================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-K
----------------
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
[ ] 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: 0-26820
CRAY INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
WASHINGTON 93-0962605
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
411 FIRST AVENUE SOUTH, SUITE 600
SEATTLE, WASHINGTON 98104-2860
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (206) 701-2000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE EXCHANGE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE EXCHANGE ACT:
COMMON STOCK, $.01 PAR VALUE
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the past 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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the Common Stock held by non-affiliates of the
Registrant as of March 28, 2002 was approximately $90,800,000, based upon the
last sale price of $2.29 reported for such date on the Nasdaq National Market
System.
As of March 28, 2002, there were 45,127,474 shares of Common Stock issued and
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement to be delivered to shareholders in connection
with the Registrant's Annual Meeting of Shareholders to be held on May 29, 2002,
are incorporated by reference into Part III.
================================================================================
CRAY INC.
FORM 10-K
FOR FISCAL YEAR ENDED DECEMBER 31, 2001
INDEX
PAGE
----
PART I
Item 1. Business 3
Item 2. Properties 17
Item 3. Legal Proceedings 17
Item 4. Submission of Matters to a Vote of Security Holders 17
Item E.O. Executive Officers of the Company 18
PART II
Item 5. Market for the Company's Common Equity and Related Stockholder Matters 20
Item 6. Selected Financial Data 21
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 22
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 27
Item 8. Financial Statements and Supplementary Data 27
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 28
PART III
Item 10. Directors and Executive Officers of the Company 29
Item 11. Executive Compensation 29
Item 12. Security Ownership of Certain Beneficial Owners and Management 29
Item 13. Certain Relationships and Related Transactions 29
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 30
2
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains forward-looking statements that
involve risks and uncertainties, as well as assumptions that, if they never
materialize or prove incorrect, could cause our results to differ materially
from those expressed or implied by such forward-looking statements. All
statements other than statements of historical fact are statements that could be
deemed forward-looking statements, including any projections of earnings,
revenues or other financial items; any statements of the plans, strategies and
objectives of management for future operations; any statements concerning
proposed new products, services or developments; any statements regarding future
economic conditions or performance; statements of belief and any statement of
assumptions underlying any of the foregoing.
The risks, uncertainties and assumptions referred to above include the timely
development, production and acceptance of products and services and their
features; the level of governmental support for supercomputers; our dependency
on third-party suppliers to build and deliver necessary components; our need for
additional credit and financial facilities; the challenge of managing asset
levels, including inventory; the difficulty of keeping expense growth at modest
levels while increasing revenue; our ability to retain and motivate key
employees; and other risks that are described from time to time in our
Securities and Exchange Commission reports, including but not limited to the
items discussed in "Factors That Could Affect Future Results" set forth in
"Business" in Item 1 below in this report, and in subsequently filed reports. We
assume no obligation to update these forward-looking statements.
PART I
ITEM 1. BUSINESS
INTRODUCTION
We design, build, sell and service high performance computer systems,
commonly known as supercomputers, and provide professional services to support
our emphasis on providing solutions to our customers. We have leading edge
technology, multiple product platforms, approximately 840 employees, a
substantial worldwide installed base of computers, major manufacturing and
service capabilities and extensive global customer relationships. We believe
that our current products and those under development represent the future of
supercomputing.
We were incorporated under the laws of the State of Washington in December
1987. Our corporate headquarters offices are located at 411 First Avenue South,
Suite 600, Seattle, Washington, 98104-2860, and our telephone number is (206)
701-2000.
CRAY ACQUISITION
On April 1, 2000, we acquired the operating assets of the Cray Research
business unit from Silicon Graphics, Inc. ("SGI"), and changed our corporate
name from Tera Computer Company to Cray Inc. With that acquisition we became the
leading company in the world dedicated solely to the development and sale of
supercomputers. Prior to the acquisition, we had been developing for ten years
one supercomputer product based on multithreaded architecture. We had sales to
one customer, limited revenue, and approximately 125 employees. Through the
acquisition we acquired about 775 employees located in over 20 countries,
ongoing sales of supercomputer systems with several products in development,
major manufacturing operations, an established service organization and
substantial inventory.
In particular, we acquired the Cray SV1 and T3E product lines and the
code-named SV2 and other products under development, a service organization
supporting Cray supercomputers installed in about 200 sites in the United States
and overseas, integrated design and manufacturing capabilities, software
products and related experience and expertise, approximately 775 employees,
product and service inventory, real property located in Chippewa Falls,
Wisconsin, and the Cray brand name. Pursuant to a Technology Agreement, SGI
assigned to us
--------
Cray, Cray-1, UNICOS and UNICOS/mk are federally registered trademarks of Cray
Inc., and Cray C90, Cray J90, Cray T90, Cray T3E, Cray SV1, Cray SV1ex, Cray
SV2, Cray SX-6, Cray MTA, Cray MTA-2 and Cray MTX are trademarks of Cray Inc.
Other trademarks used in this Annual Report on Form 10-K are the property of
their respective owners.
3
various patents and other intellectual property and licensed to us the rights to
other patents and intellectual property. We paid SGI $15 million in cash upon
closing, $35.3 million pursuant to a non-interest bearing note that we paid in
full in December 2000 and 1,000,000 shares of our common stock. We assumed real
property leases for other Cray offices and holiday and other benefit obligations
for the personnel who transferred from SGI to us.
In acquiring the service of the installed base of Cray supercomputers, we
assumed responsibility for the cost of servicing the Cray T90 vector computers.
Because certain components in the T90 systems sold by SGI have unusually high
failure rates, the cost of servicing these computers exceeds the related service
revenue. We are continuing to take action that commenced prior to our
acquisition of the Cray Research operations to address this problem, which will
not be resolved until all T90 systems are removed from service. We recorded an
initial reserve of $46.3 million to provide for anticipated future losses on the
T90 service contracts. We apply a portion of this reserve to offset service
costs quarterly based on our T90 service activities during that quarter. As of
December 31, 2001, this reserve was $14.5 million.
As part of the acquisition we agreed with SGI that we would not utilize
specified technology to develop successor products to the T3E product line. In
addition, we agreed that for a period of the earlier of three years or until SGI
was sold, we would not sell or otherwise transfer any or all of the Cray
products, rights under the intellectual property transferred to us under the
Technology Agreement, or the service and maintenance relationships with the
installed base to Hewlett-Packard Company, Sun Microsystems, Inc., International
Business Machines Corporation, Compaq Computer Corporation, NEC Corporation or
Gores Technology Group.
For these reasons, period to period comparisons that include periods prior to
April 1, 2000, are not indicative of future results. Discussions that relate to
periods prior to April 1, 2000, refer to our operations as Tera Computer Company
and discussions that relate to periods after April 1, 2000, refer to our
combined operations as Cray Inc.
PRODUCT AND SERVICE OFFERINGS AND THE HIGH PERFORMANCE COMPUTER MARKET
Since the pioneering Cray-1(R) system arrived in 1976, supercomputers --
defined simply as the most powerful class of computers at any time -- have
contributed substantially to the advancement of knowledge and the quality of
human life. Problems of major economic, scientific and strategic importance
typically are addressed by supercomputers years before becoming tractable on
less-capable systems. For scientific applications, the increased need for
computing power has been driven by highly challenging problems that can be
solved only through numerically intensive computation. For engineering
applications, high performance computers boost productivity and decrease the
time to market for companies and products in a broad range of industries. The
U.S. government has recognized that the continued development of high
performance computer systems, which typically sell for multiple millions of
dollars each, is of critical importance to the economic, scientific and
strategic competitiveness of the United States.
In conjunction with some of the world's most creative scientific and
engineering minds, these formidable tools already have made automobiles safer
and more fuel-efficient; located new deposits of oil and gas; saved lives and
property by predicting severe storms; created new materials and life-saving
drugs; powered advances in electronics and visualization; safeguarded national
security; and unraveled mysteries ranging from protein-folding mechanisms to the
shape of the universe.
Applications promising future competitive and scientific advantage create a
demand for more supercomputer power -- 10 to 1,000 times greater than anything
available today, according to users. Automotive companies are targeting
increased passenger cabin comfort, improved safety and handling. Aerospace firms
envision more-efficient planes and space vehicles. The petroleum industry wants
to "see" subsurface phenomena in greater detail. Urban planners hope to ease
traffic congestion. Genomic and proteonomic research for safer and faster drug
development are high on the wish list in medicine. The sequencing of the human
genome promises to open an era of burgeoning research and commercial enterprise
in the life sciences.
Our customized supercomputer products provide high bandwidth and other
capabilities needed for exploiting new and existing market opportunities. Among
supercomputer vendors, we offer the largest variety of products and
4
services in order to address the broadest range of customer requirements and
market segments. A brief description of our products and professional services
follows.
Vector Supercomputer Systems. For certain important classes of scientific and
industrial applications, vector supercomputer systems remain unequaled. Starting
in 1976, Cray Research pioneered the use of vector systems in a variety of
market sectors. Vector systems typically use a moderate number (one to 64) of
custom processors, each of which is two to 100 times faster in practice than the
fastest commercially available microprocessors at any time. Earlier, vector
systems effectively were the only type of system available and therefore
dominated the supercomputer market. In the past decade, supercomputers employing
alternative designs ("architectures"), including the Cray T3E(TM) parallel
system and other highly parallel systems, have emerged to capture substantial
market-share. Today, increasingly powerful vector systems remain an important
market factor and are typically reserved for the most demanding class of
applications and workloads. Our vector systems include unique features,
traditionally employed by classified government customers, that in preliminary
tests have demonstrated substantial performance advantages over
microprocessor-based systems for mainstream problem solving in the emerging
bioinformatics market. The same unique features also are included in our Cray
MTA-2(TM) systems.
The Cray SV1ex(TM) system provides substantial enhancements to the
predecessor Cray SV1(TM) product. The system's clock rate, at 500 megahertz, is
among the fastest of any currently available supercomputer, vector or
non-vector; and the Cray SV1ex system's cache-based memory, unique among vector
supercomputers, significantly improves performance for problems that make good
use of cache memory. The targeted selling focus for the SV1ex systems is 8 to 64
gigaflops (billions of calculations per second), with typical selling prices
ranging from $1 million to $2 million. We expect to sell SV1ex systems primarily
to existing customers as upgrades to older vector systems and to new customers
engaged in bioinformatics research.
In May 2001, our agreement with NEC Corporation to distribute and service NEC
SX series vector supercomputers and their successors became effective. This
agreement provides us with exclusive distribution and servicing rights in the
United States, Canada and Mexico, and non-exclusive rights in the rest of the
world. We currently market the NEC SX-6 system, rebranded as the Cray SX-6, to
industrial, academic and governmental customers requiring intense computing
power, very large high-performance memory and high I/O rates on a vector
platform. These systems offer superior reliability in a balanced, commercial
quality system. The targeted selling focus for the SX-6 supercomputers will be
from 16 to 64 gigaflops, with expected selling prices ranging from $1.5 million
to $3 million.
Microprocessor-based Highly Parallel Systems. In recent years highly parallel
supercomputer products have captured substantial market share by providing
greater performance and price/performance on a range of less-challenging
applications. Highly parallel supercomputers, often referred to as "clusters,"
typically link together tens, hundreds or thousands of standard microprocessors
to act either concurrently on multiple tasks, or in concert on a single
computationally-intensive task. In these systems, each processor typically is
directly connected to its own private ("distributed" or "local") memory and the
programmer must manage the movement of data among memory units. As a result,
computer systems relying on this architecture can be difficult to program and
are most suited for applications that can be partitioned easily into discrete
tasks that do not need to communicate often with each other and do not require
the high memory and interconnect system bandwidth of supercomputers such as the
Cray SX-6 system or the forthcoming Cray SV2(TM) and Cray MTA-2 systems.
The Cray T3E system, introduced in 1996 and able to employ up to 2,048
processors, is widely recognized as the first technically and commercially
successful highly parallel system. The Cray T3E is among the world's fastest
supercomputers for actual ("sustained") performance on real applications and was
named "Supercomputer Product of the Year" for the year 2000 by the readers of
Scientific Computing & Instrumentation magazine. In 2000 and 2001 we sold and
installed T3E systems for approximately $18.5 million and $21 million,
respectively, and we anticipate a T3E system sale of approximately $15 million
in 2002. T3E systems utilize some components no longer possible to obtain, and
will be succeeded for the most challenging classes of problems by the Cray SV2
system and for less-challenging problems by Cray cluster solutions.
In February 2002 we announced plans to market high-performance cluster
solutions and services worldwide using PowerEdge servers obtained from Dell
Computer Corporation. We will sell and provide direct customer support for high
performance computer solutions that combine scalable, cost-effective Dell
PowerEdge servers and storage, open-source Linux based operating software
operating systems and our value-added high performance computer technologies and
services. In addition to installation, maintenance and support services, we
offer site
5
planning, system integration and training, and hardware and software
customization services through our Professional Services organization. Target
markets are enterprises seeking production quality high-performance computing at
attractive pricing. We expect primarily to sell cluster systems combined with
professional and maintenance services, with expected prices ranging from
$500,000 to $2.5 million.
Cray SV2 System (code named). We are currently developing the revolutionary
code-named Cray SV2 system, which incorporates in its design both vector
processing capabilities from the long line of Cray Research vector systems and
highly parallel capabilities analogous to those of our T3E system. The SV2 is an
"extreme performance" supercomputer aimed at the high end of the vector
processing market and the high end of the market for highly parallel systems.
The SV2 has been under development since 1997, and first customer ship is
scheduled for the second half of 2002. Our expected selling focus for the SV2 is
200 gigaflops to multiple tens of teraflops (trillions of calculations per
second). The U.S. government is providing substantial funding support for the
development of the SV2 system and conducts rigorous progress reviews on a
quarterly basis. Our SV2 development has satisfactorily completed all quarterly
reviews to date.
Multithreading Systems. We were formed originally to pursue a significant
breakthrough in high-performance computing by developing a scalable uniform
shared memory, latency tolerant system that utilizes a multithreaded
architecture and a high bandwidth interconnection system. In 2000 and 2001 we
were heavily engaged in reimplementing the MTA(TM) system from gallium arsenide
technology to more-mainstream CMOS (complementary metal-oxide silicon)
technology. The first MTA-2 system was delivered in December 2001 to the
Electronic Navigation Research Institute in Japan. In February 2002, we
delivered a 16-processor MTA-2 system to the Naval Research Laboratory, and plan
to increase that system to 40 processors in April 2002. The Naval Research
Laboratory plans to make this system available for investigative purposes to its
own researchers and to the Department of Defense national research community.
With the MTA-2 system, we are targeting customers in the defense community, in
scientific research -- including burgeoning new life sciences fields such as
bioinformatics, and in advanced imaging. The MTA-2 is aimed at new applications
not well served by vector or highly parallel systems, such as dynamically
adaptive meshes, data sorting and problems benefiting from advanced scalability,
large uniform shared memory and easier parallel programming. The MTA-2 has shown
a significant performance advantage, for example, on so-called Monte Carlo codes
used in a wide range of sectors, from nuclear physics to medicine to finance.
Professional Services. In December 2001, we formed a Professional Services
organization to support our emphasis on providing solutions rather than just
computer systems to our customers. Our professional services team provides
consulting, integration, custom hardware and software engineering, advanced
computer training, site engineering, data center operation and time-share
computing services. These professional services leverage our reputation and
skills for services and industry technical knowledge. We offer these services
into all high-performance computing markets, both in connection with and
independent of product sales.
SOFTWARE
We offer UNIX-based operating systems, compiler software and diagnostic
tools. We currently support multiple operating systems, including UNICOS/mk(R)
in the T3E, UNICOS(R) in the SV1ex and earlier vector processing systems and a
UNIX-based system called Cray MTX(TM) for the Cray MTA-2 system. The SV2
operating system will be UNIX-based with common UNICOS extensions. The Cray SX-6
system and successors use NEC's SUPER-UX(TM) operating system, also based on
UNIX.
We continue to design and build highly optimizing programming environments
and performance management diagnostic software products that allow our customers
to obtain maximum benefit from our systems. In addition to supporting
third-party applications, we also research advanced algorithms and other
approaches to improving application performance. We also purchase or license
software technologies from third parties when necessary to provide appropriate
support to our customers, while focusing on our own resources where we add the
highest value.
MAINTENANCE AND SUPPORT
Our extensive worldwide maintenance and support systems provide us with a
competitive advantage. Our employees providing these services include field
service engineers, product and applications specialists and product support
engineers, usually based at customer sites and supported by a central support
services group located in Chippewa Falls, Wisconsin. On December 31, 2001, we
had 109 support personnel in the field in the U.S., another
6
87 support personnel in other countries and 43 employees providing central
support services, including extensive data center operations.
In 2000 and 2001 we have been performing maintenance services under existing
SGI maintenance contracts as a sub-contractor to SGI; we now have been
successful in having almost all of these contracts assigned to us. Support
services are provided under separate maintenance contracts with our customers.
These contracts generally provide for support services on an annual basis,
although some cover multiple years. While most customers pay for support
monthly, others pay on a quarterly or annual basis.
SALES
We primarily sell our system products through our direct sales force that
operates throughout the United States and in all significant international
markets. We serve smaller international markets through representatives and
distributors.
We had 28 sales staff, including sales representatives, sales managers,
pre-sale analysts and administrative personnel located in the United States and
45 sales staff located internationally, as of year-end 2001.
No single end-user customer accounted for 10% or more of our revenue for each
of the last three years, but agencies of the United States government, both
directly and indirectly through system integrators and other resellers,
accounted for approximately 85% of our 2001 revenue and 54% of our 2000 revenue.
Information with respect to our international operations and export sales is set
forth in Note 14 to the Consolidated Financial Statements included in Part II,
Item 8 of this Form 10-K.
MARKETING
Our marketing staff has a strategic focus on issue areas and those solutions
that will facilitate our customers' success in solving their most challenging
scientific and engineering problems. On December 31, 2001, we had 29 employees
in our marketing group, all in the United States.
RESEARCH AND DEVELOPMENT
We are committed to leadership in the high performance computer market. Our
leadership depends on successful development and introduction of new products
and enhancements to existing products. Prior to April 2000, our primary research
and development activity was the design of the hardware components and software
required for our MTA system. Since April 2000, we have continued development of
the MTA-2 system, enhancements to the Cray T3E system and to the Cray SV1 series
that led to the SV1ex system, and the SV2 system. In 2002 the SV2 system and
its successors will consume a major portion of our research and development
expenditures. We expect that our cluster system offerings will involve software
development with minimal hardware engineering, and we do not anticipate any
development expenditures on the Cray SX-6 and successor SX systems.
Our research and development expenses, net of governmental funding, were
$15.2 million in 1999, $48.4 million in 2000 and $53.9 million in 2001. These
amounts represent 720%, 41% and 40%, respectively, of total revenue. We received
government funding of $72,000 in 1999, $9.3 million in 2000 and $12.6 million in
2001. While we will be required to continue to devote a substantial portion of
our resources to research and development activities, our goal is to have
research and development expenses represent approximately 15-18% of revenue. We
expect to achieve this goal primarily by increasing revenue while maintaining
tight control of research and development expenditures and seeking additional
government support for our research and development activities.
MANUFACTURING
While we design many of the hardware components for all of our products, we
subcontract the manufacture of these components, including integrated circuits,
printed circuit boards, flex circuits, memory modules, machined enclosures and
support structures, cooling systems, high performance cables and other items to
third-party suppliers. Our strategy is to avoid the large capital commitment and
overhead associated with establishing full-scale manufacturing facilities and to
maintain the flexibility to adopt new technologies as they become available
without the risk of equipment obsolescence. We perform final system integration
and testing, and design and maintain our system software internally.
7
Our manufacturing facilities are located in Chippewa Falls, Wisconsin. We
maintain a development and support capability in Seattle, Washington. At
December 31, 2001, we had 128 full-time employees in manufacturing, with 106
located in Chippewa Falls, Wisconsin.
Our systems incorporate components that are available from one or limited
sources. Key components that are sole-sourced include our integrated circuits
and processors, interconnect systems and memory products. We obtain integrated
circuits for our vector and SV2 systems from IBM and for the MTA-2 system from
Taiwan Semiconductor Manufacturing Corporation; IBM also provides packaging for
our vector and SV2 systems while Kyocera America, Inc., provides packaging for
our MTA-2 system; we obtain processors for our T3E system from Compaq Computer;
we obtain custom interconnect components for our T3E and MTA-2 systems from
InterCon Systems, Inc., and we obtain input/output systems for our MTA-2 and SV2
systems from Sun Microsystems, Inc. We obtain custom memory products for our
vector, MTA-2 and T3E systems from Samsung Semiconductor, Inc. We acquire power
modules and spray cap cooling systems for the SV2 from SAE Power Incorporated
and Parker Hannifin Corporation, respectively. We use Celestica, Inc., to
assemble our vector, SV2 and T3E systems and for repair of components for these
systems.
Our purchases from these vendors are primarily through purchase orders. We
have chosen to deal with sole sources in these cases because of specific
technologies, economic advantages and other factors. We also have sole or
limited sources for less critical components, such as peripherals, power
supplies, cooling and chassis. Reliance on single or limited source vendors
involves several risks, including the possibility of shortages of key
components, long lead times, reduced control over delivery schedules and changes
in direction by vendors.
COMPETITION
The high performance computer market is intensely competitive. The barriers
to entry are high, as is the cost of remaining competitive. Our competitors can
be divided into two general categories: established companies that are
well-known in the high performance computer market and new entrants capitalizing
on developments in architecture or techniques to increase computer performance
through linking together clusters or networks of microprocessor based systems --
servers, workstations or personal computers.
Participants in the high performance computer market include IBM and NEC
Corporation. To date, Japanese suppliers have been largely unsuccessful in the
U.S. high performance computer market but have been enjoying success in foreign
markets. We have exclusive rights to market NEC vector processing supercomputers
in North America, subject to certain volume requirements; we have non-exclusive
rights to market these computers elsewhere, and we are competing with NEC in the
rest of the world. We compete by offering systems with superior performance,
coupled with our excellent post-sale service capabilities and established
customer relationships.
A number of companies, including IBM, Silicon Graphics, Inc., Sun
Microsystems, Inc., Hewlett-Packard Corporation and Compaq Computer Corporation,
offer clusters or other highly parallel systems for the high performance market.
While our T3E system competes primarily on performance, we expect that our
cluster offerings will compete on price/performance, increasingly differentiated
software capabilities and superior pre-sales and post-sales services.
In the provision of professional services, we compete with other high
performance computer companies, such as IBM, Compaq Computer and Silicon
Graphics, when the professional services opportunity relates to a supercomputer
sale. In circumstances not related to a product sale, we compete with
competitors such as IBM Global Services, Science Applications International
Corporation and various smaller consulting firms. We compete primarily based on
the technical expertise of our employees.
Each of our competitors named above has substantially greater engineering,
manufacturing, marketing and financial resources than we do.
INTELLECTUAL PROPERTY
We attempt to protect our trade secrets and other proprietary rights through
formal agreements with our employees, customers, suppliers and consultants, and
through patent protection. Although we intend to protect our rights vigorously,
there can be no assurance that our contractual and other security arrangements
will be successful.
8
There can be no assurance that such arrangements will not be terminated or that
we will be able to enter into similar arrangements on favorable terms if
required in the future. In addition, if such agreements were breached, there can
be no assurance that we would have adequate remedies for any breach. Although we
have not been a party to any material intellectual property litigation, third
parties may assert proprietary rights claims covering certain of our products
and technologies.
We have a number of patents relating to our hardware and software systems. We
license certain patents and other intellectual property from SGI as part of our
acquisition of the Cray Research operations. These licenses contain restrictions
on use of the underlying technology, generally limiting the use to historic Cray
products, vector processor computers and the Cray SV2 systems. Our general
policy is to seek patent protection for those inventions and improvements likely
to be incorporated into our products and services or to give us a competitive
advantage. While we believe our patents and applications have value, no single
patent is in itself essential to us as a whole or to any of our key products.
Any of our proprietary rights could be challenged, invalidated or circumvented
and may not provide significant competitive advantage.
There can be no assurance that the steps we take will be adequate to protect
or prevent the misappropriation of our intellectual property. Litigation may be
necessary in the future to enforce patents we obtain, and to protect copyrights,
trademarks, trade secrets and know-how we own. Such litigation, if necessary,
could result in substantial expense to us and a diversion of our efforts.
EMPLOYEES
As of December 31, 2001, we employed 842 employees (compared to 886 at the
end of 2000) on a full-time basis, of whom 300 were in development and
engineering, 128 were in manufacturing, 73 were in sales, 29 were in marketing,
270 were in field service and 42 were in administration. We also employed 51
individuals on a part-time or temporary basis or as interns. We have no
collective bargaining agreement with our employees. We have never experienced a
work stoppage and believe that our employee relations are excellent.
FACTORS THAT COULD AFFECT FUTURE RESULTS
The following factors should be considered in evaluating our business,
operations and prospects and may affect our future results and financial
condition.
OUR INABILITY TO OVERCOME THE TECHNICAL CHALLENGES OF COMPLETING THE DEVELOPMENT
OF OUR SYSTEMS COULD CAUSE OUR BUSINESS TO FAIL. We expect that our success in
2002 and following years will depend upon completing the development of the
MTA-2 and the SV2 systems. These development efforts are lengthy and technically
challenging processes, and require a significant investment of capital,
engineering and other resources. Delays in completing the design of the hardware
components or software of these systems or in integrating the full systems would
make it difficult for us to develop and market these systems. We are dependent
on our vendors to manufacture components for our systems, and few companies can
meet our design requirements. If our vendors are unable to manufacture our
components to our design specifications on a timely basis, the completion of our
products will be delayed. During the development process we have had, and in the
future we may have, to redesign components because of previously unforeseen
design flaws. We also may find flaws in our system software which require
correction. Redesign work may be costly and cause delays in the development of
these systems, and could make it more difficult for these systems to be
successful as commercial products.
LACK OF CUSTOMER ORDERS FOR OUR EXISTING PRODUCTS AND OUR INABILITY TO SELL OUR
PRODUCTS AT EXPECTED PRICES WOULD LIMIT OUR REVENUE AND OUR ABILITY TO BE
PROFITABLE. We will depend on sales of our current products - the Cray SV1ex
series, T3E systems, Cray SX-6 and cluster systems - for significant product
revenue in 2002. To obtain these sales, we need to assure our customers of
product performance and cost effectiveness and overcome market difficulties
applicable to each system. Most of our potential customers already own or lease
very high-performance computer systems. Some of our competitors may offer
trade-in allowances or substantial discounts to potential customers, and we may
not be able to match these sales incentives. We may be required to provide
discounts to make sales or to provide lease financing for our products, which
would result in a deferral of our receipt of cash for these systems. These
developments would limit our revenue and resources and would reduce our ability
to be profitable.
9
LACK OF SALES OF THE SX-6 SYSTEM COULD DECREASE OUR REVENUE AND DELAY
PROFITABILITY. Cray SX-6 systems from Japan have just become available for
delivery in North America, which has delayed our sales efforts. These sales
would be adversely affected if NEC does not develop a follow-on product to the
SX-6. Supercomputers from Japan have not been available for sale in the United
States since 1997, and there may be reluctance among traditional customers, such
as governmental agencies and research organizations and industrial users, to
purchase supercomputers from non-U.S. sources. In addition, we must
appropriately place the SX-6 system within our own product line to avoid
customer and market confusion. If we do not obtain certain volumes of sales of
Cray SX-6 systems through March 2003, we may lose our North American exclusivity
for this product. Competing successfully with NEC with respect to sales of the
SX-6 system outside of North America is difficult.
WE MAY NOT BE SUCCESSFUL IN CONTRACTING TO PROVIDE OUR PROFESSIONAL SERVICES,
WHICH WOULD DECREASE REVENUE AND AFFECT PROFITABILITY. Our entry into the
professional services market is new. We will be using our employees with subject
matter expertise, led by experienced professional service leaders we have
recently hired, to staff professional services projects on a project-by-project
and customer-focused basis. We need to refine our approach and develop
methodologies that change the way we have conducted business in the past. We
compete with companies with larger staffs and more experience in the marketing
and provision of professional services. For these reasons our entry into the
professional services market may not be successful.
LACK OF SALES OF CLUSTER SYSTEMS WOULD REDUCE OUR REVENUE AND DELAY
PROFITABILITY. We expect that sales of cluster systems will begin in the second
half of 2002. There are many competitive cluster solutions and pressure on
margins is severe. We expect to compete based on increasingly differentiated
software, pre-sales integration services, our reputation for excellent
post-sales maintenance and support services and our professional services
assisting cluster customers finding solutions for their problems. If we cannot
develop commercially acceptable software solutions or our services are not
sufficiently well-received, then we will have difficulty selling cluster
solutions at prices that generate appropriate margins.
GENERAL ECONOMIC AND MARKET CONDITIONS COULD DECREASE OUR REVENUE, INCREASE OUR
NEED FOR CASH AND DELAY PROFITABILITY. While most of our business is related to
the government sector, which is relatively immune to short-term economic cycles,
a slow-down in the overall U.S. and global economy and resultant decreases in
capital expenditures has affected sales to our industrial customers and may
continue to do so. Cancellations or delays in purchases would decrease our
revenue, increase our need for working capital and delay profitability.
LACK OF GOVERNMENT SUPPORT FOR SUPERCOMPUTER SYSTEMS WOULD INCREASE OUR CAPITAL
REQUIREMENTS AND DECREASE OUR ABILITY TO CONDUCT RESEARCH AND DEVELOPMENT. We
have targeted U.S. and foreign government agencies and research laboratories as
important sales prospects for all of our products. A few of these agencies fund
a portion of our development efforts. The U.S. government historically has
facilitated the development of, and has constituted a market for, new and
enhanced very high-performance computer systems. Congressional action with
respect to the 2002 budget was delayed due to the events of September 11, 2001.
The failure of U.S. and foreign government agencies to continue to fund these
development efforts, due to lack of funding, change of priorities or for any
other reason, or continued delays in funding, would cause us to increase our
need for capital and reduce our research and development expenditures.
PROPOSALS AND PURCHASES BASED ON THEORETICAL PEAK PERFORMANCE REDUCE OUR ABILITY
TO MARKET OUR SYSTEMS. Our high-performance systems are designed to provide high
actual sustained performance on difficult computational problems. Many of our
competitors offer systems with higher theoretical peak performance numbers,
although their actual sustained performance frequently is a small fraction of
their theoretical peak performance. Nevertheless, many requests for proposals,
primarily from governmental agencies in the U.S. and elsewhere, have criteria
based on theoretical peak performance. Until these criteria are changed, we are
foreclosed from bidding or proposing our systems on such proposals, which will
limit our revenue potential.
IF THE U.S. GOVERNMENT PURCHASES FEWER SUPERCOMPUTERS, OUR REVENUE WOULD BE
REDUCED. Historically, sales to the U.S. government have been a significant
market for supercomputers. In the twelve months ended December 31, 2001,
approximately 85% of our revenue was derived from sales to various agencies and
departments of the U.S. government. Sales to the U.S. government may be affected
by factors outside
10
our control, such as changes in procurement policies and budget considerations.
If the U.S. government were to stop or reduce its use and purchases of
supercomputers, our revenue would be reduced.
OUR RELIANCE ON THIRD-PARTY SUPPLIERS POSES SIGNIFICANT RISKS TO OUR BUSINESS
AND PROSPECTS. We subcontract the manufacture of substantially all of our
hardware components for all of our products, including integrated circuits,
printed circuit boards, flex circuits and power supplies, on a sole or limited
source basis to third-party suppliers. We also use a contract manufacturer to
assemble our SV1ex and T3E components, and plan to do so for our MTA-2 and SV-2
systems also. We are exposed to substantial risks because of our reliance on
these and other limited or sole source suppliers. For example:
- if a reduction or interruption of supply of our components occurred, it
could take us a considerable period of time to identify and qualify
alternative suppliers to redesign our products as necessary and to begin
manufacture of the redesigned components;
- if we were ever unable to locate a supplier for a component, we would be
unable to assemble and deliver our products;
- one or more suppliers may make strategic changes in their product lines,
which may result in the delay or suspension of manufacture of our components
or systems; and
- some of our key suppliers are small companies with limited financial and
other resources, and consequently may be more likely to experience financial
difficulties than larger, well-established companies.
We have experienced delays in obtaining circuit boards, integrated circuits and
flex circuits on a timely basis from our suppliers, which have resulted in
delays in the development of our products.
OUR QUARTERLY PERFORMANCE MAY VARY SIGNIFICANTLY AND COULD CAUSE OUR STOCK PRICE
TO BE VOLATILE. One or a few system sales may account for a substantial
percentage of our quarterly and annual revenue. This is due to the high average
sales price of our products, particularly the Cray T3E system, and the expected
high average sales prices for our MTA-2, SX-6 and SV2 systems, and the timing of
purchase orders and product acceptances. Because a number of our prospective
customers receive funding from the U.S. or foreign governments, the timing of
orders from such customers may be subject to the appropriation and funding
schedules of the relevant government agencies. The timing of orders and
shipments also could be affected by other events outside our control, such as:
- changes in levels of customer capital spending;
- the introduction or announcement of competitive products;
- the availability of components;
- timing of the receipt of necessary export licenses; or
- currency fluctuations and international conflicts or economic crises.
Because of these factors, revenue, net income or loss and cash flow are likely
to fluctuate significantly from quarter to quarter.
ADDITIONAL FINANCINGS MAY BE DILUTIVE TO EXISTING SHAREHOLDERS. Over the next
twelve months our significant cash requirements relate to operational expenses,
primarily for personnel, inventory and third-party engineering services, and
acquisition of capital goods. We expect to have positive cash flow over the next
twelve months from our anticipated product sales, professional services,
maintenance services and government funding of research and development expenses
coupled with limitations on operating expenses and capital expenditures. At any
time, given the high average selling price of our products, our cash position is
impacted by the timing of product sales, receipt of prepaid maintenance and
receipt of government funding of research and development activities. Delays in
the development of either the MTA-2 or SV2 system may require additional capital
earlier than planned. While we believe our cash resources will be adequate for
the next twelve months, we may need to raise additional equity and/or debt
capital if we experience lower than anticipated product sales due to delays in
product availability, general economic conditions and/or failure to receive
sufficient governmental support for our products and research activities. In
addition, we may raise additional funds to enhance our working capital position.
Financings may not be available to us when needed or, if available, may not be
available on satisfactory terms and may be dilutive to our shareholders.
OUR UNCERTAIN PROSPECTS FOR EARNINGS COULD CAUSE OUR STOCK PRICE TO DECLINE.
While we have had a substantial increase in revenue with the acquisition of the
business operations of
11
Cray Research and have had two profitable quarters since that acquisition,
whether we will achieve earnings on a consistent basis will depend on a number
of factors, including:
- our ability to market and sell the SV1ex, T3E, SX-6 and cluster systems,
engage professional services clients and complete the development of the
MTA-2 and SV2 systems;
- the level of revenue in any given period;
- the cost of servicing the T90 installed base;
- the terms and conditions of sale or lease for our products; and
- our expense levels, particularly for research and development and
manufacturing and service costs.
FAILURE TO OBTAIN RENEWAL OF SERVICE CONTRACTS WILL REDUCE OUR REVENUE AND
EARNINGS. High-performance computer systems are typically sold with maintenance
service contracts. These contracts generally are for annual periods, although
some are for multi-year periods. In 2000 and 2001 we have been performing
maintenance services under existing SGI maintenance contracts as a subcontractor
to SGI; we now have been successful in having almost all of these contracts
assigned to us. As these contracts expire, however, we need to sell new
maintenance service contracts to these customers. Revenue from service contracts
have declined from approximately $125 million in 1999 to approximately $83
million in 2001 and are expected to further decline until we develop, sell and
install new products. If customers do not renew their maintenance service
contracts with us, our revenue and earnings will be reduced.
THE ABSENCE OF THIRD-PARTY APPLICATION SOFTWARE COULD MAKE IT MORE DIFFICULT FOR
US TO SELL OUR SYSTEMS TO COMMERCIAL CUSTOMERS. To make sales in the automotive,
aerospace, chemistry and other engineering and commercial markets, we must be
able to attract independent software vendors to port their software application
programs so that they will run on our systems. The relatively low volume of
supercomputer sales makes it difficult for us to attract these vendors. We also
modify and rewrite third-party software applications to run on our systems and
so facilitate the expansion of our potential markets. There can be no assurance
that we will be able to induce independent software vendors to rewrite their
applications, or that we will successfully rewrite third-party applications for
use on our systems.
FAILURE TO OBTAIN CREDIT FACILITIES MAY RESTRICT OUR OPERATIONS. While we have
obtained a $15 million secured credit facility based on domestic accounts
receivables and maintenance revenue, we are seeking additional credit facilities
of up to approximately $4 million, such as bank lines of credit, vendor credit
and capitalized equipment lease lines. The absence of a consistent record of
revenue and earnings makes obtaining such facilities more difficult; if we
obtain such facilities, they may have high interest rates, contain restrictions
on our operations and require security. Failure to obtain such credit facilities
may limit our planned operations and our ability to acquire needed
infrastructure and other capital items would reduce or eliminate our cash
reserves and increase our need for capital.
THE COST OF SERVICE OF THE T90 INSTALLED BASE WILL REDUCE OUR EARNINGS. Some of
the components in the T90 vector computers sold by SGI before our acquisition of
the operations of Cray Research have an unusually high failure rate. The cost of
servicing the T90 computers exceeds the related service revenue. We are
continuing to take action that commenced before the acquisition to address this
problem, and have recorded a warranty reserve, with a balance of $14.5 million
as of December 31, 2001, to provide for anticipated future losses on the T90
maintenance service contracts.
IF WE ARE NOT ABLE TO KEEP UP WITH RAPID TECHNOLOGICAL CHANGE, OUR PRODUCTS WILL
NOT BE COMPETITIVE. Our market is characterized by rapidly changing technology,
accelerated product obsolescence and continuously evolving industry standards.
Our success will depend upon our ability to sell our current products, to
complete development of the MTA-2 and the SV2 systems and to develop successor
systems in the future. We will need to introduce new products and features in a
timely manner to meet evolving customer requirements. We may not succeed in
these efforts. Even if we succeed, products or technologies developed by others
may render our products or technologies noncompetitive or obsolete. If we incur
delays in developing our products or if such products do not gain broad market
acceptance or become obsolete, our ability to develop and market our products
will be reduced.
IF WE CANNOT ATTRACT, RETAIN AND MOTIVATE KEY PERSONNEL, WE MAY BE UNABLE TO
IMPLEMENT EFFECTIVELY OUR BUSINESS PLAN. Our success also depends in large part
upon our ability to attract, retain and motivate highly skilled management,
technical and marketing and sales personnel.
12
Competition for highly skilled management, technical, marketing and sales
personnel is intense, and we may not be successful in attracting and retaining
such personnel. We have no employment contracts with any of our employees.
A SUBSTANTIAL NUMBER OF OUR SHARES ARE ELIGIBLE FOR FUTURE SALE AND COULD
DEPRESS MARKET PRICES OF OUR STOCK AND HINDER OUR ABILITY TO OBTAIN ADDITIONAL
FINANCING. Sale of a substantial number of our shares of common stock in the
public market or the prospect of sales could cause the market price of our
common stock to decline. As of December 31, 2001, we had outstanding:
- 42,217,859 shares of common stock;
- 3,125,000 shares of Series A preferred stock convertible into 3,125,000
shares of common stock;
- warrants to purchase 15,178,198 shares of common stock;
- debentures convertible into an indeterminable number of shares of common
stock (a minimum of 3,957,447 shares); and
- stock options to purchase an aggregate of 10,990,772 shares of common stock,
of which 4,936,938 options were then exercisable.
Almost all of our outstanding shares of common stock may be sold without
substantial restrictions. All of the shares purchased under the warrants and
exercisable options are available for sale in the public market, subject in some
cases to volume and other limitations. The shares of common stock underlying the
Series A preferred stock are not available for public sale until May 2003. Sales
in the public market of substantial amounts of our common stock, including sales
of common stock issuable upon the exercise of warrants, debentures and options,
could depress prevailing market prices for the common stock. Even the perception
that sales could occur may impact market prices. The existence of outstanding
convertible debentures, warrants and options may prove to be a hindrance to our
future equity financings. Further, the holders of the warrants and options may
exercise them at a time when we would otherwise be able to obtain additional
equity capital on terms more favorable to us. Such factors could impair our
ability to meet our capital needs.
THE CONVERSION OF THE DEBENTURES AND THE EXERCISE OF THE WARRANTS MAY
SUBSTANTIALLY DILUTE OUR COMMON SHAREHOLDERS. In November 2001, we issued 5%
convertible subordinated debentures in the aggregate original principal amount
of $9,300,000, convertible into shares of our common stock as described below,
and common stock purchase warrants for an aggregate of 367,590 shares of our
common stock at an initial exercise price of $4.4275 per share, exercisable
until November 6, 2004. The holders of the debentures can choose to convert all
or a portion of the principal amount outstanding into shares of our common stock
at any time before the maturity date of November 6, 2004. The debentures are
convertible into common stock at a fixed conversion price of $2.35 per share
from the date of issuance until maturity. In addition, during each three-month
period beginning on February 6, 2002, each holder may convert on a cumulative
basis up to 25% of the original principal amount of each holder's debenture at a
floating conversion price. The floating conversion price is equal to 94% of the
average of the 7 lowest daily volume weighted average prices during the 20
trading days immediately prior to the date upon which the debenture is
converted.
The following table outlines the number of shares of common stock that would
be issuable upon conversion in full of the debentures at several hypothetical
conversion prices. The table also sets forth the total number of shares the
investors would beneficially own at such hypothetical adjustment prices, and
assuming exercise in full of the warrants, and the percentage that such shares
would constitute of our resulting outstanding common stock, assuming the
investors had not purchased or sold any of our securities.
During the period from January 1, 2001, through March 28, 2002, the closing
price of our common stock has ranged from a low of $1.53 to a high of $3.45 per
share, while in 2000, the closing prices ranged from a low of $1.125 to a high
of $11.50 per share.
13
Shares Issuable
Under Shares Issuable Total Shares Total Shares as a
Hypothetical Convertible Under Issuable to Percent of
Conversion Price (1) Debentures (1) Warrants Investors Outstanding Stock (2)
-------------------- --------------- --------------- ------------ ---------------------
$1.00 9,300,000 367,590 9,667,590 17.6%
$1.25 7,440,000 367,590 7,807,590 14.7%
$1.50 6,200,000 367,590 6,567,590 12.7%
$1.75 5,314,286 367,590 5,681,876 11.2%
$2.00 4,650,000 367,590 5,017,590 10.0%
$2.25 4,133,333 367,590 4,500,923 9.1%
$2.35 (3) 3,957,447 367,590 4,325,037 8.7%
----------
(1) Assumes conversion in full of all debentures at the hypothetical conversion
price set forth above. Assumes interest is paid in cash and not in shares of
common stock.
(2) Based on 45,127,474 shares of common stock outstanding on March 28, 2002,
plus the shares issuable to the investors under the debentures and the warrants
shown above.
(3) At floating conversion prices above $2.35 per share, the investors would
convert at the fixed conversion price of $2.35 per share.
The conversion prices of the debentures and the exercise price of the
warrants could be lower than the trading price of our common stock from time to
time. The debentures are convertible into common stock at a fixed conversion
price of $2.35 per share from the date of issuance until maturity, and a
floating conversion price as described earlier. The floating conversion price
generally ensures that the debentures can be converted at a discount from the
market price of our common stock at the time of conversion. For that reason, we
expect the investors ultimately to convert the entire principal amount of the
debentures and to resell the common stock issued to them. The potential or
actual issuance of shares under the debentures and upon exercise of the warrants
could have a substantial dilutive impact on the holders of our common stock.
THE SALES OF MATERIAL AMOUNTS OF OUR COMMON STOCK UPON CONVERSION OF THE
DEBENTURES, OR THE PROSPECT OF SUCH SALES, COULD REDUCE THE MARKET PRICE OF OUR
COMMON STOCK AND ENCOURAGE SHORT SALES. Our common stock price may decrease if
the holders of the debentures elect to convert and resell their shares of common
stock. In particular, as the price of our common stock decreases, if the holders
of the debentures elect to convert, we will be required to issue more shares of
our common stock, based on the floating conversion price, for any given dollar
amount invested by the holders of the debentures. See the table above under "The
Conversion of the Debentures and the Exercise of the Warrants May Substantially
Dilute Our Common Shareholders." Any future issuance of a significant number of
common shares, or any future sales by the investors of a significant number of
common shares, or the prospect of such issuances or sales, could reduce the
market price of our common stock. This may encourage short sales by third
parties, which could place further downward pressure on the price of our common
stock.
OUR ABILITY TO OBTAIN FUTURE FINANCING MAY BE HINDERED BY THE UNCERTAIN AND
POTENTIALLY SUBSTANTIAL NUMBER OF SHARES ISSUABLE UNDER THE DEBENTURES. The
shares issuable upon conversion of the debentures are linked to a percentage
discount to the market price of our common stock at the time of the conversion.
We cannot predict the number of shares of common stock that may be issued upon
conversion. The lower the price of our common stock at the time of conversion,
the more shares of common stock that we will be required to issue upon
conversion, which will further dilute holders of our other securities. See the
table above under "The Conversion of the Debentures and the Exercise of the
Warrants May Substantially Dilute Our Common Shareholders." In addition, any
financing transactions prior to May 6, 2002, require the consent of the holders
of a majority of the debentures then outstanding. These provisions may hinder
our ability to obtain additional financing.
14
OUR STOCK PRICE MAY BE VOLATILE. The trading price of our common stock is
subject to significant fluctuations in response to:
- changes in analysts' estimates;
- our future capital raising activities;
- announcements of technological innovations by us or our competitors; and
- general conditions in our industry.
The stock market has been and is subject to price and volume fluctuations that
particularly affect the market prices for small capitalization, high technology
companies like ourselves.
IF WE ARE UNABLE TO COMPETE SUCCESSFULLY IN THE HIGH-PERFORMANCE COMPUTER
MARKET, OUR REVENUE WILL DECLINE. The performance of our products may not be
competitive with the computer systems offered by our competitors, and we may not
compete successfully over time against new entrants or innovative competitors at
the lower end of the market. Periodic announcements by our competitors of new
high-performance computer systems and price adjustments may reduce customer
demand for our products. Our competitors are established companies that are well
known in the high-performance computer market, including IBM, Sun Microsystems,
Compaq Computer, Hewlett-Packard, Silicon Graphics, and NEC Corporation (outside
of North America). Each of these competitors has broader product lines and
substantially greater research, engineering, manufacturing, marketing and
financial resources than we do. We also compete with new entrants capitalizing
on developments in parallel processing and increased computer performance
through networking and clustering systems. Currently, these products are limited
in applicability and scalability and can be difficult to program. A breakthrough
in architecture or software technology could make parallel systems more
attractive to potential customers. Such a breakthrough would impair our ability
to sell our products and reduce our revenue.
WE MAY NOT BE ABLE TO PROTECT OUR PROPRIETARY INFORMATION AND RIGHTS ADEQUATELY.
We rely on a combination of patent, copyright and trade secret protection,
non-disclosure agreements and licensing arrangements to establish, protect and
enforce our proprietary information and rights. We have a number of patents and
have additional applications pending. There can be no assurance, however, that
patents will be issued from the pending applications or that any issued patents
will protect adequately those aspects of our technology to which such patents
will relate. Despite our efforts to safeguard and maintain our proprietary
rights, we cannot be certain that we will succeed in doing so or that our
competitors will not independently develop or patent technologies that are
substantially equivalent or superior to our technologies. At any time, third
parties may assert intellectual property claims against us. Such claims, if
proved, could require us to pay substantial damages or redesign our existing
products. Even meritless claims would require management attention and would
cause us to incur significant expense to defend. The laws of some countries do
not protect intellectual property rights to the same extent or in the same
manner as do the laws of the United States. Although we continue to implement
protective measures and intend to defend our proprietary rights vigorously,
these efforts may not be successful.
OUR ABILITY TO BUILD SOME PRODUCTS IS LIMITED BY OUR AGREEMENT WITH SILICON
GRAPHICS, WHICH MAY LIMIT OUR ABILITY TO COMPETE WITH SILICON GRAPHICS AND OTHER
COMPANIES. The technology agreement through which we acquired and licensed
patent, know-how and other intellectual property rights from Silicon Graphics
contains restrictions on our ability to develop some products, including
specified successors to the T3E system, and restrictions on the use of other
technology, such as SGI's IRIX operating system to the SV2.
IT MAY BECOME MORE DIFFICULT TO SELL OUR STOCK IN THE PUBLIC MARKET. Our common
stock is listed for quotation on the Nasdaq National Market. To keep our listing
on this market, Cray must meet Nasdaq's listing maintenance standards. If the
bid price of our common stock falls below $1.00 for an extended period, or we
are unable to continue to meet Nasdaq's listing maintenance standards for any
other reason, our common stock could be delisted from the Nasdaq National
Market. If our common stock were delisted, we likely would seek to list the
common stock on the Nasdaq SmallCap Market, the American Stock Exchange or on a
regional stock exchange. Listing on such other market or exchange could reduce
the liquidity for our common stock. If our common stock were not listed on the
SmallCap Market or an exchange, trading of our common stock would be conducted
in the over-the-counter market on an electronic bulletin board established for
unlisted securities or directly through market makers in our common stock. If
our common stock were to trade in the over-the-counter market, an investor would
find it more difficult to dispose of, or to obtain accurate quotations for the
price of, the
15
common stock. A delisting from the Nasdaq National Market and failure to obtain
listing on such other market or exchange would subject our securities to
so-called penny stock rules that impose additional sales practice and
market-making requirements on broker-dealers who sell or make a market in such
securities. Consequently, removal from the Nasdaq National Market and failure to
obtain listing on another market or exchange could affect the ability or
willingness of broker-dealers to sell or make a market in our common stock and
the ability of purchasers of our common stock to sell their securities in the
secondary market. In addition, when the market price of our common stock is less
than $5.00 per share, we become subject to penny stock rules even if our common
stock is still listed on the Nasdaq National Market. While the penny stock rules
should not affect the quotation of our common stock on the Nasdaq National
Market, these rules may further limit the market liquidity of our common stock
and the ability of investors to sell our common stock in the secondary market.
U.S. EXPORT CONTROLS COULD HINDER OUR ABILITY TO MAKE SALES TO FOREIGN CUSTOMERS
AND OUR FUTURE PROSPECTS. The U.S. government regulates the export of
high-performance computer systems such as our products. Occasionally we have
experienced delays in receiving appropriate approvals necessary for certain
sales, which has delayed the shipment of our products. Delay or denial in the
granting of any required licenses could make it more difficult to make sales to
foreign customers, eliminating an important source of potential revenue.
PROVISIONS IN OUR AGREEMENT WITH SILICON GRAPHICS MAKE IT MORE DIFFICULT FOR
SPECIFIED COMPANIES TO ACQUIRE US. The terms of our purchase of the assets of
Cray Research contain provisions restricting our ability to transfer the assets
of Cray Research. Sales of these assets to Hewlett-Packard, Sun Microsystems,
IBM, Compaq Computer, NEC or Gores Technology Group, or their affiliates, are
prohibited until the earlier of March 31, 2003, or if Silicon Graphics were
sold.
PROVISIONS OF OUR ARTICLES AND BYLAWS COULD MAKE A PROPOSED ACQUISITION THAT IS
NOT APPROVED BY OUR MANAGEMENT MORE DIFFICULT. Provisions of our restated
articles of incorporation and restated bylaws could make it more difficult for a
third party to acquire us. These provisions could limit the price that investors
might be willing to pay in the future for our common stock. For example, our
articles of incorporation and bylaws provide for:
- a staggered board of directors, so that only two or three of eight directors
are elected each year;
- removal of a director only in limited circumstances and only upon the
affirmative vote of not less than two-thirds of the shares entitled to vote
to elect directors;
- the issuance of preferred stock, without shareholder approval, with rights
senior to those of the common stock;
- no cumulative voting of shares;
- calling a special meeting of the shareholders only upon demand by the
holders of not less than 30% of the shares entitled to vote at such a
meeting;
- amendments to our restated articles of incorporation require the affirmative
vote of not less than two-thirds of the outstanding shares entitled to vote
on the amendment, unless the amendment was approved by a majority of our
continuing directors, who are defined as directors who have either served as
a director since August 31, 1995 or were nominated to be a director by the
continuing directors;
- special voting requirements for mergers and other business combinations,
unless the proposed transaction was approved by a majority of continuing
directors;
- special procedures must be followed to bring matters before our shareholders
at our annual shareholders' meeting; and
- special procedures must be followed in order for nominating members for
election to our board of directors.
WE DO NOT ANTICIPATE DECLARING ANY DIVIDENDS. We have never paid any dividends
on our common stock and we intend to continue our policy of retaining any
earnings to finance the development and expansion of our business.
16
ITEM 2. PROPERTIES
The Company's principal properties are as follows:
APPROXIMATE
LOCATION OF PROPERTY USES OF FACILITY SQUARE FOOTAGE
-------------------- ---------------- --------------
Chippewa Falls, Wisconsin ...... Manufacturing, vector and SV2 hardware development, 222,000
central service and warehouse
Seattle, Washington............. Executive offices, MTA and cluster hardware and 85,000
software development, marketing
Mendota Heights, Minnesota ..... Vector and SV2 software development, sales and marketing 40,000
operations
We lease the properties described above except that we own 179,000 square
feet of manufacturing, development, service and warehouse space in Chippewa
Falls, Wisconsin.
We also lease a total of approximately 10,654 square feet, primarily for
sales and service offices, in various domestic locations. In addition, various
foreign sales and service subsidiaries have leased an aggregate of approximately
22,720 square feet of office space. We believe our facilities are adequate to
meet our needs in 2002.
ITEM 3. LEGAL PROCEEDINGS
We are not a party to any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our shareholders during the fourth
quarter of 2001.
17
ITEM E.O. EXECUTIVE OFFICERS OF THE COMPANY
Our executive officers as of April 1, 2002, were as follows:
NAME AGE POSITION
---- --- --------
Burton J. Smith 61 Chief Scientist
James E. Rottsolk 57 Chairman, President and Chief Executive Officer
Kenneth W. Johnson 59 Vice President - Legal, General Counsel, and Secretary
Lori C. Kaiser 44 Vice President - Marketing and Strategic Planning
David R. Kiefer 53 Vice President - Product Engineering and Manufacturing
Gerald E. Loe 52 Vice President - Worldwide Sales and Service
Douglas C. Ralphs 43 Vice President - Finance and Chief Financial Officer
Richard M. Russell 57 Vice President - Sales and Service, Asia Pacific
Burton J. Smith is one of our co-founders and has been our Chief Scientist
and a Director since our inception in 1987. He served as our Chairman from 1987
to June 1999. He is a recognized authority on high performance computer
architecture and programming languages for parallel computers, and is the
principal architect of the MTA system. Mr. Smith was a Fellow of the
Supercomputing Research Center (now Center for Computing Sciences), a division
of the Institute for Defense Analyses, from 1985 to 1988. He was honored in 1990
with the Eckert-Mauchly Award given jointly by the Institute for Electrical and
Electronic Engineers and the Association for Computing Machinery, and was
elected a Fellow of both organizations in 1994. Mr. Smith received S.M., E.E.
and Sc.D. degrees from the Massachusetts Institute of Technology.
James E. Rottsolk is one of our co-founders and serves as our Chairman,
President and Chief Executive Officer. He served as our President and Chief
Executive Officer since our inception through September 2001, and was
reappointed to those positions in March 2002. He has served as Chairman of the
Board since December 2000. Prior to 1987, Mr. Rottsolk served as an executive
officer with several high technology start-up companies. Mr. Rottsolk received a
B.A. degree from St. Olaf College and A.M. and J.D. degrees from the University
of Chicago.
Kenneth W. Johnson serves as Vice President - Legal, General Counsel and
Secretary and has held those positions since joining us in September 1997. From
September 1997 to December 2001 he also served as our Vice President - Finance
and Chief Financial Officer. Prior to joining us, Mr. Johnson practiced law in
Seattle for twenty years with Stoel Rives LLP and predecessor firms, where his
practice emphasized corporate finance. Mr. Johnson received an A.B. degree from
Stanford University and a J.D. degree from Columbia University Law School.
Lori C. Kaiser serves as Vice President - Marketing and Strategic Planning, a
position she has held since December 2001. She joined us in May 2001 as Director
of Strategic Planning. Before joining us, she consulted with software start-up
companies from 2000 to 2001, and she held senior operational and sales positions
at Icicle Seafoods, Inc. from 1995 to 2000. Prior to 1995 she held various
marketing, operations and financial management positions in several industries,
including audit and consulting positions with Deloitte & Touche LLP from 1981 to
1991. Ms. Kaiser has a B.A. in business from the University of Washington and is
a certified public accountant in the State of Washington.
David R. Kiefer serves as Vice President - Product Engineering and
Manufacturing, a position he has held since December 2001. From April 2000, when
he joined us, through December 2001, he held the position of Vice President -
Hardware Engineering. From 1996 to 2000, Mr. Kiefer was Director of Hardware
Engineering at the Cray Research operations of Silicon Graphics, Inc. Prior to
joining Silicon Graphics, he held a variety of engineering and engineering
management positions with Univac and Cray Research, Inc. Mr. Kiefer received his
B.S. in Electrical Engineering from the University of Wisconsin.
Gerald E. Loe serves as Vice President - Worldwide Sales and Service, a
position he has held since December 2001. He joined us in 1992 as Vice President
- Hardware Engineering; he was named Vice President - Hardware Engineering in
1996 and Vice President - Worldwide Service in April 2000. Prior to joining us,
he was Vice President of Operations at Siemens Quantum Inc., a high-end
radiology ultrasound company, from 1989 to 1992. Mr. Loe received a B.S.M.E.
from the Massachusetts Institute of Technology and a M.B.A. from Harvard
Business School.
18
Douglas C. Ralphs serves as Vice President - Finance and Chief Financial
Officer, positions he has held since December 2001. Previously he served as Vice
President - Corporate Controller from November 2000, when he joined us. He was
chief financial officer at Interpoint, Inc. from 1998 until October 2000, and
held various financial management positions at Itron, Inc. from 1989 to 1998,
serving as treasurer from 1997 to 1998. He previously held financial positions
with Hewlett-Packard Co. and Morrison Knudsen. He received a M.B.A. from the
University of Chicago and a B.A. from Boise State University.
Richard M. Russell serves as Vice President - Sales and Service, Asia
Pacific, a position he has held since December 2001. He joined us as Director of
New Business Development in 1995 and was named as Vice President - Marketing in
March 1998. In February 2000 he was appointed Vice President - International.
Prior to joining us, he worked in a variety of sales and marketing positions at
several high technology companies, including Cray Research, Inc. from 1976
through 1990 and Kendall Square Research Corporation from 1991 through 1994. Mr.
Russell was educated in England.
19
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is traded on the Nasdaq National Market under the symbol
CRAY; prior to April 1, 2000, our stock traded under the symbol TERA. On March
28, 2002, we had 45,127,474 shares of common stock outstanding that were held by
841 holders of record. We have not paid cash dividends on our common stock. We
currently anticipate that we will retain all available funds for use in our
business and do not anticipate paying any cash dividends on our common stock in
the foreseeable future. In addition, our credit facilities restrict our ability
to pay cash dividends.
The quarterly high, low and closing sales prices of our common stock for the
periods indicated are as follows:
2000 2001
--------------------------- ---------------------------
HIGH LOW CLOSE HIGH LOW CLOSE
----- ----- ----- ----- ----- -----
First Quarter ...... 11.50 4.13 6.44 2.94 1.59 1.84
Second Quarter ..... 6.88 3.00 3.44 2.71 1.53 2.38
Third Quarter ...... 7.63 3.28 4.67 3.45 1.71 1.96
Fourth Quarter ..... 4.50 1.13 1.50 2.91 1.71 1.87
On March 28, 2002, the closing sales price for the common stock was $2.29.
Unregistered Private Sales of Securities
In November 2001, we sold to six accredited investors (i) 5% convertible
subordinated debentures in the aggregate original principal amount of
$9,300,000, convertible into shares of our common stock as described below, and
(ii) common stock purchase warrants exercisable into an aggregate of 367,590
shares of our common stock at an initial exercise price of $4.4275 per share,
exercisable until November 6, 2004. The placement closed in two tranches, on
November 6 and 15, 2001. The six investors were Riverview Group, LLC, Omicron
Partners, LP, Laterman & Co., Forevergreen Partners, Clarion Capital Corporation
and The Morton A. Cohen Revocable Living Trust. We received gross proceeds of
$9,300,000 in exchange for the issuance of the debentures and the warrants.
After payment of the finder's fee and other expenses of the offering, the net
proceeds of the offering were approximately $8,550,000. No underwriters were
involved in this private placement.
The Convertible Subordinated Debentures. The debentures bear interest at the
rate of 5% per year, payable semi-annually commencing May 6, 2002. We can elect
to pay interest in cash or in shares of our common stock. The debentures mature
on November 6, 2004.
The holders of the debentures can choose to convert all or a portion of the
principal amount outstanding into shares of our common stock at any time before
the maturity date of November 6, 2004. The debentures are convertible into
common stock at a fixed conversion price of $2.35 per share from the date of
issuance until maturity. In addition, during each three-month period beginning
on February 6, 2002, each holder may convert on a cumulative basis up to 25% of
the original principal amount of each holder's debenture at a floating
conversion price. The floating conversion price is equal to 94% of the average
of the 7 lowest daily volume weighted average prices during the 20 trading days
immediately prior to the date upon which the debenture is converted.
On the maturity date of November 6, 2004, the holders are obligated to
convert any remaining principal into common stock at a conversion price equal to
the average of the closing prices during the 15 trading days immediately prior
to the maturity date.
We are not required to issue to the debenture holders in excess of 8,422,204
shares below the market price of our common stock in accordance with Nasdaq
rules, or such greater number of shares permitted under Nasdaq Rule 4350(i). In
such event, the debenture holders may elect to require us to convert the
debentures at the lowest possible conversion price that complies with Nasdaq
rules or to redeem the portion of the debentures which were not able to be
converted by payment of 105% of the outstanding principal, plus accrued
interest, if the redemption were by May 6, 2002, or of 110% of the outstanding
principal, plus accrued interest, if the redemption were after May 6, 2002,
provided that we are not obligated to redeem more than 25% of the original
principal amount of the debentures every three months on a cumulative basis
beginning on February 6, 2002.
20
A debenture holder may not convert its debenture or receive shares of our
common stock as payment of interest to the extent that, at the time of the
conversion or payment, the sum of (i) the number of shares of our common stock
beneficially owned by the holder plus (ii) the number of shares to be issued
upon conversion and payment would exceed 4.999% of the number of shares of our
common stock then issued and outstanding, including other shares of our common
stock issuable upon conversion of, or payment of interest on, the holder's
debenture. The holder may terminate this restriction upon 61 days' prior notice
to us.
The Warrants. The warrants are exercisable for a total of 367,590 shares of
our common stock at an exercise price of $4.4275 payable in cash. The warrants
are exercisable until November 6, 2004. The number of shares issuable upon
exercise and the exercise price are subject to adjustment in the event of a
stock dividend, a stock split or combination or a reclassification of our common
stock, but otherwise do not have exercise price adjustments.
The sale of the debentures and the warrants to the investors was exempt from
the registration provisions of the Securities Act, under Sections 4(2) and 4(6)
of the Securities Act, and the rules and regulations thereunder, because of the
nature of the offerees and investors and the manner in which the offering was
conducted.
Further information regarding the debentures, the warrants and this
transaction is contained in our Report on Form 8-K filed with the Securities and
Exchange Commission on November 28, 2001.
ITEM 6. SELECTED FINANCIAL DATA
Financial data for fiscal year 2000 in the following table includes nine
months of activity of the Cray Research business unit acquired on April 1, 2000.
Period to period comparisons that include periods prior to April 1, 2000, are
not indicative of future results. See "Business - Cray Acquisition" above.
YEARS ENDED DECEMBER 31,
-------------------------------------------------------------------------
1997 1998 1999 2000 2001
--------- --------- --------- --------- ---------
Operating Data:
Product Revenue .......................... $ $ 1,274 $ 1,794 $ 46,617 $ 51,105
Service Revenue .......................... 714 320 71,455 82,502
Cost of Product Revenue .................. 3,759 15,165 32,505 30,657
Cost of Service Revenue .................. 584 273 34,077 41,181
Research and Development ................. 13,142 13,664 15,216 48,426 53,926
Net Loss ................................. (15,755) (19,803) (34,532) (25,388) (35,228)
Comprehensive Loss ....................... (18,672) (20,736) (34,647) (25,516) (35,862)
Net Loss per Common Share ................ $ (2.13) $ (1.70) $ (1.74) $ (0.78) $ (0.87)
Weighted Average Outstanding Shares ...... 8,785 12,212 19,906 32,699 40,632
Balance Sheet Data:
Cash and Cash Equivalents ................ $ 13,329 $ 3,162 $ 10,069 $ 4,626 $ 12,377
Working Capital .......................... 14,342 7,269 9,208 (25,970) (5,724)
Warranty Reserves, Long-term Portion ..... 14,285 8,479
Capital Leases, Long-term Portion ........ 532 573 390 284 421
Term Loan Payable ........................ 6,071
Notes Payable, Long-term Portion ......... 1,022 254 8,387
Total Assets ............................. 20,859 20,288 23,410 136,193 127,087
Redeemable Securities .................... 9,478
Shareholders' Equity ..................... 6,368 11,889 14,307 36,147 39,750
Statistical Data:
Number of Full-time Employees ............ 84 109 123 886 842
21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
PRELIMINARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
The information set forth in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" below includes "forward-looking
statements" within the meaning of Section 21E of the Securities Exchange Act of
1934, and is subject to the safe harbor created by that Section. Factors that
realistically could cause results to differ materially from those projected in
the forward-looking statements are set forth in this section and earlier in this
report under "Business -- Factors That Could Affect Future Results" beginning on
page 9. The following discussion should also be read in conjunction with the
Financial Statements and accompanying Notes thereto.
OVERVIEW
We design, develop, market and service high-performance computer systems,
commonly known as supercomputers. We presently market four computer systems, the
Cray SV1ex, Cray T3E, Cray SX-6 and cluster solutions, and provide maintenance
services to the world-wide installed base of these and earlier models of Cray
computers. We are developing two new computer systems, the MTA-2, based on our
multithreaded architecture system, and the SV2, which will combine elements of
the SV1 and T3E computers. We recently have commenced offering professional
services to leverage our reputation and skills for services and industry
technical knowledge.
In 2000 and for part of 2001 we largely were involved in the separation of
the Cray Research operations from those of SGI and integrating them with our
own. This process included establishing separate network, communications and
other infrastructure services, reconstituting the marketing and sales
operations, setting up subsidiary operations for international sales and
services, implementing new operational policies and procedures, and identifying
and filling openings in management, administration and other areas. This process
largely has been completed.
We have experienced net losses in each year of operations. We incurred net
losses of approximately $35.2 million in 2001, $25.4 million in 2000 and $34.5
million in 1999.
We recognize revenue from sales of our computer systems upon acceptance by
the customer, although in limited circumstances, depending on sales contract
terms, revenue may be recognized when title passes upon shipment or may be
delayed until funding is certain. We recognize service revenue from the
maintenance of our computer systems ratably over the term of each maintenance
agreement. Funds from maintenance contracts that are paid in advance are
recorded as deferred revenue.
Factors that should be considered in evaluating our business, operations and
prospects and that may affect our future results and financial condition are set
forth above, beginning on page 9.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
This discussion as well as disclosures included elsewhere in this Form 10-K
are based upon our consolidated financial statements, which have been prepared
in accordance with accounting principles generally accepted in the United States
of America. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingencies. On an ongoing
basis, we evaluate the estimates used, including those related to estimates of
warranty liabilities, valuation of inventory at the lower of cost or market and
impairment of goodwill. We base our estimates on historical experience, current
conditions and on various other assumptions that we believe to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources as well as identifying and assessing our
accounting treatment with respect to commitments and contingencies. Actual
results may differ from these estimates under different assumptions or
conditions. We believe the following critical accounting policies involve the
more significant judgments and estimates used in the preparation of the
consolidated financial statements:
22
T90 Reserve. We acquired service contracts in the Cray Research acquisition
for T90 vector computers. Some of the components in the T90 vector computers,
which were sold prior to the acquisition, have an unusually high failure rate.
At the date of the acquisition we recorded a warranty reserve of $47.5 million
to reflect our estimate of the amount by which the cost of servicing the T90
vector computers would exceed the revenue generated from servicing them until
they were no longer in use by our customers. As we incur costs to service these
computers, we reduce the amount of the warranty reserve. As of December 31,
2001, our total warranty reserve balance is $15.0 million, of which $14.5
million relates to the T90 vector computers. We continually monitor the
reasonableness of our estimate of the warranty reserve. This involves analysis
of our assumptions with regard to the length of time the T90 vector computers
will be in use by our customers, the failure rate of modules in the computers
considering actual historical failure rates, and personnel and resources,
including service spares, that will be required to correct failures that occur
in the future. To date, our estimates of the costs incurred to service the T90
vector computers have approximated the actual costs we have incurred. We believe
that the warranty reserve balance at December 31, 2001, is a reasonable estimate
of the extent to which our costs to service these computers will exceed the
revenue generated from existing service contracts. It is possible, however, that
our estimates may prove to be inaccurate and that our actual costs may differ
materially from our estimates.
Inventories. We record our inventories at the lower of cost or market. We
regularly evaluate the technological usefulness of various inventory components.
When it is discovered that previously inventoried components do not function as
intended in a fully operational system, the costs associated with these
components are expensed. Due to rapid changes in technology and the increasing
demands of our customers, we are continually developing new products. As a
result, it is possible that older products we have developed may become obsolete
or we may require to sell these products below cost. When we determine that we
will likely not recover the cost of inventory items through future sales, we
write down the related inventory to our estimate of its market value. As of
December 31, 2001, we had an allowance for excess and obsolete inventory of $8.5
million applied against our gross inventory balance of $27.4 million. Because
the products we sell have high average sales prices and because a high number of
our prospective customers receive funding from U.S. or foreign governments, it
is difficult to estimate future sales of our products and the timing of such
sales. It also is difficult to determine whether the cost of our inventories
will ultimately be recovered through future sales. While we believe our
inventory is stated at the lower of cost or market and that our estimates and
assumptions to determine any adjustments to the cost of our inventories are
reasonable, our estimates may prove to be inaccurate. We may have future sales
of inventory previously written down to zero. We may also have additional
expense to write down inventory to its estimated market value. Adjustments to
these estimates in the future may materially impact our operating results.
Goodwill. Approximately 18% of our assets as of December 31, 2001, consist
of goodwill resulting from our acquisition of Silicon Graphics in 2000.
As discussed below in the "Recent Accounting Pronouncements" section, we adopted
SFAS No. 142 on January 1, 2002, and will no longer amortize goodwill associated
with the acquisition, but we will be required to conduct ongoing analyses of the
recorded amount of goodwill in comparison to its estimated fair value. These
ongoing analyses of whether the fair value of recorded goodwill is impaired will
involve a substantial amount of judgment. Future charges related to goodwill
could be material depending on future developments and changes in technology and
our business.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
With the acquisition of the Cray Research business unit on April 1, 2000,
period-to-period comparisons of our operating results that include periods prior
to the acquisition are not indicative of results for any subsequent period.
Revenue. We had revenue from product sales of $51.1 million for 2001, up from
$46.6 million in 2000 and $1.8 million in 1999. Product revenue represented 38%
of total revenue for 2001 and consisted primarily of $19.1 million for our SV1
and SV1ex product line and $27.3 million for our T3E product line, including
$2.2 million from the sale of inventory previously written down to a zero cost
basis. Product sales revenue were less than anticipated due to delays in
completing the SV1ex enhancements, with the first complete SV1ex product
shipment not occurring until late November 2001. Product sales for Cray Research
products declined during each of the three years prior to our acquisition of the
Cray Research business unit, primarily because SGI had stopped development
funding of new Cray Research products. We expect that our product sales revenue
will increase as we introduce
23
upgrades to the current product line and our new products currently under
development. 1999 revenue included $1.7 million from the upgrade of the MTA
system at the San Diego Supercomputer Center to eight processors.
We had service revenue of $82.5 million in 2001, up from $71.5 million for
2000 and $320,000 in 1999. Services are provided under separate maintenance
contracts with our customers. These contracts generally provide for maintenance
services for one year, although some are for multi-year periods. The overall
increase in service revenue is due to the acquisition of the Cray product line
and related service business in April 2000. Service revenue on an annualized
basis has continued to decline over the periods prior to our acquisition of the
Cray Research business unit and we expect this decline to continue over the next
year or so as older systems are withdrawn from service and then to stabilize as
our new systems are placed in service. Service revenue represented 62% and 61%
of total revenues for 2001 and 2000, respectively.
Operating Expenses. Cost of product revenue was $30.7 million for 2001, $32.5
million for 2000 and $15.2 million for 1999. Cost of product revenue represented
60%, 70%, and 845% of product revenue for 2001, 2000 and 1999, respectively. The
high cost of product revenue in 2000 is due to the age of the SV1 and T3E
product lines and inventory adjustments for SV1 and MTA gallium arsenide parts.
Cost of product revenue was high in 1999 as a percentage of the revenue due to
the inclusion of manufacturing costs and inventory adjustments relating to the
MTA product line and favorable pricing terms provided to our first MTA customer.
Cost of service revenue was $41.2 million for 2001, $34.1 million for 2000
and $273,000 for 1999. Cost of service revenue represented 50%, 48%, and 85% of
service revenue for 2001, 2000 and 1999.
Research and development expenses reflect our costs associated with the
enhancements to the Cray SV1 and T3E systems and the development of the MTA and
SV2 systems, including related software development. These costs also include
personnel expenses, allocated overhead and operating expenses, software,
materials and engineering expenses, including payments to third parties. These
costs are offset in part by governmental development funding. Net research and
development expenses were $53.9 million in 2001, $48.4 million for 2000 and
$15.2 million for 1999 with governmental developmental funding being $12.6
million in 2001, $9.3 million in 2000 and $72,000 in 1999. Research and
development expenses represented 40%, 41%, and 720% of revenue for 2001, 2000,
and 1999, respectively. We expect that research and development expenses will
decrease in 2002, due to reductions in third-party non-recurring engineering
expenses as we complete development of the MTA-2 and SV-2 systems, reductions in
personnel and increased governmental funding. Over time, with receipt of
increased revenue from products currently under development, sales of the Cray
SX-6 series of computers and cluster systems and professional services
engagements, we expect research and development expenses to decrease as a
percentage of overall revenue.
Marketing and sales expense were $20.0 million in 2001, $14.4 million in 2000
and $2.5 million in 1999. The increase in these expenses from 1999 to 2001 was
due to the acquisition of the Cray Research business unit, which required us to
re-establish the Cray sales and customer support staff and increase expenditures
in connection with sales and marketing, benchmarks and development of third
party applications software. We expect marketing and sales expense in 2002 to be
relatively even with 2001 expense levels.
General and administrative expenses were $9.2 million for 2001, $7.0 million
in 2000 and $3.1 million in 1999. The increase in these expenses from 1999 to
2001 was due to the acquisition of the Cray Research operations, which required
us to add managerial and administrative staff and increases in legal, accounting
and consulting expenses in connection with establishing foreign operations and
implementing new accounting systems. General and administrative expenses should
stabilize or decrease from 2001 levels and decline as a percentage of revenue.
We incurred a restructuring charge of $3.8 million in 2001. These charges
are primarily for severance expenses related to the termination of approximately
102 employees in the third and fourth quarters of 2001. As of December 31, 2001
we had paid $2.1 million of this charge and the remaining $1.7 million is
included in accrued payroll and related expenses.
We incurred amortization expense of $7.0 million in 2001 and $5.2 million in
2000, primarily related to the goodwill from the acquisition of the Cray
Research business unit. The Company will apply SFAS No. 142 beginning in the
first quarter of 2002. Application of the non-amortization provisions of SFAS
No. 142 is expected to reduce amortization expense in 2002. See "Recent
Accounting Pronouncements" below.
24
Interest Income (Expense). Interest income was $224,000 for 2001, $690,000
for 2000, and $537,000 for 1999. The higher amounts in 2000 and 1999 reflect the
Company's increased cash position due to the sales of equity securities in the
first quarter of 2000, and in 1999.
Interest expense was $2.0 million for 2001, $2.4 million for 2000 and
$815,000 for 1999. The increase in 2001 and 2000 over 1999 was largely due to
$1.0 million of non-cash interest associated with the value of the conversion
feature of certain investor promissory notes and $1.0 million of interest paid
on our term loan, line of credit, capital lease and debt obligations in 2001. In
2000, we recognized imputed interest expense of $1.4 million on the non-interest
bearing note issued to SGI, a non-cash interest expense of approximately
$336,000 associated with the value of the conversion feature of certain investor
promissory notes, a non-cash expense of $200,000 for the value of warrants
issued in conjunction with investor promissory notes and $92,000 of interest
paid on a line of credit.
Taxes. We made a provision of $994,000 and $831,000 for international income
taxes in 2001 and 2000, respectively. As of December 31, 2001, we had net
operating loss carry-forwards of approximately $137.1 million which expire in
years 2003 through 2020, if not utilized.
Net Loss. Our net loss in 2001 of $35.2 million was greater than our net loss
in 2000 of $25.4 million and $34.5 million in 1999. The 2001 net loss largely
was due to the delays in completing the SV1ex enhancements until late November
2001. The 2000 net loss includes a loss of $8.0 million during the first
quarter, prior to our acquisition of the Cray Research business operations. We
continue to incur substantial research and development expenses, particularly as
a percentage of revenue. To become profitable we need to increase our product
revenue from sales of our enhancements of our current products and our products
under development and control expenses to match conservative revenue
projections. See "Business -- Product and Service Offerings and the High
Performance Computer Market" and "Business -- Research and Development."
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents totaled $12.4 million at December 31, 2001 compared
to $4.6 million at December 31, 2000. Restricted cash balances, which serve as
collateral for capital equipment loans and leases, totaled $353,000 at December
31, 2001, and $761,000 at December 31, 2000. As of December 31, 2001, we had a
working capital deficit of $5.7 million compared to a $25.9 million deficit at
the end of 2000.
Net cash used by operating activities was $26.2 million for the year ended
December 31, 2001, compared to net cash provided of $5.1 million in 2000. For
2001, net operating cash flows were primarily attributed to our net loss offset
by depreciation and amortization, along with decreases in accounts payable and
warranty reserves. The increase in net cash used in operating activities in 2001
over 2000 was primarily attributed to the acquisition of the Cray Research
business unit in April of 2000.
Net cash used in investing activities was approximately $9.5 million for the
year ended December 31, 2001, compared to $57.4 million for 2000. In 2001, the
net cash used in investing activities was primarily for electronic test
equipment and computer hardware purchases. In 2000, we paid a total of $51.6
million to acquire the Cray Research business unit. We also spent $5.8 million
on fixed assets, primarily consisting of computer hardware and software and
electronic test equipment.
Net cash provided by financing activities was $44.0 million for the year
ended December 31, 2001, compared to $47.0 million for 2000. In 2001, we raised
$24.9 million through the sale of preferred stock to NEC, and in November we
issued $9.3 million in convertible subordinated notes. Also in 2001, we obtained
a three-year term loan of $7.5 million. In early 2000, we raised $25.2 million
in a private placement of 5.2 million shares of common stock and $8.9 million
from the exercise of common stock warrants. We also raised $12.5 million in the
fall of 2000 through the issuance of promissory notes to two investors, retiring
$4.2 million of these notes by year-end through conversion into common stock and
the remainder in the first four months of 2001 by additional conversions.
Over the next twelve months our significant cash requirements will relate to
operational expenses, primarily for personnel, inventory and third-party
engineering services, and acquisition of capital goods. These expenses include
our commitments to acquire components and manufacturing and engineering
services. We expect that anticipated product sales, professional services,
maintenance services and government funding of research and development
25
expenses over the next twelve months, coupled with limitations on operating
expenses and capital expenditures, will generate overall positive cash flow. At
any particular time, given the high average selling price of our products, our
cash position is affected by the timing of payment of product sales, receipt of
prepaid maintenance revenue and receipt of government funding for research and
development activities. In addition, any delays in either of the development of
the MTA-2 or the SV2 system may require additional capital earlier than planned.
While we believe our cash resources will be adequate for the next twelve months,
we may need to raise additional equity and/or debt capital if we experience
lower than anticipated product sales due to delays in product availability and
general economic conditions or if we do not receive sufficient governmental
support for our products and research activities. In addition we may raise
additional funds to enhance our working capital position. Financings may not be
available to us when needed or, if available, may not be available on
satisfactory terms and may be dilutive to our shareholders. A summary of our
contractual cash obligations follows:
Payments Due By Periods
----------------------------------------------------------------
Less than 1-3 4-5 After 5
Total 1 year years years years
-------- --------- -------- -------- --------
Contractual Obligations
Notes payable $ 486 $ 486
Term loan payable 6,071 2,143 3,928
Capital lease obligations 898 425 473
Operating leases 20,768 3,494 9,023 5,500 2,751
Unconditional purchase obligations 1,961 1,961
-------- -------- -------- -------- --------
Total Contractual Cash Obligations $ 30,184 $ 8,509 $ 13,424 $ 5,500 $ 2,751
======== ======== ======== ======== ========
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 141, Business Combinations and SFAS No. 142, Goodwill and Other Intangible
Assets. SFAS No. 141 requires business combinations initiated after June 30,
2001 to be accounted for using the purchase method of accounting, and broadens
the criteria for recording intangible assets separate from goodwill. SFAS No.
142 requires the use of a non-amortization approach to account for purchased
goodwill and certain intangibles. Under a non-amortization approach, goodwill
and certain intangibles will not be amortized into results of operations, but
instead would be reviewed for impairment and written down and charged to results
of operations only in the periods in which the recorded value of goodwill and
certain intangibles is more than its fair value. We will apply SFAS No. 142
beginning in the first quarter of 2002. We will test goodwill for impairment
using the two-step approach prescribed in SFAS No. 142. The first step is a
screen for potential impairment, while the second step measures the amount of
the impairment, if any. We expect to perform the first of the required
impairment tests of goodwill in the first six months of 2002. Any impairment
charge resulting from these transitional impairment tests will be reflected as
the cumulative effect of a change in accounting principle in the first six
months of 2002.
In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations. This statement establishes accounting standards for recognition and
measurement of a liability for an asset retirement obligation and the associated
asset retirement cost. This statement is effective for financial statements
issued for fiscal years beginning after June 15, 2002. We do not expect the
adoption of SFAS No. 143 to have a material effect on our financial position or
results of operations.
In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment
or Disposal of Long-Lived Assets. This statement supercedes SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for Assets to Be Disposed
Of, and the accounting and reporting provisions of APB Opinion 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, for the disposal of a segment of a business (as previously defined
in that Opinion). SFAS No. 144 establishes a single accounting model, based on
the framework established in SFAS No. 121, for long-lived assets to be disposed
of by sale. It retains the fundamental provisions of SFAS
26
No. 121 for (a) recognition and measurement of the impairment of long-lived
assets to be held and used and (b) measurement of long-lived assets to be
disposed of by sale. SFAS No. 144 is effective for fiscal years beginning after
December 15, 2001, with earlier application encouraged. We have not yet
determined the impact of adopting SFAS No. 144 on our financial position or
results of operations
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Substantially all of our cash equivalents and marketable securities are held
in money market funds or commercial paper of less than 90 days that is held to
maturity. Accordingly, we believe that the market risk arising from our holdings
of these financial instruments is minimal. We sell our products primarily in
North America, but with significant sales in Asia and Europe. As a result, our
financial results could be affected by factors such as changes in foreign
currency exchange rates or weak economic conditions in foreign markets. Our
products are generally priced in U.S. dollars, and a strengthening of the dollar
could make our products less competitive in foreign markets. While we commonly
sell products with payments in U.S. dollars, our product sales contracts
occasionally call for payment in foreign currencies and to the extent we do so,
we are subject to foreign currency exchange risks. We believe that a 10% change
in foreign exchange rates would not have a material impact on the financial
statements. Our foreign maintenance contracts are paid in local currencies and
provide a natural hedge against local expenses. To the extent that we wish to
repatriate any of these funds to the United States, however, we are subject to
foreign exchange risks. We do not hold any derivative instruments and have not
engaged in hedging transactions. At December 31, 2001, we had fixed rate
convertible debentures of $9.3 million and a variable rate term loan $6.1
million that are both due in 2004. Our minimum payment commitment on the term
loan is fixed during the term. Interest payments on our term loan fluctuate
with movements of interest rates, increasing in periods of rising rates of
interest and declining in periods of decreasing rates of interest.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS*
Consolidated Balance Sheets at December 31, 2000 and December 31, 2001................ F-1
Consolidated Statements of Operations and Comprehensive Loss for each of the
three years in the period ended December 31, 2001................................... F-2
Consolidated Statements of Shareholders' Equity for each of the three years
in the period ended December 31, 2001............................................... F-3
Consolidated Statements of Cash Flows for each of the three years in the
period ended December 31, 2001...................................................... F-4
Notes to Consolidated Financial Statements............................................ F-5
Independent Auditors' Report.......................................................... F-26
----------
* The Financial Statements are located following page 35.
QUARTERLY FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The following table presents unaudited quarterly financial information for
the two years ended December 31, 2001. In the opinion of management, this
information contains all adjustments, consisting only of normal recurring
adjustments, necessary for a fair presentation thereof. The operating results
are not necessarily indicative of results for any future periods.
2000 2001
------------------------------------------- -------------------------------------------
3/31 6/30 9/30 12/31 3/31 6/30 9/30 12/31
-------- -------- -------- -------- -------- -------- -------- --------
FOR THE QUARTER ENDED
Revenue .............................. $ 43 $ 50,973 $ 33,688 $ 33,368 $ 48,747 $ 9,423 $ 29,376 $ 26,061
Cost of Sales ........................ 2,029 27,503 18,426 18,624 22,455 14,990 17,112 17,281
Gross margin ......................... (1,986) 23,470 15,262 14,744 26,292 4,433 12,264 8,780
Research and Development ............. 4,483 13,865 13,272 16,806 13,039 14,148 13,211 13,528
Marketing and Sales .................. 768 2,822 4,397 6,378 4,701 4,882 5,276 5,102
General and Administrative ........... 1,101 1,898 1,645 2,389 2,139 2,244 1,937 2,906
Restructuring Charge ................. 1,284 2,518
Net Income (loss) .................... (8,005) 2,661 (6,097) (13,947) 2,789 (9,886) (10,799) (17,332)
Comprehensive income (loss) .......... (8,005) 2,661 (6,097) (13,875) 1,956 (9,869) (10,159) (17,790)
Net Income (loss) Per Common
Share, Basic and Diluted ........... $ (0.27) $ 0.08 $ (0.18) $ (0.41) $ 0.07 $ (0.24) $ (0.26) $ (0.41)
27
On April 1, 2000, we acquired the operating assets of the Cray Research
business unit from Silicon Graphics, Inc. ("SGI"), and changed our corporate
name from Tera Computer Company to Cray Inc. With that acquisition we changed
from a development stage company with 125 employees (almost all located in
Seattle, Washington), limited revenue and one product under development, to a
company with nearly 900 employees located in over 20 countries, ongoing sales of
supercomputer systems with several products in development, major manufacturing
operations, an established service organization and substantial inventory. For
these reasons, period to period comparisons that include periods prior to April
1, 2000, are not indicative of future results. Discussions that relate to
periods prior to April 1, 2000, refer to our operations as Tera Computer Company
and discussions that relate to periods after April 1, 2000, refer to our
combined operations as Cray Inc.
Revenue in the quarter ended June 30, 2000 was high due to the sale of a
$17.1 million T3E system while revenue decreased in the subsequent two quarters
of 2000 due to lower than planned product sales. Net loss for the quarter ended
December 31, 2000 increased over the quarter ended September 30, 2000 primarily
due to an impairment loss of $3.3 million on MTA test equipment, higher
prototype expenses for the MTA2 and SV2, as well as higher sales expenses from
our foreign subsidiaries. Revenue in the quarter ended March 31, 2001, was the
highest for the year due to the sale of a $21 million T3E system to the U.S.
Department of Defense while revenue declined in the following three quarters due
to lower than planned product sales, primarily due to the delay in completing
the SV1ex systems until late November 2001, the cancellation of the SuperCluster
project and delays in completing the development of the MTA-2 system. Second
quarter 2001 revenue were lowest during the year due to the product delays, a
$3.0 million sale that slipped into the first week of the third quarter, and
lost sales opportunities. In the 2001 second quarter, research and development
expenses were high due to higher prototype costs relating to the SV2 and MTA
programs and general and administrative expenses were high due to higher legal
and audit fees. In the 2001 fourth quarter we had $4.8 million of one-time
reserves and charges. The restructuring charge in 2001 related to severance
expenses in connection with the termination of an aggregate of 102 employees in
the third and fourth quarters of 2001.
The Company's future operating results may be subject to quarterly
fluctuations as a result of a number of factors, including the timing of
deliveries of the Company's products. See "Business -- Factors That Could Affect
Future Results." Quarter-to-quarter comparisons should not be relied upon as
indicators of future performance.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
28
PART III
Certain information required by Part III is omitted from this Report as we
will file a definitive proxy statement for the Annual Meeting of Shareholders to
be held on May 29, 2002, pursuant to Regulation 14A (the "Proxy Statement") not
later than 120 days after the end of the fiscal year covered by this Report, and
certain information included in the Proxy Statement is incorporated herein by
reference. Only those sections of the Proxy Statement which specifically address
the items set forth herein are incorporated by reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
Information with respect to our Directors may be found under the captions
"The Board of Directors" and "Election of Two Directors" in our Proxy Statement.
Such information is incorporated herein by reference. Information with respect
to Executive Officers may be found beginning on page 18 above, under the caption
"Executive Officers of the Company." Information with respect to compliance
with Section 16(a) of the Exchange Act by the persons subject thereto may be
found under the caption "Information About Our Common Stock Ownership - Section
16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement and is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information in the Proxy Statement set forth under the captions "How We
Compensate Directors," "How We Compensate Executive Officers," "The Board of
Directors" and "The Committees of the Board" is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information in the Proxy Statement set forth under the caption
"Information about Our Common Stock Ownership" is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information set forth under the captions "Compensation Committee
Interlocks and Insider Participation" and "Certain Transactions" in the Proxy
Statement is incorporated herein by reference.
29
Part IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) Financial Statements
Consolidated Balance Sheets at December 31, 2000 and December 31, 2001
Consolidated Statements of Operations and Comprehensive Loss for each of the
three years in the period ended December 31, 2001
Consolidated Statements of Shareholders' Equity for each of the three years in
the period ended December 31, 2001
Consolidated Statements of Cash Flows for each of the three years in the period
ended December 31, 2001
Notes to Consolidated Financial Statements
Independent Auditors' Report
(a)(2) Financial Statement Schedules
Supplemental schedules are not provided because they are not required or
because the required information is provided in the financial statements or
in the notes thereto.
(a)(3) Exhibits
EXHIBIT
NUMBER DESCRIPTION
------- -----------
2.1 Asset Purchase Agreement between Silicon Graphics, Inc. and the
Company, dated as of March 1, 2000(3)
2.2 Amendment No. 1 to the Asset Purchase Agreement between Silicon
Graphics, Inc., and the Company, dated as of March 31, 2000(3)
3.1 Restated Articles of Incorporation(1)
3.2 Statements of Rights and Preferences of the Series A Convertible
Preferred Stock(12)
3.3 Restated Bylaws(11)
4.1 Convertible Subordinated Debentures and Warrants Purchase
Agreement, dated as of November 6, 2001, between Cray Inc. and the
investors(9)
4.2 Form of 5% Convertible Subordinated Debenture, due November 6,
2004, issued to the investors(9)
4.3 Form of Stock Purchase Warrant, dated November 6, 2001, issued to
the investors(9)
4.4 Amendment No. 1 to the Convertible Subordinated Debentures and
Warrants Purchase Agreement and Other Transaction Documents,
between Cray Inc. and the investors(9)
10.1 1988 Stock Option Plan(2)
10.2 1993 Stock Option Plan(2)
10.3 1995 Stock Option Plan(2)
10.4 1995 Independent Director Stock Option Plan(2)
10.5 1999 Stock Option Plan(5)
10.6 2000 Non-Executive Stock Option Plan(5)
10.7 Lease Agreement between Merrill Place, LLC and the Company, dated
November 21, 1997(6)
10.8 Fab I Building Lease Agreement between Union Semiconductor
Technology Corporation and the Company, dated as of June 30,
2000(7)
10.9 Conference Center Lease Agreement between Union Semiconductor
Technology Corporation and the Company, dated as of June 30,
2000(7)
10.10 Mendota Heights Office Lease Agreement between the Teachers
Retirement System of the State of Illinois and the Company, dated
as of August 10, 2000(7)
10.11 Agreement between Foothill Capital Corporation and the Company,
dated March 28, 2001(8)
10.12 Technology Agreement between Silicon Graphics and the Company,
effective as of March 31, 2000(4)
10.13 Services Contract Agreement between Silicon Graphics, Inc. and the
Company, dated as of March 31, 2000(4)
10.14 Transition Services Agreement between Silicon Graphics, Inc., and
the Company, dated as of March 31, 2000(4)
10.15 Distribution Agreement between NEC Corporation and Cray Inc., dated
as of February 28, 2001(12)
30
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.16 Sales and Marketing Services Agreement among NEC Corporation, HNSX
Supercomputers, Inc. and Cray Inc., dated as of February 28,
2001(12)
10.17 Maintenance Agreement between NEC Corporation and Cray Inc., dated
as of February 28, 2001(12)
10.18 Form of Management Continuation Agreement between the Company and
its executive officers and certain other employees(10)
10.19 Form of Amendment to the Management Continuation Agreement between
the Company and Messrs Smith, Rottsolk, Johnson and Loe
10.20 Letter of Agreement effective October 1, 2001 between the Company
and Michael P. Haydock regarding his employment
21.1 Subsidiaries of the Company
23.1 Independent Auditors' Consent
------------
(1) Incorporated by reference to the Company's Report on Form 10-Q, as filed
with the Commission on August 14, 2000.
(2) Incorporated by reference to Form SB-2 Registration Statement, Registration
No. 33-95460-LA, as filed with the Commission on August 3, 1995.
(3) Incorporated by reference to the Company's Report on Form 8-K, as filed
with the Commission on April 17, 2000.
(4) Incorporated by reference to the Company's Report on Form 10-Q, as filed
with the Commission on May 15, 2000.
(5) Incorporated by reference to the Company's Registration Statement on Form
S-8, Registration No. 333-57970, as filed with the Commission on March 30,
2001.
(6) Incorporated by reference to the Company's Report on Form 10-K, as filed
with the Commission for the fiscal year ended December 31, 1997.
(7) Incorporated by reference to the Company's Report on Form 10-K, as filed
with the Commission for the fiscal year ended December 31, 2000.
(8) Incorporated by reference to the Company's Report on Form 10-Q, as filed
with the Commission on May 15, 2001.
(9) Incorporated by reference to the Company's Report on Form 8-K, as filed
with the Commission on November 28, 2001.
(10) Incorporated by reference to the Company's Report on Form 10-Q, as filed
with the Commission on May 17, 1999.
(11) Incorporated by reference to the Company's Report on Form 8-K, as filed
with the Commission on October 10, 2001.
(12) Incorporated by reference to the Company's Report on Form 8-K, as filed
with the Commission on May 14, 2001.
31
(d) Reports on Form 8-K
A report on Form 8-K for an event of October 1, 2001, was filed on
October 10, 2001, reporting the appointment of Michael P. Haydock as
President and Chief Executive Officer of the Company under Item 5, "Other
Events."
A report on Form 8-K for an event of November 6, 2001, was filed on
November 28, 2001, reporting the private placement of convertible
subordinated debentures to six accredited investors under Item 5, "Other
Events."
A report on Form 8-K for an event of December 14, 2001, was filed on
December 18, 2001, reporting a consulting contract between the Company and
Alan Kay under Item 5, "Other Events."
32
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of
Seattle, State of Washington, on April 1, 2002.
CRAY INC.
By /s/ JAMES E. ROTTSOLK
--------------------------------
James E. Rottsolk
Chairman, President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of Company and
in the capacities indicated on April 1, 2002.
SIGNATURE TITLE
--------- -----
By /s/ JAMES E. ROTTSOLK President, Chief Executive
------------------------------------ Officer and Chairman of the
James E. Rottsolk Board of Directors
By /s/ BURTON J. SMITH Chief Scientist and Director
------------------------------------
Burton J. Smith
By /s/ DOUGLAS C. RALPHS Chief Financial Officer and
------------------------------------ Chief Accounting Officer
Douglas C. Ralphs
By /s/ DAVID N. CUTLER Director
------------------------------------
David N. Cutler
By /s/ DANIEL J. EVANS Director
------------------------------------
Daniel J. Evans
By /s/ KENNETH W. KENNEDY Director
------------------------------------
Kenneth W. Kennedy
By /s/ STEPHEN C. KIELY Director
------------------------------------
Stephen C. Kiely
By /s/ WILLIAM A. OWENS Director
------------------------------------
William A. Owens
By /s/ DEAN D. THORNTON Director
------------------------------------
Dean D. Thornton
33
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------- -----------
2.1 Asset Purchase Agreement between Silicon Graphics, Inc. and the
Company, dated as of March 1, 2000(3)
2.2 Amendment No. 1 to the Asset Purchase Agreement between Silicon
Graphics, Inc., and the Company, dated as of March 31, 2000(3)
3.1 Restated Articles of Incorporation(1)
3.2 Statements of Rights and Preferences of the Series A Convertible
Preferred Stock(12)
3.3 Restated Bylaws(11)
4.1 Convertible Subordinated Debentures and Warrants Purchase
Agreement, dated as of November 6, 2001, between Cray Inc. and the
investors(9)
4.2 Form of 5% Convertible Subordinated Debenture, due November 6,
2004, issued to the investors(9)
4.3 Form of Stock Purchase Warrant, dated November 6, 2001, issued to
the investors(9)
4.4 Amendment No. 1 to the Convertible Subordinated Debentures and
Warrants Purchase Agreement and Other Transaction Documents,
between Cray Inc. and the investors(9)
10.1 1988 Stock Option Plan(2)
10.2 1993 Stock Option Plan(2)
10.3 1995 Stock Option Plan(2)
10.4 1995 Independent Director Stock Option Plan(2)
10.5 1999 Stock Option Plan(5)
10.6 2000 Non-Executive Stock Option Plan(5)
10.7 Lease Agreement between Merrill Place, LLC and the Company, dated
November 21, 1997(6)
10.8 Fab I Building Lease Agreement between Union Semiconductor
Technology Corporation and the Company, dated as of June 30,
2000(7)
10.9 Conference Center Lease Agreement between Union Semiconductor
Technology Corporation and the Company, dated as of June 30,
2000(7)
10.10 Mendota Heights Office Lease Agreement between the Teachers
Retirement System of the State of Illinois and the Company, dated
as of August 10, 2000(7)
10.11 Agreement between Foothill Capital Corporation and the Company,
dated March 28, 2001(8)
10.12 Technology Agreement between Silicon Graphics and the Company,
effective as of March 31, 2000(4)
10.13 Services Contract Agreement between Silicon Graphics, Inc. and the
Company, dated as of March 31, 2000(4)
10.14 Transition Services Agreement between Silicon Graphics, Inc., and
the Company, dated as of March 31, 2000(4)
10.15 Distribution Agreement between NEC Corporation and Cray Inc., dated
as of February 28, 2001(12)
10.16 Sales and Marketing Services Agreement among NEC Corporation, HNSX
Supercomputers, Inc. and Cray Inc., dated as of February 28,
2001(12)
10.17 Maintenance Agreement between NEC Corporation and Cray Inc., dated
as of February 28, 2001(12)
10.18 Form of Management Continuation Agreement between the Company and
its executive officers and certain other employees (10)
10.19 Form of Amendment to the Management Continuation Agreement between
the Company and Messrs Smith, Rottsolk, Johnson and Loe
10.20 Letter of Agreement effective October 1, 2001 between the Company
and Mr. Michael Haydock regarding his employment
21.1 Subsidiaries of the Company
23.1 Independent Auditors' Consent
---------------
34
(1) Incorporated by reference to the Company's Report on Form 10-Q, as filed
with the Commission on August 14, 2000.
(2) Incorporated by reference to Form SB-2 Registration Statement, Registration
No. 33-95460-LA, as filed with the Commission on August 3, 1995.
(3) Incorporated by reference to the Company's Report on Form 8-K, as filed
with the Commission on April 17, 2000.
(4) Incorporated by reference to the Company's Report on Form 10-Q, as filed
with the Commission on May 15, 2000.
(5) Incorporated by reference to the Company's Registration Statement on Form
S-8, Registration No. 333-57970, as filed with the Commission on March 30,
2001.
(6) Incorporated by reference to the Company's Report on Form 10-K, as filed
with the Commission for the fiscal year ended December 31, 1997.
(7) Incorporated by reference to the Company's Report on Form 10-K, as filed
with the Commission for the fiscal year ended December 31, 2000.
(8) Incorporated by reference to the Company's Report on Form 10-Q, as filed
with the Commission on May 15, 2001.
(9) Incorporated by reference to the Company's Report on Form 8-K, as filed
with the Commission on November 28, 2001.
(10) Incorporated by reference to the Company's Report on Form 10-Q, as filed
with the Commission on May 17, 1999.
(11) Incorporated by reference to the Company's Report on Form 8-K, as filed
with the Commission on October 10, 2001.
(12) Incorporated by reference to the Company's Report on Form 8-K, as filed
with the Commission on May 14, 2001.
35
CRAY INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
ASSETS
December 31, December 31,
2000 2001
------------ ------------
Current assets:
Cash and cash equivalents $ 4,626 $ 12,377
Restricted cash 761 353
Accounts receivable, net of allowance of $936 in 2001 25,159 24,764
Inventory, net 25,872 18,950
Prepaid expenses and other assets 2,835 3,954
--------- ---------
Total current assets 59,253 60,398
Property and equipment, net 25,535 27,668
Service spares, net 18,904 12,267
Goodwill, net of accumulated amortization of $5,328 and $12,226 29,578 22,680
Long-term receivable 550
Deferred tax asset 743
Other assets 2,923 2,781
--------- ---------
TOTAL $ 136,193 $ 127,087
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 16,247 $ 11,295
Accrued payroll and related expenses 12,028 12,063
Accrued loss on purchase commitment 6,006 4,602
Other accrued liabilities 6,574 5,850
Deferred revenue 17,666 22,762
Current portion of warranty reserves 17,996 6,574
Current portion of obligations under capital leases 349 347
Current portion of term loan 2,143
Current portion of notes payable 8,357 486
--------- ---------
Total current liabilities 85,223 66,122
Warranty reserves 14,285 8,479
Obligations under capital leases 284 421
Term loan payable 3,928
Notes payable 254 8,387
Commitments
Shareholders' equity:
Series A Convertible Preferred Stock, par $.01 - Authorized,
issued and outstanding, 3,125 shares in 2001 24,946
Common Stock, par $.01 - Authorized, 100,000 shares;
issued and outstanding, 35,250 and 42,187 shares 158,799 173,318
Accumulated other comprehensive loss (128) (762)
Accumulated deficit (122,524) (157,752)
--------- ---------
36,147 39,750
--------- ---------
TOTAL $ 136,193 $ 127,087
========= =========
See accompanying notes
F-1
CRAY INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(in thousands, except per share data)
Years ended December 31,
---------------------------------------
1999 2000 2001
--------- --------- ---------
Revenue:
Product $ 1,794 $ 46,617 $ 51,105
Service 320 71,455 82,502
--------- --------- ---------
Total revenue 2,114 118,072 133,607
--------- --------- ---------
Operating expenses:
Cost of product revenue 15,165 32,505 30,657
Cost of service revenue 273 34,077 41,181
Research and development 15,216 48,426 53,926
Marketing and sales 2,517 14,365 19,961
General and administrative 3,091 7,033 9,226
Restructuring charge 3,802
Amortization of goodwill and intangible assets 5,217 6,981
--------- --------- ---------
Total operating expenses 36,262 141,623 165,734
--------- --------- ---------
Loss from operations (34,148) (23,551) (32,127)
Other income (expense), net (106) 675 (336)
Interest income (expense), net (278) (1,681) (1,771)
--------- --------- ---------
Loss before income taxes (34,532) (24,557) (34,234)
Provision for income taxes 831 994
--------- --------- ---------
Net loss (34,532) (25,388) (35,228)
Other comprehensive income (loss):
Currency translation adjustment (128) (634)
Preferred stock dividend (115)
--------- --------- ---------
Comprehensive loss $ (34,647) $ (25,516) $ (35,862)
========= ========= =========
Basic and diluted net loss per common share $ (1.74) $ (0.78) $ (0.87)
========= ========= =========
Weighted average shares outstanding, basic
and diluted 19,906 32,699 40,632
========= ========= =========
See accompanying notes
F-2
CRAY INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands)
YEARS ENDED DECEMBER 31, 1999, 2000 AND 2001
Series A Series B
Preferred Stock Preferred Stock Common Stock
------------------------ ------------------------ -----------------------
Number of Number of Number of
Shares Amount Shares Amount Shares Amount
--------- --------- --------- --------- --------- ---------
BALANCE, January 1, 1999 6 $ 5,674 14,204 $ 68,745
Issuance of shares under Employee
Stock Purchase Plan 55 270
Preferred stock dividend distributed
in common stock 36 190
Common stock issued in private
placement, net of issuance costs
of $1,378 7,685 33,148
Beneficial conversion feature in notes
and interest expense recognized on
convertible warrants 595
Conversion of Series B preferred shares (6) (5,674) 1,275 5,559
Issuance of shares under Company
401(k) Plan 36 144
Exercise of stock options 112 55
Exercise of warrants 1,375 14
Options issued for services 77
Warrants issued for services 602
Common stock issued in exchange
for notes 434 2,046
Net loss
--------- --------- --------- --------- --------- ---------
BALANCE, December 31, 1999 25,212 111,445
Issuance of shares under Employee
Stock Purchase Plan 179 754
Cash received on subscribed common stock 900
Common stock issued in private
placement, net of issuance costs
of $1,830 5,227 24,287
Beneficial conversion feature in notes
and interest expense recognized on
convertible warrants 1,283
Common stock issued in exchange
for notes 1,671 3,906
Issuance of shares under Company
401(k) Plan 14 92
Exercise of stock options 69 182
Exercise of warrants 1,878 8,885
Options issued for services 156
Warrants issued for services 209
Issuance of common stock to SGI 1,000 6,700
Other comprehensive loss:
Cumulative currency translation adjustment
Net loss
--------- --------- --------- --------- --------- ---------
BALANCE, December 31, 2000 35,250 158,799
Issuance of shares under Employee
Stock Purchase Plan 692 1,190
Options issued for debt 225
Common stock issued 1,747 3,430
Series A preferred stock, net
of issuance costs of $54 3,125 $ 24,946
Beneficial conversion feature in notes
and warrants 1,194
Stock issued to consultants 75 141
Common stock issued in exchange
for notes, net of issuance costs of $821 4,077 7,479
Issuance of shares under Company
401(k) Plan 330 683
Exercise of stock options 16 28
Warrants issued for services 24
Warrants issued for credit facility 125
Other comprehensive loss:
Cumulative currency translation adjustment
Net loss
--------- --------- --------- --------- --------- ---------
BALANCE, December 31, 2001 3,125 $ 24,946 42,187 $ 173,318
========= ========= ========= ========= ========= =========
Accumulated
Preferred Other
Stock Accumulated Comprehensive
Dividend Deficit Loss Total
---------- ----------- ------------- ---------
BALANCE, January 1, 1999 $ 75 $ (62,604) $ 11,890
Issuance of shares under Employee
Stock Purchase Plan 270
Preferred stock dividend distributed
in common stock (75) 115
Common stock issued in private
placement, net of issuance costs
of $1,378 33,148
Beneficial conversion feature in notes
and interest expense recognized on
convertible warrants 595
Conversion of Series B preferred shares (115)
Issuance of shares under Company
401(k) Plan 144
Exercise of stock options 55
Exercise of warrants 14
Options issued for services 77
Warrants issued for services 602
Common stock issued in exchange
for notes 2,046
Net loss (34,532) (34,532)
--------- --------- --------- ---------
BALANCE, December 31, 1999 (97,136) 14,309
Issuance of shares under Employee
Stock Purchase Plan 754
Cash received on subscribed common stock 900
Common stock issued in private
placement, net of issuance costs
of $1,830 24,287
Beneficial conversion feature in notes
and interest expense recognized on
convertible warrants 1,283
Common stock issued in exchange
for notes 3,906
Issuance of shares under Company
401(k) Plan 92
Exercise of stock options 182
Exercise of warrants 8,885
Options issued for services 156
Warrants issued for services 209
Issuance of common stock to SGI 6,700
Other comprehensive loss:
Cumulative currency translation adjustment $ (128) (128)
Net loss (25,388) (25,388)
--------- --------- --------- ---------
BALANCE, December 31, 2000 (122,524) (128) 36,147
Issuance of shares under Employee
Stock Purchase Plan 1,190
Options issued for debt 225
Common stock issued 3,430
Series A preferred stock, net
of issuance costs of $54 24,946
Beneficial conversion feature in notes
and warrants 1,194
Stock issued to consultants 141
Common stock issued in exchange
for notes, net of issuance costs of $821 7,479
Issuance of shares under Company
401(k) Plan 683
Exercise of stock options 28
Warrants issued for services 24
Warrants issued for credit facility 125
Other comprehensive loss:
Cumulative currency translation adjustment (634) (634)
Net loss (35,228) (35,228)
--------- --------- --------- ---------
BALANCE, December 31, 2001 $(157,752) $ (762) $ 39,750
========= ========= ========= =========
See accompanying notes
F-3
CRAY INC. AND SUBSIDIARIES
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1999, 2000 AND 2001
1999 2000 2001
-------- -------- --------
Operating activities
Net loss $(34,532) $(25,388) $(35,228)
Adjustments to reconcile net loss to
net cash provided (used) by operating activities:
Depreciation and amortization 1,881 14,349 14,157
Amortization of intangible assets -- 5,217 6,981
Write-off of related party notes -- -- 347
Loss on disposal of assets -- 3,289 --
Imputed interest -- 1,437 --
Amortization of beneficial conversion feature of notes payable 595 336 814
Common stock issued to consultant -- -- 141
Non-cash warrant and option expense 602 567 372
Deferred income taxes -- -- (743)
Cash provided (used) by changes in operating assets and
liabilities, net of the effects of the Cray Research acquisition:
Accounts receivable 78 (20,483) (74)
Spares -- -- (389)
Inventory 4,542 2,681 8,221
Long-term receivable -- -- (550)
Prepaid expenses and other assets 467 (2,416) (1,060)
Accounts payable (501) 11,587 (4,952)
Accrued purchase commitment and other accrued liabilities (49) 5,331 (2,128)
Accrued payroll and related expenses 603 6,032 35
Warranty reserve -- (15,053) (17,228)
Deferred revenue 49 17,598 5,096
-------- -------- --------
Net cash provided (used) by operating activities (26,265) 5,084 (26,188)
Investing activities
Cash used for acquisition -- (51,585) --
Purchases of property and equipment (427) (5,835) (9,472)
-------- -------- --------
Net cash used by investing activities (427) (57,420) (9,472)
Financing activities
Restricted cash (1,132) 371 408
Related party (receivable)/payments (34) (129) 122
Issuance of notes payable 1,900 12,500 9,300
Issuance of common stock 33,488 26,033 5,305
Issuance costs on common stock (821)
Proceeds from exercise of options 55 182 28
Proceeds from exercise of warrants -- 8,885 --
Proceeds from term loan -- -- 7,500
Principal payments on term loan -- -- (1,429)
Principal payments on bank note (71) (253) (943)
Sale of preferred stock -- -- 24,946
Principal payments on capital leases (607) (568) (371)
-------- -------- --------
Net cash provided by financing activities 33,599 47,021 44,045
-------- -------- --------
Effect of foreign exchange rate changes on
cash and cash equivalents -- (128) (634)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 6,907 (5,443) 7,751
Cash and cash equivalents
Beginning of period 3,162 10,069 4,626
-------- -------- --------
End of period $ 10,069 $ 4,626 $ 12,377
======== ======== ========
Supplemental disclosure of cash flow information:
Cash paid for interest $ 174 $ 347 $ 968
Cash paid for income taxes -- -- 1,337
Non-cash investing and financing activities
Inventory reclassified to fixed assets 1,191 5,233 --
Common stock issued for acquisition of assets 6,700 --
Fixed asset additions through issuance of common stock 164 -- --
Fixed asset additions through issuance of notes payable 933 -- 585
Fixed assets acquired through capital leases 493 199 506
Note payable converted to common stock 2,045 4,200 8,300
Accounts payable converted to notes 594 -- --
Stock dividends 190 -- --
Beneficial conversion feature on notes payable and related warrants -- 1,083 1,194
See accompanying notes
F-4
CRAY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
($ TABLES IN THOUSANDS)
NOTE 1 DESCRIPTION OF BUSINESS
Cray Inc. ("Cray" or the "Company") (formerly "Tera Computer
Company") designs, develops, markets and services
high-performance computer systems. The Company presently markets
four computer models: the Cray SV1ex system, the Cray T3E system,
cluster systems using Dell Computer Corporation PowerEdge
servers, and on an exclusive basis in North America the NEC SX-6
system, rebranded under the Cray brand as the Cray SX-6 system.
We also provide maintenance services to the installed base of
these and earlier models of Cray computers. The Company is
developing two new systems, the MTA-2, based on multithreaded
architecture, and the SV2, which combines elements of the SV1 and
T3E computers.
The Company has incurred net losses of $35.2 million, $25.4
million and $34.5 million in 2001, 2000 and 1999, respectively.
Additionally, in 2001 the Company used $25.8 million in cash from
operating activities. The Company's continued existence is
dependent upon several factors, including its ability to increase
revenue levels and reduce costs of operations to generate
positive cash flows. The Company has implemented, and plans to
continue to implement, certain initiatives to increase revenues,
reduce costs and better position the Company to compete under
current market conditions. The Company believes cash resources
will be adequate to sustain operations for the next twelve
months. To the extent future revenues are not sufficient to allow
the Company to generate positive cash flows, the Company plans to
pursue additional initiatives to further reduce costs and/or seek
additional financing. The Company has received $5.7 million in
equity financing subsequent to December 31, 2001 and has an
available $7.5 million revolving line of credit. However, there
can be no assurance that the Company will be successful in its
efforts to achieve future profitable operations or generate
sufficient cash from operations, or obtain additional funding
sources in the event its current financial resources are not
sufficient.
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ACCOUNTING PRINCIPLES
The consolidated financial statements and accompanying notes are
prepared in accordance with accounting principles generally
accepted in the United States of America.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. Intercompany balances
and transactions have been eliminated.
BUSINESS COMBINATIONS
For business combinations that have been accounted for under the
purchase method of accounting, the Company includes the results
of operations of the acquired business from the date of
acquisition. Net assets of the companies acquired are recorded at
their fair value at the date of acquisition. The excess of the
purchase price over the fair value of tangible net assets
acquired is included in goodwill in the accompanying
consolidated balance sheets.
USE OF ESTIMATES
Preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect
F-5
CRAY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)
the amounts reported in the financial statements and accompanying
notes. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of highly liquid financial
instruments that are readily convertible to cash and have
original maturities of three months or less at the time of
acquisition.
ACCOUNTS RECEIVABLE
Accounts receivable is primarily composed of amounts due from
government funded research and development projects and amounts
contractually due from product and service revenue. The allowance
for doubtful accounts as of December 31, 2001 was $936,000.
RESTRICTED CASH
Restricted cash consists of cash equivalents that serve as
collateral pursuant to lease and indebtedness agreements entered
into for the acquisition of capital equipment.
GOODWILL
Goodwill represents the excess of the purchase price of the Cray
Research business unit acquired on April 1, 2000 over the fair
value of the net assets acquired. Goodwill is amortized on a
straight-line basis over five years. The Company periodically
analyzes the carrying value of its goodwill to determine that the
recorded amount is reasonable and is not impaired. Management
considers whether specific events have occurred, such as a loss
of a major customer or abandonment or loss of a product line, in
determining whether goodwill is impaired at each balance sheet
date. The determination of whether an impairment exists is based
on any excess of the carrying value over the expected future cash
flows, as estimated through undiscounted cash flows, excluding
interest charges. Any resulting necessary impairment charge would
be measured based on the difference between the carrying value of
recorded goodwill and its fair value, as estimated through
expected future discounted cash flows, discounted at a rate of
return for an alternate similar investment. Based on its most
recent analysis, Cray believes that no impairment exists at
December 31, 2001.
FAIR VALUES OF FINANCIAL INSTRUMENTS
At December 31, 2001, the Company had the following financial
instruments: cash and cash equivalents, accounts receivable,
accounts payable, accrued liabilities, notes payable and term
loan. The carrying value of cash and cash equivalents, accounts
receivable, accounts payable, accrued liabilities, notes payable,
and long-term debt approximates their fair value based on the
liquidity of these financial instruments or based on borrowing
rates currently available to the Company.
REVENUE RECOGNITION
Cray generally recognizes revenue from product sales upon
customer acceptance; however, depending on sales contract terms,
revenue may be recognized upon shipment, or delayed until funding
is definite. Service revenues from the maintenance of computers
are recognized ratably over the term of the maintenance contract.
Funds from maintenance contracts that are paid in advance are
recorded as deferred revenue.
F-6
CRAY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)
FOREIGN CURRENCY TRANSLATION
The functional currency of the Company's foreign subsidiaries is
the local currency. Assets and liabilities of foreign
subsidiaries are translated into US dollars at year-end exchange
rates, and revenues and expenses are translated at average rates
prevailing during the year. Translation adjustments are included
in accumulated other comprehensive loss, a separate component of
shareholders' equity. Transaction gains and losses arising from
transactions denominated in a currency other than the functional
currency of the entity involved, which have been insignificant,
are included in the consolidated statements of operations.
RESEARCH AND DEVELOPMENT
Research and development costs include costs incurred in the
development and production of the Company's hardware and
software, costs incurred to enhance and support existing software
features and expenses related to future implementations of
systems. Research and development costs are expensed as incurred.
Statement of Financial Accounting Standards (SFAS) No. 86,
Accounting for the Costs of Computer Software to Be Sold, Leased,
or Otherwise Marketed, requires the capitalization of certain
software product costs after technological feasibility of the
software is established. Due to the relatively short period
between the technological feasibility of a product and completion
of product development, and the insignificance of related costs
incurred during this period, no software development costs have
been capitalized.
INVENTORIES
Inventories are valued at the lower of cost (first-in, first-out)
or market. The Company regularly evaluates the technological
usefulness of various inventory components and the expected use
of the inventory. When it is discovered that previously
inventoried components do not function as intended in a fully
operational system, or quantities on hand are in excess of
requirements, the costs associated with these components are
expensed.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost less accumulated
depreciation and amortization. Depreciation is calculated on a
straight-line basis over the estimated useful lives of the
related assets, ranging from three to seven years. Equipment
under capital leases is depreciated over the lease term.
Leasehold improvements are amortized over the lesser of their
estimated useful lives or the term of the lease.
SERVICE SPARES
Service spares are primarily utilized to fulfill the Company's
service obligations related to the T90 vector supercomputers. The
cost of service spares is allocated as the related assets are
used in service. The warranty reserve includes these service
spares as part of the cost of fulfilling the warranty obligation.
IMPAIRMENT OF LONG-LIVED ASSETS
Pursuant to SFAS No. 121, management periodically evaluates
long-lived assets, consisting primarily of property and equipment
and intangible assets, to determine whether there has been any
impairment of these assets and the appropriateness of their
remaining useful lives. The Company evaluates
F-7
CRAY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)
impairment whenever events or changes in circumstances indicate
that the carrying amount of the Company's assets might not be
recoverable. Accordingly, during 2000, the Company recorded an
impairment loss of $3.3 million on certain obsolete fixed assets
included in cost of product sales in the Consolidated Statements
of Operations and Comprehensive Loss. The fixed assets consisted
primarily of test equipment used to support the gallium arsenide
Cray MTA-1 product line. As the Company transitioned from gallium
arsenide technology to CMOS (complementary metal-oxide silicon)
technology, the gallium arsenide equipment had no further value
to the Company and was written off completely. Fair value is zero
as there is no future use or salvage value for this equipment.
INCOME TAXES
The Company accounts for income taxes under SFAS No. 109,
Accounting for Income Taxes. Deferred tax assets and liabilities
are determined based on temporary differences between financial
reporting and tax bases of assets and liabilities and are
measured using the enacted tax rates and laws that will be in
effect when the differences are expected to reverse. The Company
provides a valuation allowance, as necessary, to reduce deferred
tax assets to their estimated realizable value.
RECLASSIFICATIONS
Certain prior-year amounts have been reclassified to conform with
the current-year presentation.
NET LOSS PER SHARE
Basic and diluted net loss per share is computed based on the
weighted average number of shares of common stock outstanding.
Net loss per share has been computed in accordance with SFAS No.
128, Earnings per Share. Under the provisions of SFAS No. 128,
basic net loss per share is computed by dividing the net loss for
the period by the weighted average number of common shares
outstanding. Common stock equivalent shares of 234,000 related to
stock options, warrants and shares subject to repurchase are
excluded from the calculation as their effect is antidilutive.
Accordingly, basic and diluted net loss per share are equivalent.
SEGMENT INFORMATION
The Company has organized and managed its operations in a single
operating segment providing global sales and service of high
performance computers. See note 14 - Segment Information.
WARRANTY RESERVE
Certain components in the T90 vector computers sold by Silicon
Graphics, Inc. ("SGI") prior to the Company's acquisition of the
Cray Research operations have an unusually high failure rate. The
cost of servicing the T90 computers exceeds the related service
revenues. The Company is continuing to take action that commenced
prior to the acquisition to address this problem, and has
recorded a reserve to provide for anticipated future losses on
the T90 maintenance service contracts. Included in warranty
reserves at December 31, 2001, is an accrual of $14.5 million for
estimated losses on service contracts covering the T90 product
line. The reserve is calculated as the excess of estimated
service costs over estimated service revenues for the term of the
related contracts. Estimated service costs include cost of
service spares, direct costs of service, indirect labor, and
overhead allocations based on management estimates of time
dedicated to service T-90 contracts.
F-8
CRAY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)
A summary of the warranty reserve is as follows (in thousands):
Balance Balance
December 31, 2000 2000 December 31,
1999 Additions Deductions 2000
------------ --------- ---------- ------------
Warranty Reserve $ -- $ 47,461 $(15,180) $ 32,281
======== ======== ======== ========
Balance Balance
December 31, 2001 2001 December 31,
2000 Additions Deductions 2001
------------ --------- ---------- ------------
Warranty Reserve $ 32,281 $ 365 $(17,593) $ 15,053
======== ======== ======== ========
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (FASB)
issued SFAS No. 141, Business Combinations and SFAS No. 142,
Goodwill and Other Intangible Assets. SFAS No. 141 requires
business combinations initiated after June 30, 2001 to be
accounted for using the purchase method of accounting, and
broadens the criteria for recording intangible assets separate
from goodwill. SFAS No. 142 requires the use of a
non-amortization approach to account for purchased goodwill and
certain intangibles. Under a non-amortization approach, goodwill
and certain intangibles with indefinite useful lives will not be
amortized into results of operations, but instead would be
reviewed for impairment and written down and charged to results
of operations only in the periods in which the recorded value of
goodwill and certain intangibles is more than its fair value. The
Company will apply SFAS No. 142 beginning in the first quarter of
2002. The Company will test goodwill for impairment using the
two-step approach prescribed in SFAS No. 142. The first step is a
test for potential impairment, while the second step measures the
amount of the impairment, if any. The Company expects to perform
the first of the required impairment tests of goodwill as of
January 1, 2002 in the first six months of 2002. Any impairment
charge resulting from these transitional impairment tests will be
reflected as the cumulative effect of a change in accounting
principle in the first six months of 2002.
In June 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations. This statement establishes accounting
standards for recognition and measurement of a liability for an
asset retirement obligation and the associated asset retirement
cost. This statement is effective for financial statements issued
for fiscal years beginning after June 15, 2002. The Company does
not expect the adoption of SFAS No. 143 to have a material effect
on its financial position or results of operations.
In August 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. This statement
supercedes SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Assets to Be Disposed Of, and the
accounting and reporting provisions of Accounting Principles
Board (APB) Opinion 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, for the disposal of a segment of a
business (as previously defined in that Opinion). SFAS No. 144
establishes a single accounting model, based on the
F-9
CRAY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)
framework established in SFAS No. 121, for long-lived assets to
be disposed of by sale. It retains the fundamental provisions of
SFAS No. 121 for (a) recognition and measurement of the
impairment of long-lived assets to be held and used and (b)
measurement of long-lived assets to be disposed of by sale. SFAS
No. 144 is effective for fiscal years beginning after December
15, 2001, with earlier application encouraged. The Company has
not yet determined the impact of adopting SFAS No. 144 on its
financial position or results of operations.
NOTE 3 PROPERTY AND EQUIPMENT, NET
A summary of property and equipment is as follows (in thousands):
December 31,
-----------------------
2000 2001
-------- --------
Land $ 139 $ 139
Building 8,130 8,766
Furniture and equipment 1,504 6,269
Computer equipment 28,754 33,204
Leasehold improvements 2,309 3,021
-------- --------
40,836 51,399
Accumulated depreciation (15,301) (23,731)
-------- --------
Property and equipment, net $ 25,535 $ 27,668
======== ========
NOTE 4 INVENTORY, NET
A summary of inventory is as follows (in thousands):
December 31,
-----------------------
2000 2001
-------- --------
Components and subassemblies $ 19,846 $ 14,874
Work in process 10,148 10,994
Finished goods 936 1,545
-------- --------
30,930 27,413
Allowance for excess and obsolete (5,058) (8,463)
-------- --------
Inventory, net $ 25,872 $ 18,950
======== ========
F-10
CRAY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)
Balance Balance
January 1, 1999 1999 December 31,
1999 Additions Deductions 1999
---------- --------- ---------- ------------
Allowance for excess
and obsolete $ 275 $ 6,117 $ (918) $ 5,474
======== ======== ======== ========
Balance Balance
December 31, 2000 2000 December 31,
1999 Additions Deductions 2000
------------ --------- ---------- ------------
Allowance for excess
and obsolete $ 5,474 $ 3,200 $ (3,616) $ 5,058
======== ======== ======== ========
Balance Balance
December 31, 2001 2001 December 31,
2000 Additions Deductions 2001
------------ --------- ---------- ------------
Allowance for excess
and obsolete $ 5,058 $ 3,530 $ (125) $ 8,463
======== ======== ======== ========
In 2001, revenues included $2.2 million from the sale of
inventory recorded at a zero cost basis, since they were deemed
obsolete on the date of the Cray Research business acquisition on
April 1, 2000.
NOTE 5 SERVICE SPARES, NET
A summary of service spares is as follows (in thousands):
December 31,
-----------------------
2000 2001
-------- --------
Service spares $ 24,254 $ 22,602
Accumulated amortization (5,350) (10,335)
-------- --------
Service spares, net $ 18,904 $ 12,267
======== ========
F-11
CRAY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)
NOTE 6 ACQUISITION
The Company acquired certain assets of the Cray Research business
unit from SGI on April 1, 2000, in exchange for cash of $15.0
million, the issuance of one million shares of common stock
valued at
$6.7 million, and the issuance of a $35.3 million non-interest
bearing promissory note. Commencing April 1, 2000, the Company
has included the results of operations of the Cray Research
business unit in its consolidated results of operations.
The Company has accounted for this transaction under the purchase
method of accounting in accordance with the APB Opinion No. 16.
Under the purchase method of accounting, the purchase price was
allocated to the assets acquired and liabilities assumed based on
their estimated fair values.
The following table summarizes the purchase accounting for the
acquisitions (in thousands):
Current and long-term assets $ 80,165
Goodwill 34,906
Liabilities assumed (58,223)
--------
Net assets acquired 56,848
Less: acquisition costs (1,326)
--------
Purchase price $ 55,522
========
The following table presents the results of operations of the
Company on a pro forma basis. These results are based on the
individual historic results of the Company and the Cray Research
business unit and reflect adjustments to give effect to the
acquisitions as if they had occurred at the beginning of the
periods presented (in thousands):
F-12
CRAY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)
(unaudited)
December 31,
----------------------
1999 2000
-------- --------
Revenue $287,771 $183,820
======== ========
Net income $ 31,536 $ 5,142
======== ========
Basic and diluted net income per common share $ 1.51 $ 0.16
======== ========
Weighted average shares used to compute
basic and diluted net income per common share 20,906 32,949
======== ========
NOTE 7 RELATED PARTY TRANSACTIONS
During 2001, the Company issued full recourse notes payable for
$326,000 related to the exercise of employee stock options. These
notes bear interest at a rate of 2.05% per year, had an original
maturity of twelve months from date of issuance and were secured
by a stock pledge agreement. The maturity date has subsequently
been amended several times and notes are now due December 31,
2004. Given the uncertainty related to collectibility, the notes
have been fully reserved in 2001. The options related to the full
recourse notes are variable in nature given the renewal of the
note due date and non-market interest rate. There has been no
compensation expense recorded as of December 31, 2001 or 2000 as
the options' exercise price is equal to or greater than the fair
value of the Company's stock.
The Company also had an unsecured promissory note in the
aggregate principal amount of $138,000 from the Chief Executive
Officer of the Company. The note was due and paid in full on
February 6, 2001, including accrued interest at a rate of 9.5%.
The Company recorded interest income of $3,278 for the year ended
December 31, 2001, on the note.
The Company paid fees related to private debt and equity
placements to a company whose Chairman, CEO, and principal
shareholder was one of the Company's directors. Amounts incurred
for the years ended December 31, 2000 and 2001 for private
placement services totaled $1.8 million and $1.4 million,
respectively, with $626,000 payable at December 31, 2001.
NOTE 8 LEASE AGREEMENTS
The Company leases certain property and equipment under capital
leases pursuant to master equipment lease agreements and has
non-cancelable operating leases for facilities. Under the master
equipment lease agreements, the Company has acquired computer and
other equipment in the amount of $2,114,000 and $2,620,000, for
which $1,550,000 and $1,837,000 of accumulated depreciation was
recorded as of December 31, 2000, and 2001, respectively. Rent
expense under leases accounted for as operating leases for 1999,
2000 and 2001 was $1,929,000, $2,520,000 and $3,322,000,
respectively.
F-13
CRAY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)
Minimum lease commitments are (in thousands):
Capital Operating
leases leases
--------- ---------
2002 $ 425 $ 3,494
2003 298 3,013
2004 175 3,082
2005 2,928
2006 2,750
Thereafter 5,501
-------- --------
898 $ 20,768
=========
Less amounts representing interest (130)
--------
$ 768
========
NOTE 9 ACCRUED LOSS ON PURCHASE COMMITMENT
As part of the acquisition of the Cray Research business unit
from SGI on April 1, 2000, the Company assumed a purchase
commitment for $6.3 million for which a loss was accrued. The
$6.3 million consisted of cancellation fees and commitments under
contractual obligations to acquire inventory components deemed
unusable. In 2000 and 2001 the Company satisfied a portion of the
purchase commitment obligation through receipt of inventory of
zero and $1 million, respectively. In 2000 and 2001, the Company
negotiated reductions in cancellation fees of $332,000 and
$361,000, respectively. As of December 31, 2001 the Company has a
remaining obligation of $4.6 million.
NOTE 10 FEDERAL INCOME TAXES
Due to continued losses from operations, there has been no
provision for or payments of U.S. federal income taxes for any
period. The provision for income taxes consisted of (in
thousands):
December 31,
---------------------------------
1999 2000 2001
------- ------- -------
State:
Current $ $ $ 143
Deferred
Foreign:
Current 831 1,594
Deferred (743)
------- ------- -------
Total provision for income taxes $ $ 831 $ 994
======= ======= =======
F-14
CRAY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)
Loss before provision for income taxes consisted of (in
thousands):
December 31,
--------------------------------------
1999 2000 2001
-------- -------- --------
United States $(34,532) $(26,388) $(32,715)
International 1,831 (1,519)
-------- -------- --------
$(34,532) $(24,557) $(34,234)
======== ======== ========
The following table reconciles the federal statutory income tax
rate to the Company's effective tax rate.
1999 2000 2001
-------- -------- ---------
Federal income tax rate -35.00% -35.00% -35.00%
State taxes -1.67%
Foreign taxes 3.27% 0.17%
Goodwill 5.11%
R&D tax credit -4.38%
Other 0.38%
Effect of valuation allowance on
deferred tax assets 35.00% 35.00% 38.29%
-------- -------- ---------
Effective income tax rate 0.00% 3.27% 2.90%
======== ======== =========
Deferred income taxes reflect the net tax effects of temporary
differences between the tax basis of assets and liabilities and
the corresponding financial statement amounts. Significant
components of the Company's deferred income tax assets are as
follows:
2000 2001
-------- --------
Warranty reserve $ 10,976 $ 6,139
Inventory reserve 699 7,530
Accrued compensation 735 1,736
Fixed assets 3,340 3,379
Research and experimentation 4,541 6,484
Deferred service revenue 729
Net operating loss carryforwards 42,086 50,775
Other 1,470
-------- --------
Net deferred tax assets 62,377 78,242
Valuation allowance for deferred tax assets (62,377) (77,499)
-------- --------
Deferred tax asset $ $ 743
======== ========
F-15
CRAY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)
As of December 31, 1999, 2000 and 2001, the Company had federal
net operating loss carryforwards of approximately $89.0 million,
$119.4 million and $137.1 million, respectively. The Company also
had federal research and experimentation tax credit carryforwards
of approximately $2.5 million, $4.5 million and $6.5 million,
respectively. The net operating loss credit carryforwards will
expire at various dates beginning in 2003 through 2021 if not
utilized. There is significant uncertainty regarding the
utilization of the federal net operating loss and credit
carryforwards due to annual limitations resulting from ownership
changes of stock in prior years and uncertainty regarding
generation of future taxable income.
The net change in the valuation allowance during the years ended
December 31, 1999, 2000 and 2001 was $13.0, $25.3 million and
$15.1 million, respectively.
F-16
CRAY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)
NOTE 12 NOTES PAYABLE
Notes payable consists of the following at December 31, 2000 and 2001 (in
thousands except original principal and discount amounts):
2000 2001
-------- --------
Note payable to bank, dated August 31, 1999,
original principal of $544,000, interest at 10.48%,
due August 31, 2002, secured by equipment $ 323 $ 136
Note payable to bank, dated October 7, 1999,
original principal of $389,000, interest at 8.71%,
due October 7, 2002, secured by equipment 249 118
Note payable to bank, dated April 25, 2001,
original principal of $585,000, interest at 12.00%,
due October 25, 2003, secured by equipment 446
Convertible notes payable to investors, dated November 6
and 15, 2001, original principal of $9,300,000, interest at 5.00%,
due November 6, 2004, unsecured, net of discount
of $1,127,000. (Note 12) 8,173
Convertible note payable to vendor, dated March 25,
1999, original principal of $494,000, interest at 8.00%,
unsecured, net of remaining discount of $8,000,
paid in full on March 31, 2001. 486
Notes payable to investors, dated October 18, 2000,
original principal of $7,500,000, interest at 6.00%,
unsecured. Converted to common stock
in 2001. (Note 12) 3,300
Notes payable to investors, dated December 12, 2000,
original principal of $5,000,000, interest at 6.00%,
unsecured, net of discount of $747,000
Converted to common stock in 2001. (Note 12) 4,253
-------- --------
8,611 8,873
Less current portion (8,357) (486)
-------- --------
Total long-term notes payable $ 254 $ 8,387
======== ========
F-17
CRAY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)
The aggregate maturities of notes payable for the years 2002
through 2004 are as follows: $486,000, $214,000, and $9,300,000.
In March 2001, the Company entered into a credit agreement with
Foothill Capital Corporation. The credit agreement makes
available $15 million through March 2004. The credit agreement
provides $7.5 million of borrowings in the form of a revolving
line of credit based on eligible domestic and foreign product
accounts receivable, and $7.5 million of borrowings in the form
of a term loan. Borrowings under the credit agreement are secured
by property, plant and equipment and bear interest at the prime
rate plus 2% for the revolving line of credit and at the prime
rate plus 3.25% for the term loan. The credit agreement contains
certain financial covenants which the Company was in compliance
with at December 31, 2001. The Company received $7.5 million on
March 28, 2001 as part of the term loan. Monthly principal
payments on the term loan are $179,000, and as of December 31,
2001 the term loan balance was $6.1 million. As of December 31,
2001, the Company had no borrowings under the revolving line of
credit.
NOTE 12 SHAREHOLDERS' EQUITY
PREFERRED STOCK: In February 2001, the Company signed a
distribution agreement with NEC Corporation to distribute and
service NEC SX-6 vector processor computers and its successors.
As part of the agreement, NEC invested $25 million of cash in
Cray, in exchange for 3,125,000 non-voting, preferred shares,
convertible into Cray common stock at a fixed conversion price of
$8.00 per share, subject to antidilution protection provisions.
CONVERTIBLE LOAN AGREEMENTS: In October and December 2000, the
Company entered into convertible loan agreements with certain
investors, under which it borrowed $12.5 million at 6% per annum.
The loan was convertible into common stock at a discount. In
accordance with EITF Issue No. 00-27, the Company recorded a
beneficial conversion feature of $1.1 million. The discount to
notes payable as a result of recording this beneficial conversion
feature is being amortized over the related term of the notes or
as conversions occur as interest expense and was $168,000 and
$932,000 for the years ended December 31, 2000 and December 31,
2001, respectively. The Company had converted $4.2 million and
$8.3 million of the notes as of December 31, 2000 and 2001,
respectively. In addition, in 2001, the Company sold $2.5 million
of common stock at a negotiated price of $2.18 per share and
$930,000 of common stock at a negotiated price of $1.55 per share
to holders of the notes.
In November 2001, the Company entered into convertible loan
agreements with certain investors, under which it borrowed $9.3
million at 5% per annum. The loan is convertible into common
stock at a discount. In conjunction with this convertible note,
the Company issued warrants to purchase 367,590 shares of common
stock at $4.4275 per share. The warrants expire on November 6,
2004. The Company allocated $318,000 of the proceeds to the
warrants based on their fair value, as determined using the
Black-Scholes option pricing model with the following
assumptions: risk-free interest rate of 2.76%, an expected life
of 3 years, volatility of 98% and no dividends. In accordance
with EITF Issue No. 00-27, the Company also recorded a beneficial
conversion feature of $876,000. The total discount of $1,194,000,
representing the total of the fair value of the warrants and the
beneficial conversion feature is being amortized as interest
expense over the related term of the notes or as conversions
occur. Total amortization was $66,000 for the year ended December
31, 2001. There were no conversions as of December 31, 2001.
F-18
CRAY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)
SHAREHOLDER WARRANTS: At December 31, 2001, the Company had
outstanding and exercisable warrants to purchase an aggregate of
15,178,198 shares of common stock, as follows:
Shares of Exercise Price Expiration
Common Stock per share Date of Warrants
-------------- --------------- -----------------
97,208 $6.00 February 28, 2002
282,500 $3.94 April 21, 2002
7,311,055 $4.08 June 21, 2002
155,000 $4.50 June 25, 2002
87,500 $6.00 December 23, 2002
80,672 $4.72 September 28, 2003
100,000 $6.00 January 20, 2004
200,000 $4.72 March 9, 2004
25,000 $5.16 March 9, 2004
1,111,111 $4.72 March 9, 2004
100,000 $6.00 March 30, 2004
14,829 $5.00 March 31, 2004
367,590 $4.43 November 6, 2004
100,000 $1.76 March 28, 2005
5,801 $6.00 November 7, 2005
524 $6.00 May 21, 2006
5,139,408 $2.53 June 21, 2009
-----------
15,178,198
===========
As part of a financing completed on June 21, 1999, the Company
issued a warrant to a director of the Company, in exchange for
cash of $200,000, exercisable for a minimum of 1,591,723 shares
of common stock. In 2000, the number of shares subject to this
warrant increased to 10% of the Company's issued and outstanding
shares on a fully diluted basis, with certain limited exceptions,
up to a maximum of 5,139,408 shares.
F-19
CRAY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)
STOCK OPTION PLANS: The Company has six stock option plans that
provide for option grants to employees, directors and others.
Four of these plans, the 1988 Employee Stock Option Plan, the
1993 Employee Stock Option Plan, the 1995 Employee Stock Option
Plan, and the 1995 Independent Director Stock Option Plan were
terminated by the Board of Directors in 1995 and 1999. Options
granted under the Company's option plans generally vest over four
years or as otherwise determined by the plan administrator.
Options to purchase shares expire no later than ten years after
the date of grant.
A summary of Cray's stock option activity and related information
follows:
Weighted Weighted
Average Average
Options Exercise Options Exercise
Outstanding Price Exercisable Price
------------- ------------ ------------ ----------
Balance, January 1, 1999 2,583,036 $ 5.68 1,158,125 $ 4.15
Granted 1,320,439 5.17
Exercised (107,513) 0.56
Canceled (100,616) 4.65
------------
Balance, December 31, 1999 3,695,346 5.68 1,699,744 5.29
Granted 4,924,513 5.48
Exercised (69,479) 2.69
Canceled (326,375) 5.16
------------
Balance, December 31, 2000 8,224,005 5.61 2,428,813 5.59
Granted 3,203,284 2.26
Exercised (15,856) 1.76
Canceled (420,661) 4.61
------------
Balance, December 31, 2001 10,990,772 $ 4.68 4,936,938 $ 5.59
============
Available for grant at
December 31, 2001 3,753,216
============
Outstanding and exercisable options by price range as of December
31, 2001 are as follows:
Options Outstanding Options Exercisable
------------------------------------------------------------------- ----------------------------
Weighted Weighted Weighted
Range of Average Average Average
Exercise Price Number Remaining Exercise Number Exercise
Per Share Outstanding Life (Years) Price Exercisable Price
------------------- ----------- ------------ ---------- ------------- -----------
$ 0.35 - $ 3.00 3,346,210 9.1 $ 2.23 341,753 $ 1.87
3.01 - 6.00 5,140,263 7.3 4.87 3,027,005 4.98
6.01 - 9.00 2,495,299 7.6 7.54 1,562,180 7.54
9.01 - 12.00 -- -- -- -- --
12.01 - 15.00 9,000 6.3 13.69 6,000 13.69
---------------- ---------- ------ ------ ---------- ------
$ 0.35 - $ 15.00 10,990,772 7.9 $ 4.68 4,936,938 $ 5.59
---------------- ---------- ------ ------ ---------- ------
F-20
CRAY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)
FAIR VALUE INFORMATION: The Company applies APB Opinion No. 25,
Accounting for Stock Issued to Employees, and related
Interpretations, in accounting for its stock option and purchase
plans. Had compensation cost for the Company's stock option plans
and its stock purchase plan been determined based on the fair
value at the grant dates for awards under those plans consistent
with the method of SFAS No. 123, Accounting for Stock-Based
Compensation, the Company's net loss and net loss per common
share for the years ended December 31, 1999, 2000, and 2001 would
have been increased to the pro forma amounts indicated below:
Net loss (in thousands):
1999 2000 2001
--------- --------- ---------
As reported $ (34,532) $ (25,388) $ (35,228)
Pro forma $ (38,148) $ (32,705) $ (45,214)
Basic and diluted net loss per common share:
1999 2000 2001
--------- --------- ---------
As reported $ (1.74) $ (0.78) $ (0.87)
Pro forma $ (1.92) $ (1.00) $ (1.11)
The weighted average Black-Scholes value of options granted under
the stock option plans during 1999, 2000 and 2001 was $4.21,
$4.40 and $1.95. Fair values were estimated as of the dates of
grant using the Black-Scholes option-pricing model with the
following weighted-average assumptions: no dividend yield,
expected volatility of 85%, 98 % and 97% for 1999, 2000 and 2001,
respectively, risk-free interest rate of 6.6%, 5.2%, and 5.0% for
1999, 2000 and 2001, respectively, and an expected term of 8.4,
8.4, and 8.2 years for 1999, 2000 and 2001, respectively.
In 1996, the Company established an Employee Stock Purchase Plan
(1996 ESPP). The maximum number of shares of the Company's common
stock that employees may acquire under the 1996 ESPP is 1,000,000
shares. Eligible employees are permitted to acquire shares of the
Company's common stock through payroll deductions not exceeding
15% of base wages. The purchase price per share under the 1996
ESPP is the lower of (a) 85% of the fair market value of the
Company's common stock at the beginning of each six month
offering period or (b) the fair market value of the common stock
at the end of each six month offering period. As of December 31,
2001 988,344 shares have been issued under the 1996 ESPP. The
Company will replace the 1996 ESPP with the 2001 ESPP upon
shareholder approval in May 2002. The 2001 ESPP will allow
employees to acquire a maximum of 4,000,000 shares. The terms of
the 2001 ESPP are the same as the 1996 ESPP, except that the 2001
ESPP will use three month offering periods rather than six months
used in the 1996 ESPP.
NOTE 13 401(k) PLAN
The Company has a defined contribution retirement plan covering
substantially all employees that provides for voluntary salary
deferral contributions on a pre-tax basis in accordance with
Section 401(k) on the Internal Revenue Code of 1986, as amended.
The Company may make voluntary
F-21
CRAY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)
matching contributions in amounts determined annually by the
Board of Directors, which may be payable in cash or common stock
of the Company. Defined contribution pension expense was
$183,000, $713,000 and $1,142,000 for 1999, 2000 and 2001,
respectively.
NOTE 14 SEGMENT INFORMATION
SFAS No. 131, Disclosure about Segments of an Enterprise and
Related Information, establishes standards for reporting
information about operating segments and for related disclosures
about products and services and geographic areas. Operating
segments are identified as components of an enterprise about
which separate discrete financial information is available for
evaluation by the chief operating decision-maker, or
decision-making group, in making decisions on allocating
resources and assessing performance. Cray's chief decision-maker,
as defined under SFAS No. 131, is the Chief Executive Officer and
the executive management team. As of December 31, 2001, Cray
operates in one business segment: global sales and service of
high performance computers.
Revenue from U.S. Government agencies or commercial customers
primarily serving the U.S. Government totaled approximately $63.4
million and $113.6 million in 2000 and 2001.
The Company's significant operations outside the United States
include sales and service offices in Europe, the Middle East, and
Africa (EMEA), Japan, and Asia Pacific (Australia, Korea, China
and Taiwan). Intercompany transfers between operating segments
and geographic areas are primarily accounted for at prices that
approximate arm's length transactions.
Geographic revenue and long-lived assets related to operations
were as follows (in thousands):
Twelve months ended December 31, 2000:
United Asia
States EMEA Japan Pacific Total
-------- -------- -------- -------- --------
Product revenue $ 41,368 2,748 2,501 $ -- $ 46,617
======== ======== ======== ======== ========
Service revenue $ 43,926 $ 17,706 $ 7,015 $ 2,808 $ 71,455
======== ======== ======== ======== ========
Long-lived assets $ 66,774 $ 5,245 $ 3,406 $ 1,515 $ 76,940
======== ======== ======== ======== ========
Twelve months ended December 31, 2001:
United Asia
States EMEA Japan Pacific Total
-------- -------- -------- -------- --------
Product revenue $ 46,597 $ 3,823 $ 427 $ 258 $ 51,105
======== ======== ======== ======== ========
Service revenue $ 53,326 $ 22,588 $ 5,237 $ 1,351 $ 82,502
======== ======== ======== ======== ========
Long-lived assets $ 60,381 $ 2,540 $ 2,074 $ 951 $ 65,946
======== ======== ======== ======== ========
F-22
CRAY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)
NOTE 15 RESTRUCTURING CHARGES
During 2001, the Company recorded restructuring charges totaling
$3.8 million associated with the termination of approximately 102
employees in the third and fourth quarters of 2001. Substantially
all of the restructuring charge represents severance expenses for
the terminated employees. As of December 31, 2001, approximately
$1.7 million of these severance amounts had not year been paid,
and this amount is included in accrued payroll and related
expense in the accompanying consolidated balance sheets as of
December 31, 2001.
NOTE 16 SUBSEQUENT EVENTS
On February 15, 2002, the Company raised an aggregate of $5.7
million, before offering expenses estimated at $100,000, in two
separate transactions with two institutional investors. The
Company issued a total of 2,869,549 shares of common stock. As
part of one of these transactions, warrants expiring on June 21,
2002, covering 969,549 shares were exercised at a price of $2.00
per share and warrants covering 1,454,321 shares otherwise
expiring on June 21, 2002, were extended to June 21, 2004, at an
exercise price of $3.00 per share.
F-23
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of Cray Inc.
Seattle, Washington
We have audited the accompanying consolidated balance sheets of Cray Inc. and
subsidiaries (the Company) as of December 31, 2001 and 2000, and the related
consolidated statements of operations and comprehensive loss, shareholders'
equity, and cash flows for each of the three years in the period ended December
31, 2001. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Cray, Inc. and subsidiaries as of
December 31, 2001 and 2000, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2001, in
conformity with accounting principles generally accepted in the United States of
America.
DELOITTE & TOUCHE LLP
Seattle, Washington
March 27, 2002
F-24