e10vq
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|
|
|
þ |
|
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended: June 30, 2010
Or
|
|
|
o |
|
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: 000-26820
CRAY INC.
(Exact name of registrant as specified in its charter)
|
|
|
Washington
|
|
93-0962605 |
(State or Other Jurisdiction of
Incorporation or Organization)
|
|
(I.R.S. Employer Identification No.) |
|
|
|
901 Fifth Avenue, Suite 1000
Seattle, Washington
|
|
98164 |
(Address of Principal Executive Office)
|
|
(Zip Code) |
Registrants Telephone Number, Including Area Code:
(206) 701-2000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days: Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large
accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the
Exchange Act. (Check one):
Large accelerated filer o |
Accelerated filer þ |
Non-accelerated filer o (Do not check if a smaller reporting company) |
Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act) Yes o No þ
As of July 31, 2010, there were 35,988,162 shares of Common Stock issued and outstanding.
CRAY INC.
TABLE OF CONTENTS
Available Information
Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K,
amendments to those reports and proxy statements filed or furnished pursuant to Section 13(a) or
15(d) of the Securities Exchange Act are available free of charge at our website at www.cray.com as
soon as reasonably practicable after we electronically file such reports with the SEC.
2
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
CRAY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
|
2010 |
|
|
2009 |
|
|
|
(unaudited) |
|
|
|
|
|
ASSETS |
|
Current assets: |
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
80,039 |
|
|
$ |
105,018 |
|
Restricted cash |
|
|
5,212 |
|
|
|
5,161 |
|
Short-term investments, available-for-sale |
|
|
|
|
|
|
2,999 |
|
Accounts and other receivables, net |
|
|
37,695 |
|
|
|
38,207 |
|
Inventory |
|
|
110,554 |
|
|
|
29,011 |
|
Prepaid expenses and other current assets |
|
|
9,327 |
|
|
|
5,514 |
|
|
|
|
|
|
|
|
Total current assets |
|
|
242,827 |
|
|
|
185,910 |
|
Property and equipment, net |
|
|
20,856 |
|
|
|
19,809 |
|
Service inventory, net |
|
|
1,529 |
|
|
|
1,719 |
|
Deferred tax assets |
|
|
2,684 |
|
|
|
2,661 |
|
Other non-current assets |
|
|
12,707 |
|
|
|
13,561 |
|
|
|
|
|
|
|
|
TOTAL ASSETS |
|
$ |
280,603 |
|
|
$ |
223,660 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND SHAREHOLDERS EQUITY |
|
|
|
|
|
|
|
|
|
|
Current liabilities: |
|
|
|
|
|
|
|
|
Accounts payable |
|
$ |
64,870 |
|
|
$ |
18,783 |
|
Accrued payroll and related expenses |
|
|
11,995 |
|
|
|
16,219 |
|
Other accrued liabilities |
|
|
5,963 |
|
|
|
9,735 |
|
Deferred revenue |
|
|
75,915 |
|
|
|
42,414 |
|
|
|
|
|
|
|
|
Total current liabilities |
|
|
158,743 |
|
|
|
87,151 |
|
Long-term deferred revenue |
|
|
8,406 |
|
|
|
9,627 |
|
Other non-current liabilities |
|
|
2,413 |
|
|
|
2,719 |
|
|
|
|
|
|
|
|
TOTAL LIABILITIES |
|
|
169,562 |
|
|
|
99,497 |
|
Commitments and contingencies (Note 12) |
|
|
|
|
|
|
|
|
Shareholders equity: |
|
|
|
|
|
|
|
|
Preferred stock Authorized and undesignated, 5,000,000 shares; no shares issued or outstanding |
|
|
|
|
|
|
|
|
Common stock and additional paid-in capital, par value $.01 per share Authorized, 75,000,000
shares; issued and outstanding 35,942,571 and 35,181,407 shares, respectively |
|
|
555,511 |
|
|
|
551,220 |
|
Accumulated other comprehensive income |
|
|
6,970 |
|
|
|
6,148 |
|
Accumulated deficit |
|
|
(451,440 |
) |
|
|
(433,205 |
) |
|
|
|
|
|
|
|
TOTAL SHAREHOLDERS EQUITY |
|
|
111,041 |
|
|
|
124,163 |
|
|
|
|
|
|
|
|
TOTAL LIABILITIES AND SHAREHOLDERS EQUITY |
|
$ |
280,603 |
|
|
$ |
223,660 |
|
|
|
|
|
|
|
|
See accompanying notes
3
CRAY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited and in thousands, except per share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Revenue: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product |
|
$ |
9,253 |
|
|
$ |
42,101 |
|
|
$ |
18,318 |
|
|
$ |
101,563 |
|
Service |
|
|
19,480 |
|
|
|
20,643 |
|
|
|
38,803 |
|
|
|
35,662 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue |
|
|
28,733 |
|
|
|
62,744 |
|
|
|
57,121 |
|
|
|
137,225 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenue: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of product revenue |
|
|
4,587 |
|
|
|
22,263 |
|
|
|
12,593 |
|
|
|
68,597 |
|
Cost of service revenue |
|
|
12,828 |
|
|
|
11,952 |
|
|
|
26,576 |
|
|
|
22,228 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenue |
|
|
17,415 |
|
|
|
34,215 |
|
|
|
39,169 |
|
|
|
90,825 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit |
|
|
11,318 |
|
|
|
28,529 |
|
|
|
17,952 |
|
|
|
46,400 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development, net |
|
|
7,044 |
|
|
|
13,710 |
|
|
|
14,738 |
|
|
|
24,925 |
|
Sales and marketing |
|
|
6,572 |
|
|
|
6,341 |
|
|
|
12,836 |
|
|
|
12,404 |
|
General and administrative |
|
|
4,018 |
|
|
|
3,901 |
|
|
|
8,305 |
|
|
|
8,047 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
17,634 |
|
|
|
23,952 |
|
|
|
35,879 |
|
|
|
45,376 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations |
|
|
(6,316 |
) |
|
|
4,577 |
|
|
|
(17,927 |
) |
|
|
1,024 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other expense, net |
|
|
(148 |
) |
|
|
(737 |
) |
|
|
(51 |
) |
|
|
(1,491 |
) |
Interest income (expense), net |
|
|
22 |
|
|
|
(351 |
) |
|
|
39 |
|
|
|
(884 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes |
|
|
(6,442 |
) |
|
|
3,489 |
|
|
|
(17,939 |
) |
|
|
(1,351 |
) |
Income tax expense |
|
|
(196 |
) |
|
|
(69 |
) |
|
|
(296 |
) |
|
|
(117 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) |
|
$ |
(6,638 |
) |
|
$ |
3,420 |
|
|
$ |
(18,235 |
) |
|
$ |
(1,468 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted net income (loss) per common share |
|
$ |
(0.19 |
) |
|
$ |
0.10 |
|
|
$ |
(0.53 |
) |
|
$ |
(0.04 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic weighted average shares outstanding |
|
|
34,246 |
|
|
|
33,580 |
|
|
|
34,101 |
|
|
|
33,390 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted weighted average shares outstanding |
|
|
34,246 |
|
|
|
33,965 |
|
|
|
34,101 |
|
|
|
33,390 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes
4
CRAY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited and in thousands)
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
|
2010 |
|
|
2009 |
|
Operating activities: |
|
|
|
|
|
|
|
|
Net loss |
|
$ |
(18,235 |
) |
|
$ |
(1,468 |
) |
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities: |
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
|
4,457 |
|
|
|
4,490 |
|
Share-based compensation expense |
|
|
2,489 |
|
|
|
3,403 |
|
Inventory write-down |
|
|
492 |
|
|
|
956 |
|
Amortization of debt issuance costs |
|
|
|
|
|
|
79 |
|
Loss on repurchase of Notes |
|
|
|
|
|
|
910 |
|
Amortization of convertible notes debt discount |
|
|
|
|
|
|
828 |
|
Deferred income taxes |
|
|
(23 |
) |
|
|
94 |
|
Cash provided (used) due to changes in operating assets and liabilities: |
|
|
|
|
|
|
|
|
Accounts receivable |
|
|
511 |
|
|
|
47,580 |
|
Inventory |
|
|
(84,890 |
) |
|
|
27,776 |
|
Prepaid expenses and other assets |
|
|
(3,097 |
) |
|
|
5,871 |
|
Accounts payable |
|
|
46,320 |
|
|
|
2,070 |
|
Accrued payroll and related expenses and other accrued liabilities |
|
|
(5,480 |
) |
|
|
(39,433 |
) |
Other non-current liabilities |
|
|
(304 |
) |
|
|
95 |
|
Deferred revenue |
|
|
32,444 |
|
|
|
(34,699 |
) |
|
|
|
|
|
|
|
Net cash provided by (used in) operating activities |
|
|
(25,316 |
) |
|
|
18,552 |
|
|
|
|
|
|
|
|
|
|
Investing activities: |
|
|
|
|
|
|
|
|
Sales/maturities of short-term investments |
|
|
3,000 |
|
|
|
5,350 |
|
Purchases of short-term investments |
|
|
|
|
|
|
(5,481 |
) |
Decrease in restricted cash |
|
|
|
|
|
|
785 |
|
Purchases of property and equipment |
|
|
(2,329 |
) |
|
|
(2,225 |
) |
|
|
|
|
|
|
|
Net cash provided by (used in) investing activities |
|
|
671 |
|
|
|
(1,571 |
) |
|
|
|
|
|
|
|
|
|
Financing activities: |
|
|
|
|
|
|
|
|
Repurchase of Notes |
|
|
|
|
|
|
(27,150 |
) |
Proceeds from issuance of common stock through employee stock purchase plan |
|
|
275 |
|
|
|
255 |
|
Proceeds from exercises of stock options |
|
|
43 |
|
|
|
28 |
|
2009 stock option repurchase tender offer, purchase of options |
|
|
|
|
|
|
(669 |
) |
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities |
|
|
318 |
|
|
|
(27,536 |
) |
|
|
|
|
|
|
|
|
|
Effect of foreign exchange rate changes on cash and cash equivalents |
|
|
(652 |
) |
|
|
(331 |
) |
|
|
|
|
|
|
|
Net decrease in cash and cash equivalents |
|
|
(24,979 |
) |
|
|
(10,886 |
) |
|
|
|
|
|
|
|
|
|
Cash and cash equivalents: Beginning of period |
|
|
105,018 |
|
|
|
72,373 |
|
|
|
|
|
|
|
|
End of period |
|
$ |
80,039 |
|
|
$ |
61,487 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosure of cash flow information: |
|
|
|
|
|
|
|
|
Cash paid for interest |
|
$ |
2 |
|
|
$ |
393 |
|
Cash paid for income taxes |
|
$ |
967 |
|
|
$ |
91 |
|
Non-cash investing and financing activities: |
|
|
|
|
|
|
|
|
Inventory transfers to fixed assets and service inventory |
|
$ |
2,855 |
|
|
$ |
1,273 |
|
Value of Shares issued for 401(k) match |
|
$ |
1,484 |
|
|
$ |
1,311 |
|
See accompanying notes
5
CRAY INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 Basis of Presentation
In these notes, Cray Inc. and its wholly-owned subsidiaries are collectively referred to as
the Company. In the opinion of management, the accompanying Condensed Consolidated Balance Sheets
and Condensed Consolidated Statements of Operations and Statements of Cash Flows have been prepared
in accordance with accounting principles generally accepted in the United States of America
(GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP
for complete financial statements. Management believes that all adjustments (consisting of normal
recurring adjustments) considered necessary for fair presentation have been included. Interim
results are not necessarily indicative of results for a full year. The information included in this
Form 10-Q should be read in conjunction with Managements Discussion and Analysis of Financial
Condition and Results of Operations and the financial statements and notes thereto included in the
Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2009 (the 2009 Form
10-K).
The Companys revenue, results of operations and cash balances are likely to fluctuate
significantly from quarter-to-quarter. These fluctuations are due to such factors as the high
average sales prices and limited number of sales of the Companys products, the timing of purchase
orders and product deliveries, the revenue recognition accounting policy of generally not
recognizing product revenue until customer acceptance and other contractual provisions have been
fulfilled and the timing of payments for product sales, maintenance services, government research
and development funding and purchases of inventory. Given the nature of the Companys business, its
revenue, receivables and other related accounts are likely to be concentrated among a few
customers.
During the six months ended June 30, 2010, the Company incurred a net loss of $18.2 million
and used $25.3 million of cash in operating activities. The Company had $84.1 million of working
capital as of June 30, 2010. Managements plans project that the Companys current cash resources
and cash to be generated from operations will be adequate to meet the Companys liquidity needs for
at least the next twelve months. These plans assume sales, shipment, acceptance and subsequent
collections from several large customers, as well as cash receipts on future sales opportunities
not yet contracted.
Principles of Consolidation
The accompanying condensed consolidated financial statements include the accounts of Cray Inc.
and its wholly-owned subsidiaries. All material intercompany accounts and transactions have been
eliminated.
Use of Estimates
Preparation of financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the amounts reported in the condensed consolidated financial
statements and accompanying notes. These estimates are based on managements best knowledge of
current events and actions the Company may undertake in the future. Estimates are used in
accounting for, among other items, fair value or selling price determinations used in revenue
recognition, percentage of completion accounting, estimates of proportional performance on
co-funded engineering contracts and prepaid engineering services, realization of accounts
receivable, valuation of inventory, useful lives for depreciation and amortization, determination
of future cash flows associated with impairment testing for long-lived assets, determination of the
fair value of stock options and assessments of fair value, realization of deferred income tax
assets, potential income tax assessments and other contingencies. The Company bases its estimates
on historical experience, current conditions and on other assumptions that it believes to be
reasonable under the circumstances. Actual results could differ materially from those estimates.
Revenue Recognition
The Company recognizes revenue when it is realized or realizable and earned. The Company
considers revenue realized or realizable and earned when it has persuasive evidence of an
arrangement, delivery has occurred, the sales price is fixed or determinable, and collectibility is
reasonably assured. Delivery does not occur until the products have been shipped or services
provided to the customer, risk of loss has transferred to the client, and a customer acceptance has
been obtained. The sales price is not considered to be fixed or determinable until all material
contingencies related to the sales have been resolved. The Company records revenue in the Condensed
Consolidated Statements of Operations net of any sales, use, value added or certain excise
taxes imposed by governmental authorities on specific sales transactions. In addition to the
aforementioned general policy, the following are our statements of policy with regard to
multiple-element arrangements and specific revenue recognition policies for each major category of
revenue.
6
Multiple-Element Arrangements. The Company commonly enters into revenue arrangements that
include multiple deliverables of its product and service offerings due to the needs of its
customers. Product may be delivered in phases over time periods which can be as long as five years.
Maintenance services generally begin upon acceptance of the first equipment delivery and future
deliveries of equipment generally have an associated maintenance period. The Company considers the
maintenance period to commence upon acceptance of the product, which may include a warranty period
and accordingly allocates a portion of the arrangement consideration as a separate deliverable
which is recognized as service revenue over the entire service period. Other services such as
training and engineering services can be delivered as a discrete delivery or over the term of the
contract. A multiple-element arrangement is separated into more than one unit of accounting if the
following criteria are met:
|
|
|
The delivered item(s) has value to the customer on a
standalone basis; and |
|
|
|
If the arrangement includes a general right of return relative
to the delivered item(s), delivery or performance of the undelivered item(s) is considered
probable and substantially in the control of the Company. |
If these criteria are not met, the arrangement is accounted for as one unit of accounting
which would result in revenue being recognized ratably over the contract term or being deferred
until the earlier of when such criteria are met or when the last undelivered element is delivered.
If these criteria are met for each element and there is a relative selling price for all units of
accounting in an arrangement, the arrangement consideration is allocated to the separate units of
accounting based on each units relative estimated selling price.
The Company follows a selling price hierarchy in determining the best estimate of the selling
price of each deliverable. Certain products and services are sold separately in standalone
arrangements for which the Company is sometimes able to determine vendor specific objective
evidence (VSOE). The Company determines VSOE based on normal pricing and discounting practices for
the product or service when sold separately.
When the Company is not able to establish VSOE for all deliverables in an arrangement with
multiple elements, the Company attempts to establish the selling price of each element based on
third-party evidence (TPE). The Companys inability to establish VSOE is often due to a relatively
small sample of customer contracts that differ in system size and contract terms which can be due
to infrequently selling each element separately, not pricing products within a narrow range, or
only having a limited sales history, such as in the case of certain advanced and emerging
technologies. TPE is determined based on competitor prices for similar deliverables when sold
separately. Generally, the Companys offerings contain a significant level of customization and
differentiation from those of competitors such that the comparable pricing of products with similar
functionality cannot be obtained. The Company is also often unable to reliably determine what
similar competitor products selling prices are on a standalone basis as important details of
competitive bids are not available. Therefore, the Company is typically not able to determine TPE.
When the Company is unable to establish selling price using VSOE or TPE, as is the case most
of the time, the Company uses estimated selling price (ESP) in its allocation of arrangement
consideration. The objective of ESP is to determine the price at which we would transact a sale if
the product or service were sold on a standalone basis. The Company determines ESP for a product or
service by considering multiple factors, including, but not limited to, internal costs, gross
margin objectives, and pricing practices. ESP is often based on data collected from prior sales,
but that may not have the sample size or consistency to establish VSOE.
Product. The Company recognizes revenue from sales of products, other than the Cray CX
systems, upon customer acceptance of the system, when the price is fixed or determinable,
collection is reasonably assured and no significant unfulfilled obligations exist. Revenue from
sales of our Cray CX systems is generally recognized upon shipment when title and risk of loss
transfers to the customer and collection is reasonably assured.
Service. Maintenance services are provided under separate maintenance contracts with
customers. These contracts generally provide for maintenance services for one year, although some
are for multi-year periods, often with prepayments for the term of the contract. The Company
considers the maintenance period to commence upon acceptance of the product, which may include a
warranty period. When service is part of a multiple element arrangement, the Company allocates a
portion of the arrangement consideration to maintenance service revenue based on estimates of
selling price. Maintenance revenue is recognized ratably over the term of the maintenance contract.
Maintenance contracts that are paid in advance are recorded as deferred revenue.
Revenue from engineering services is recognized as services are performed.
7
Project. Revenue from design and build contracts is recognized under the
percentage-of-completion (POC) method. Under the POC method, revenue is recognized based on the
costs incurred to date as a percentage of the total estimated costs to fulfill the contract. If
circumstances arise that change the original estimates of revenues, costs, or extent of progress
toward completion, revisions to the estimates are made. These revisions may result in increases or
decreases in estimated revenues or costs, and such revisions are recorded in income in the period
in which the circumstances that gave rise to the revision become known by management. The Company
performs ongoing profitability analyses of its contracts accounted for under the POC method in
order to determine whether the latest estimates of revenue, costs and extent of progress require
updating. If at any time these estimates indicate that the contract will be unprofitable, the
entire estimated loss for the remainder of the contract is recorded immediately.
The Company records revenue from research and development contracts which include milestones,
and may require the development of a prototype system, using the milestone method if the milestones
are determined to be substantive. A milestone is considered to be substantive if management
believes there is substantive uncertainty that it will be achieved and the milestone consideration
meets all of the following criteria:
|
|
|
It is commensurate with either of the following: |
|
|
|
The Companys performance to achieve the milestone; or |
|
|
|
The enhancement of value of the delivered item or items as a result
of a specific outcome resulting from the Companys performance to achieve the
milestone. |
|
|
|
It relates solely to past performance. |
|
|
|
It is reasonable relative to all of the deliverables and payment terms (including
other potential milestone consideration) within the arrangement. |
The individual milestones are determined to be substantive or nonsubstantive in their entirety
and milestone consideration is not bifurcated.
Revenue from projects is classified as Product Revenue or Service Revenue, based on the nature
of the work performed.
Note 2 New Accounting Pronouncements
In October 2009, the Financial Accounting Standards Board (FASB) issued Accounting Standards
Update (ASU) No. 2009-13, Multiple-Deliverable Revenue Arrangements. The guidance in ASU 2009-13
provides amendments to the criteria for separating consideration in multiple-deliverable
arrangements. The amendments establish a selling price hierarchy for determining the selling price
of a deliverable, which replaces fair value in the revenue allocation guidance, as the allocation
of revenue will be based on entity-specific assumptions rather than assumptions of a marketplace
participant. The amendments in ASU 2009-13 are effective for revenue transactions entered into
during fiscal years beginning on or after June 15, 2010. The Company adopted this guidance
effective January 1, 2010. The adoption of ASU 2009-13 did not have a significant impact on the
Companys financial results nor would it have had a material impact had the guidance been adopted
on January 1, 2009. ASU 2009-13 did not to significantly change the Companys determination of
units of accounting or arrangement consideration allocation methodology used to recognize revenue.
In October 2009, the FASB issued ASU No. 2009-14, Certain Revenue Arrangements that Include
Software Elements. The guidance in ASU 2009-14 changes the accounting model for revenue
arrangements that include both tangible products and software elements. Tangible products
containing software components and non-software components that function together to deliver the
tangible products essential functionality are excluded from the guidance applicable to software
revenue recognition. The amendments in ASU 2009-14 are effective for revenue transactions entered
into during fiscal years beginning on or after June 15, 2010. The Company adopted this guidance
effective January 1, 2010. The adoption of ASU 2009-14 did not have a significant impact on the
Companys financial results nor would it have had a material impact had the guidance been adopted
on January 1, 2009.
In April 2010, the FASB issued ASU No. 2010-17, Revenue Recognition Milestone Method (Topic
605): Milestone Method of Revenue Recognition. ASU 2010-17 provides guidance on defining a
milestone and determining when it may be appropriate to apply the milestone method of revenue
recognition for research or development transactions. Consideration that is contingent on
achievement of a milestone in its entirety may be recognized as revenue in the period in which the
milestone is achieved only if the milestone is judged to be substantive by meeting
specific criteria. The amendments in ASU 2010-17 are effective for milestones achieved in fiscal
years, and interim periods within those years, beginning on or after June 15, 2010. In accordance
with the guidance, the Company elected to early adopt its provisions as of January 1, 2010. The
adoption of this guidance did not have a material impact on the Companys financial results.
8
Note 3 Fair Value Measurement
Under FASB ASC Topic 820, Fair Value Measurements and Disclosures, based on the observability
of the inputs used in the valuation techniques used to determine the fair value of certain
financial assets and liabilities, the Company is required to provide the following information
according to the fair value hierarchy. The fair value hierarchy ranks the quality and reliability
of the information used to determine fair values.
In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in
active markets for identical assets or liabilities. Fair values determined by Level 2 inputs
utilize observable inputs other than Level 1 prices, such as quoted prices for similar assets or
liabilities, quoted prices in markets that are not active or other inputs that are observable or
can be corroborated by observable market data for substantially the full term of the related assets
or liabilities. Fair values determined by Level 3 inputs are unobservable data points for the asset
or liability, and include situations where there is little, if any, market activity for the asset
or liability. The following table presents information about the Companys financial assets and
liabilities that have been measured at fair value as of June 30, 2010, and indicates the fair value
hierarchy of the valuation inputs utilized to determine such fair value (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quoted |
|
|
Significant |
|
|
|
|
|
|
|
Prices in |
|
|
Other |
|
|
|
Fair Value |
|
|
Active |
|
|
Observable |
|
|
|
at June 30, |
|
|
Markets |
|
|
Inputs |
|
Description |
|
2010 |
|
|
(Level 1) |
|
|
(Level 2) |
|
Assets: |
|
|
|
|
|
|
|
|
|
|
|
|
Cash, cash equivalents and restricted cash |
|
$ |
85,251 |
|
|
$ |
85,251 |
|
|
$ |
|
|
Foreign exchange forward contracts (1) |
|
|
83 |
|
|
|
|
|
|
|
83 |
|
|
|
|
|
|
|
|
|
|
|
Assets measured at fair value at June 30, 2010 |
|
$ |
85,334 |
|
|
$ |
85,251 |
|
|
$ |
83 |
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange forward contracts (2) |
|
$ |
(951 |
) |
|
$ |
|
|
|
$ |
(951 |
) |
|
|
|
|
|
|
|
|
|
|
Liabilities measured at fair value at June 30, 2010 |
|
$ |
(951 |
) |
|
$ |
|
|
|
$ |
(951 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Included in Prepaid expenses and other current assets on the Companys Condensed
Consolidated Balance Sheets. |
|
(2) |
|
Included in Other accrued liabilities on the Companys Condensed Consolidated Balance
Sheets. |
Foreign Currency Derivatives
The Company may enter into foreign currency derivatives to hedge future cash receipts on
certain sales transactions that are payable in foreign currencies.
As of June 30, 2010, the Company had outstanding forward contracts which were designated as
cash flow hedges of anticipated future cash receipts on sales contracts payable in foreign
currencies. The outstanding notional amounts were approximately 9.8 million British pound sterling
and 64.2 million Swedish krona and hedged foreign currency exposure of approximately $22.5 million.
Cash receipts associated with the hedged contracts are expected to be received in 2010 and 2011,
during which time the revenue on the associated sales contracts are expected to be recognized.
As of June 30, 2010, the Company also had outstanding forward currency contracts that were not
designated as cash flow hedges at June 30, 2010, that were subsequently in July 2010 with notional
amounts of approximately 5.0 million British pound sterling and 8.3 million Swedish krona and
foreign currency exposure of $8.7 million.
As of December 31, 2009, the Company had outstanding forward contracts designated as cash flow
hedges with notional amounts of approximately 9.8 million British pound sterling, 1.4 million euro
and 2.4 million Swiss franc. These contracts hedged foreign currency exposure of $18.5 million. The
euro and Swiss franc hedges were settled during the three months ended March 31, 2010 when payment
was received; however, revenue on the associated transactions was recognized in 2009.
9
Fair Values of Derivative Instruments (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value |
|
Fair Value |
|
|
|
|
as of |
|
as of |
|
|
|
|
June 30, |
|
December 31, |
Hedge Classification |
|
Balance Sheet Location |
|
2010 |
|
2009 |
Foreign currency contracts |
|
Prepaid expenses and other assets |
|
$ |
83 |
|
|
$ |
51 |
|
Foreign currency contracts |
|
Other accrued liabilities |
|
$ |
(951 |
) |
|
$ |
(1,659 |
) |
|
|
|
|
|
|
|
|
|
|
Total derivatives classified
as hedging instruments |
|
|
|
$ |
(868 |
) |
|
$ |
(1,608 |
) |
|
|
|
|
|
|
|
|
|
As of June 30, 2010 and December 31, 2009, foreign currency gains of $4.0 million and $2.9
million, respectively, were included in Accumulated other comprehensive income on the Companys
Condensed Consolidated Balance Sheets. For the three and six months ended June 30, 2009, the
Company recorded approximately $512,000 and $488,000, respectively, in net reclassification
adjustments, which increased product revenue, as revenue on the associated sales contracts was
recognized. No reclassification adjustments were recorded in the three and six months ended June
30, 2010.
Note 4 Earnings (Loss) Per Share (EPS)
Basic EPS is computed by dividing net income available to common shareholders by the weighted
average number of common shares, excluding unvested restricted stock, outstanding during the
period. Diluted EPS is computed by dividing net income available to common shareholders by the
weighted average number of common and potential common shares outstanding during the period, which
includes the additional dilution related to conversion of stock options, unvested restricted stock
and restricted stock units as computed under the treasury stock method and, in 2009, the common
shares issuable upon conversion of the then outstanding 3.0% Convertible Senior Subordinated Notes
due 2024 (Notes).
For the three and six month periods ended June 30, 2010, outstanding stock options, unvested
restricted stock grants and restricted stock units were antidilutive because of net losses and, as
such, their effect has not been included in the calculation of basic or diluted net loss per share.
For the three months ended June 30, 2009, outstanding stock options and unvested restricted stock
of 385,000 shares were included in the diluted weighted average shares outstanding. For the six
months ended June 30, 2009, outstanding stock options, unvested restricted stock grants and
restricted stock units and warrants and shares issuable upon conversion of the Notes were
antidilutive because of net losses and, as such, their effect has not been included in the
calculation of basic or diluted net loss per share. For the three and six month periods ended June
30, 2010, potential gross common shares of 5.3 million were antidilutive and not included in
computing diluted EPS. For the three and six month periods ended June 30, 2009, potential gross
common shares of 4.8 million and 5.2 million, respectively, were antidilutive and not included in
computing diluted EPS.
Note 5 Comprehensive Loss
The components of comprehensive loss were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Net income (loss) |
|
$ |
(6,638 |
) |
|
$ |
3,420 |
|
|
$ |
(18,235 |
) |
|
$ |
(1,468 |
) |
Unrealized net gain (loss) on available-for-sale investments |
|
|
(1 |
) |
|
|
4 |
|
|
|
(4 |
) |
|
|
|
|
Cash flow hedges: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net gain (loss) on cash flow hedges |
|
|
90 |
|
|
|
(1,515 |
) |
|
|
1,004 |
|
|
|
(979 |
) |
Reclassification adjustment to revenue |
|
|
|
|
|
|
(512 |
) |
|
|
|
|
|
|
(488 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
90 |
|
|
|
(2,027 |
) |
|
|
1,004 |
|
|
|
(1,467 |
) |
Foreign currency translation adjustment |
|
|
(373 |
) |
|
|
(1,409 |
) |
|
|
(178 |
) |
|
|
(971 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive loss |
|
$ |
(6,922 |
) |
|
$ |
(12 |
) |
|
$ |
(17,413 |
) |
|
$ |
(3,906 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
10
Note 6 Accounts and Other Receivables, Net
Net accounts and other receivables consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
|
2010 |
|
|
2009 |
|
Trade accounts receivable |
|
$ |
28,088 |
|
|
$ |
26,375 |
|
Unbilled receivables |
|
|
2,511 |
|
|
|
5,791 |
|
Advance billings |
|
|
4,037 |
|
|
|
2,968 |
|
Other receivables |
|
|
3,245 |
|
|
|
3,245 |
|
|
|
|
|
|
|
|
|
|
|
37,881 |
|
|
|
38,379 |
|
Allowance for doubtful accounts |
|
|
(186 |
) |
|
|
(172 |
) |
|
|
|
|
|
|
|
Accounts and other receivables, net |
|
$ |
37,695 |
|
|
$ |
38,207 |
|
|
|
|
|
|
|
|
Unbilled receivables represent amounts where the Company has recognized revenue in advance of
the contractual billing terms. Advance billings represent billings made based on contractual terms
for which revenue has not been recognized.
As of June 30, 2010 and December 31, 2009, accounts receivable included $25.3 million and
$19.5 million, respectively, due from U.S. government agencies and customers primarily serving the
U.S. government. Of this amount, $1.6 million and $4.1 million were unbilled as of June 30, 2010
and December 31, 2009, respectively, based upon contractual billing arrangements with these
customers. As of June 30, 2010, no non-U.S. government accounts receivable were greater than 10% of
total accounts receivable. As of December 31, 2009, one non-U.S. government customer accounted for
13% of total accounts receivable.
Note 7 Inventory
Inventory consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
|
2010 |
|
|
2009 |
|
Components and subassemblies |
|
$ |
47,083 |
|
|
$ |
10,687 |
|
Work in process |
|
|
25,070 |
|
|
|
14,383 |
|
Finished goods |
|
|
38,401 |
|
|
|
3,941 |
|
|
|
|
|
|
|
|
Total |
|
$ |
110,554 |
|
|
$ |
29,011 |
|
|
|
|
|
|
|
|
Finished goods inventory of $27.3 million and $3.6 million was located at customer sites
pending acceptance as of June 30, 2010 and December 31, 2009, respectively. At June 30, 2010, four
customers accounted for $29.4 million, and at December 31, 2009, three customers accounted for $3.3
million of finished goods inventory.
During the six months ended June 30, 2010, the Company wrote off $0.5 million of inventory,
primarily related to scrap, excess or obsolete inventory of the Cray XT product line. During the
three and six months ended June 30, 2009, the Company wrote off $0.8 million and $1.0 million,
respectively, of inventory, primarily related to scrap, excess or obsolete inventory of the Cray XT
product line.
Note 8 Deferred Revenue
Deferred revenue consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
|
2010 |
|
|
2009 |
|
Deferred product revenue |
|
$ |
58,440 |
|
|
$ |
18,305 |
|
Deferred service revenue |
|
|
25,881 |
|
|
|
33,736 |
|
|
|
|
|
|
|
|
Total deferred revenue |
|
|
84,321 |
|
|
|
52,041 |
|
Less long-term deferred revenue |
|
|
(8,406 |
) |
|
|
(9,627 |
) |
|
|
|
|
|
|
|
Deferred revenue in current liabilities |
|
$ |
75,915 |
|
|
$ |
42,414 |
|
|
|
|
|
|
|
|
As of June 30, 2010, three customers accounted for 60% of total deferred revenue. At December
31, 2009, two customers accounted for 44% of total deferred revenue.
11
Note 9 Share-Based Compensation
The Company accounts for its share-based compensation based on an estimate of fair value of
the grant on the date of grant.
The fair value of unvested restricted stock and restricted stock units is based on the market
price of a share of the Companys common stock on the date of grant.
In determining fair value of stock options, the Company uses the Black-Scholes option pricing
model and employed the following key weighted average assumptions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
June 30, |
|
June 30, |
|
|
2010 |
|
2009 |
|
2010 |
|
2009 |
Risk-free interest rate |
|
|
1.8 |
% |
|
|
1.6 |
% |
|
|
1.8 |
% |
|
|
1.6 |
% |
Expected dividend yield |
|
|
0 |
% |
|
|
0 |
% |
|
|
0 |
% |
|
|
0 |
% |
Volatility |
|
|
75 |
% |
|
|
79 |
% |
|
|
75 |
% |
|
|
79 |
% |
Expected life |
|
4.0 years |
|
4.0 years |
|
4.0 years |
|
4.0 years |
Weighted average Black-Scholes value of options granted |
|
$ |
3.08 |
|
|
$ |
2.20 |
|
|
$ |
3.09 |
|
|
$ |
2.19 |
|
The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of
grant. The Company does not anticipate declaring dividends in the foreseeable future. Volatility
is based on historical data. The expected life of an option is based on the assumption that options
will be exercised, on average, about two years after vesting occurs. The Company recognizes
compensation expense for only the portion of options or stock units that are expected to vest.
Therefore, management applies an estimated forfeiture rate that is derived from historical employee
termination data and adjusted for expected future employee turnover rates. The estimated forfeiture
rate for stock option grants during the three and six month periods ended June 30, 2010 was 7% and
8% respectively. The estimated forfeiture rate for stock option grants during the three and six
month periods ended June 30, 2009 was 8% for each period. If the actual number of forfeitures
differs from those estimated by management, additional adjustments to compensation expense may be
required in future periods. The Companys stock price volatility, option lives and expected
forfeiture rates involve managements best estimates at the time of such determination, which
impact the fair value of the option calculated under the Black-Scholes methodology and, ultimately,
the expense that will be recognized over the vesting period or requisite service period of the
option. The Company typically issues stock options with a four-year vesting period (the requisite
service period) and amortizes the fair value of stock options (stock compensation cost) ratably
over the requisite service period. The fair value of unvested restricted stock and restricted stock
units is based on the market price of a share of the Companys common stock on the date of grant
and is amortized over the vesting period.
The Company also has an employee stock purchase plan (ESPP) which allows employees to
purchase shares of the Companys common stock at 95% of fair market value on the fourth business
day after the end of each offering period. The ESPP is deemed non-compensatory and therefore is not
subject to the fair value provisions.
The following table sets forth the gross share-based compensation cost resulting from stock
options and unvested restricted stock grants and restricted stock units (before consideration of
any offsets for research and development co-funding) that was recorded in the Companys Condensed
Consolidated Statements of Operations for the three and six months ended June 30, 2010 and 2009 (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Cost of product revenue |
|
$ |
53 |
|
|
$ |
33 |
|
|
$ |
101 |
|
|
$ |
124 |
|
Cost of service revenue |
|
|
111 |
|
|
|
81 |
|
|
|
203 |
|
|
|
298 |
|
Research and development, net |
|
|
398 |
|
|
|
347 |
|
|
|
785 |
|
|
|
1,239 |
|
Sales and marketing |
|
|
215 |
|
|
|
148 |
|
|
|
410 |
|
|
|
512 |
|
General and administrative |
|
|
501 |
|
|
|
424 |
|
|
|
990 |
|
|
|
1,230 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
1,278 |
|
|
$ |
1,033 |
|
|
$ |
2,489 |
|
|
$ |
3,403 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12
A summary of the Companys year-to-date stock option activity and related information follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
Weighted |
|
|
Average |
|
|
|
|
|
|
|
Average |
|
|
Remaining |
|
|
|
|
|
|
|
Exercise |
|
|
Contractual |
|
|
|
Options |
|
|
Price |
|
|
Term |
|
Outstanding at December 31, 2009 |
|
|
3,116,522 |
|
|
$ |
6.43 |
|
|
|
|
|
Grants |
|
|
678,450 |
|
|
$ |
5.48 |
|
|
|
|
|
Exercises |
|
|
(7,611 |
) |
|
$ |
5.67 |
|
|
|
|
|
Cancellations |
|
|
(60,236 |
) |
|
$ |
9.60 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at June 30, 2010 |
|
|
3,727,125 |
|
|
$ |
6.20 |
|
|
7.6 years |
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at June 30, 2010 |
|
|
1,635,817 |
|
|
$ |
7.57 |
|
|
5.9 years |
|
|
|
|
|
|
|
|
|
|
|
|
Available for grant at June 30, 2010 |
|
|
3,075,412 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of June 30, 2010, there was $2.5 million of aggregate intrinsic value of outstanding stock
options, including $0.8 million of aggregate intrinsic value of exercisable stock options.
Intrinsic value represents the total pretax intrinsic value for all in-the-money options (i.e.,
the difference between the Companys closing stock price on the last trading day of its second
quarter of 2010 and the exercise price, multiplied by the number of shares of common stock
underlying the stock options) that would have been received by the option holders had all option
holders exercised their options on June 30, 2010. During the three and six months ended June 30,
2010, stock options covering 7,611 shares of common stock, with a total intrinsic value of $8,000,
were exercised. During the three and six months ended June 30, 2009, stock options covering 4,775
shares of common stock, with a total intrinsic value of $7,000, were exercised.
A summary of the Companys unvested restricted stock grants and restricted stock units and
changes during the period ended June 30, 2010 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
Average |
|
|
|
|
|
|
|
Grant Date |
|
|
|
Shares |
|
|
Fair Value |
|
Outstanding at December 31, 2009 |
|
|
1,431,885 |
|
|
$ |
5.22 |
|
Granted |
|
|
432,000 |
|
|
|
5.61 |
|
Forfeited |
|
|
|
|
|
|
|
|
Vested |
|
|
(269,351 |
) |
|
|
5.90 |
|
|
|
|
|
|
|
|
|
Outstanding at June 30, 2010 |
|
|
1,594,534 |
|
|
$ |
5.21 |
|
|
|
|
|
|
|
|
|
The aggregate fair value of restricted stock vested during the six months ended June 30, 2010
was $1.4 million.
As of June 30, 2010, the Company had $10.9 million of total unrecognized compensation cost
related to unvested stock options and unvested restricted stock and restricted stock units, which
is expected to be recognized over a weighted average period of 2.6 years.
In March 2009, the Company completed a tender offer to purchase 1.8 million of eligible vested
and unvested employee and director stock options outstanding for $669,000. The tender offer was for
options with a grant price of $8.00 or more, which were granted prior to May 2007. The amount
charged to shareholders equity for stock options purchased at or below the estimated fair value of
the options on the date of repurchase was $587,000, with the balance of $82,000 charged to
compensation expense as amounts paid were in excess of estimated fair value. The Company recorded
$1.4 million of stock-based compensation expense in the six months ended June 30, 2009 related to
previously unrecognized compensation cost of unvested stock options that were purchased.
Note 10 Taxes
The Company recorded income tax expense of $196,000 and $296,000, respectively, for the three
and six months ended June 30, 2010. The Company recorded income tax expense of $69,000 and
$117,000, respectively, for the three and six months ended June 30, 2009. The expense recorded was
primarily related to foreign income taxes payable.
The Company continues to provide a full valuation allowance against net operating losses and
other net deferred tax assets arising in certain jurisdictions, primarily in the United States and
Canada, as the realization of such assets is not considered to be more likely than not.
13
In March 2008, Cray U.K. Limited, a wholly-owned subsidiary of the Company, received notice
from HM Revenue & Customs, the United Kingdom equivalent of the Internal Revenue Service, of its
intent to open an inquiry into Cray U.K. Limiteds 2005 and 2006 corporate income tax returns. At
this time, it is not possible to determine the extent or the outcome of such inquiry.
Note 11 Geographic Segment Information
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 regarding allocation of resources and assessing
performance. Crays chief decision-maker is the Chief Executive Officer. The Company continues to
operate in a single operating segment.
The Companys geographic operations outside the United States include sales and service
offices in Canada, Brazil, Europe, the Middle East, Japan, Australia, India, Korea and Taiwan. The
following data presents the Companys revenue for the United States and all other countries, which
is determined based upon a customers geographic location (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States |
|
|
Other Countries |
|
|
Total |
|
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Three months ended June 30, |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product revenue |
|
$ |
2,480 |
|
|
$ |
29,057 |
|
|
$ |
6,773 |
|
|
$ |
13,044 |
|
|
$ |
9,253 |
|
|
$ |
42,101 |
|
Service revenue |
|
|
14,851 |
|
|
|
15,023 |
|
|
|
4,629 |
|
|
|
5,620 |
|
|
|
19,480 |
|
|
|
20,643 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue |
|
$ |
17,331 |
|
|
$ |
44,080 |
|
|
$ |
11,402 |
|
|
$ |
18,664 |
|
|
$ |
28,733 |
|
|
$ |
62,744 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States |
|
|
Other Countries |
|
|
Total |
|
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Six months ended June 30, |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product revenue |
|
$ |
11,177 |
|
|
$ |
79,766 |
|
|
$ |
7,141 |
|
|
$ |
21,797 |
|
|
$ |
18,318 |
|
|
$ |
101,563 |
|
Service revenue |
|
|
29,161 |
|
|
|
24,650 |
|
|
|
9,642 |
|
|
|
11,012 |
|
|
|
38,803 |
|
|
|
35,662 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue |
|
$ |
40,338 |
|
|
$ |
104,416 |
|
|
$ |
16,783 |
|
|
$ |
32,809 |
|
|
$ |
57,121 |
|
|
$ |
137,225 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product and service revenue from U.S. government agencies and customers primarily serving the
U.S. government totaled approximately $17.1 million and $36.6 million, respectively, for the three
and six months ended June 30, 2010, compared to approximately $42.6 million and $99.1 million,
respectively, for the three and six months ended June 30, 2009.
Note 12 Litigation
In 2009 a complaint was filed against the Company and Mellon Investor Services, LLC (the Companys
stock transfer agent) claiming damages relating to the participation of an individual in a 1999
financing of Cray. The plaintiff is the receiver that has been appointed for certain entities
related to the individual and the claims brought by the plaintiff arise from, among other things,
plaintiffs assertion that there has been an inappropriate delay in receiving a replacement for a
lost stock certificate allegedly due to the receiver. The Company will continue to evaluate the
claim but does not expect the outcome to have a material impact on its financial position.
|
|
|
Item 2. |
|
Managements Discussion and Analysis of Financial Condition and Results of Operations |
Preliminary Note Regarding Forward-Looking Statements
This quarterly report on Form 10-Q contains forward-looking statements that involve risks and
uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could
cause our actual results to differ materially from those expressed or implied by such
forward-looking statements. Forward-looking statements are based on our managements beliefs and
assumptions and on information currently available to them. In some cases you can identify
forward-looking statements by terms such as may, will, should, could, would, expect,
plans, anticipates, believes, estimates, projects, predicts, and potential, and
similar expressions intended to identify forward-looking statements, but the absence of these words
does not mean that a statement is not forward-looking. All statements other than statements of
historical fact are statements that could be deemed forward-looking statements, and examples of
forward-looking statements include any projections of earnings, revenue or other results of
operations or financial items; any statements of the plans, strategies and objectives of management
for future operations; any statements concerning proposed new products, technologies or services; any statements regarding future research and
development or co-funding for such efforts; any statements regarding future economic conditions or
performance; and any statements of belief and any statement of assumptions underlying any of the
foregoing.
14
These forward-looking statements are subject to the safe harbor created by Section 27A
of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. Our actual results could differ materially from those anticipated in these
forward-looking statements for many reasons, including the risks faced by us and described in Item
1A. Risk Factors in Part II and other sections of this report and our other filings with the
Securities and Exchange Commission (SEC). You should not place undue reliance on these
forward-looking statements, which apply only as of the date of this report. You should read this
report completely and with the understanding that our actual future results may be materially
different from what we expect. We assume no obligation to update these forward-looking statements,
whether as a result of new information, future events, or otherwise.
Overview and Executive Summary
We design, develop, manufacture, market and service high-performance computing (HPC)
systems, commonly known as supercomputers, and provide engineering services related to HPC systems
and solutions. Our supercomputer systems provide capability and sustained performance far beyond
typical server-based computer systems and address challenging scientific, economic, engineering and
national security computing problems.
We believe we are well-positioned to meet the HPC markets demanding needs by providing
superior supercomputer systems with performance and cost advantages when sustained performance on
challenging applications and total cost of ownership are taken into account. We differentiate
ourselves from our competitors primarily by concentrating our research and development efforts on
the interconnect, packaging and system software capabilities that enable our systems to provide
efficient and high sustained performance at scale that is, to continue to increase performance
as our systems grow in size. Purpose-built for the supercomputer market, our higher-end systems
balance highly capable processors, highly scalable system software and very high speed interconnect
and communications capabilities. Our current plans are based on gaining market share in the
high-end supercomputer market segment (which is expected to grow), extending our technology
leadership, maintaining our focus on execution and profitability and expanding our addressable
market through broadening of our engineering services offerings, specifically our Custom
Engineering practices, and selling our new Cray CX and Cray XTm systems.
The Companys revenue, results of operations and cash balances are likely to fluctuate
significantly from quarter-to-quarter. These fluctuations are due to such factors as the high
average sales prices and limited number of sales of the Companys products, the timing of purchase
orders and product deliveries, the revenue recognition accounting policy of generally not
recognizing product revenue until customer acceptance and other contractual provisions have been
fulfilled, the timing of payments for product sales, maintenance services, government research and
development funding, the impact of the timing of new products on customer orders, and purchases of
inventory during periods of inventory build-up. As a result of these factors, revenue, gross
margin, expenses, and certain balance sheet accounts are expected to vary significantly quarter to
quarter and year to year. Also, given the nature of the Companys business, its revenue,
receivables and other related accounts are likely to be concentrated among a few customers.
Product revenues for the three and six months ended June 30, 2010 were significantly lower
than the prior period primarily due to the anticipated release of the new XT6 in the second quarter
and the new Cray XE6 system (formerly referred to as our Baker systems) in the second half of
2010, lowering first half revenue; and the recognition of revenue in the first half of 2009 from
product deliveries at the end of 2008. Several customers have deferred purchases pending the
release of Cray XE6 systems, the successor product to the Cray XT5 and Cray XT6, that are expected
to be delivered and accepted during the second half of 2010, with revenue from these system sales
expected to be highly concentrated in the fourth quarter of 2010.
Summary of First Six Months of 2010 Results
Total revenue decreased $80.1 million for the first six months of 2010, from $137.2 million to
$57.1 million, compared to the first six months of 2009, due to decreased product revenue of $83.2
million, largely from Cray XT systems, partially offset by increased service revenue of $3.1
million.
Net loss for the first six months of 2010 was $18.2 million compared to a net loss of $1.5
million for the same period in 2009, due to decreased gross profit of $28.4 million partially
offset by a $9.5 million decrease in operating expenses. Operating expenses decreased primarily due to a reduction in net research and development expenses resulting from lower
outside engineering costs and the completion of milestones under funded research and development
contracts.
15
Net cash used in operations was $25.3 million for the first six months of 2010 compared to net
cash provided by operations of $18.6 million for the first six months of 2009. Cash and short-term
investment balances, including restricted cash balances, were $85.3 million as of June 30, 2010
compared to $113.2 million as of December 31, 2009.
Market Overview and Challenges
Significant trends in the HPC industry include:
|
|
|
The commoditization of HPC hardware,
particularly processors and interconnect systems; |
|
|
|
|
The growing commoditization of software, including plentiful building blocks and more
capable open source software; |
|
|
|
|
Supercomputing with many-core commodity processors driving increasing scalability
requirements; |
|
|
|
|
Electrical power requirements becoming a design constraint and driver in total cost of
ownership determinations; |
|
|
|
|
Increased micro-architectural diversity, including many-core processors with vector
extensions and growing experimentation with accelerators, as the rate of per-core
performance increases slows; and |
|
|
|
|
Data needs growing faster than computational needs. |
Several of these trends have resulted in the expansion and acceptance of lower-bandwidth
cluster systems using processors manufactured by Intel, AMD and others combined with commercially
available commodity networking and other components, particularly in the middle and lower portions
of the HPC market. These systems may offer higher theoretical peak performance for equivalent cost,
and price/peak performance is often the dominant factor in HPC procurements outside of the
high-end supercomputer market segment. Vendors of such systems often put pricing pressure on us in
competitive procurements, even at times in larger procurements where time to solution is of
significant importance.
In the markets for the largest systems, those costing significantly in excess of $1 million,
the use of commodity processors and networking components can result in increasing data transfer
bottlenecks as these components do not balance processor power with network communication
capability. With the arrival of increasing processor core counts due to new many-core processors,
these unbalanced systems will typically have even lower productivity, especially in larger systems
running more complex applications. We and other vendors have also begun to augment standard
microprocessors with other processor types, such as field programmable gate arrays and graphics
processing units, in order to increase computational power, further complicating programming
models. In addition, with increasing scale, bandwidth and processor core counts, large computer
systems use progressively higher amounts of power to operate and require special cooling
capabilities.
To position ourselves to meet the markets demanding needs, we concentrate our research and
development efforts on the interconnect, system software and packaging capabilities that enable our
supercomputers to perform at scale that is, to continue to increase actual performance as
systems grow ever larger in size. We also have demonstrated expertise in several processor
technologies. Further, we offer unique capabilities in high-speed, high bandwidth system
interconnect design, compiler technology, system software and packaging capabilities. We believe
our experience and capabilities across each of these fronts are becoming ever more important,
especially in larger procurements. We expect to be in a comparatively advantageous position as
larger many-core processors become available and as multiple processing technologies become
integrated into single systems. In addition, we intend to expand our addressable market by
leveraging our technologies and customer base, the Cray brand and industry trends by introducing
complementary products and services to new and existing customers, as demonstrated by our emphasis
on Custom Engineering projects and the introduction of our Cray CX family, Cray XT5m and Cray XT6m
systems.
16
Key Performance Indicators
Our management monitors and analyzes several key performance indicators in order to manage our
business and evaluate our financial and operating performance, including:
Revenue. Product revenue generally constitutes the major portion of our revenue in any
reporting period and, for the reasons discussed elsewhere in this quarterly report on Form 10-Q, is
subject to significant variability from period to period. In the short term, we closely review the
status of product shipments, installations and acceptances in order to forecast revenue and cash
receipts; longer-term, we monitor the status of the pipeline of product sales opportunities, fiscal
funding and product development cycles. Revenue growth is the best indicator of whether we are
achieving our objective of increased market share in the markets we address. The introduction of
the Cray XT family and our longer-term product roadmap, including our Intel initiative and our
Baker system (now referred to as Cray XE6), are efforts to increase product revenue. We also plan
to increase our engineering services offerings, specifically our Custom Engineering initiative, and
market new products, such as the Cray CX and Cray XT5m and successor systems, to increase revenue.
Maintenance service revenue is more constant in the short term and assists, in part, to offset the
impact that the variability in product revenue has on total revenue in any particular period.
Gross profit. Our total gross profit margin and our product gross profit margin for the first
six months of 2010 were 31% and 31%, respectively, which reflect decreases from the respective 2009
levels of 34% and 32%, respectively. Product gross profit margin for the first six months of 2010
was negatively impacted by a low margin transaction in the first quarter and a $0.5 million charge
for estimated excess inventory. Service gross profit margin of 32% for the first half of 2010 was
down from 38% during the same period in 2009. This was primarily due to the increase in personnel
and third-party costs associated with our increased Custom Engineering activities without
sufficient current quarter revenue to maintain the gross margin. Additionally, service revenue was
reduced by $1 million due to an increase in the estimated costs to complete a Custom Engineering
contract that required the reversal of revenue that had been recognized in prior periods. Gross
profit in the first six months of 2009 was negatively impacted by a large, low gross profit
contract (on which $36 million was recognized in the first quarter of 2009) and a delay in signing
of a contract and related revenue recognition issues relating to an anticipated Custom Engineering
project on which costs were incurred. We continue to focus on maintaining and improving our product
gross profit over the long term, which we believe is best achieved through product differentiation.
Operating expenses. Our operating expenses are driven largely by headcount, the level of
recognized co-funding for research and development and contracted third-party research and
development services. As part of our ongoing efforts to control operating expenses, we monitor
headcount levels in specific geographic and operational areas. Operating expenses for the first six
months of 2010 were approximately $9.5 million less than the first six months of 2009 resulting
from a reduction in net research and development expenses due to the achievement of milestones
under funded research and development contracts. Operating expenses can increase significantly in
profitable quarters where incentive compensation can be high.
Liquidity and cash flows. Due to the variability in product revenue and new contracts, our
cash position also varies from quarter-to-quarter and within a quarter. We closely monitor our
expected cash levels, particularly in light of increased inventory purchases for large system
installations and the risk of delays in product shipments and acceptances and, longer-term, in
product development. Sustained profitability over annual periods is our primary objective, which
should improve our cash position.
Critical Accounting Policies and Estimates
This discussion, as well as disclosures included elsewhere in this quarterly report on Form
10-Q, are based upon our Condensed Consolidated Financial Statements, which have been prepared in
accordance with GAAP. The preparation of these financial statements requires us to make estimates
and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and
related disclosure of contingencies. In preparing our financial statements in accordance with GAAP,
there are certain accounting policies that are particularly important. These include revenue
recognition, inventory valuation, accounting for income taxes, research and development expenses
and share-based compensation. Our significant accounting policies are set forth in Note 2 to the
Condensed Consolidated Financial Statements included in our 2009 Form 10-K and should be reviewed
in conjunction with the accompanying Condensed Consolidated Financial Statements and notes thereto
as of June 30, 2010, as they are integral to understanding our results of operations and financial
condition in this interim period. In some cases, these policies represent required accounting. In
other cases, they may represent a choice between acceptable accounting methods or may require
substantial judgment or estimation.
Additionally, we consider certain judgments and estimates to be significant, including those
relating to the fair value and selling price
determination used in revenue recognition, percentage
of completion accounting, estimates of proportional performance on co-funded engineering contracts
and prepaid engineering services, realization of accounts receivable, determination of inventory at
the lower of cost or market, useful lives for depreciation and amortization, determination of
future cash flows associated with impairment testing of long-lived assets, determination of the
fair value of stock options and other assessments of fair value, realization of deferred income tax
assets, including our ability to utilize such assets, potential income tax assessments and other
contingencies. We base our estimates on historical experience, current conditions and on other
assumptions that we believe to be reasonable under the circumstances. Actual results may differ
materially from these estimates and assumptions.
17
Our management has discussed the selection of significant accounting policies and the effect
of judgments and estimates with the Audit Committee of our Board of Directors.
Revenue Recognition
The Company recognizes revenue when it is realized or realizable and earned. The Company
considers revenue realized or realizable and earned when it has persuasive evidence of an
arrangement, delivery has occurred, the sales price is fixed or determinable, and collectibility is
reasonably assured. Delivery does not occur until the products have been shipped or services
provided to the customer, risk of loss has transferred to the client, and a customer acceptance has
been obtained. The sales price is not considered to be fixed or determinable until all
contingencies related to the sales have been resolved. The Company records revenue in the Condensed
Consolidated Statements of Operations net of any sales, use, value added or certain excise taxes
imposed by governmental authorities on specific sales transactions. In addition to the
aforementioned general policy, the following are our statements of policy with regard to
multiple-element arrangements and specific revenue recognition policies for each major category of
revenue.
Multiple-Element Arrangements. The Company commonly enters into revenue arrangements that
include multiple deliverables of its product and service offerings due to the needs of its
customers. Product may be delivered in phases over time periods which can be as long as five years.
Maintenance services generally begin upon acceptance of the first equipment delivery and future
deliveries of equipment generally have an associated maintenance period. The Company considers the
maintenance period to commence upon acceptance of the product, which may include a warranty period
and accordingly allocates a portion of the arrangement consideration as a separate deliverable
which is recognized as service revenue over the entire service period. Other services such as
training and engineering services can be delivered as a discrete delivery or over the term of the
contract. A multiple-element arrangement is separated into more than one unit of accounting if the
following criteria are met:
|
|
|
The delivered item(s) has value to the customer on a
standalone basis; and |
|
|
|
|
If the arrangement includes a general right of return relative
to the delivered item(s), delivery or performance of the undelivered item(s) is considered
probable and substantially in the control of the Company. |
If these criteria are not met, the arrangement is accounted for as one unit of accounting
which would result in revenue being recognized ratably over the contract term or being deferred
until the earlier of when such criteria are met or when the last undelivered element is delivered.
If these criteria are met for each element and there is a relative selling price for all units of
accounting in an arrangement, the arrangement consideration is allocated to the separate units of
accounting based on each units relative estimated selling price.
The Company follows a selling price hierarchy in determining the best estimate of the selling
price of each deliverable. Certain products and services are sold separately in standalone
arrangements for which the Company is sometimes able to determine vendor specific objective
evidence (VSOE). The Company determines VSOE based on normal pricing and discounting practices for
the product or service when sold separately.
When the Company is not able to establish VSOE for all deliverables in an arrangement with
multiple elements, the Company attempts to establish the selling price of each element based on
third-party evidence (TPE). The Companys inability to establish VSOE is often due to a relatively
small sample of customer contracts that differ in system size and contract terms which can be due
to infrequently selling each element separately, not pricing products within a narrow range, or
only having a limited sales history, such as in the case of certain advanced and emerging
technologies. TPE is determined based on competitor prices for similar deliverables when sold
separately. Generally, the Companys offerings contain a significant level of customization and
differentiation from those of competitors such that the comparable pricing of products with similar
functionality cannot be obtained. The Company is also often unable to reliably determine what
similar competitor products selling prices are on a standalone basis as important details of
competitive bids are not available. Therefore, the Company is typically not able to determine TPE.
18
When the Company is unable to establish selling price using VSOE or TPE, as is the case most
of the time, the Company uses estimated selling price (ESP) in its allocation of arrangement
consideration. The objective of ESP is to determine the price at which we would transact a sale if
the product or service were sold on a standalone basis. The Company determines ESP for a product or
service by considering multiple factors, including, but not limited to, internal costs, gross
margin objectives, and pricing practices. ESP is often based on data collected from prior sales,
but that may not have the sample size or consistency to establish VSOE.
Product. The Company recognizes revenue from sales of products, other than the Cray CX
systems, upon customer acceptance of the system, when the price is fixed or determinable,
collection is reasonably assured and no significant unfulfilled obligations exist. Revenue from
sales of our Cray CX systems is generally recognized upon shipment when title and risk of loss
transfers to the customer and collection is reasonably assured.
Service. Maintenance services are provided under separate maintenance contracts with
customers. These contracts generally provide for maintenance services for one year, although some
are for multi-year periods, often with prepayments for the term of the contract. The Company
considers the maintenance period to commence upon acceptance of the product, which may include a
warranty period. When service is part of a multiple-element arrangement, the Company allocates a
portion of the arrangement consideration to maintenance service revenue based on estimates of
selling price. Maintenance revenue is recognized ratably over the term of the maintenance contract.
Maintenance contracts that are paid in advance are recorded as deferred revenue.
Revenue from engineering services is recognized as services are performed.
Project. Revenue from design and build contracts is recognized under the
percentage-of-completion (POC) method. Under the POC method, revenue is recognized based on the
costs incurred to date as a percentage of the total estimated costs to fulfill the contract. If
circumstances arise that change the original estimates of revenues, costs, or extent of progress
toward completion, revisions to the estimates are made. These revisions may result in increases or
decreases in estimated revenues or costs, and such revisions are recorded in income in the period
in which the circumstances that gave rise to the revision become known by management. The Company
performs ongoing profitability analyses of its contracts accounted for under the POC method in
order to determine whether the latest estimates of revenue, costs and extent of progress require
updating. If at any time these estimates indicate that the contract will be unprofitable, the
entire estimated loss for the remainder of the contract is recorded immediately.
The Company records revenue from research and development contracts which include milestones,
and may require the development of a prototype system, using the milestone method if the milestones
are determined to be substantive. A milestone is considered to be substantive if management
believes there is substantive uncertainty that it will be achieved and the milestone consideration
meets all of the following criteria:
|
|
|
It is commensurate with either of the following: |
|
|
|
The Companys performance to achieve the milestone; or |
|
|
|
|
The enhancement of value of the delivered item or items as a result
of a specific outcome resulting from the Companys performance to achieve the
milestone. |
|
|
|
It relates solely to past performance. |
|
|
|
|
It is reasonable relative to all of the deliverables and payment terms (including
other potential milestone consideration) within the arrangement. |
The individual milestones are determined to be substantive or nonsubstantive in their entirety
and milestone consideration is not bifurcated.
Revenue from projects is classified as Product Revenue or Service Revenue, based on the nature
of the work performed.
Inventory Valuation
We record our inventory at the lower of cost or market. We regularly evaluate the
technological usefulness and anticipated future demand for our inventory components. Due to rapid
changes in technology and the increasing demands of our customers, we are continually developing
new products. Additionally, during periods of product or inventory component upgrades or
transitions, we may acquire significant quantities of inventory to support estimated current and
future production and service requirements. As a result, it is possible that older inventory items
we have purchased may become obsolete, be sold below cost or be deemed in excess of quantities
required for production or service requirements. When we determine it is not likely we will recover
the cost of inventory items through future sales, we write down the related inventory to our
estimate of its market value.
19
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 have sold inventory previously reduced in part or in whole
to zero, and we may have future sales of previously written-down inventory. We also may 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. During the first half of 2010,
we recorded a charge of $0.5 million related to inventory in excess of estimated future demand. The
largest portion of this write-down related to a Cray custom-made component used on the Cray XT
products known as the Cray SeaStar interconnect purchased in 2008 under a last-time buy
procurement.
Accounting for Income Taxes
Deferred tax assets and liabilities are determined based on differences between financial
reporting and tax bases of assets and liabilities and operating loss and tax credit carryforwards
and are measured using the enacted tax rates and laws that will be in effect when the differences
and carryforwards are expected to be recovered or settled. A valuation allowance for deferred tax
assets is provided when we estimate that it is more likely than not that all or a portion of the
deferred tax assets may not be realized through future operations. This assessment is based upon
consideration of available positive and negative evidence, which includes, among other things, our
recent results of operations and expected future profitability. We consider our actual historical
results to have stronger weight than other more subjective indicators when considering whether to
establish or reduce a valuation allowance on deferred tax assets. Estimated interest and penalties
are recorded as a component of interest expense and other expense, respectively.
As of June 30, 2010, we had approximately $142.2 million of net deferred tax assets, against
which we provided a $139.5 million valuation allowance, resulting in a net deferred tax asset of
$2.7 million. Our net deferred tax assets relate primarily to certain foreign jurisdictions where
we believe it is more likely than not that such assets will be realized. We continue to provide a
full valuation allowance against net operating losses and other net deferred tax assets arising in
certain jurisdictions, primarily in the United States and Canada, as the realization of such assets
is not considered to be more likely than not.
Research and Development Expenses
Research and development expenses include costs incurred in the development and production of
our hardware and software, costs incurred to enhance and support existing product features and
costs related to future product development. Research and development expenses are expensed as
incurred, and may be offset by co-funding from third parties. We may also enter into arrangements
whereby we make advance, non-refundable payments to a vendor to perform certain research and
development services. These payments are deferred and recognized over the vendors estimated
performance period. During the third quarter of 2009, we amended a vendor agreement to settle
outstanding performance issues. We had made advance payments of $16.2 million to the vendor. The
amendment called for us to receive a refund of $10.0 million of amounts previously paid to the
vendor and the right to receive rebates on future purchases. As of June 30, 2010, the full balance
of the refund had been received. The rebate right of $6.2 million is classified in Other
non-current assets in the Condensed Consolidated Balance Sheets. No gain or loss was recorded as a
result of this amendment.
Amounts to be received under co-funding arrangements with the U.S. government are based on
either contractual milestones or costs incurred. These co-funding milestone payments are recognized
in operations as performance is estimated to be completed and are measured as milestone
achievements occur or as costs are incurred. These estimates are reviewed on a periodic basis and
are subject to change, including in the near term. If an estimate is changed, net research and
development expense could be impacted significantly.
We do not record a receivable from the U.S. government prior to completing the requirements
necessary to bill for a milestone or cost reimbursement. Funding from the U.S. government is
subject to certain budget restrictions and milestones may be subject to completion risk, and as
such, there may be periods in which research and development costs are expensed as incurred for
which no reimbursement is recorded, as milestones have not been completed or the U.S. government
has not funded an agreement.
We classify amounts to be received from funded research and development projects as either
revenue or a reduction to research and development expense, based on the specific facts and
circumstances of the contractual arrangement, considering total costs expected to be incurred
compared to total expected funding and the nature of the research and development contractual
arrangement. In the event
that a particular arrangement is determined to represent revenue, the corresponding research
and development costs are classified as cost of revenue.
20
Share-based Compensation
We account for share-based compensation by estimating the fair value of share-based
compensation using the Black-Scholes option pricing model. We utilize assumptions related to stock
price volatility, stock option term and forfeiture rates that are based upon both historical
factors as well as managements judgment.
New Accounting Pronouncements
In October 2009, the Financial Accounting Standards Board (FASB) issued Accounting Standards
Update (ASU) No. 2009-13, Multiple-Deliverable Revenue Arrangements. The guidance in ASU 2009-13
provides amendments to the criteria for separating consideration in multiple-deliverable
arrangements. The amendments establish a selling price hierarchy for determining the selling price
of a deliverable, which replaces fair value in the revenue allocation guidance, as the allocation
of revenue will be based on entity-specific assumptions rather than assumptions of a marketplace
participant. The amendments in ASU 2009-13 are effective for revenue transactions entered into
during fiscal years beginning on or after June 15, 2010. The Company adopted this guidance
effective January 1, 2010. The adoption of ASU 2009-13 did not have a significant impact on the
Companys financial results nor would it have had a material impact had the guidance been adopted
on January 1, 2009. ASU 2009-13 did not to significantly change the Companys determination of
units of accounting or arrangement consideration allocation methodology used to recognize revenue.
In October 2009, the FASB issued ASU No. 2009-14, Certain Revenue Arrangements that Include
Software Elements. The guidance in ASU 2009-14 changes the accounting model for revenue
arrangements that include both tangible products and software elements. Tangible products
containing software components and non-software components that function together to deliver the
tangible products essential functionality are excluded from the guidance applicable to software
revenue recognition. The amendments in ASU 2009-14 are effective for revenue transactions entered
into during fiscal years beginning on or after June 15, 2010. The Company adopted this guidance
effective January 1, 2010. The adoption of ASU 2009-14 did not have a significant impact on the
Companys financial results nor would it have had a material impact had the guidance been adopted
on January 1, 2009.
In April 2010, the FASB issued ASU No. 2010-17, Revenue Recognition Milestone Method (Topic
605): Milestone Method of Revenue Recognition. ASU 2010-17 provides guidance on defining a
milestone and determining when it may be appropriate to apply the milestone method of revenue
recognition for research or development transactions. Consideration that is contingent on
achievement of a milestone in its entirety may be recognized as revenue in the period in which the
milestone is achieved only if the milestone is judged to be substantive by meeting
specific criteria. The amendments in ASU 2010-17 are effective for milestones achieved in fiscal
years, and interim periods within those years, beginning on or after June 15, 2010. In accordance
with the guidance, the Company elected to early adopt its provisions as of January 1, 2010. The
adoption of this guidance did not have a material impact on the Companys financial results.
Results of Operations
The Companys revenue, results of operations and cash balances are likely to fluctuate
significantly from quarter-to-quarter. These fluctuations are due to such factors as the high
average sales prices and limited number of sales of the Companys products, the timing of purchase
orders and product deliveries, the revenue recognition accounting policy of generally not
recognizing product revenue until customer acceptance and other contractual provisions have been
fulfilled, the timing of payments for product sales, maintenance services, government research and
development funding, the impact of the timing of new products on customer orders, and purchases of
inventory during periods of inventory build-up. As a result of these factors, revenue, gross
margin, expenses, cash, and inventory are expected to vary significantly quarter to quarter and
year to year.
21
Revenue and Gross Profit Margins
Our revenue, cost of revenue and gross profit margin for the three and six months ended June
30, 2010 and 2009, respectively, were (in thousands, except for percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Product revenue |
|
$ |
9,253 |
|
|
$ |
42,101 |
|
|
$ |
18,318 |
|
|
$ |
101,563 |
|
Less: Cost of product revenue |
|
|
4,587 |
|
|
|
22,263 |
|
|
|
12,593 |
|
|
|
68,597 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product gross profit |
|
$ |
4,666 |
|
|
$ |
19,838 |
|
|
$ |
5,725 |
|
|
$ |
32,966 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product gross profit margin |
|
|
50 |
% |
|
|
47 |
% |
|
|
31 |
% |
|
|
32 |
% |
|
Service revenue |
|
$ |
19,480 |
|
|
$ |
20,643 |
|
|
$ |
38,803 |
|
|
$ |
35,662 |
|
Less: Cost of service revenue |
|
|
12,828 |
|
|
|
11,952 |
|
|
|
26,576 |
|
|
|
22,228 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service gross profit |
|
$ |
6,652 |
|
|
$ |
8,691 |
|
|
$ |
12,227 |
|
|
$ |
13,434 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service gross profit margin |
|
|
34 |
% |
|
|
42 |
% |
|
|
32 |
% |
|
|
38 |
% |
|
Total revenue |
|
$ |
28,733 |
|
|
$ |
62,744 |
|
|
$ |
57,121 |
|
|
$ |
137,225 |
|
Less: Total cost of revenue |
|
|
17,415 |
|
|
|
34,215 |
|
|
|
39,169 |
|
|
|
90,825 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gross profit |
|
$ |
11,318 |
|
|
$ |
28,529 |
|
|
$ |
17,952 |
|
|
$ |
46,400 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gross profit margin |
|
|
39 |
% |
|
|
45 |
% |
|
|
31 |
% |
|
|
34 |
% |
Product Revenue
Product revenue for the three and six months ended June 30, 2010 was $9.3 million and $18.3
million, respectively, primarily from sales of Cray XT5 systems and third-party equipment. Product
revenue for the three and six months ended June 30, 2009 was $42.1 million and $101.6 million,
respectively, primarily from sales of and upgrades to Cray XT systems. Product revenue for the
three and six months ended June 30, 2010 were significantly lower than the prior period primarily
due to the anticipated release of the new Cray XE6 system in the second half of 2010 and the
recognition of revenue in the first half of 2009 from product deliveries at the end of 2008.
Several customers have deferred purchases pending the release of Cray XE6 systems, the successor
product to the Cray XT5 and Cray XT6, that are expected to be delivered and accepted during the
second half of 2010, with revenue from these system sales expected to be concentrated in the fourth
quarter of 2010.
Service Revenue
Service revenue for the three months ended June 30, 2010 was $19.5 million compared to $20.6
million for the same period in 2009. This decrease was caused by delays on certain Custom
Engineering contracts. Service revenue for the six months ended June 30, 2010 was $38.8 million
compared to $35.7 million for the same period in 2009, an increase of $3.1 million. This increase
was driven principally by revenue from our Custom Engineering initiative offset somewhat by a $0.5
million decrease in maintenance services revenue.
Cost of Product Revenue and Product Gross Profit
For the three and six months ended June 30, 2010, cost of product revenue decreased $17.7
million and $56.0 million, respectively, based on lower product revenues. For the three months
ended June 30, 2010, product gross profit margin increased 3 percentage points to 50 percent,
compared to the same period in 2009 due to a higher proportion of high margin products being sold
on low volume. Product gross margin for the quarter ended June 30, 2010 and 2009 is not indicative
of expected full year results. For the six months ended June 30, 2010, product gross profit margin
dropped 1 percentage point from the same period in 2009 partially due to a single low margin
transaction in the first quarter and a $0.5 million charge in the first quarter for an inventory
write-down.
Cost of Service Revenue and Service Gross Profit
Cost of service revenue increased $0.9 million and service gross profit margin decreased by 8
percentage points to 34% during the three months ended June 30, 2010 compared to the same period in
2009. These changes were principally due to the increase in personnel and third-party costs
associated with our increased Custom Engineering activities ahead of revenue. For the six months
ended June 30, 2010, cost of service revenue increased $4.3 million and service gross profit margin
decreased by 6 percentage points to 32% compared
to the same period in 2009. These changes were primarily due to the increase in personnel and
third-party costs associated with our
increased Custom Engineering activities and a revision in
estimated progress toward completion on a contract accounted for under the percentage completion
method during the three months ended March 31, 2010 and six months ended June 30, 2010.
22
Research and Development Expenses
Research and development expenses for the three and six months ended June 30, 2010 and 2009,
respectively, were (in thousands, except for percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Gross research and development expenses |
|
$ |
19,051 |
|
|
$ |
24,874 |
|
|
$ |
39,245 |
|
|
$ |
50,892 |
|
Less: Amounts included in cost of revenue |
|
|
(7 |
) |
|
|
(713 |
) |
|
|
(7 |
) |
|
|
(1,295 |
) |
Less: Reimbursed research and
development (excludes amounts in
revenue) |
|
|
(12,000 |
) |
|
|
(10,451 |
) |
|
|
(24,500 |
) |
|
|
(24,672 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net research and development expenses |
|
$ |
7,044 |
|
|
$ |
13,710 |
|
|
$ |
14,738 |
|
|
$ |
24,925 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percentage of total revenue |
|
|
25 |
% |
|
|
22 |
% |
|
|
26 |
% |
|
|
18 |
% |
Gross research and development expenses in the table above reflect all research and
development expenditures. Research and development expenses include personnel expenses,
depreciation, allocations for certain overhead expenses, software, prototype materials and outside
contracted engineering expenses.
For the three months ended June 30, 2010, gross research and development expenses decreased
$5.8 million from the same period in 2009, due to $4.3 million lower expenditures on outside
services as a process improvement consulting project was completed in 2009 and $1.3 million lower
salary and related expenses. The total of reimbursed research and development and amounts included
in cost of revenue increased $0.8 million for the three months ended June 30, 2010 compared to the
same period in 2009, principally due to higher reimbursement on Defense Advanced Research Projects
Agency High Productivity Computing Systems (DARPA) programs. Per our agreement with DARPA, we
have one remaining milestone planned for review and completion in 2010 for $12.0 million. For the
six months ended June 30, 2010, gross research and development expenses decreased $11.6 million
from the same period in 2009, due principally to lower outside services from the completion of the
process improvement consulting costs in 2009 and reduced salary and related expenses.
In February 2010, the Company and DARPA amended the Phase III agreement. As with the previous
contract, we expect to receive reimbursement after the achievement of a series of pre-defined
milestones culminating in the delivery of a prototype system in 2012. Consistent with this change,
certain deliverables have been eliminated from the contract, reducing the overall scope and cost of
the project. The remaining amount of the milestones under the contract was reduced by $60 million.
As of June 30, 2010, we had earned $122 million of reimbursement under the DARPA Phase III
agreement. Pursuant to the recently-amended contract, we are required to spend $285 million on our
DARPA Phase III project in order to receive the full $190 million of co-funding.
Sales and Marketing and General and Administrative Expenses
Our sales and marketing and general and administrative expenses for the three and six months
ended June 30, 2010 and 2009, respectively, were (in thousands, except for percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
June 30, |
|
June 30, |
|
|
2010 |
|
2009 |
|
2010 |
|
2009 |
Sales and marketing |
|
$ |
6,572 |
|
|
$ |
6,341 |
|
|
$ |
12,836 |
|
|
$ |
12,404 |
|
Percentage of total revenue |
|
|
23 |
% |
|
|
10 |
% |
|
|
22 |
% |
|
|
9 |
% |
General and administrative |
|
$ |
4,018 |
|
|
$ |
3,901 |
|
|
$ |
8,305 |
|
|
$ |
8,047 |
|
Percentage of total revenue |
|
|
14 |
% |
|
|
6 |
% |
|
|
15 |
% |
|
|
6 |
% |
Sales and Marketing. Sales and marketing expense for the three and six months ended June 30,
2010 increased $0.2 million and $0.4 million, respectively, from the same periods in 2009,
primarily due to higher salaries and benefits related to our strategic initiatives as well as
increased expenses in our foreign locations offset by lower commissions and bonus expense.
23
General and Administrative. General and administrative expense for the three and six months
ended June 30, 2010 increased $0.1 million and $0.3 million, respectively, from the same periods in
2009, primarily due to higher salaries and benefits.
Operating expenses can vary significantly from quarter to quarter depending on the level of
incentive compensation earned, which is based largely on year-to-date operating results, and
milestones completed under externally funded research and development contracts.
Other Income (Expense), net
For the three months ended June 30, 2010, we recognized net other expense of $148,000 compared
to net other expense of $737,000 for the same period in 2009. Net other expense for the three
months ended June 30, 2010 was principally the result of foreign currency transaction losses. Net
other expense for the three months ended June 30, 2009 was principally the result of a loss on the
repurchase of Notes partially offset by foreign currency transaction gains. For the six months
ended June 30, 2010, we recognized net other expense of $51,000 compared to net other expense of
$1,491,000 for the same period in 2009. Net other expense for the six months ended June 30, 2009
was principally the result of a loss on the repurchase of Notes and foreign currency transaction
losses.
Interest Income (Expense), net
Our interest income and interest expense for the three and six months ended June 30, 2010 and
2009, respectively, were (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Interest income |
|
$ |
48 |
|
|
$ |
110 |
|
|
$ |
89 |
|
|
$ |
380 |
|
Interest expense |
|
|
(26 |
) |
|
|
(461 |
) |
|
|
(50 |
) |
|
|
(1,264 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income
(expense), net |
|
$ |
22 |
|
|
$ |
(351 |
) |
|
$ |
39 |
|
|
$ |
(884 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income decreased during the three and six months ended June 30, 2010 compared to the
same periods in 2009 as a result of lower invested balances and short-term interest rates. Interest
expense decreased significantly due to the retirement of our Notes in 2009.
Interest expense for the three months ended June 30, 2009 included $0.1 million of contractual
interest on our Notes, non-cash amortization of our Notes debt discount of $0.3 million and
non-cash amortization of capitalized issuance costs of $27,000. Interest expense for the six months
ended June 30, 2009 included $0.3 million of contractual interest on our Notes, non-cash
amortization of our Notes debt discount of $0.8 million and non-cash amortization of capitalized
issuance costs of $0.1 million.
Taxes
We recorded an income tax expense of $196,000 and $69,000 for the three months ended June 30,
2010 and 2009, respectively, principally from our foreign operations. We recorded an income tax
expense of $296,000 and $117,000 for the six months ended June 30, 2010 and 2009, respectively,
principally from our foreign operations.
Liquidity and Capital Resources
The Company generates cash from operations predominantly from the sale of high performance
computer systems and related services. The Company typically has a small number of significant
contracts that make up the majority of total revenue. The material changes in certain of the
Companys balance sheet accounts are due to the timing of product deliveries, customer acceptances,
contractually determined billings and cash collections. Working capital requirements, including
inventory purchases and normal capital expenditures, are generally funded with cash from
operations.
At June 30, 2010 the Company was in the middle of a very large production ramp to deliver a
new Cray XE6 supercomputer to several customers. This production ramp has resulted in a
significant increase in inventory to $110.6 million compared to $29.0 million at December 31, 2009.
Associated with this increase is a large increase in accounts payable to $64.9 million compared to
$18.8 million at year-end. Partially offsetting these impacts on our liquidity position has been
an increase in the current portion of deferred revenues to
$75.9 million from $42.4 million at December 31, 2009 resulting principally from contractual
rights to bill certain of these customers for part of the contract before full customer acceptance
and related revenue recognition.
24
Later in 2010 or in early 2011 we anticipate that the impacts of
this large production ramp on our liquidity will reverse at least in part, however any delays in
deliveries or acceptances of our systems could also delay such reversal and significantly reduce
the Companys liquidity and cash position.
Cash and cash equivalents, restricted cash and short-term investments totaled $85.3 million at
June 30, 2010 compared to $113.2 million at December 31, 2009. Management expects cash to decrease
in the third quarter of 2010 as the Company continues to build inventory in advance of the delivery
and acceptance of certain large-scale systems.
Cash flow information includes the following:
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
June 30, |
|
|
2010 |
|
2009 |
Cash provided by (used in): |
|
|
|
|
|
|
|
|
Operating Activities |
|
$ |
(25,316 |
) |
|
$ |
18,552 |
|
Investing Activities |
|
$ |
671 |
|
|
$ |
(1,571 |
) |
Financing Activities |
|
$ |
318 |
|
|
$ |
(27,536 |
) |
Operating Activities. Net cash used in operating activities for the six months ended June 30,
2010 was $25.3 million compared to net cash provided by operating activities of $18.6 million for
the same period in 2009. For the six months ended June 30, 2010, net cash used in operating
activities was principally the result of a buildup of inventory related to certain large-scale
system contracts, much of which management expects to be converted to cash in the second half of
2010. For the six months ended June 30, 2009, net cash provided by operating activities was
principally the result of decreases in accounts receivable and inventory as acceptance and payment
were received for certain large-scale systems.
Investing Activities. Net cash provided by investing activities was $0.7 million for the six
months ended June 30, 2010, compared to net cash used in investing activities of $1.6 million for
the same 2009 period. Net cash provided by investing activities for the six months ended June 30,
2010 was due principally to the sale of short-term investments partially offset by the purchase of
property and equipment. Net cash used in investing activities for the six months ended June 30,
2009 was principally due to purchases of property and equipment.
Financing Activities. Net cash provided by financing activities for the six months ended June
30, 2010 was $0.3 million, compared to net cash used in financing activities of $27.5 million for
the same period in 2009. Net cash provided by financing activities for the six months ended June
30, 2010 resulted primarily from cash received from the issuance of common stock through our
employee stock purchase plan. Net cash used in financing activities for the six months ended June
30, 2009 resulted primarily from the repurchase of our Notes and our stock options from our 2009
stock option repurchase tender offer, partially offset by the issuance of common stock through our
employee stock purchase plan and exercises of stock options.
In addition, we lease certain equipment and facilities used in our operations under operating
leases in the normal course of business and have contractual commitments under certain development
arrangements. The following table summarizes our contractual obligations at June 30, 2010 (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amounts Committed by Year |
|
|
|
|
|
|
|
2010 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Less than |
|
|
|
|
|
|
|
|
|
|
Contractual Obligations |
|
Total |
|
|
1 Year) |
|
|
2011-2012 |
|
|
2013-2014 |
|
|
Thereafter |
|
Development agreements |
|
$ |
18,110 |
|
|
$ |
8,794 |
|
|
$ |
9,191 |
|
|
$ |
125 |
|
|
$ |
|
|
Operating leases |
|
|
28,210 |
|
|
|
2,077 |
|
|
|
6,702 |
|
|
|
6,519 |
|
|
|
12,912 |
|
Unrecognized income tax benefits |
|
|
488 |
|
|
|
265 |
|
|
|
223 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total contractual cash obligations |
|
$ |
46,808 |
|
|
$ |
11,136 |
|
|
$ |
16,116 |
|
|
$ |
6,644 |
|
|
$ |
12,912 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company had $3.5 million of unused borrowing on a line of credit of $3.5 million at June
30, 2010 and December 31, 2009.
We believe that current cash and cash equivalents balances will be sufficient to meet our
anticipated operating cash needs for at least the next 12 months. However, any projections of
future cash needs and cash flows are subject to substantial uncertainty. For example; If we are
unable to manufacture, deliver and obtain customer acceptances of our Cray XE6 systems scheduled
for delivery in the second half of 2010, our 2010 revenue and cash will be substantially reduced
and our financial results will be significantly adversely affected. During the second half of 2010
there will likely be a period of time where our liquidity position is significantly lower than at
June 30,
2010 levels. We have discussed and been granted extended payment terms with certain key
suppliers to help us mitigate the impact of our new product manufacturing ramp.
25
In addition we
have been discussing with a bank the addition of a secured credit line of between $15 and $25
million that could be accessed if necessary to fund our temporary working capital needs. Should
there be significant delays in product acceptances for the new Cray XE6 systems the Company may
need to assess these and potentially other sources of financing. There can be no assurance that
extended supplier credit terms, additional lines of credit or other financing will be available in
amounts or on terms needed or acceptable to us, if at all.
We continually evaluate opportunities to sell equity or debt securities, access existing
credit facilities or obtain new credit facilities to further strengthen our financial position. The
sale of additional equity or convertible debt securities would likely be dilutive to our
shareholders. In addition, we will, from time to time, consider the acquisition of, or investment
in, complementary businesses, products, services, and technologies, which might affect our
liquidity requirements or cause us to issue additional equity or debt securities. There can be no
assurance that these financing instruments will be available in amounts or on terms needed or
acceptable to us, if at all.
Contractual Obligations
There have been no significant changes in our contractual obligations during the six months
ended June 30, 2010, as compared to the contractual obligations disclosed in Managements
Discussion and Analysis of Financial Condition and Results of Operations, set forth in Part II,
Item 7, of our Annual Report on Form 10-K for the fiscal year ended December 31, 2009.
|
|
|
Item 3. |
|
Quantitative and Qualitative Disclosures About Market Risk |
We are exposed to financial market risks, including changes in interest rates and foreign
currency fluctuations.
Interest Rate Risk: We invest our available cash principally in highly liquid investment-grade
debt instruments of corporate issuers and in debt instruments of the U.S. government and its
agencies. We do not have any derivative instruments in our investment portfolio. We protect and
preserve invested funds by limiting default, market and reinvestment risk.
Foreign Currency Risk: We sell our products primarily in North America, 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
may call for payment in foreign currencies and to the extent we do so, or engage with our foreign
subsidiaries in transactions deemed to be short-term in nature, we are subject to foreign currency
exchange risks. As of June 30, 2010, we were a party to forward exchange contracts that hedged
approximately $31.3 million of anticipated cash receipts on specific foreign currency denominated
sales contracts. These forward contracts hedge the risk of foreign exchange rate changes between
the time that the related contract was signed and when the cash receipts are expected to be
received. Our foreign maintenance contracts are typically paid in local currencies and provide a
natural hedge against foreign exchange exposure. To the extent that we wish to repatriate any of
these funds to the United States, however, we are subject to foreign exchange risks. As of June 30,
2010, a 10% change in foreign exchange rates could impact our annual earnings and cash flows by
approximately $0.6 million.
|
|
|
Item 4. |
|
Controls and Procedures |
Evaluation of disclosure controls and procedures. Under the supervision and with the
participation of our senior management, including our chief executive officer and chief financial
officer, we conducted an evaluation of the effectiveness of the design and operation of our
disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as of the end of the period covered by this quarterly report.
Based on this evaluation, our chief executive officer and chief financial officer concluded as of
June 30, 2010, that our disclosure controls and procedures were effective such that the information
required to be disclosed in our SEC reports (i) is recorded, processed, summarized and reported
within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated
to our management, including our chief executive officer and chief financial officer, as
appropriate to allow timely decisions regarding required disclosure.
Changes in internal control over financial reporting. There have been no changes in our
internal control over financial reporting that occurred during the quarter ended June 30, 2010 that
have materially affected or are reasonably likely to materially affect our internal control over
financial reporting.
26
Limitations on effectiveness of control. Our management, including our chief executive officer
and chief financial officer, does not expect that our disclosure controls and procedures or our
internal controls will prevent all errors and all fraud. A control system, no matter how well
conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of
the control system are met. Further, the design of a control system must reflect the fact that
there are resource constraints, and the benefits of controls must be considered relative to their
costs. Because of the inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if any, within our
company have been detected.
Part II. OTHER INFORMATION
You should carefully consider the risks described below together with all of the other
information included in this quarterly report on Form 10-Q and in our 2009 annual report on Form
10-K. If any of these risks actually occur, our business, financial condition or operating results
could be materially adversely affected and the trading price of our common stock could decline.
Our operating results may fluctuate significantly and we may not achieve profitability in any
given period. Our operating results are subject to significant fluctuations which make estimating
revenue and operating results for any specific period very difficult, particularly as a material
portion of product revenue recognized in any given quarter and year typically depends on a very
limited number of system sales expected for that quarter and year and the product revenue may
depend on the timing of product acceptances by customers and contractual provisions affecting
revenue recognition. Delays in recognizing revenue from a product transaction or transactions due
to development or product delivery delays, not receiving needed components timely or with
anticipated quality and performance, not achieving customer acceptances of installed systems,
contractual provisions or for other reasons, could have a material adverse effect on our operating
results in any specific quarter, and could shift associated revenue, gross profit and cash receipts
from one quarter into another, including from one year to another in the case of revenue expected
to be realized in the fourth quarter of any year. In addition, because our revenue is often
concentrated in particular quarters rather than evenly spread throughout a year, as it is expected
to be this year, we may not be able to sustain profitability over successive quarters even if we
are profitable for the year.
We have experienced net losses in recent periods and last recorded positive annual net income
in 2003. For example, we recorded a net loss of $10.6 million in 2007, a net loss of $40.7 million
in 2008, including a non-cash goodwill impairment charge of approximately $54.5 million, a net loss
of $0.6 million in 2009 and a net loss of $18.2 million for the six months ended June 30, 2010.
Whether we will be able to increase our revenue and achieve and sustain profitability on a
quarterly and annual basis depends on a number of factors, including:
|
|
|
manufacturing and delivering our new Cray XE6 systems (formerly referred to as our
Baker systems) in sufficient quantities and in a timely fashion and achieving acceptances
of Cray XE6 systems delivered in 2010; |
|
|
|
|
the level of revenue recognized in any given period, which is affected by the very high
average sales prices and limited number of system sales in any quarter, the timing of
product acceptances by customers and contractual provisions affecting the timing and amount
of revenue recognition; |
|
|
|
|
achieving acceptances of Cray XT6 system deliveries in 2010; |
|
|
|
|
successfully selling and delivering our Cray XT6, Cray XE6, and Cray XT6m systems and
upgrade and successor systems; |
|
|
|
|
the successful continued expansion of our Custom Engineering strategic initiative; |
|
|
|
|
our expense levels, including research and development expense net of government funding,
which are affected by the amount and timing of such funding and the meeting of contractual
development milestones, including the milestones under our DARPA HPCS program; |
|
|
|
|
our ability to successfully and timely design, integrate and secure competitive
processors into and for our systems, including for successors to our Cray XT6 and Cray XE6
systems; |
27
|
|
|
the competitiveness of our products; |
|
|
|
|
maintaining our product development projects on schedule and within budgetary
limitations; |
|
|
|
|
the level of product gross profit contribution in any given period due to volume or
product mix, strategic transactions, product life cycle, currency fluctuations and component
costs; |
|
|
|
|
the level and timing of maintenance contract renewals with existing customers; |
|
|
|
|
the level and timing of our engineering services contract closures, including the amount
of non-billable time incurred; |
|
|
|
|
revenue delays or losses due to customers postponing purchases to wait for future
upgraded or new systems, delays in delivery of upgraded or new systems and longer than
expected customer acceptance cycles; and |
|
|
|
|
the terms and conditions of sale or lease for our products and services. |
The receipt of orders and the timing of shipments and acceptances impact our quarterly and
annual results, including cash flows and are affected by events outside our control, such as:
|
|
|
the timely availability of acceptable components in sufficient quantities to meet
customer delivery schedules; |
|
|
|
|
the timing and level of government funding for research and development contracts and
product acquisitions, which may be adversely affected by the current economic and fiscal
situation and governmental budgetary limitations; |
|
|
|
|
the availability of adequate customer facilities to install and operate new Cray systems; |
|
|
|
|
price fluctuations in the commodity electronics, processor and memory markets; |
|
|
|
|
general economic trends, including changes in levels of customer capital spending; |
|
|
|
|
the introduction or announcement of competitive products; |
|
|
|
|
currency fluctuations, international conflicts or economic crises; and |
|
|
|
|
the receipt and timing of necessary export licenses. |
Because of the numerous factors affecting our revenue and results of operations, we may not
have net income on a quarterly or annual basis in the future. We anticipate that our quarterly
results will fluctuate significantly, and include losses. Delays in component availability, product
development, receipt of orders, product acceptances, reductions in outside funding for our research
and development efforts and achieving contractual development milestones have had a substantial
adverse effect on our past results and could continue to have such an effect on our results in 2010
and in future years.
If we are unable to manufacture, deliver and obtain customer acceptances of our Cray XE6
systems scheduled for delivery in 2010, our 2010 revenue and cash will be substantially reduced and
our financial results will be significantly adversely affected. Our 2010 expected financial results
are dependent upon our Cray XE6 systems (formerly referred to as our Baker systems) that we have
just begun shipping to customers as a substantial portion of our 2010 revenue and cash flow are
expected to be derived from these system sales. To obtain revenue and cash from these sales, we
must manufacture the systems to be delivered, deliver them to customers and obtain customer
acceptances of the systems typically based on performance, functionality and reliability testing.
If we are unable to manufacture and deliver the systems early enough in the year to allow for
customer acceptance testing, or if the systems do not perform as required, we may not be able to
obtain customer acceptances in 2010. To accomplish this, we must also successfully manufacture what
for us would be an extremely large number of system cabinets in a relatively short period of time.
Finally, we must complete customer acceptance testing and meet our contractual requirements to
obtain the customer acceptance of the system and realize the revenue and receive payment for the
system. Because of the complexity of our systems, there are often additional updates or development
work that must be completed even after delivery of a system to a customer to meet the system
acceptance requirements, and we expect that such additional work will likely be required to achieve acceptances of these
systems.
28
If we are unable to complete all of these items in 2010 for Cray XE6 systems scheduled to
be delivered in 2010, our 2010 revenue and cash will be substantially reduced. We have already
incurred expenses and used a significant amount of cash in 2010 to develop and deliver these
systems and must continue to do so regardless of whether customer acceptances are obtained in 2010,
and therefore our overall financial results and our cash will be significantly adversely affected
if we are not able to obtain revenue and cash from these system sales in 2010. We are working to
obtain extended payment terms with certain key suppliers and are considering adding an additional
credit line to help us mitigate the impact of the requirement that we spend considerable cash in
advance of delivery and acceptance of these systems. Should there be significant delays in product
acceptances for the new Cray XE6 systems the Company may need to assess these and potentially other
sources of financing. There can be no assurance that extended supplier credit terms, additional
lines of credit or other financing will be available in amounts or on terms needed or acceptable to
us, if at all.
If the Defense Advanced Research Projects Agency (DARPA) terminates our DARPA High
Productivity Computing Systems (HPCS) program in whole or in part or if we are unable to achieve
and obtain acceptance of key DARPA milestones when or as expected or at all, our desired strategy
would be adversely affected, our net research and development expenditures and capital requirements
would increase significantly and our ability to conduct research and development would decrease.
The DARPA HPCS program calls for the delivery of prototype systems in 2012, and currently provides
for a contribution by DARPA to us of up to $190 million assuming we meet certain milestones, $122
million of which we have already earned. In February of 2010, we completed negotiations with DARPA
to change the scope and schedule of this program, including changes to milestones and payments
allocated to individual milestones, and that resulted in a reduction in the total possible
contribution from DARPA over the term of the HPCS program from $250 million to $190 million. We
have one additional milestone that could be completed in 2010. If the completion of any development
milestone is delayed, our reported net research and development expenses, and our operating
results, would be adversely affected. If we are unable to complete the remaining milestones, or one
or more milestone payments are delayed, reduced and/or eliminated or the program is terminated, our
cash flows and expenses would be adversely impacted and our product development programs would be
put at risk. If we do not achieve and have accepted a milestone in the period we had originally
estimated, we may incur research and development expense without offsetting co-funding, resulting
in increased net research and development expense during the period. We incurred some delays in
payments for program milestones by DARPA in 2007 and 2008; in addition, as a result of our recent
discussions with DARPA on the changes in scope and program schedule, third and fourth quarters of
2009 and full-year 2009 results were adversely impacted by delays in completing development
milestones. The amount of DARPA funds we can recognize as an offset to our periodic research and
development expenses depends on our estimates of the total costs and the time to complete the
program; changes in our estimates may decrease the amount of funding recognized in any period,
which may increase the amount of net research and development expense recognized in that quarter.
By the projects completion, we must spend at least $285 million on the project for us to receive
all of the DARPA $190 million reimbursements; failure to do so would result in a lower level of
DARPA contribution and could result in a termination of the funding contract. DARPAs future
financial commitments are subject to subsequent Congressional and federal inter-agency action, and
our development efforts and the level of reported research and development expenses would be
adversely impacted if DARPA does not receive expected funding, which could result in a delay in
payment for completed milestones, a delay in the timing of milestones or a decision to terminate
all or part of the program before completion.
If our strategic initiatives targeting markets outside of the high end of the HPC market,
particularly our Custom Engineering initiative, are not successful, our ability to grow our
revenues and achieve and sustain profitability will be adversely affected. Our ability to
materially grow our revenues and achieve and sustain profitability will be adversely affected if we
are unable to generate sufficient revenue from strategic initiatives targeting markets outside of
the high end of the HPC market, particularly if that segment of the market does not grow
significantly. We currently have three such new strategic initiatives: Custom Engineering; selling
our Cray XT6m and successor systems; and selling our Cray CX and successor systems. Our Custom
Engineering initiative has demonstrated the most growth to date, and we believe it represents the
best opportunity for us to diversify our revenue. To grow our revenue from Custom Engineering, we
must continue to win awards for new contracts, timely perform on existing contracts and develop our
capability for business development, notwithstanding that this is a relatively new initiative and
we do not have significant experience targeting the markets relevant to our Custom Engineering
practices. In addition, many of the new Custom Engineering projects will be for the U.S. government
and likely will require us to enter into agreements that are subject to new or additional Federal
Acquisition Regulations, including costing and pricing requirements to which we have not previously
been subject. These regulations are complex and subject to audit to ensure compliance. We may need
to enhance existing financial and costing systems to accommodate these new requirements. Errors
made in interpreting and complying with these regulations could result in significant penalties.
The Cray XT6m and successor systems require successful sales in a lower priced segment of the
supercomputer market. These efforts require monetary investments ahead of revenue, including adding
experienced personnel and initiating new marketing efforts. Although we have not introduced a
product relying primarily on indirect sales in the past, sales of Cray CX systems will depend upon
continuing to build a new global network of independent resellers in Europe, North America and Asia-Pacific and having
those resellers successfully sell these new Cray CX systems in the competitive workgroup server
market.
29
If we are unable to successfully sell and deliver our Cray XT6 and Cray XE6 systems and
develop, sell and deliver successor systems, our operating results will be adversely affected. We
expect that a significant portion of our revenue in the foreseeable future will come from sales and
deliveries of Cray XT6, Cray XE6 (formerly referred to as Baker) and successor systems, and
upgrades. Because of the long technology development cycles required to compete effectively in this
market, we must begin development of products years ahead of our ability to sell such systems. With
procurements for large systems that require that we link together multiple cabinets containing
powerful processors and other components into an integrated system, our Cray XT6, Cray XE6 and
successor systems must also scale to unprecedented levels of performance. During our internal
testing and the customer acceptance processes, we may discover that we cannot achieve acceptable
system stability across these large systems without incurring significant additional delays and
expense. Any additional delays in receiving acceptable components or in product development,
assembly, final testing and obtaining large system stability would delay delivery, installation and
acceptance of Cray XT6, Cray XE6 and successor systems.
Many factors affect our ability to successfully develop and sell these systems, including the
following:
|
|
|
The level of product differentiation in our Cray XT6, Cray XE6 and successor systems. We
need to compete successfully against HPC systems from large established companies and lower
bandwidth, commodity cluster systems from both large established companies and smaller
firms and demonstrate the value of our balanced high bandwidth systems. |
|
|
|
|
Our ability to meet all customer requirements for acceptance. Even once a system has been
delivered, we sometimes do not meet all of the contract requirements for customer acceptance
and ongoing reliability of our systems within the provided-for acceptance period, which has
resulted in contract penalties and delays in our ability to recognize revenue from system
deliveries. Most often these penalties adversely affect the gross profit through the
provision of additional equipment and services and/or service credits to satisfy delivery
delays and performance shortfalls. The risk of contract penalties is increased when we bid
for new business prior to completing development of new products when we must estimate
future system performance, such as was required with successors to the Cray XT5 system. |
|
|
|
|
Our ability to source competitive, key components in appropriate quantities, in a timely
fashion and on acceptable terms and conditions. For example, in March 2008, we placed a
last-time buy for a key component for our Cray XT4, Cray XT5, Cray XT6 and Cray XMT systems
prior to it becoming unavailable, which had to be placed before we could know all the
possible sales prospects for these products or when the key component could be made obsolete
by a successor component. If we underestimated our needs, we could limit the number of
possible sales of these products and reduce potential revenue, or if we overestimated, we
could incur inventory obsolescence charges and reduce our gross profit. Through the second
quarter of 2010, we have written off approximately $5.0 million of estimated excess
inventory primarily related to this key component, and we may be required to write off some
of the $3.0 million remaining inventory in the future. |
Failure to successfully sell our Cray XT6 and Cray XE6 systems and develop and sell successor
systems into the high end of the HPC market will adversely affect our operating results.
The continuing commoditization of HPC hardware and software has resulted in pricing pressure
and may adversely affect our operating results. The continuing commoditization of HPC hardware,
particularly processors and interconnect systems, and the growing commoditization of software,
including plentiful building blocks and more capable open source software, has resulted in the
expansion and acceptance of lower-bandwidth cluster systems using processors manufactured by Intel,
AMD and others combined with commercially available commodity networking and other components,
particularly in the middle and lower portions of the HPC market. These systems may offer higher
theoretical peak performance for equivalent cost, and price/peak performance is often the
dominant factor in HPC procurements outside of the high-end HPC or supercomputer market segment.
Vendors of such systems often put pricing pressure on us in competitive procurements, even at times
in larger procurements, and this pricing pressure may cause us to reduce our pricing in order to
remain competitive which can negatively impact our gross margins and adversely affect our operating
results.
Failure to overcome the technical challenges of developing competitive supercomputer systems
years before they can be sold would adversely affect our revenue and operating results in
subsequent years. We continue to develop successor systems to the Cray XT6 and Cray XE6 (formerly
referred to as Baker) systems, incorporate Intel technologies into our products and complete our
DARPA HPCS program. We are also exploring the incorporation of potentially key technological
alternatives into our products, such as graphic processing units.
30
These development efforts are lengthy and technically challenging
processes, and require a significant investment of capital, engineering and other resources well
ahead of the time when we can be assured they will result in competitive products. We may invest
significant resources in alternatives that prove ultimately unfruitful. Unanticipated performance
and/or development issues may require more engineers, time or testing resources than are currently
available. In the past several years, directing engineering resources to solving current issues has
adversely affected the timely development of successor products required for our longer-term
product roadmap. Given the breadth of our engineering challenges and our limited engineering and
technical personnel resources, we periodically review the anticipated contributions and expense of
our product programs to determine their long-term viability, and we may substantially modify or
terminate one or more development programs. We may not be successful in meeting our development
schedules for technical reasons and/or because of insufficient engineering resources, which could
cause a lack of confidence in our capabilities among our key customers. To the extent we incur
delays in completing the design, development and production of hardware components, delays in
development of requisite system software, cancellation of programs due to technical or economic
infeasibility or invest in unproductive development efforts, our revenue, results of operations and
cash flows, and the reputation of such systems in the market, could be adversely affected.
Our reliance on third-party suppliers poses significant risks to our operating results,
business and prospects. We use service providers to co-develop key technologies, including
integrated circuit design and verification. We subcontract the manufacture of a majority of the
hardware components for our high-end products, including integrated circuits, printed circuit
boards, connectors, cables, power supplies and memory parts, on a sole or limited source basis to
third-party suppliers. We use contract manufacturers to assemble certain important components for
all of our systems. We also rely on third parties to supply key software and hardware capabilities,
such as file systems and storage subsystems. In addition, we use original equipment manufacturers
to deliver complete Cray CX systems. We are subject to substantial risks because of our reliance on
these and other limited or sole source suppliers, including the following risks:
|
|
|
If a supplier does not provide components that meet our specifications in sufficient
quantities on time, then production and sales of our systems could be delayed. |
|
|
|
|
If an interruption of supply of our components, services or capabilities occurs because a
supplier changes its technology roadmap, decides to no longer provide those products or
services, increases the price of those products or services significantly or imposes
allocations on its customers, it could take us a considerable period of time to identify and
qualify alternative suppliers, to redesign our products as necessary and to begin to
manufacture the redesigned components or otherwise obtain those services or capabilities. In
some cases, such as with key integrated circuits and memory parts, we may not be able to
redesign such components or find alternate sources that we could use in any realistic
timeframe. |
|
|
|
|
If a supplier providing us with key research and development and design services or core
technology components with respect to integrated circuit design, network communication
capabilities or software is late, fails to provide us with effective functionality or loses
key internal talent, our development programs may be delayed or prove to be impossible to
complete. |
|
|
|
|
If a supplier cannot provide a competitive key component or eliminates key features from
components, such as processors, our systems may be less competitive than systems using
components with greater capabilities. |
|
|
|
|
If a supplier provides us with hardware or software that contains bugs or other errors or
is different from what we expected, our development projects and production systems may be
adversely affected through additional design testing and verification efforts, re-spins of
integrated circuits and/or development of replacement components, the production and sales
of our systems could be delayed and systems installed at customer sites could require
significant, expensive field component replacements. |
|
|
|
|
Some of our key component and service suppliers are small companies with limited
financial and other resources, and consequently may be more likely to experience financial
and operational difficulties than larger, well-established companies, which increases the
risk that they will be unable to deliver products as needed. |
|
|
|
|
If a key supplier is acquired or has a significant business change, such as the
acquisition of our file system software provider by our competitor Sun Microsystems and the
subsequent acquisition of Sun by Oracle, the production and sales of our systems and
services may be delayed or adversely affected, or our development programs may be delayed or
may be impossible to complete. |
For example, our DARPA HPCS project was adversely affected by changes by Intel in its high
performance technology roadmap that affected our ability to complete that program successfully and
resulted in a reduction in the amount of funding we could receive from DARPA by $60 million. In
addition, our Cray XT5, Cray XT6 and Cray XE6 (formerly referred to as Baker) systems are based
on certain AMD Opteron processors. Delays in the availability of certain acceptable reliable
components, including processors and memory parts, and increases in order lead times for certain
components, adversely affected our revenue and operating results in prior periods, and could continue to adversely affect results for 2010 and in subsequent periods. The failure by
the original equipment manufacturer of our Cray CX1 systems to timely obtain necessary
certifications also adversely affected our ability to introduce and ramp up sales of this product
in 2009.
31
If the U.S. government purchases fewer supercomputers, our revenue would be reduced and our
operating results would be adversely affected. Historically, sales to the U.S. government and
customers primarily serving the U.S. government have represented the largest single market segment
for supercomputer sales worldwide, including our products and services. In 2007, 2008 and 2009 and
the first six months of 2010, approximately 60%, 81%, 72% and 64%, respectively, of our revenue was
derived from such sales. Our plans for 2010 and the foreseeable future contemplate significant
sales to U.S. government agencies. Sales to government agencies, including further sales pursuant
to existing contracts, may be adversely affected by factors outside our control, such as changes in
procurement policies, budgetary considerations including Congressional delays in completing
appropriation bills, the current economic uncertainty and its effect on government budgets,
domestic crises, and international political developments. If agencies and departments of the
United States or other governments were to stop, reduce or delay their use and purchases of
supercomputers, our revenue and operating results would be adversely affected.
If we are unable to compete successfully in the highly competitive HPC market, our business
will not be successful. The market for HPC systems is very competitive. An increase in competitive
pressures in our market or our failure to compete effectively may result in pricing reductions,
reduced gross margins and loss of market share and revenue. Many of our competitors are established
companies well known in the HPC market, including IBM, NEC, Hewlett-Packard, Fujitsu, Hitachi,
Silicon Graphics International, Bull S.A. and Sun Microsystems. Most of these competitors have
substantially greater research, engineering, manufacturing, marketing and financial resources than
we do. We also compete with systems builders and resellers of systems that are constructed from
commodity components using processors manufactured by Intel, AMD and others. These competitors
include the previously named companies and Dell, with IBM using both third-party processors and its
own proprietary processors, as well as smaller firms that benefit from the low research and
development costs needed to assemble systems from commercially available commodity products. Such
companies, because they can offer high peak performance per dollar, can put pricing pressure on us
in certain competitive procurements. In addition, to the extent that Intel, IBM and other processor
suppliers develop processors with greater capabilities than the processors we currently use from
AMD or design in over time, our Cray XT6, Cray XT6m, Cray XE6 (formerly referred to as Baker) and
successor systems may be at a competitive disadvantage to systems utilizing such other processors
until we can design in, integrate and secure competitive processors, if at all. Although our April
2008 collaboration with Intel is intended to help mitigate this risk, Intel processors are not
expected to be delivered in our Cray XT/XE line of supercomputers until 2012 or 2013.
Periodic announcements by our competitors of new HPC systems or plans for future systems and
price adjustments may reduce customer demand for our products. Many of our potential customers
already own or lease high performance computer systems. Some of our competitors may offer
substantial discounts to potential customers. We have in the past and may again be required to
provide substantial discounts to make strategic sales, which may reduce or eliminate any gross
profit on such transactions, or to provide lease financing for our products, which could result in
a deferral of our receipt of cash and revenue for these systems. These developments limit our
revenue and resources and reduce our ability to be profitable.
We may fail in our efforts to keep up with rapid technological changes in the HPC industry.
Our market is characterized by rapidly changing technology, accelerated product obsolescence and
continuously evolving industry standards. Our success depends upon our ability to sell our current
products, and to develop successor systems and enhancements in a timely manner to meet evolving
customer requirements, which may be influenced by competitive offerings. 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. The development process is lengthy and costly
and requires us to commit a significant amount of resources well in advance of sales. A
breakthrough in technology could make lower bandwidth cluster systems even more attractive to our
existing and potential customers. Such a breakthrough would impair our ability to sell our products
and would reduce our revenue and operating results.
We are subject to increasing government regulations and other requirements due to the nature
of our business, which may adversely affect our business operations. In 2008 and 2009 and the first
six months of 2010, 81%, 72% and 64%, respectively, of our revenue were derived from the U.S.
government or customers primarily serving the U.S. government. Our growth in Custom Engineering is
also primarily directed at the government market. In addition to normal business risks, our
contracts with the U.S. government are subject to unique risks, some of which are beyond our
control. In addition, other government regulations affect our business operations.
The funding of U.S. government programs is subject to congressional appropriations. Many of the
U.S. government programs in which we participate may extend for several years; however, these
programs are normally funded annually. Changes in U.S. strategy and priorities may affect our
future procurement opportunities and existing programs. Long-term government contracts and
related orders are subject to cancellation, or delay, if appropriations for subsequent performance
periods are not made. The termination of funding for existing or new U.S. government programs
could result in a material adverse effect on our results of operations and financial condition.
32
The U.S. government may modify, curtail or terminate its contracts with us. The U.S. government
may modify, curtail or terminate its contracts and subcontracts with us, without prior notice at
its convenience upon payment for work done and commitments made at the time of termination.
Modification, curtailment or termination of our major programs or contracts could have a material
adverse effect on our results of operations and financial condition.
Our U.S. government contract costs are subject to audits by U.S. government agencies. U.S.
government representatives may audit the costs we incur on our U.S. government contracts,
including allocated indirect costs. Such audits could result in adjustments to our contract
costs. Any costs found to be improperly allocated to a specific contract will not be reimbursed,
and such costs already reimbursed must be refunded. If any audit uncovers improper or illegal
activities, we may be subject to civil and criminal penalties and administrative sanctions,
including termination of contracts, forfeiture of profits, suspension of payments, fines and
suspension or prohibition from doing business with the U.S. government.
Our business is subject to potential U.S. government inquiries and investigations. We may be
subject to U.S. government inquiries and investigations of our business practices due to our
participation in government contracts. Any such inquiry or investigation could potentially result
in a material adverse effect on our results of operations and financial condition.
Our U.S. government business is also subject to specific procurement regulations and other
requirements. These requirements, although customary in U.S. government contracts, increase our
performance and compliance costs. These costs might increase in the future, reducing our margins,
which could have a negative effect on our financial condition. Failure to comply with these
regulations and requirements could lead to suspension or debarment, for cause, from U.S.
government contracting or subcontracting for a period of time and could have a negative effect on
our reputation and ability to secure future U.S. government contracts.
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 HPC systems such as our products.
Occasionally we have experienced delays for up to several months in receiving appropriate
approvals necessary for certain sales, which have 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. Our ability to have
certain components manufactured in foreign countries for a lower cost has also been adversely
affected by export restrictions covering information necessary to allow such foreign
manufacturers to manufacture components for us.
If we cannot retain, attract and motivate key personnel, we may be unable to effectively
implement our business plan. Our success depends in large part upon our ability to retain, attract
and motivate highly skilled management, development, marketing, sales and service personnel. The
loss of and failure to replace key engineering management and personnel could adversely affect
multiple development efforts. Recruitment and retention of senior management and skilled technical,
sales and other personnel is very competitive, and we may not be successful in either attracting or
retaining such personnel. From time to time, we have lost key personnel to other high technology
companies. As part of our strategy to attract and retain key personnel, we may offer equity
compensation through stock options and restricted stock grants. Potential employees, however, may
not perceive our equity incentives as attractive, and current employees who have significant
options with exercise prices significantly above current market values for our common stock may
seek other employment. In addition, due to the intense competition for qualified employees, we may
be required to increase the level of compensation paid to existing and new employees, which could
materially increase our operating expenses.
Our stock price is volatile. The trading price of our common stock is subject to significant
fluctuations in response to many factors, including our quarterly operating results, changes in
analysts estimates or our outlook, our capital raising activities, announcements of technological
innovations and customer contracts by us or our competitors, general economic conditions and
conditions in our industry.
We may infringe or be subject to claims that we infringe the intellectual property rights of
others. Third parties in the past have asserted, and may in the future assert intellectual property
infringement claims against us, and such future claims, if proved, could require us to pay
substantial damages, redesign our existing products or pay fees to obtain cross-license agreements.
Regardless of the merits, any claim of infringement would require management attention and could be
expensive to defend.
33
We incorporate software licensed from third parties into the operating systems for our
products as well as in our tools to design products and any significant interruption in the
availability of these third-party software products or defects in these products could reduce the
demand for our products or cause delay in development. The operating system software we develop for
our HPC systems contains components that are licensed to us under open source software licenses.
Our business could be disrupted if this software, or functional equivalents of this software, were
either no longer available to us or no longer offered to us on commercially reasonable terms. In
either case we would be required to redesign our operating system software to function with
alternative third-party software, or develop these components ourselves, which would result in
increased costs and could result in delays in product shipments. Our Cray CX, Cray XT, Cray XE and
successor systems utilize software system variants that incorporate Linux technology. The open
source licenses under which we have obtained certain components of our operating system software
may not be enforceable. Any ruling by a court that these licenses are not enforceable, or that
Linux-based operating systems, or significant portions of them, may not be copied, modified or
distributed as provided in those licenses, would adversely affect our ability to sell our systems.
In addition, as a result of concerns about the risks of litigation and open source software
generally, we may be forced to protect our customers from potential claims of infringement. In any
such event, our financial condition and results of operations may be adversely affected.
We also incorporate proprietary incidental software from third parties, such as for file
systems, job scheduling and storage subsystems. We have experienced some functional issues in the
past with implementing such software with our supercomputer systems. In addition, we may not be
able to secure needed software systems on acceptable terms, which may make our systems less
attractive to potential customers. These issues may result in lost revenue, additional expense by
us and/or loss of customer confidence.
We are required to evaluate our internal control over financial reporting under Section 404 of
the Sarbanes-Oxley Act of 2002 at the end of each fiscal year, and any adverse results from such
future evaluations could result in a loss of investor confidence in our financial reports and have
an adverse effect on our stock price. Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we
are required to furnish a report by our management and a report by our independent registered
public accounting firm on our internal control over financial reporting in our annual reports on
Form 10-K as to whether we have any material weaknesses in our internal controls over financial
reporting. Depending on their nature and severity, any future material weaknesses could result in
our having to restate financial statements, could make it difficult or impossible for us to obtain
an audit of our annual financial statements or could result in a qualification of any such audit.
In such events, we could experience a number of adverse consequences, including our inability to
comply with applicable reporting and listing requirements, a loss of market confidence in our
publicly available information, delisting from the NASDAQ Global Market, an inability to complete a
financing, loss of other financing sources such as our line of credit, and litigation based on the
events themselves or their consequences.
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, nondisclosure 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. 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. Additionally, under certain conditions, the U.S. government might obtain non-exclusive
rights to certain of our intellectual property. Although we continue to implement protective
measures and intend to defend our proprietary rights vigorously, these efforts may not be
successful.
Provisions of our Restated Articles of Incorporation and Bylaws could make a proposed
acquisition of Cray that is not approved by our Board of Directors more difficult. Provisions of
our Restated Articles of Incorporation and 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 Restated Articles of Incorporation and Bylaws provide
for:
|
|
|
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 ability of our Board of Directors to issue up to 5,000,000 shares of preferred stock,
without shareholder approval, with rights senior to those of the common stock; |
|
|
|
|
no cumulative voting of shares; |
34
|
|
|
the right of shareholders to call 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; |
|
|
|
|
the affirmative vote of not less than two-thirds of the outstanding shares entitled to
vote on an 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 to bring matters before our shareholders at our annual shareholders
meeting; and |
|
|
|
|
special procedures to nominate members for election to our Board of Directors. |
These provisions could delay, defer or prevent a merger, consolidation, takeover or other
business transaction between us and a third-party that is not approved by our Board of Directors.
31.1 |
|
Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) of the Securities
Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
|
31.2 |
|
Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) of the Securities
Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
|
32.1 |
|
Certificate pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 |
35
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934, the registrant
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
|
|
|
|
|
|
CRAY INC.
|
|
Date: August 6, 2010 |
/s/ PETER J. UNGARO
|
|
|
Peter J. Ungaro |
|
|
President and Chief Executive Officer |
|
|
|
|
|
|
/s/ BRIAN C. HENRY
|
|
|
Brian C. Henry |
|
|
Executive Vice President and Chief Financial Officer |
|
|
|
|
|
|
/s/ CHARLES D. FAIRCHILD
|
|
|
Charles D. Fairchild |
|
|
Vice President, Corporate Controller and Chief Accounting Officer |
|
|
36