined
business, elimination of excess data center capacity and economies of scale for
the combined company's telecommunications costs. Although we expect that we will
realize cost synergies with the merger, we cannot state the amount with any
certainty. Micron Electronics and Interland estimate that we will incur direct
transaction costs of approximately $7.7 million associated with the merger. We
expect to incur additional costs associated with the consolidation and
integration of the companies' products and operations. We cannot accurately
estimate these costs at this time. If the total costs of the merger and related
consolidation and integration exceed estimates, or if the cost synergies of the
merger are less than expected, the financial results of the combined company
would suffer. Any shortfall in anticipated operating results of the combined
company, if the merger is completed, could cause the market price of our common
stock to decline. In addition, the market price of our common stock could
decline significantly if we do not experience the business benefits of the
merger as quickly or in as great amounts as security analysts expect.
The merger could harm key customers and third-party relationships. The proposed
merger could harm relationships with customers and other third parties with
which we do business. For example, the continuance of our customer relationships
is generally based on continued customer goodwill and satisfaction rather than
long-term orders or other contractual commitments. Customers might postpone or
cancel sales orders for our services if they perceive that customer services and
support would decline as a result of the merger. Any changes in customer
relationships could harm our business. Our customers and other third parties
may, in response to the announcement of the merger, delay or defer decisions
concerning using us as their service provider.
We will incur significant accounting charges relating to the acquisition of
Interland, which will delay projected achievement of profitability for the Web
hosting business. We will account for the acquisition of Interland using the
purchase method of accounting. Under the purchase method, the purchase price of
Interland will be allocated to the assets acquired and liabilities assumed from
Interland. As a result, based on an approximate purchase price of $125.2
million, we expect to record approximately $80.2 million of intangible assets
and goodwill from the Interland acquisition on our balance sheet, which will
result in annual amortization expense of approximately $25.9 million in fiscal
2002 under accounting standards existing at May 31, 2001. These charges will
delay projected achievement of profitability for the Company. We have allocated
the total estimated purchase price for the Interland merger on a preliminary
basis based upon our current best estimates of the fair value of these assets
and liabilities, with the excess costs over the net assets acquired allocated to
goodwill and other intangible assets. This allocation is subject to change
pending a final analysis of the fair values of the assets acquired and
liabilities assumed. The impact of these changes could, for example, reduce the
combined company's reported future earnings or otherwise have a material,
negative impact on our future results of operations.
30
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-------------------------------------------------------------------------------
of Operations--Continued
------------------------
The merger could result in employees at Micron Electronics and Interland
deciding to leave their employment before or after completion of the merger.
After the merger, integration of the businesses of HostPro and Interland could
result in changes in the culture and operations of both companies that could
cause the combined company to lose key employees. The success of the combined
company will depend in part upon its ability to attract and retain highly
skilled technical, managerial and sales and marketing personnel. The loss of key
employees at any HostPro or Interland office could adversely impact HostPro's or
Interland's financial results, which could have a negative impact on the
operating results of the combined company after the merger. Competition for such
personnel is intense. After the merger, the combined company may not be able to
hire or retain the necessary personnel to complete the integration process and
implement its business strategy. In addition, the combined company may need to
pay higher compensation for employees than it currently expects.
If members of HostPro's or Interland's management leave, the potential benefits
of the merger may not be realized and could adversely affect our operating
results. The combined company will be managed by top executives from Micron
Electronics, HostPro and Interland. Success of the merger will depend, in
significant part, on the continued services of HostPro's and Interland's senior
management personnel and of its key technical and sales personnel. We experience
strong competition for these personnel in the Web hosting industry, and both
Interland and HostPro have lost some senior management and sales management
personnel to competitors. If members of the combined company's anticipated
management were to terminate their employment with HostPro or Interland, the
ability of the combined company to manage its business and workforce after the
merger would be harmed and its operations could be disrupted, and the benefits
that the combined company anticipates from the merger could be prevented or
deferred. While Micron Electronics and Interland have employment agreements with
some members of their senior management, they cannot assure you that any
incentives included as part of these agreements will be sufficient to retain
these employees.
Failure to complete the merger with Interland could harm our stock price and our
future business and operations. The merger is subject to several closing
conditions, including approval by Interland's and Micron Electronics'
shareholders, and we cannot assure you that the merger will be successfully
completed. In the event that the merger is not successfully completed, we may be
subject to a number of material risks, including the following:
. we may be required to pay Interland a termination fee of up to $3.5
million, if Interland or Micron Electronics terminates the merger
agreement because our shareholders have not approved the proposals to be
voted upon by them at our special meeting ;
. the trading price of our common stock may decline to the extent that the
current market price reflects a market assumption that the merger will be
completed; and
. costs associated to the proposed merger, such as legal,
accounting and financial advisory fees must be paid by us, even if the
merger is not completed.
If the merger is not completed, we may be unable to restore the status of our
business as it existed prior to the announcement of the merger.
HostPro customers may react adversely to our plans to change the name of our Web
hosting business and the Company to "Interland, Inc." In connection with the
planned merger with Interland, we intend to change the name of our Web hosting
business and the Company to "Interland, Inc." To the extent that existing
customers of HostPro identify with the "HostPro" brand name or do not identify
with the "Interland" brand name, those customers could choose to terminate their
relationships with HostPro. A significant loss of customers could adversely
affect the operating results of the combined company.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
------------------------------------------------------------------
We use the U.S. Dollar as our functional currency. Aggregate transaction gains
and losses included in the determination of net income have not been material.
Substantially all of our cash equivalents, liquid investments and a majority of
our debt are at fixed interest rates, and therefore the fair value of these
instruments is affected by changes in market interest rates. As of May 31, 2001,
management believes the reported amounts of liquid investments and debt to be
reasonable approximations of their fair values. As a result, management believes
that the market risk arising from its holdings of financial instruments is
minimal.
31
PART II. Other Information
--------------------------
Part II.
--------
Item 1. Legal Proceedings
--------------------------
On June 1, 2001, Plaintiff Kimberley Smith filed a Complaint and Demand for Jury
Trial in the U.S. District Court for Idaho alleging violations of the Fair Labor
Standards Act ("FLSA"), in particular alleged failures to pay non-exempt
employees overtime for hours worked in excess of 40 in a week as well as other
alleged violations of the FLSA and state wage and hour laws. On June 8, 2001, an
Amended Complaint and Demand for Jury Trial was filed by Plaintiff Smith in
which an additional individual, Plaintiff Michael Hinckley, joined. Ms. Smith
and Mr. Hinckley seek individual damages and class certification and relief as
well as injunctive relief, prejudgment interest and attorneys' fees and costs.
Thus far, twenty-eight additional, mostly former employees have filed written
notice of consents seeking to join in the action. The Company filed an answer to
the Complaint on June 29, 2001, and is defending the matter. The claim is
currently in its early stages and we are therefore unable to estimate total
expenses, possible loss or range of losses that may ultimately be connected with
this matter.
Item 6. Exhibits and Reports on Form 8-K
-----------------------------------------
(a) The following are filed as a part of this report:
Exhibit Description
------- -----------
2.05 Membership Interest Purchase Agreement, dated as of April
30, 2001, by and between the Registrant and GTG PC Holdings,
LLC. (1)
2.06 First Amendment to Membership Interest Purchase Agreement
and Form of Contribution Agreement, dated as of May 31,
2001, by and between the Registrant and GTG PC Holdings,
LLC. (2)
10.87 Amended Retention Agreement between Micron Electronics, Inc.
and Steve Arnold, dated as of April 7, 2001.
10.88 Retention Agreement between Micron Electronics, Inc. and
Jeff Moeser, dated as of February 23, 2001.
10.89 Micron Electronics 2001 Equity Incentive Plan.
10.90 Operating lease for property located at 3250 Wilshire Blvd.,
Los Angeles, CA, dated as of March 16, 1998.
10.91 Operating lease for property located at 3250 Wilshire Blvd.,
Los Angeles, CA, dated as of March 19, 1999.
10.92 Operating lease for property located at 1450 Eagle Flight
Way, Boise, ID, dated as of January 7, 2000.
10.93 Operating lease for property located at 3326 160th Avenue
SE, Bellevue, WA, dated as of December 16, 1999.
(b) Reports on Form 8-K:
On April 10, 2001, the Company filed a report on Form 8-K, which described,
under Item 5, certain aspects of the Agreement and Plan of Merger with
Interland, Inc.
On April 10, 2001, the Company filed a report on Form 8-K, which described,
under Item 5, certain aspects of the Purchase Agreement for the sale of the
SpecTek business to Micron Technology, Inc.
On April 20, 2001, the Company filed a report on Form 8-K, which described,
under Item 2, certain aspects of the Purchase Agreement for the sale of the
SpecTek business and included, under Item 7, certain pro forma financial
information regarding the SpecTek business.
--------------------
(1) Incorporated by reference herein from exhibit 2.01 to MEI's Current
Report on Form 8-K, filed June 13, 2001, with respect to the completion of the
sale of the PC Systems business to GTG PC Holdings, LLC.
(2) Incorporated by reference herein from exhibit 2.02 to MEI's Current
Report on Form 8-K, filed June 13, 2001, with respect to the completion of the
sale of the PC Systems business to GTG PC Holdings, LLC.
32
SIGNATURES
Pursuant to the requirements 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.
Micron Electronics, Inc.
---------------------------------------------------
(Registrant)
Dated: July 16, 2001
/s/ David A. Buckel
---------------------------------------------------
David A. Buckel, Senior Vice President and
Chief Financial Officer (Principal Financial and
Accounting Officer)
33