<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended December 2, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to _________________
Commission file number 17932
MICRON ELECTRONICS, INC.
--------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1404301
------------------------------------ ---------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
900 EAST KARCHER ROAD
NAMPA, IDAHO 83687
--------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(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__
---
As of January 10, 2000, the Registrant had outstanding 96,294,809
shares of its common stock, par value $0.001 per share.
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
-----------------------------
Micron Electronics, Inc.
Consolidated Statements of Income
(Amounts in thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Fiscal quarter ended December 2, 1999 December 3, 1998
----------------------------------------------------------------------------------------------
<S> <C> <C>
Net sales $352,952 $403,496
Cost of goods sold 266,232 334,678
-------- --------
Gross margin 86,720 68,818
Selling, general and administrative 68,626 52,396
Research and development 576 1,451
Other expense, net 665 40
-------- --------
Operating income 16,853 14,931
Interest income, net 4,031 4,027
-------- --------
Income before taxes 20,884 18,958
Income tax provision 6,264 7,299
-------- --------
Net income $ 14,620 $ 11,659
======== ========
Earnings per share:
Basic $ 0.15 $ 0.12
Diluted 0.15 0.12
Number of shares used in per share calculation:
Basic 96,279 95,953
Diluted 96,448 97,316
</TABLE>
The accompanying notes are an integral part of the financial statements.
2
<PAGE>
Micron Electronics, Inc.
Consolidated Balance Sheets
(Amounts in thousands, except par value amounts)
(Unaudited)
<TABLE>
<CAPTION>
As of December 2, 1999 September 2, 1999
-----------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash and cash equivalents $158,549 $200,950
Liquid investments 204,727 137,528
Receivables, net 148,979 152,658
Inventories 22,766 17,521
Deferred income taxes 13,152 14,819
Other current assets 7,942 20,590
-------- --------
Total current assets 556,115 544,066
Property, plant and equipment, net 171,612 159,859
Acquired intangibles and goodwill, net 21,910 22,580
Other assets 6,255 7,026
-------- --------
Total assets $755,892 $733,531
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued expenses $225,708 $214,426
Accrued licenses and royalties 20,911 20,231
Current debt 3,002 7,000
-------- --------
Total current liabilities 249,621 241,657
Long-term debt 2,844 5,001
Deferred income taxes 12,634 11,926
Other liabilities 17,328 16,448
-------- --------
Total liabilities 282,427 275,032
-------- --------
Common stock, $.01 par value, authorized 150.0 million shares;
issued and outstanding 96.3 million and 96.3 million shares,
respectively 963 963
Additional capital 128,299 127,951
Retained earnings 344,203 329,585
-------- --------
Total shareholders' equity 473,465 458,499
-------- --------
Total liabilities and shareholders' equity $755,892 $733,531
======== ========
</TABLE>
The accompanying notes are an integral part of the financial statements.
3
<PAGE>
Micron Electronics, Inc.
Consolidated Statements of Cash Flows
(Amounts in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Fiscal quarter ended December 2, 1999 December 3, 1998
---------------------------------------------------------------------------------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 14,620 $ 11,659
Adjustments to reconcile net income to net cash
provided by (used for) operating activities:
Depreciation and amortization 8,120 7,894
Provision for (recovery of) doubtful accounts 709 (158)
Changes in operating assets and liabilities:
Receivables 2,971 (38,009)
Inventories (5,245) 1,520
Other current assets 12,647 (19)
Accounts payable and accrued expenses 12,114 25,220
Accrued licenses and royalties 681 12,100
Deferred income taxes 2,284 3,038
Other 189 418
-------- --------
Net cash provided by operating activities 49,090 23,663
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Expenditures for property, plant and equipment (20,084) (12,987)
Purchases of held-to-maturity investment securities (99,750) (42,613)
Proceeds from maturities of investment securities 32,405 16,125
Other 3,714 (262)
-------- --------
Net cash used in investing activities (83,715) (39,737)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Repayments of debt (8,124) (1,823)
Proceeds from issuance of common stock 348 2,772
-------- --------
Net cash (used in) provided by financing activities (7,776) 949
-------- --------
Net decrease in cash and cash equivalents (42,401) (15,125)
Effect of exchange rate changes on cash and cash equivalents - 372
Cash and cash equivalents at beginning of period 200,950 328,537
-------- --------
Cash and cash equivalents at end of period $158,549 $313,784
======== ========
</TABLE>
The accompanying notes are an integral part of the financial statements.
4
<PAGE>
MICRON ELECTRONICS, INC.
Notes to Financial Statements
(Tabular amounts in thousands, except per share amounts)
(Unaudited)
1. Unaudited Interim Financial Statements
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 Micron
Electronics, Inc. and its subsidiaries (collectively, the "Company") and their
results of operations and cash flows. Operating results for the three-month
period ended December 2, 1999 are not necessarily indicative of the results that
may be expected for the full year. Certain reclassifications, none of which
affects net income, have been made to present the financial statements on a
consistent basis.
This report on Form 10-Q for the first quarter ended December 2, 1999,
should be read in conjunction with the Company's Report on Form 10-K for the
fiscal year ended September 2, 1999. Portions of the accompanying financial
statements are derived from the audited year-end financial statements of the
Company dated September 2, 1999. The Company's fiscal year is a 52 or 53 week
period ending on the Thursday closest to August 31.
Revenue from product sales to customers is generally recognized upon
shipment. A provision for estimated sales returns and discounts is recorded in
the period in which the sales are recognized. Revenue from E-Services is
recognized as the services are performed. Revenue from service and support
contracts for which the Company is primarily obligated is recognized over the
term of the contract. Revenue from sales of third party service contracts for
which the Company is not obligated is recognized at the time of sale.
Recently issued accounting standards include Statement of Financial
Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments
and Hedging Activities," issued in June 1998. SFAS No. 133 requires all
derivatives to 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 investments. Along with the derivatives, the
underlying hedged items are also to be marked-to-market on an ongoing basis.
These market value adjustments are to be included either in the statement of
operations or as a component of comprehensive income, depending on the nature of
the transaction. Implementation of SFAS No. 133 is required for the Company by
the first quarter of fiscal 2001. The Company is currently evaluating the effect
SFAS No. 133 will have on its future results of operations and financial
position.
The Security and Exchange Commission issued Staff Accounting Bulletin (SAB)
No. 101, "Revenue Recognition in Financial Statements" in December 1999. The SAB
summarizes certain of the staff's views in applying generally accepted
accounting principles to revenue recognition in the financial statements.
Adoption is required by the first quarter of fiscal 2001, and early adoption is
permitted. The Company is currently evaluating the effect this SAB may have on
its revenue recognition practices and results of operations.
2. Receivables
December 2, 1999 September 2, 1999
----------------------------------------------------------------------------
Trade receivables $143,051 $144,996
Receivables from affiliates 408 1,435
Income taxes recoverable from MTI 6,602 6,602
Other 5,103 5,974
Allowance for doubtful accounts (3,556) (3,846)
Allowance for returns and discounts (2,629) (2,503)
-------- --------
$148,979 $152,658
======== ========
5
<PAGE>
Micron Electronics, Inc.
Notes to Financial Statements --Continued
(Tabular amounts in thousands, except per share amounts)
(Unaudited)
3. Inventories
<TABLE>
<CAPTION>
December 2, 1999 September 2, 1999
------------------------------------------------------------------------------------
<S> <C> <C>
Raw materials and supplies $ 9,489 $ 5,931
Work in progress 9,333 8,582
Finished goods 3,944 3,008
-------- --------
$ 22,766 $ 17,521
======== ========
4. Property, Plant and Equipment
December 2, 1999 September 2, 1999
------------------------------------------------------------------------------------
Land $ 1,234 $ 1,234
Buildings 38,518 38,081
Equipment and software 188,753 152,363
Assets in progress 34,247 52,816
-------- --------
262,752 244,494
Less accumulated depreciation and amortization (91,140) (84,635)
-------- --------
$171,612 $159,859
======== ========
5. Acquired Intangibles and Goodwill
December 2, 1999 September 2, 1999
------------------------------------------------------------------------------------
Acquired intangibles $ 5,400 $ 5,400
Goodwill 17,386 17,386
-------- --------
22,786 22,786
Less accumulated amortization (876) (206)
-------- --------
$ 21,910 $ 22,580
======== ========
6. Accounts Payable and Accrued Expenses
December 2, 1999 September 2, 1999
------------------------------------------------------------------------------------
Trade accounts payable $145,851 $150,957
Payable to affiliates 45,558 31,055
Salaries, wages and benefits 15,081 16,850
Income taxes payable 2,915 36
Deferred revenue - current 4,550 3,328
Accrued warranty - current 9,854 10,116
Other 1,899 2,084
-------- --------
$225,708 $214,426
======== ========
</TABLE>
6
<PAGE>
Micron Electronics, Inc.
Notes to Financial Statements --Continued
(Tabular amounts in thousands, except per share amounts)
(Unaudited)
7. Other Liabilities
December 2, 1999 September 2, 1999
------------------------------------------------------------------------------
Accrued stock compensation $ 4,405 $ 3,892
Deferred revenue - long term 5,062 4,126
Accrued warranty - long term 1,438 1,542
Other 6,423 6,888
-------- --------
$ 17,328 $ 16,448
======== ========
8. Debt
<TABLE>
<CAPTION>
December 2, 1999 September 2, 1999
--------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Notes payable in periodic installments through September 2001,
weighted average interest rate of 7.93% and 7.85%, respectively $ 3,647 $ 9,722
Capitalized lease obligations payable in monthly installments through
October 2002, interest rate of 10.04% and 7.61%, respectively 2,199 2,279
-------- --------
5,846 12,001
Less current portion (3,002) (7,000)
-------- --------
$ 2,844 $ 5,001
======== ========
</TABLE>
The Company has an unsecured credit agreement, expiring June 2001, with a
group of financial institutions providing for borrowings totaling $100.0
million. As of December 2, 1999, the Company was eligible to borrow the full
amount under the agreement, but had no borrowings outstanding. Under the
agreement, the Company is subject to certain financial and other covenants
including certain financial ratios and limitations on the amount of dividends
declared or paid by the Company.
Certain of the Company's notes payable are collateralized by equipment with
a total cost of $10.1 million and accumulated depreciation of $7.1 million as of
December 2, 1999. Equipment under capital leases net of accumulated amortization
was $2.2 million as of December 2, 1999.
9. Transactions with Affiliates
<TABLE>
<CAPTION>
December 2, 1999 September 2, 1999
---------------------------------------------------------------------------------------------
<S> <C> <C>
Net sales $ 1,569 $ 598
Inventory purchases 21,042 11,129
Component recovery agreement expenses 25,429 16,085
Administrative services and other expenses 125 114
Property, plant and equipment purchases 299 1,870
Property, plant and equipment sales 1,806 -
</TABLE>
Effective September 2, 1999, the Company and MTI entered into an amended
and restated Component Recovery Agreement (the "Component Recovery Agreement")
which expires August 30, 2001 unless terminated earlier as described below.
Under the Component Recovery Agreement, MTI is required to offer to the Company
all of the nonstandard memory components produced at MTI's semiconductor
operations. These components are used in the Company's SpekTek Operations. The
Component Recovery Agreement provides that the cost of components obtained from
MTI will be negotiated on a quarterly basis, but in no event will the cost be
less than 50% of pre-tax income. During the first quarter of fiscal 2000, the
cost of obtaining such components was 50% of pre-tax income attributable to the
sale of such components, and the cost for such components will be 62.5% of pre-
tax income in the second quarter of fiscal 2000. The maximum cost payable by the
Company to MTI for components for the remainder of fiscal 2000
7
<PAGE>
Micron Electronics, Inc.
Notes to Financial Statements --Continued
(Tabular amounts in thousands, except per share amounts)
(Unaudited)
will be as follows: third quarter, 75% of pre-tax income; and fourth quarter,
87.5% of pre-tax income. The cost to the Company for components obtained from
MTI during fiscal 2001 is not subject to any maximum. The Company recognizes
costs incurred under the Component Recovery Agreement as a component of cost of
goods sold in the consolidated statements of income.
Under the Component Recovery Agreement, as of the commencement of the
second quarter of fiscal 2000 the Company has an option to require MTI to
purchase the property and equipment of SpecTek Operations for a purchase price
equal to net book value. At the commencement of fiscal 2001, MTI has an option
to require the Company to sell the property and equipment of SpecTek Operations
under the same terms and conditions. Additionally, the Company has an option to
require MTI to purchase, and MTI has the option to require the Company to sell,
the assets of SpecTek Operations at book value if MTI's ownership in the Company
falls below 50% or if an unrelated third party acquires more than 30% of the
Company. The Component Recovery Agreement would terminate if MTI purchases the
property and equipment of SpecTek Operations pursuant to the exercise of the
above described options.
10. Income Taxes
The effective income tax rate for the three months ended December 2, 1999
and December 3, 1998 was 30% and 38.5%, respectively, principally reflecting the
federal statutory rate, net of the effect of state taxes. The decrease is
principally due to benefits received from the Company's tax-exempt securities,
foreign sales corporation, and federal research and development credits.
11. Comprehensive Income
The Company adopted Statements of Financial Accounting Standard ("SFAS")
No. 130, "Reporting Comprehensive Income" as of the first quarter of fiscal
1999. The adoption of this statement had no impact on the Company's current or
previously reported net income or shareholders' equity.
Fiscal quarter ended December 2, 1999 December 3, 1998
---------------------------------------------------------------------
Net income $14,620 $11,659
Foreign currency translation - (350)
------- -------
Comprehensive income $14,620 $11,309
======= =======
12. Earnings Per Share
Basic earnings per share is computed using the weighted average number of
common shares outstanding. Diluted earnings per share is computed using the
weighted average number of common shares outstanding and common equivalent
shares outstanding. Common equivalent shares result from the assumed exercise of
outstanding stock options. Diluted earnings per share excludes the effect of
antidilutive stock options, aggregating 5.3 million and 0.2 million in the first
quarters of fiscal 2000 and 1999, respectively.
<TABLE>
<CAPTION>
Fiscal quarter ended December 2, 1999 December 3, 1998
-------------------------------------------------------------------------------------
<S> <C> <C>
Net income available to common shareholders $14,620 $11,659
======= =======
Common shares outstanding:
Weighted average shares outstanding - basic 96,279 95,953
Effect of dilutive stock options 169 1,363
------- -------
Weighted average shares outstanding - diluted 96,448 97,316
======= =======
Earnings per share:
Basic $ 0.15 $ 0.12
Diluted 0.15 0.12
</TABLE>
8
<PAGE>
Micron Electronics, Inc.
Notes to Financial Statements --Continued
(Tabular amounts in thousands, except per share amounts)
(Unaudited)
13. Commitments
As of December 2, 1999, the Company had commitments of $15.5 million for
purchases of equipment and software, and $1.0 million for construction of
buildings. In addition, the Company is required to make minimum royalty payments
under certain agreements and periodically enters into purchase commitments with
certain suppliers.
14. Contingencies
Periodically, the Company is made aware that technology used by the Company
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 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 could require changes in the
Company's products or processes.
The Company is involved in other non-intellectual property litigation and
administrative proceedings primarily arising in the normal course of its
business. In the opinion of management, the Company's recovery, if any, or the
Company's liability, if any, under any litigation or administrative proceedings
would not materially affect its financial condition, results of operations or
cash flows.
During the first quarter of fiscal 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 the liability of the Company, if any, for non-remittance of
sales and use taxes prior to such agreements' effective dates. The Company has
accrued a liability for the estimated settlement costs of issues related to
sales and use taxes not covered by such agreements. Management believes the
resolution of any matters relating to the non-remittance of sales and use taxes
will not materially affect the Company's financial condition or results of
operations.
15. Acquisitions
On August 2, 1999, the Company acquired all of the outstanding common stock
of NetLimited, Inc., d.b.a. HostPro, for $21.9 million in cash. The acquisition
was accounted for as a purchase, and the purchase price was allocated to the net
assets acquired, including identified intangible assets and in-process research
and development, based on their fair values. On September 2, 1999, the Company
purchased the property and equipment of Micron Technology, Inc.'s Internet
service operating division, Micron Internet Services ("MIS"), for $2.2 million
in cash. The transaction was accounted for at historical cost. The assets will
be depreciated over their remaining useful lives.
The following unaudited pro forma information reflects the results of the
Company's results of operations for the fiscal quarter of 1999 as if the
acquisitions of HostPro and MIS had occurred at the beginning of fiscal 1999.
These pro forma results have been prepared for comparative purposes only and do
not purport to be indicative of what operating results would have been had the
acquisition occurred at the beginning of fiscal 1999 or operating results which
may occur in the future.
Fiscal quarter ended December 3, 1998
----------------------------------------------------------------------------
Net sales $405,925
Net income 10,699
Earnings per share:
Basic 0.11
Diluted 0.11
9
<PAGE>
Micron Electronics, Inc.
Notes to Financial Statements --Continued
(Tabular amounts in thousands, except per share amounts)
(Unaudited)
16. 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 fiscal
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 the Company's reportable segments. SFAS
131 also requires disclosures about products and services, geographic areas, and
major customers.
The Company's predominant operations are to market, design, develop and
manufacture PC products, offer Internet access and Web hosting services, and
manufacture SpecTek memory products. The Company's reportable segments have been
determined based on the nature of its operations, products offered to customers
and information used by the Chief Operating Decision Maker as defined by FAS
131. The Company's three reportable segments are PC Systems, E-Services and
SpecTek Operations. The PC Systems segment's primary products include a wide
range of desktop and notebook PC Systems, multiprocessor network servers, and
hardware services. The E-Services segment focuses on Internet access and Web
hosting through Micron Internet Services and HostPro. The primary products of
the SpecTek Operations include DRAM's, SDRAM's, and memory modules.
The accounting policies of the segments are the same as those described in
the Summary of Significant Accounting Policies. Segment operating results are
measured based on operating income (loss). The elimination of internal net sales
primarily reflects charges between PC Systems and SpecTek Operations. Such
charges are based on estimated costs.
<TABLE>
<CAPTION>
Fiscal quarter ended December 2, 1999 December 3, 1998
------------------------------------------------------------------------------------
<S> <C> <C>
Net Sales
PC Systems $259,541 $364,159
E-Services 4,140 -
SpecTek Operations 90,017 39,889
-------- --------
Total segment sales 353,698 404,048
Elimination of internal net sales (746) (552)
-------- --------
Total consolidated net sales $352,952 $403,496
======== ========
Operating Income (Loss)
PC Systems $(28,717) $ 2,000
E-Services (1,931) -
SpecTek Operations 48,029 12,930
-------- --------
Total segment operating income 17,381 14,930
Elimination of intersegment income (528) -
-------- --------
Total segment operating income $ 16,853 $ 14,930
======== ========
Capital Expenditures on Property, Plant and
Equipment
PC Systems $ 16,294 $ 7,094
E-Services 1,140 -
SpecTek Operations 2,650 5,893
-------- --------
Total segment capital expenditures $ 20,084 $ 12,987
======== ========
</TABLE>
10
<PAGE>
Micron Electronics, Inc.
Notes to Financial Statements --Continued
(Tabular amounts in thousands, except per share amounts)
(Unaudited)
17. Subsequent Event
On December 14, 1999, the Company acquired LightRealm, Inc. ("LightRealm"),
a Kirkland, Washington-based Web and applications hosting and Internet access
company serving small and medium-sized businesses. The Company acquired all of
the outstanding stock of LightRealm for approximately $47.5 million in cash.
This acquisition will be accounted for using the purchase method of accounting.
11
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-------------------------------------------------------------------------------
of Operations
-------------
(Tabular amounts in thousands)
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. 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
December 2, 1999, September 2, 1999 or December 3, 1998, unless otherwise
indicated. All tabular dollar amounts are stated in thousands.
Overview
Micron Electronics, Inc. and its subsidiaries (hereinafter referred to
collectively as "Micron" or the "Company") is a leading provider of personal
computers, business Internet offerings, Web hosting and business-to-business e-
commerce applications for small and medium businesses, government and education
markets. Under the micronpc.com, HostPro, Micron Internet Services and SpecTek
brands, the Company offers a wide range of innovative products, services and
support. The Company's three reportable segments are PC Systems, E-Services and
SpecTek Operations. The PC Systems segment's primary products include a wide
range of desktop and notebook PC Systems, multiprocessor network servers, and
hardware services. The E-Services segment focuses on Internet access and Web
hosting through Micron Internet Services and HostPro. The SpecTek Operations
segment's primary products include DRAM's, SDRAM's, and memory modules.
The Company expects to continue its expansion and acquisition strategy to
increase its E-Services capabilities. On August 2, 1999, the Company acquired
100% of the outstanding stock of NetLimited, Inc. (d.b.a. "HostPro"), a Web and
applications hosting provider. On September 2, 1999, the Company acquired the
property and equipment of Micron Internet Services ("MIS"), formerly a division
of MTI, a provider of dedicated, nationwide dial-up and broadband Internet
access, virtual private network solutions, and e-commerce services. Subsequent
to quarter end, the Company acquired LightRealm, Inc., a Web and applications
hosting and Internet access company. See "Subsequent Event."
In October 1999 the Company announced a new initiative called "Subscription
Computing". This strategic initiative is designed around four core computing
pillars: Web hosting, e-commerce, connectivity, and computer hardware and
desktop management. Subscription Computing, or "computing on demand," allows
customers to choose from an extensive menu of E-Services and hardware products
and services, upgrading the "subscriptions" as they grow their businesses.
The Company was formed through the April 7, 1995 merger of three
businesses: Micron Computer, Inc., Micron Custom Manufacturing Services, Inc.,
("MCMS") and ZEOS International, Ltd.
12
<PAGE>
Item 2. Management's Discussion and Analysis
--------------------------------------------
of Financial Condition and Results of Operations--Continued
-----------------------------------------------------------
(Tabular amounts in thousands)
Results of Operations
Net income for the first quarter of fiscal 2000 was $14.6 million, or $0.15
per diluted share, on net sales of $353.0 million compared to net income of
$11.7 million, or $0.12 per diluted share, on net sales of $403.5 million for
the first quarter of fiscal 1999.
Net Sales
The following table summarizes the Company's net sales by operating
segment:
First Quarter
-------------------------------------------
2000 1999
-------------------- --------------------
Amount % of Sales Amount % of Sales
-------- ---------- -------- ----------
PC Systems $258,795 73.3% $364,159 90.3%
E-Services 4,140 1.2% - -
SpecTek Operations 90,017 25.5% 39,337 9.7%
-------- ----- -------- -----
Total net sales $352,952 100.0% $403,496 100.0%
======== ===== ======== =====
PC Systems
In the first quarter of fiscal 2000, unit shipments of the Company's PC
products decreased 25.8% from the first quarter of fiscal 1999. This decrease
was due primarily to a 65% decline in consumer sales compounded by vendor supply
issues, which contributed to unit shipment declines of notebook and desktop
products of 44% and 23%, respectively. The significant decline in consumer sales
is due in part to the Company's effort to refocus its PC Systems resources
towards small business, commercial and government customers. The decline in
notebook shipments is primarily due to supply constraints from Taiwan component
vendors following the September 1999 earthquake. The supply issues caused by the
earthquake appear to have been resolved by the beginning of the second fiscal
quarter of 2001. Desktop product shipments during the first fiscal quarter of
2000 were affected by supply restrictions on the Intel 733 Mhz processor.
Average selling prices declined overall by 9% during the quarter primarily due
to lower desktop pricing in the government market.
Sales to governmental entities decreased 19% in the first quarter of fiscal
2000, compared with the first quarter of fiscal 1999, reflecting increased
pricing competition and lower than usual purchases by federal government
agencies. Sales to government customers, however, accounted for 39% of net sales
of PC products in the first quarter of fiscal 2000, compared to 34% in the
corresponding period in fiscal 1999. Sales to commercial customers accounted for
29% of net sales of PC products in the first quarter of fiscal 2000, compared
with 22% in the first quarter of fiscal 1999, due in part to the Company's
expanded mid-market sales efforts. Consumer and small business sales accounted
for 24% of PC Systems sales in the first quarter of fiscal 2000, compared with
37% in the first quarter of fiscal 1999, due primarily to the 65% decline in
consumer sales, offset by a 22% increase in sales to small businesses.
E-Services
Revenue in the E-Services segment was $4.1 million for the first fiscal
quarter of 2000, which was the first full quarter of operations of this
business. The number of paid hosting accounts was more than 17,000 and the
number of Internet access accounts was nearly 28,000 as of the end of the first
fiscal quarter of 2000.
SpecTek Operations
Net sales of semiconductor memory products were 129% higher in the first
quarter of fiscal 2000 compared to the first quarter of fiscal 1999 primarily
due to an 81% increase in megabits of memory shipped and a 25% increase in
average selling prices. The increase in megabits of memory shipped was primarily
due to product transition to the 64-megabit component from the 16-megabit
component, resulting in increased throughput for substantially all memory
products. Historically, the SpekTek Operations have experienced significant
volatility in product prices, and further volatility in prices for future sales
of these products is anticipated. SpecTek's results of operations are influenced
by a number of factors including pricing for nonstandard semiconductor memory
components and the availability of those components. See "Certain Factors--
SpecTek Operations--Pricing of Memory Products."
13
<PAGE>
Item 2. Management's Discussion and Analysis
--------------------------------------------
of Financial Condition and Results of Operations--Continued
-----------------------------------------------------------
(Tabular amounts in thousands)
Gross Margin
First Quarter
-------------------------------------------
2000 1999
------------------- -------------------
Amount % of Sales Amount % of Sales
------- ---------- ------- ----------
PC Systems $35,982 13.9% $54,505 15.0%
E-Services 1,297 31.3% - -
SpecTek memory products 49,442 54.9% 14,313 36.4%
------- -------
Total gross margin $86,720 24.6% $68,818 17.1%
======= =======
PC Systems
Gross margin from the Company's PC operations was 13.9% in the first
quarter of fiscal 2000 compared with 15.0% in the first quarter of the prior
year. Higher costs of memory components along with pricing pressure on sales to
government customers reduced the overall PC Systems gross margin percentage. The
PC Systems gross margin was further affected by reduced shipments of notebook
products, which typically contribute higher gross margin percentages than those
of desktop products. As a percentage of overall unit shipments, notebooks
decreased to 12% in the first quarter of fiscal 2000, compared with 16% in the
first quarter of fiscal 1999.
The Company expects to continue to experience significant gross margin
pressure on sales of its PC products as a result of intense competition in the
PC industry and customer demands for more powerful PC Systems at lower prices.
In addition, the Company's gross margin percentage will continue to depend in
large part on its ability to effectively forecast demand and manage its
inventories of PC components. See "Certain Factors--PC Systems-- Competition"
and "Certain Factors--PC Systems--Inventory Management."
E-Services
The gross margin from E-Services was $1.3 million for the first quarter of
fiscal 2000, which was the first full quarter of operations of this business.
Cost of sales for E-Services primarily represents telecommunications expenses,
maintenance and depreciation of data center and related telecommunication and
Web hosting equipment, salary and benefits for data center and support
personnel, and the cost of hardware and software sold.
SpecTek Operations
The gross margin realized by the Company's SpecTek Operations was 245%
higher in the first fiscal quarter of 2000 compared to the first fiscal quarter
of 1999 due to the 81% increase in megabits shipped, 25% increase in average
selling prices, and product transition to the 64 megabit component from the 16
megabit component, resulting in increased throughput for substantially all
memory products. The Company has experienced significant volatility in selling
prices and expects average selling prices for its SpecTek Operations products to
continue to exhibit significant volatility. As a result, the gross margin for
the Company's SpecTek Operations could decline and adversely affect the
Company's business, results of operations and cash flows. Additionally, under
the Component Recovery Agreement, the maximum cost to the Company to obtain
components from MTI increases from quarter to quarter during the extended term
and will likely be significantly higher than historical costs, which could have
a material adverse effect on the Company's results of operations, including
gross margin. During the first quarter of fiscal 2000, the cost of obtaining
such components was 50% of pre-tax income attributable to the sale of such
components. The cost of obtaining such components will be 62.5% of pre-tax
income attributable to the sale of such components for the second quarter of
fiscal 2000. The maximum cost payable by the Company to MTI for components
during the remainder of fiscal 2000 will be as follows: third quarter, 75% of
pre-tax income, and fourth quarter, 87.5% of pre-tax income. Had the 62.5% cost
level scheduled for the second quarter of fiscal 2000 been in effect during the
first quarter of fiscal 2000, the result would have been a decrease in SpecTeks'
gross margin of approximately $6.5 million, or 7.2% of net sales. See "Certain
Factors--SpecTek Operations--Dependence on Component Recovery Agreement with
MTI."
14
<PAGE>
Item 2. Management's Discussion and Analysis
--------------------------------------------
of Financial Condition and Results of Operations-Continued
----------------------------------------------------------
(Tabular amounts in thousands)
Selling, General and Administrative
First Quarter
--------------------------------
2000 % Change 1999
------- -------- ------
Selling, general and administrative $68,626 31.0% 52,396
as a % of net sales 19.4% 13.0%
Selling, general and administrative expenses for the first quarter of
fiscal 2000 were $68.6 million versus $52.4 million in the first quarter of
fiscal 1999. The increase in costs is primarily related to marketing and
advertising costs associated with a major launch of Subscription Computing
services in addition to increased levels of personnel, technical and
professional fees related to the newly acquired HostPro and MIS subsidiaries.
Research and Development
First Quarter
--------------------------------
2000 % Change 1999
------- -------- ------
Research and development $ 576 (60.3)% $1,451
as a % of net sales 0.2% 0.4%
Research and development expenses were lower in the first quarter of fiscal
2000 compared to the first quarter of fiscal 1999 primarily as a result of a
discontinuance of certain research and development activities.
Other expense (income), net
First Quarter
--------------------------------
2000 % Change 1999
------- -------- ------
Other expense, net $665 1,562.5% $40
The increase in other expense in the first fiscal quarter of 2000 compared
to the first fiscal quarter of 1999 primarily relates to the amortization of
goodwill associated with the August 1999 acquisition of HostPro. The amount of
goodwill and related amortization expense is expected to increase as the Company
continues to execute its acquisition strategy. See "Certain Factors -E-Services
-Acquisitions - General Acquisition Risk."
Income Tax Provision
First Quarter
--------------------------------
2000 % Change 1999
------- -------- ------
Income tax provision $6,264 (14.2)% $7,299
The annual effective tax rate was revised in the first quarter of fiscal
2000 resulting in an effective tax rate of 30.0% compared to 38.5% in the first
quarter of fiscal 1999. The decrease is principally due to benefits received
from the Company's tax-exempt securities, foreign sales corporation and federal
research and development credits.
Liquidity and Capital Resources
As of December 2, 1999, the Company had cash, cash equivalents and liquid
investments of $363.3 million, representing an increase of $24.8 million
compared to September 2, 1999. Principal sources of liquidity in the first
quarter of fiscal 2000 were cash flows from operations of $49.1 million, which
were derived exclusively from SpecTek Operations. Principal uses of cash in the
first quarter of fiscal 2000 were property, plant and equipment expenditures of
$20.1 million and a net increase in held-to-maturity investment securities of
$67.3 million.
The Company has an unsecured credit agreement, expiring June 2001, with a
group of financial institutions providing for borrowings totaling $100.0
million. As of December 2, 1999, the Company was eligible to borrow the full
amount under the agreement, but had no borrowings outstanding. Under the
agreement, the Company is subject to certain financial and other covenants
including certain financial ratios and limitations on the amount of dividends
declared or paid by the Company.
15
<PAGE>
Item 2. Management's Discussion and Analysis
--------------------------------------------
of Financial Condition and Results of Operations-Continued
----------------------------------------------------------
(Tabular amounts in thousands)
At December 2, 1999, the Company had commitments of $16.5 million related to
capital expenditures for the expansion and upgrading of facilities and
equipment. The Company anticipates capital expenditures for the expansion and
upgrading of facilities and equipment in fiscal 2000 will be in excess of $50
million. The Company expects its future working capital requirements to
increase. The Company has employed cash resources in its E-services acquisition
strategy, and it expects to continue to do so in the future. The Company
believes that currently available cash and cash equivalents, liquid investments,
cash flows from operations, current credit facilities and equipment financings
will be sufficient to fund its operations for the next twelve months.
Recently Issued Accounting Pronouncements
Recently issued accounting standards include Statement of Financial
Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments
and Hedging Activities," issued in June 1998. SFAS No. 133 requires all
derivatives to 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 investments. Along with the derivatives, the
underlying hedged items are also to be marked-to-market on an ongoing basis.
These market value adjustments are to be included either in the statement of
operations or as a component of comprehensive income, depending on the nature of
the transaction. Implementation of SFAS No. 133 is required for the Company by
the first quarter of 2001. The Company is currently evaluating the effect SFAS
No. 133 will have on its results of operations and financial position.
The Security and Exchange Commission issued Staff Accounting Bulletin (SAB)
No. 101, "Revenue Recognition in Financial Statements" in December 1999. The
SAB summarizes certain of the staff's views in applying generally accepted
accounting principles to revenue recognition in the financial statements.
Adoption is required by the first quarter of fiscal 2001, and early adoption is
permitted. The Company is currently evaluating the effect this SAB may have on
its revenue recognition practices and results of operations.
Subsequent Event
On December 14, 1999, the Company acquired LightRealm, Inc. ("LightRealm"), a
Kirkland, Washington-based Web and applications hosting and Internet access
company serving small and medium-sized businesses. The Company acquired all of
the outstanding stock of LightRealm for approximately $47.5 million in cash.
This acquisition will be accounted for using the purchase method of accounting.
16
<PAGE>
Item 2. Management's Discussion and Analysis
--------------------------------------------
of Financial Condition and Results of Operations-Continued
----------------------------------------------------------
(Tabular amounts in thousands)
CERTAIN FACTORS
In addition to factors discussed elsewhere in this Form 10-K and in other
Company filings with the Securities and Exchange Commission, the following are
important factors which could cause actual results or events to differ
materially from the historical results of the Company's operations or those
results or events contemplated in any forward-looking statements made by or on
behalf of the Company.
General
-------
Fluctuations in Operating Results and Stock Price
The Company's past operating results have been, and its future operating
results may be, subject to seasonality and other fluctuations, on a quarterly
and annual basis, as a result of a wide variety of factors, including, but not
limited to, industry competition, the Company's ability to accurately forecast
demand and selling prices for its PC products, fluctuating market pricing for
PC's and semiconductor memory products, seasonal government purchasing cycles,
inventory obsolescence, the Company's ability to effectively manage inventory
levels, changes in product mix, manufacturing and production constraints,
fluctuating component costs, the effects of product reviews and industry awards,
availability and pricing of the memory components used by the Company's SpecTek
Operations, critical component availability, seasonal cycles common in the PC
industry, the timing of new product introductions by the Company and its
competitors and global market and economic conditions. As a result, the
operating results for any particular period are not necessarily indicative of
the results that may occur in any future period. The trading price of the common
stock of the Company is subject to significant fluctuations due to general
market conditions and financial performance of the Company and other companies
in the PC industry, announcements of technological innovations, new commercial
products or new strategies by competitors, component availability and pricing,
and other factors.
Management
The Company has experienced increased complexity of its operations, operating
and financial information systems and in its scope of operations. The increased
complexity of the Company's operations results from a number of factors,
including the expansion of the Company's Internet and service offerings and the
acquisition of Internet service providers. This increased complexity has
resulted in new and increased responsibilities for the Company's management and
has placed, and continues to place, significant demands upon the Company's
management, operating and financial information systems and other resources and
systems. The Company continues to consider various expansion alternatives,
including expansion of facilities, acquisition or establishment of facilities in
new geographic regions and certain strategic relationships. There can be no
assurance that the Company's management resources, operating and financial
information systems, other resources and systems will be adequate to support the
Company's existing or future operations, the failure of which could have a
material adverse effect on the Company's business, financial position, results
of operations and cash flows.
Intellectual Property Matters
It is common in the electronics industry for patent, trademark and other
intellectual property rights claims to be asserted against companies, including
component suppliers and PC manufacturers. Periodically, the Company is made
aware that the technology it uses may infringe on intellectual property rights
held by others. The Company evaluates all such claims and, if necessary and
appropriate, seeks to obtain licenses for the continued use of such technology.
The Company has accrued a liability and charged operations for the estimated
costs of settlement or adjudication of claims for alleged infringement as of the
balance sheet date. The Company would be placed at a competitive disadvantage
if it were unable to obtain such licenses upon terms at least as favorable as
those experienced by the Company's competitors. The Company has entered into
several intellectual property license agreements, and as a majority-owned
subsidiary of MTI, is licensed under certain license agreements between MTI and
third parties. The Company's rights under license agreements between MTI and
third parties may terminate in the event that the Company is no longer a
majority-owned subsidiary of MTI. Intellectual property license agreements
generally require one-time or periodic royalty payments and are subject to
expiration at various times. If the Company or its suppliers are unable to
obtain licenses necessary to use intellectual property in their products or
processes, the Company may be forced to market products without certain
technological features or software, discontinue sales of certain of its products
and/or defend legal actions taken against it relating to allegedly protected
technology. The inability of the Company to obtain licenses necessary to use
certain technology, or an inability to obtain such licenses on competitive
terms, or any litigation determining that the Company, in the manufacture or
sale of its products, has infringed on the intellectual property rights of third
parties, could have a material adverse effect on the Company's business,
financial position, results of operations and cash flows.
17
<PAGE>
Item 2. Management's Discussion and Analysis
--------------------------------------------
of Financial Condition and Results of Operations-Continued
----------------------------------------------------------
(Tabular amounts in thousands)
Subscription Computing Initiative
In October 1999, the Company announced a new initiative called "Subscription
Computing." This strategic initiative is designed around four core computing
pillars: Web hosting, e-commerce, connectivity and computer hardware and desktop
management. Subscription Computing, or "computing on demand," allows customers
to choose from an extensive menu of e-services and hardware products and
services, upgrading the "subscriptions" as they grow their businesses. The
Company delivers the personalized computing solutions on a single monthly bill.
The introduction of Subscription Computing increases the complexity of the
Company's PC operations and may place a significant strain on operating,
financial and managerial resources. There can be no assurance that the
Company's resources will be adequate to support this initiative.
MTI Ownership of Common Stock of the Company
As of December 2, 1999, MTI owned approximately 61.3% of the Company's
outstanding common stock. In addition, two of the five directors of the Company
are also directors of MTI, including Steven R. Appleton, Chairman and Chief
Executive Officer of MTI. So long as MTI continues to own a majority of the
outstanding common stock of the Company, MTI will have the ability to control
the outcome of matters requiring shareholder approval, including the election of
directors, and generally will have the ability to control the management and
certain financial and other affairs of the Company. Termination or modification
of certain of the Company's arrangements with MTI resulting in terms less
favorable to the Company could adversely affect the Company's business,
financial position, results of operations and cash flows. In the event that
MTI's ownership of the Company were to decrease below certain levels, certain
arrangements may be terminated by MTI, which could have a material adverse
effect on the Company's business, financial position, results of operations and
cash flows. See "Intellectual Property Matters" and "SpecTek Operations--
Dependence on Component Recovery Agreement with MTI."
The level of MTI's ownership of the common stock of the Company may limit the
Company's ability to complete future equity financing. In addition, the sale on
the open market of substantial amounts of shares of common stock of the Company
currently held by MTI could adversely affect the prevailing market price of
common stock of the Company. MTI's ability to sell shares of common stock of
the Company, unless registered under the Securities Act of 1933, as amended (the
"Securities Act"), is subject to volume and other restrictions pursuant to Rule
145 promulgated under the Securities Act.
Dependence on Key Personnel
The future success of the Company will depend, in part, on its ability to
attract and retain key management, technical and sales and marketing personnel.
The Company attempts to enhance its management and technical expertise by
recruiting qualified individuals who possess desired skills and experience in
certain targeted areas. There is competition for such personnel in the
electronics, Internet and computer services industries, and the Company's
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 the Company's business,
financial position, results of operations and cash flows. There can be no
assurance that the Company will be able to retain key personnel or that the loss
of any key personnel will not have a material adverse effect on the Company's
business, financial position, results of operations and cash flows.
Year 2000
During the first two weeks of calendar 2000, the Company did not encounter any
disruption to its business operations due to Year 2000 issues in its internal
systems and so far considers the transition to calendar year 2000 to be smooth.
While still too early to determine the effects of the Year 2000 issues on its
transactions with customers and suppliers, so far the Company has not
encountered any significant disruptions to its business operations. The Company
is continuing to monitor closely both its internal systems and transactions with
customers and suppliers for any indication of Year 2000 related problems.
As of the end of the first quarter of fiscal 2000, the Company had incurred
aggregate incremental costs of $2.3 million related to Year 2000 readiness
programs with respect to internal IT and non-IT systems and third party
providers. The incremental costs include allocated costs of the Company's
information technology organization incurred in connection with Year 2000
compliance projects. With its Year 2000 readiness program essentially complete,
the Company does not anticipate incurring any further costs beyond the first
quarter of fiscal 2000 related to Year 2000 readiness programs. This estimate,
however, does not include costs related to the potential failure of key
suppliers to timely address or correct Year 2000 issues, potential costs related
to any customer or other product liability claims or the cost of internal
software and hardware replaced in the ordinary course of business. All estimates
are based on
18
<PAGE>
Item 2. Management's Discussion and Analysis
--------------------------------------------
of Financial Condition and Results of Operations-Continued
----------------------------------------------------------
(Tabular amounts in thousands)
currently known circumstances and various assumptions regarding future events,
and actual costs could differ materially from the estimates.
All Micron-branded hardware products support the Year 2000 date and
calculations. All Micron-branded hardware products shipped since August 26,
1996, have BIOS clocks that will automatically roll over to "2000" after
December 31, 1999. Additionally, the Company has made available software
utilities that will cause earlier Micron-branded hardware products to have BIOS
clocks that will recognize the century change. All NetFRAME-branded server
products shipped since March 1995 are either NSTL certified as Year 2000
compliant or self-certified as having Real Time Clock chips and a BIOS that will
process date data correctly on and after January 1, 2000. The Company has a Web-
site dedicated to communicating Year 2000 issues to its customers. During the
first two weeks of calendar year 2000, the Company has not been notified from
its customers of any significant Year 2000 problems with respect to the
Company's products.
The Company believes that it has no obligation for any costs incurred by its
customers to address Year 2000 issues. However, the Company recognizes the
potential for claims against it and other manufacturers arising from products
which may not support the century change. There can be no assurance that such
claims would not have a material adverse effect on the Company's business or
results of operations, financial condition or cash flows. On October 26, 1998,
the Company was sued in state court in Canyon County, Idaho, by Hannah Films,
Inc., on behalf of itself and on behalf of an unidentified and uncertified class
of plaintiffs alleging fraud, breach of implied warranty of merchantability,
violation of the Magnuson-Moss Consumer Protection Act, and violation of the
Idaho Consumer Protection Act arising out of the Year 2000 status of a personal
computer sold by the Company to Hannah Films, Inc., in October 1995. In May
1999, the case was dismissed with prejudice. The plaintiff has filed a notice of
appeal. While there can be no assurance as to the ultimate disposition of the
case, the Company does not currently believe that the resolution of this matter
will have a material adverse effect on the Company's business, financial
position, results of operations and cash flows.
Government Regulation
The Company is subject to a variety of federal, state, local and foreign laws
and regulations, including, but not limited to, Federal Communications
Commission regulations, governmental procurement regulations, import and export
regulations, Federal Trade Commission regulations, securities regulations,
environmental regulations, antitrust regulations, and labor regulations. Any
failure by the Company to comply with such regulations in the past, present or
future could subject the Company to liabilities and/or the suspension of its
operations, which could have a material adverse effect on the Company's
business, financial position, results of operations and cash flows.
State Taxation
During the third quarter of fiscal 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 the liability of the Company, if any, for non-remittance of
sales and use taxes prior to such agreements' effective dates. The Company has
previously accrued a liability for the estimated settlement cost of issues
related to sales and use taxes not covered by such agreements. Management
believes the resolution of any matters relating to the non-remittance of sales
or use will not materially affect the Company's business, financial position,
and results of operations.
PC Systems
----------
Competition
The PC industry is highly competitive and has been characterized by intense
pricing pressure, generally low gross margin percentages, rapid technological
advances in hardware and software, frequent introduction of new products, and
rapidly declining component costs. Competition in the PC industry is based
primarily upon brand name recognition, performance, price, reliability and
service and support. The Company's sales of PC products have historically
benefited from increased name recognition and market acceptance of the Company's
PC products, primarily resulting from the receipt by the Company of awards from
trade publications recognizing the price and performance characteristics of
Micron brand PC systems and the Company's service and support functions. As a
result of PC industry standards, the Company and its competitors use many of the
same components, typically from the same set of suppliers, which limits the
Company's ability to technologically and functionally differentiate its
products. Many of the Company's PC competitors have greater brand name
recognition and market share, offer broader product lines, and have
substantially greater financial, technical, marketing and other resources than
the Company. In addition, the Company's competitors may benefit from component
volume purchasing and product and process technology license arrangements that
are more favorable in terms of
19
<PAGE>
Item 2. Management's Discussion and Analysis
--------------------------------------------
of Financial Condition and Results of Operations-Continued
----------------------------------------------------------
(Tabular amounts in thousands)
pricing and availability than the Company's arrangements. In addition, the
Company may be at a relative cost disadvantage to certain of its competitors as
a result of the Company's U.S. dollar denominated purchases of PC components
during a period of relative weakening of the U.S. dollar. The failure of the
Company to compete effectively in the marketplace could have a material adverse
effect on the Company's business, financial position, results of operations and
cash flows.
The Company competes with a number of PC manufacturers, which sell their
products primarily through direct channels, including Dell Computer Corporation,
and Gateway 2000, Inc. The Company also competes with PC manufacturers, such as
Apple Computer, Inc., Compaq Computer Corporation, Hewlett-Packard Company,
International Business Machines Corporation, NEC Corporation and Toshiba
Corporation among others. Several of these manufacturers, which have
traditionally sold their products through national and regional distributors,
dealers and value added resellers, and retail stores, now sell their products
through the direct channel. In addition, the Company expects to face increased
competition in the U.S. direct sales market from foreign PC suppliers and from
foreign and domestic suppliers of PC products that decide to implement, or
devote additional resources to a direct sales strategy. In order to gain an
increased share of the United States PC direct sales market, these competitors
may effect a pricing strategy that is more aggressive than the current pricing
in the direct sales market or may have pricing strategies influenced by relative
fluctuations in the U.S. dollar compared to other currencies.
The Company believes that the rate of growth in worldwide sales of PC
products, particularly in the United States, where the Company sells a
substantial majority of its PC products, has declined and may remain below the
growth rates experienced in recent years. Any general decline in demand or
decline in the rate of increase in demand for PC products could increase price
competition and could have a material adverse effect on the Company's business,
financial position, results of operations and cash flows.
Inventory Management
The Company's ability to compete successfully in the PC market in the future
will depend in large part on its ability to accurately forecast demand for its
PC products and effectively manage its PC inventories to support this demand.
The Company's PC operations focus on the direct sale of assemble-to-order PC
systems that feature components incorporating the latest technological
developments in the PC industry. The Company has experienced in the past, and
could experience in the future, excess PC inventories and inventory obsolescence
resulting from, among other things, the Company's inaccurate forecasting of
demand for its PC products, the typically longer lead times associated with
notebook product supply, the fast pace of technological developments in the PC
industry and the short product life cycles of PC products and components. In
addition, because high volumes of quality components are required for the
manufacture of the Company's PC products, the Company has experienced in the
past, and expects to experience in the future, shortages and other supply
constraints of key components. Such shortages or supply constraints have in the
past adversely affected, and could in the future adversely affect, the Company's
ability to ship products on schedule or at expected gross margins. The Company
has made significant progress in changing its asset management processes where
substantial improvements have been realized with minimal material shortage
impact to customer orders, achieving dramatic growth in inventory turns, and
industry leading "days sale of inventory" ("DSI"). The Company continues to
invest in data systems tools acquisitions to further enhance sales forecasting
and supply/demand planning processes. To continue its asset management
improvements, the Company must accurately utilize these new processes,
facilities and tools to improve its forecast demand for its PC products and
obtain adequate, but not excessive, supplies of components to meet actual
demand. The failure of the Company to manage its inventories effectively could
result in excess PC inventories, inventory obsolescence, component shortages and
untimely shipment of products, any of which could have a material adverse effect
on the Company's business, financial position, results of operations and cash
flows.
Dependence on Key Sources of Supply
The Company focuses on providing PC systems that feature components and
software incorporating the latest technological developments in the PC industry,
which components are periodically in short supply and are available from sole or
a limited number of suppliers. As a result, the Company has experienced in the
past, and expects to experience in the future, shortages in the components used
in its PC systems. The microprocessors currently used in the Company's PC
systems are manufactured exclusively by Intel Corporation, and, from time to
time, the Company has been unable to obtain sufficient quantities of certain
Intel microprocessors. In addition, a significant portion of the RAM components
used in the Company's PC systems are supplied by MTI, and the Company generally
relies on MTI to supply the latest memory densities and configurations
available. The Company relies, to a certain extent, upon its suppliers'
abilities to enhance existing products in a timely and cost-effective manner, to
develop new products to meet changing customer needs and to respond to emerging
standards and other technological developments in the PC industry. The Company
also relies, to a certain extent, upon component suppliers concentrated in
specific geographic areas. The Company's supply of notebook computer parts was
disrupted in the aftermath of the Taiwan earthquake in September 1999. While
the earthquake-related supply issues appear to have been essentially resolved,
there is no assurance that sales of products affected by
20
<PAGE>
Item 2. Management's Discussion and Analysis
--------------------------------------------
of Financial Condition and Results of Operations-Continued
----------------------------------------------------------
(Tabular amounts in thousands)
such events in the future will immediately, or ever, return to levels achieved
prior to the event. The Company's reliance on a limited number of suppliers and
on a strategy of incorporating the latest technological developments into its PC
systems involves several risks, including the possibility of shortages and/or
increases in costs of components and software, and risk of reduced control over
delivery schedules, which could have a material adverse effect on the Company's
business, financial position, results of operations and cash flows.
The Company's notebook products are currently assembled in part by third-party
manufacturers. These outsourcing arrangements and any future outsourcing
arrangements that the Company may enter into may reduce the direct control the
Company has over certain components and the assembly of such products. There
can be no assurance that the outsourcing arrangements will not result in quality
problems or affect the ability to ship such products on a timely basis or the
flexibility of the Company to respond to changing market conditions.
E-Services
----------
Competition
The market for Internet access and Web hosting is extremely competitive. Some
of the primary competitive factors in this industry include having a recognized
and trusted brand name; maintaining a secure reliable national network with
sufficient capacity to support continued growth; maintaining Internet system
engineering and technical expertise; introducing new products and services in a
timely manner; maintaining sufficient financial resources; providing excellent
customer care through prompt and capable technical support and offering
competitive prices. As the growth of Internet usage increases, competition is
expected to intensify. Some of the Company's current and prospective
competitors include national, regional and local Internet service providers;
cable television companies; direct broadcast satellite and wireless
communications providers; on-line service providers; Web hosting providers;
global, national, and regional long distance companies and local exchange
telecommunications companies.
Many competitors have greater market presence, brand recognition, network
capacity and financial resources than the Company. A large number of companies
including Verio Inc. and Concentric Network Corporation offer e-services similar
to those provided by the Company. Large diversified companies such as Intel
Corporation, International Business Machines Corporation, and AT&T Corporation
have indicated their intent to enter into the e-services market, which will
intensify the competition. The Company competes with major long distance
companies who offer Internet access services, and the recent federal regulation
of the telecommunications industry has created more opportunities for local
carriers thereby further increasing competition. In addition, major cable
companies and other alternative service providers such as those companies
utilizing wireless terrestrial and satellite based service technologies have
announced plans to offer Internet access and related services. In addition to
possessing large existing customer bases, many of these companies have greater
network coverage, market presence and financial resources than the Company.
These companies also possess the ability to bundle Internet access with basic
local and long distance telecommunications services. This bundling may have an
adverse effect the Company's ability to compete effectively and may result in
pricing pressures that would adversely affect its business, financial condition,
results of operations and cash flows.
Acquisitions
In the fourth quarter of fiscal 1999, the Company acquired all of the
outstanding common stock of HostPro for approximately $21.9 million in cash and
the property and equipment of MIS, a division of MTI, for its book value of
approximately $2.2 million in cash. On December 14, 1999 the Company acquired
LightRealm for approximately $47.5 million in cash. There can be no assurance
that the integration, reconfiguration or other modification, if any, of HostPro,
MIS or LightRealm will not have a material adverse effect on the operations of
such entities or on the Company's business, financial position, results of
operations and cash flows. In addition, there can be no assurance the Company
will realize the anticipated benefits associated with the acquisitions,
including, but not limited to, retention of key personnel, intellectual property
rights, increased market presence of a broader e-services offering and economies
of consolidating certain administrative support functions.
General Acquisition Risk
------------------------
The Company expects to continue its expansion and acquisition strategy.
Material goodwill and other intangible assets could be required to be recorded
in the likely event the purchase price of the acquired businesses exceeds the
fair value of the net assets acquired. This could result in significant
amortization charges in future periods. The acquired businesses may not achieve
the revenues and earnings anticipated by the Company. As a result there could
be a material adverse effect on the Company's future
21
<PAGE>
Item 2. Management's Discussion and Analysis
--------------------------------------------
of Financial Condition and Results of Operations-Continued
----------------------------------------------------------
(Tabular amounts in thousands)
results of operations and financial condition. The Company can not assure the
timing or size of future acquisitions, or the effect that any future
acquisitions may have on its operating results.
Key Integration Risks
---------------------
In the integration of acquired operations, the Company faces certain key
risks. The difficulties experienced may have an adverse impact on the Company.
The key integration difficulties may include the loss of key employees and the
failure to integrate successfully acquired operations, equipment, facilities,
services and networks. These difficulties could adversely affect the Company's
financial position, and results of operations. There can be no assurances that
the Company will realize any benefits from the acquired operations.
Dependence on Suppliers and Sources of Supply
The Company relies on other companies to supply certain key components of its
network infrastructure, the quantity and quality of which is only available from
limited sources. The Company also relies on providers of data communication
facilities and network capacity in addition to local carriers all of whom are
oftentimes its competitors. The Company can not assure that it will be able to
obtain the necessary services on a cost-effective basis and within the time
frame it requires on an ongoing basis, which may have an adverse affect on its
business, financial condition, results of operations and cash flows.
Infrastructure Dependence
The success of the Company's E-Services is dependent upon its ability to
expand its infrastructure capacity, equipment and support services at a
competitive cost. The Company may require substantial financial, operational and
managerial resources to expand its network infrastructure to accommodate new
customer growth. It may also be necessary to enter into additional agreements
with providers of infrastructure capacity and equipment and support services.
The Company can not assure that it will be able to obtain agreements with
acceptable terms or that it will be able to make the necessary network
infrastructure modifications to meet its customer's growing demands and changes
evolving within the industry.
Changes In Technology and Industry Standards
The Internet access and Web hosting industry is subject to rapid changes in
technology, changes in customer needs, and the evolution of industry standards.
The ability to effectively advance technical expertise, develop new products
compatible with emerging technology, and adapt to customers changing needs all
in a cost-effective manner is essential for future success. The Company can not
assure that it will be successful in accomplishing these tasks. In addition, the
Company can not assure those services or technologies developed by others will
not render its services or technology noncompetitive or obsolete.
Network Failure
The Company's network, and other networks that provide services to the
Company, are vulnerable to damage or cessation of operations from earthquakes,
severe storms, power loss, fire, telecommunications failures and other similar
events. The Company's networks are designed to minimize the risk of such system
failures. However, the Company can not assure that it will not experience
network failures or even a complete network shutdown.
Network Security Breaches
Security problems represent an ongoing threat to public and private data
networks. Addressing these problems caused by computer viruses, break-ins or
other problems caused by third parties could have a material adverse effect upon
the Company's results of operations. Security measures such as limiting physical
and network access to routers are in place. However, the Company can not assure
that it can offer its customers' complete protection from computer viruses,
break-ins and other related problems. Although the Company attempts to limit
contractually its liability in such cases, the occurrence of these problems may
result in claims against the Company. These claims, regardless of their outcome,
could result in costly litigation and adversely affect the Company's business
and reputation. In addition, the ability to obtain and retain customers may be
compromised by an inability to provide secure
22
<PAGE>
Item 2. Management's Discussion and Analysis
--------------------------------------------
of Financial Condition and Results of Operations-Continued
----------------------------------------------------------
(Tabular amounts in thousands)
transmission of information over the Internet. These issues could have an
adverse impact on the Company's customer growth rate, financial condition,
results of operations and cash flows.
SpecTek Operations
------------------
Dependence on Component Recovery Agreement with MTI
Effective September 2, 1999, the Company and MTI entered into an amended and
restated Component Recovery Agreement (the "Component Recovery Agreement"),
which expires August 30, 2001, unless terminated earlier as described below.
Virtually all of the components used in the Company's SpecTek Operation are
obtained from MTI or affiliates of MTI under the Component Recovery Agreement.
Under the Component Recovery Agreement, MTI is required to offer to the
Company all of the nonstandard memory components produced at MTI's semiconductor
operations. The Component Recovery Agreement provides that the cost of
components obtained from MTI will be negotiated on a quarterly basis, but in no
event will the cost be less than 50% of pre-tax income. During the first
quarter of fiscal 2000, the cost of obtaining such components was 50% of pre-tax
income attributable to the sale of such components. The cost of obtaining such
components for the second quarter of fiscal 2000 will be 62.5% of pre-tax income
attributable to the sale of such components. The maximum cost payable by the
Company to MTI for components during the remainder of fiscal 2000 will be as
follows: third quarter, 75% of pre-tax income, and fourth quarter, 87.5% of pre-
tax income. The cost to the Company for components obtained from MTI during
fiscal 2001 is not subject to any maximum amount. There can be no assurance
that the amounts payable by the Company to MTI for components as contemplated
under the Component Recovery Agreement will be more favorable than the maximum
amounts stated in this paragraph. The quarter to quarter increase in maximum
cost to the Company to obtain components from MTI under the Component Recovery
Agreement could have a material adverse effect on the Company's financial
position, results of operations and cash flows.
The Component Recovery Agreement also provides that MTI will make commercially
reasonable efforts to obtain for the Company nonstandard memory components
produced by TECH Semiconductor Singapore Pte. Ltd. and KMT Semiconductor
Limited, joint venture companies in which MTI is affiliated. The Company, MTI
and the joint venture companies have currently agreed to utilize a pricing
matrix based on effective yields and worldwide average sales prices in order to
establish prices for the components from the joint venture companies. In such
case, the price paid by the Company for components from the joint ventures will
be determined under the matrix, rather than as a percentage of pre-tax net
income.
Under the Component Recovery Agreement, at the commencement of the second
quarter of fiscal 2000, the Company has an option to require MTI to purchase the
property and equipment of SpecTek Operations for a purchase price equal to net
book value. At the commencement of fiscal 2001, MTI has an option to require the
Company to sell the property and equipment of SpecTek Operations under the same
terms and conditions. Additionally, the Company has an option to require MTI to
purchase, and MTI has the option to require the Company to sell, the assets of
SpecTek Operations at book value if MTI's ownership in the Company falls below
50% or if an unrelated third party acquires more than 30% of the Company. The
Component Recovery Agreement would terminate if MTI purchases the property and
equipment of SpecTek operations pursuant to the exercise of the above described
options.
Historically, during various reporting periods, SpecTek Operations have had a
significant positive impact on the Company's results of operations and cash
flows. The expiration of the Component Recovery Agreement, or the sale of the
property and equipment of SpecTek Operations to MTI, could have a material
adverse effect on the Company's business, financial position, results of
operations and cash flows. In addition, a substantial majority of the
components used in SpecTek Operations were obtained from MTI under the former
Component Recovery Agreement. In the first quarter of fiscal 2000, the Company
obtained approximately 65% of its components from MTI's semiconductor
manufacturing facilities and an additional 34% of its components from MTI's
joint venture affiliates. Many semiconductor manufacturers other than MTI are
reluctant to sell nonstandard memory components because such components could
compete with their full specification memory components for similar
applications. In addition, some manufacturers are concerned that subsequent
testing performed by a recovery operation could reveal proprietary data
regarding manufacturing yields and processes. As a result, there can be no
assurance that the Company would be able to negotiate future purchases of
components on terms acceptable to the Company after expiration of the Component
Recovery Agreement.
Pricing of Memory Products
Pricing for SpecTek Operations' semiconductor memory products fluctuates, to a
large degree, based on industry-wide pricing for semiconductor memory products.
Historically, the Company has experienced significant declines in the average
selling prices of its
23
<PAGE>
Item 2. Management's Discussion and Analysis
--------------------------------------------
of Financial Condition and Results of Operations-Continued
----------------------------------------------------------
(Tabular amounts in thousands)
SpecTek Operations' semiconductor memory products as industry-wide average
selling prices for full specification semiconductor memory products experienced
sharp declines. The Company believes that such declines in average selling
prices of semiconductor memory products were due primarily to changes in the
balance of supply and demand for these commodity products and changes in
relative weakness or strength of certain currencies, and the Company is unable
to predict the impact of semiconductor memory product market dynamics in future
periods. Due to increased market risk associated with holding purchased memory
components in inventory, the Company has experienced in the past, and may
experience in the future, losses from write-downs of memory component
inventories in periods of declining prices. Further declines in pricing for
semiconductor memory products would likely result in declines in average selling
prices of SpecTek Operations' semiconductor memory products, which could have a
material adverse effect on the Company's business, financial position, results
of operations and cash flows.
Memory Product Transition
The semiconductor memory industry is characterized by, among other things,
rapid technological change, frequent product introductions and enhancements,
difficulties experienced in transitioning to new products, relatively short
product life cycles and volatile market conditions. During periods of product
transition, SpecTek Operations has experienced in the past, and may experience
in the future, significant increases in component test times and corresponding
decreases in throughput. Future gross margins for semiconductor memory products
could be adversely affected if the Company is unable to effectively transition
to new products in a timely fashion.
Exclusive Sales Representative Agreement
Effective September 2, 1999, the Company and Micron Semiconductor Products,
Inc. ("MSP"), a subsidiary of MTI, entered into an exclusive sales agreement
(the "sales agreement") under which MSP will serve as exclusive sales
representatives for SpecTek Operations' memory products. The failure of MSP to
perform its obligations under the sales agreement, including but not limited to
the sale of all SpecTek Operations' memory products, could have a material
adverse effect on the Company's business, financial position, results of
operations and cash flows.
24
<PAGE>
Item 3. Quantitative and Qualitative Disclosures About Market Risk
------------------------------------------------------------------
The Company has limited exposure to financial market risks, including changes
in interest rates. At December 2, 1999, the Company had $274.7 million in
short-term investments. These short-term investments consist of fixed rate
investments in debt obligations of highly rated entities with maturities of one
year or less. The Company believes the reported amounts of liquid investments
and debt to be reasonable approximations of their fair values and has the
ability and intent to hold these instruments to maturity. As a result, the
Company believes that the market risk arising from its holdings of financial
instruments is minimal.
The Company uses the U.S. Dollar as its functional currency. Aggregate
transaction gains and losses included in the determination of net income have
not been material.
25
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
------------------------------------------
(a) Exhibits
EXHIBIT DESCRIPTION
------- -----------
10.35 1995 Stock Option Plan, as amended (1)
10.58 Micron Electronics, Inc. Management and
Executive Incentive Plan, as amended (2)
10.66 Amendment No. 2 to Credit Agreement, dated
September 30, 1999, between the Company and
certain financial institutions named therein
10.67 Guaranty Agreement, dated September 30, 1999,
between the Company and certain financial
institutions named therein
27 Financial Data Schedule
(b) Reports on Form 8-K
On September 13, 1999 the Company filed a report on Form 8-K, which
announced the entering into an amended Component Recovery Agreement
with Micron Technology, Inc.
On October 13, 1999, the Company filed a report on form 8-K, which
announced the appointment of Jack Balousek as a director.
(1) Incorporated by reference to Registration Statement on Form S-8 (File No.
333-94745), filed on January 14, 2000.
(2) Incorporated by reference to Appendix B to the Company's definitive 14A
Proxy Statement, filed on November 1, 1999. The Company's Quarterly Report
for the quarterly period ended December 2, 1999 inadvertently omitted to
incorporate this Exhibit 10.58 by reference.
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Date: November 16, 2000.
MICRON ELECTRONICS, INC.
a Minnesota corporation
By: /s/ James R. Stewart
----------------------------
James R. Stewart,
Senior Vice President
Finance, Chief
Financial Officer
(Principal Financial
and Accounting
Officer)
27
