e10vq
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2007
OR
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o |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number 0-26820
CRAY INC.
(Exact name of registrant as specified in its charter)
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Washington
(State or other jurisdiction of
incorporation or organization)
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93-0962605
(I.R.S. Employer
Identification No.) |
411 First Avenue South, Suite 600
Seattle, WA 98104-2860
(206) 701- 2000
(Address of principal executive offices)
(Registrants telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated
filer in Rule 12b-2 of the Exchange Act:
o Large accelerated filer þ Accelerated filer o Non- accelerated
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 April 30, 2007, 32,462,739 shares of the Companys Common Stock, par value $0.01 per share,
were outstanding.
CRAY INC.
TABLE OF CONTENTS
Except as otherwise specifically noted, all numbers of shares of Cray Inc. common
stock, per share calculations and similar information involving Cray Inc. common stock in
this Quarterly Report on Form 10-Q reflect a one-for-four reverse stock split of Cray common
stock that became effective on June 8, 2006. See Note 1, Basis of Presentation Reverse
Stock Split of the Notes to the Condensed Consolidated Financial Statements contained
herein for more information.
Available Information
Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K, amendments to those reports and proxy statements filed or furnished pursuant to
Section 13(a) or 15(d) of the Securities Exchange Act are available free of charge at our
website at www.cray.com as soon as reasonably practicable after we electronically file such
reports with the SEC.
Cray is a federally registered trademark of Cray Inc., and Cray X1, Cray X1E, Cray XT3,
Cray XT4, Cray XMT and Cray XD1 are trademarks of Cray Inc. Other trademarks used in this
report are the property of their respective owners.
PART I. FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements
CRAY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited and in thousands, except share data)
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March 31, |
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December 31, |
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2007 |
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2006 |
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ASSETS
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Current assets: |
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Cash and cash equivalents |
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$ |
91,089 |
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$ |
115,328 |
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Restricted cash |
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25,000 |
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25,000 |
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Short-term investments, available-for-sale |
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31,488 |
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Accounts receivable, net |
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25,733 |
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44,790 |
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Inventory |
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53,960 |
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58,798 |
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Prepaid expenses and other current assets |
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3,368 |
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2,156 |
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Total current assets |
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230,638 |
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246,072 |
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Property and equipment, net |
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19,209 |
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21,564 |
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Service inventory, net |
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4,119 |
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4,292 |
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Goodwill |
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57,521 |
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57,138 |
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Deferred tax asset |
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746 |
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722 |
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Intangible assets, net |
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1,380 |
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1,404 |
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Other non-current assets |
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6,069 |
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6,311 |
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TOTAL ASSETS |
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$ |
319,682 |
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$ |
337,503 |
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LIABILITIES AND SHAREHOLDERS EQUITY
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Current liabilities: |
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Accounts payable |
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$ |
15,634 |
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$ |
22,450 |
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Accrued payroll and related expenses |
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10,464 |
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17,411 |
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Advance research and development payments |
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15,474 |
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21,518 |
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Other accrued liabilities |
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9,521 |
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5,121 |
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Deferred revenue |
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39,912 |
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43,248 |
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Total current liabilities |
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91,005 |
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109,748 |
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Long-term deferred revenue |
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2,069 |
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2,475 |
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Other non-current liabilities |
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3,474 |
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3,906 |
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Convertible notes payable |
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80,000 |
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80,000 |
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TOTAL LIABILITIES |
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176,548 |
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196,129 |
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Commitments and Contingencies |
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Shareholders equity: |
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Preferred Stock Authorized and undesignated, 5,000,000 shares; no shares issued or outstanding |
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Common Stock and additional paid-in capital, par value $.01 per share Authorized, 75,000,000
shares; issued and outstanding, 32,432,737 and 32,236,888 shares, respectively |
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509,900 |
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507,356 |
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Accumulated other comprehensive income |
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6,912 |
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6,855 |
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Accumulated deficit |
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(373,678 |
) |
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(372,837 |
) |
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TOTAL SHAREHOLDERS EQUITY |
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143,134 |
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141,374 |
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TOTAL LIABILITIES AND SHAREHOLDERS EQUITY |
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$ |
319,682 |
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$ |
337,503 |
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See accompanying notes
1
CRAY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited and in thousands, except per share data)
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Three Months Ended |
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March 31, |
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2007 |
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2006 |
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Revenue: |
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Product |
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$ |
33,660 |
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$ |
34,269 |
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Service |
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13,449 |
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14,246 |
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Total revenue |
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47,109 |
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48,515 |
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Cost of revenue: |
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Cost of product revenue |
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23,577 |
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26,677 |
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Cost of service revenue |
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7,998 |
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7,693 |
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Total cost of revenue |
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31,575 |
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34,370 |
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Gross margin |
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15,534 |
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14,145 |
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Operating expenses: |
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Research and development, net |
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7,880 |
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7,215 |
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Sales and marketing |
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5,268 |
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4,985 |
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General and administrative |
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4,280 |
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5,594 |
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Restructuring and severance |
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10 |
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738 |
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Total operating expenses |
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17,438 |
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18,532 |
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Loss from operations |
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(1,904 |
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(4,387 |
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Other income (expense), net |
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395 |
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(41 |
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Interest income (expense), net |
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1,033 |
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(608 |
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Loss before income taxes |
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(476 |
) |
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(5,036 |
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Provision for income taxes |
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(365 |
) |
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(269 |
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Net loss |
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$ |
(841 |
) |
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$ |
(5,305 |
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Basic and diluted net loss per share |
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$ |
(0.03 |
) |
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$ |
(0.24 |
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Basic and diluted weighted average shares outstanding |
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31,484 |
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22,338 |
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See accompanying notes
2
CRAY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited and in thousands)
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Three Months Ended |
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March 31, |
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2007 |
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2006 |
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Operating activities: |
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Net loss |
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$ |
(841 |
) |
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$ |
(5,305 |
) |
Adjustments to reconcile net loss to net cash provided by operating activities: |
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Depreciation and amortization |
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3,317 |
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4,630 |
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Share-based compensation cost |
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1,022 |
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481 |
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Inventory write-down |
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148 |
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117 |
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Amortization of issuance costs, convertible notes payable and line of credit |
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172 |
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338 |
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Deferred income taxes |
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(24 |
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(56 |
) |
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Changes in operating assets and liabilities: |
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Accounts receivable |
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18,857 |
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24,846 |
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Inventory |
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4,228 |
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7,179 |
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Prepaid expenses and other current assets |
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(1,218 |
) |
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(725 |
) |
Other non-current assets |
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(38 |
) |
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33 |
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Accounts payable |
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(6,849 |
) |
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4,519 |
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Accrued payroll and related expenses, other accrued liabilities and advance
research and development payments |
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(8,262 |
) |
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(1,957 |
) |
Other non-current liabilities |
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(434 |
) |
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559 |
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Deferred revenue |
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(3,760 |
) |
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(10,771 |
) |
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Net cash provided by operating activities |
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6,318 |
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23,888 |
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Investing activities: |
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Purchases of short-term investments |
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(31,362 |
) |
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Proceeds from sale of investment |
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239 |
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Purchases of property and equipment |
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(359 |
) |
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(996 |
) |
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Net cash used in investing activities |
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(31,721 |
) |
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(757 |
) |
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Financing activities: |
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Proceeds from issuance of common stock through employee stock purchase plan |
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119 |
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130 |
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Proceeds from exercise of options |
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1,066 |
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602 |
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Principal payments on capital leases |
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(31 |
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(30 |
) |
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Net cash provided by financing activities |
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1,154 |
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|
702 |
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Effect of foreign exchange rate changes on cash and cash equivalents |
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10 |
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34 |
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Net increase (decrease) in cash and cash equivalents |
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(24,239 |
) |
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|
23,867 |
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Cash and cash equivalents |
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Beginning of period |
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115,328 |
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|
46,026 |
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End of period |
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$ |
91,089 |
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$ |
69,893 |
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Supplemental disclosure of cash flow information: |
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Cash paid for interest |
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$ |
5 |
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$ |
212 |
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Non-cash investing and financing activities: |
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Inventory transfers to fixed assets and service inventory |
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$ |
462 |
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$ |
299 |
|
Stock issued
for 401(k) match |
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$ |
337 |
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$ |
286 |
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See accompanying notes
3
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 related 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, 2006.
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 three months ended March 31, 2007, the Company incurred a net loss of
$841,000 but generated $6.3 million of cash from operating activities. The Company had
$139.6 million of working capital as of March 31, 2007.
Managements plans project that the Companys current cash resources and cash to be
generated from operations in 2007 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 new
bookings. There can be no assurance the Company will be successful in its efforts to achieve
future profitable operations or generate sufficient cash from operations.
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 accounting principles generally
accepted in the United States of America requires management to make estimates and
assumptions that affect the amounts reported in the 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 determination used in revenue recognition, percentage of
completion accounting, estimates of proportional performance on co-funded engineering
contracts, 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 for goodwill and long-lived assets, determination of the fair value of stock options
and assessments of fair value, estimation of restructuring costs, calculation 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 from
those estimates and assumptions.
4
Reverse Stock Split
On June 6, 2006, the Companys shareholders approved an amendment to the Companys
articles of incorporation to increase the number of authorized shares of common stock from
150 million to 300 million and also approved a one-for-four reverse stock split of the
Companys authorized and outstanding common stock. These concurrent approvals resulted in 75
million of authorized shares of the Companys common stock with a par value of $0.01 per
share. The reverse stock split was effective with respect to shareholders of record at the
opening of trading on June 8, 2006, and the Companys common stock began trading as adjusted
for the reverse stock split on that same day. As a result of the reverse stock split, each
four shares of common stock were combined into one share of common stock and the total
number of shares outstanding was reduced from approximately 92 million shares to
approximately 23 million shares. The Company has retroactively adjusted all share and per
share information to reflect the reverse stock split in the condensed consolidated financial
statements and footnotes.
Note 2
Summary of New Accounting Policies
Short-term investments
Investments generally mature between three months and two years from the purchase date.
Investments with maturities beyond one year are classified as short-term based on their
highly liquid nature and because such marketable securities are readily convertible into
cash which could be used in current operations. All short-term investments are classified as
available-for-sale and are recorded at fair value, based on quoted market prices; as such,
unrealized gains and losses are reflected in other comprehensive income, pursuant to the
requirements of Financial Accounting Standards Board (FASB) Statement No. 115, Accounting
for Certain Investments in Debt and Equity Securities, (FAS 115).
Note 3 Earnings Per Share (EPS)
Basic EPS is computed by dividing net income available to common shareholders by the
weighted average number of common shares, including exchangeable shares but 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
common stock purchase warrants as computed under the treasury stock method and the common
shares issuable upon conversion of the outstanding convertible notes.
For the three months ended March 31, 2007 and 2006, outstanding stock options, unvested
stock grants, warrants and shares issuable upon conversion of the convertible notes are
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-month periods ended March
31, 2007 and 2006, potential gross common shares of 11.5 million and 11.4 million,
respectively, were antidilutive and not included in computing diluted EPS.
Note 4
Comprehensive Loss
The components of comprehensive loss were as follows (in thousands):
|
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|
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|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2007 |
|
|
2006 |
|
Net loss |
|
$ |
(841 |
) |
|
$ |
(5,305 |
) |
Unrealized gains on available-for-sale investments |
|
|
17 |
|
|
|
|
|
Unrealized losses on hedged transactions |
|
|
(288 |
) |
|
|
|
|
Foreign currency translation adjustment |
|
|
328 |
|
|
|
72 |
|
|
|
|
|
|
|
|
Comprehensive loss |
|
$ |
(784 |
) |
|
$ |
(5,233 |
) |
|
|
|
|
|
|
|
5
Note 5 Accounts Receivable
Net accounts receivable consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
|
2007 |
|
|
2006 |
|
Trade accounts receivable |
|
$ |
21,496 |
|
|
$ |
39,766 |
|
Unbilled receivables |
|
|
4,065 |
|
|
|
4,045 |
|
Advance billings |
|
|
271 |
|
|
|
1,078 |
|
|
|
|
|
|
|
|
|
|
|
25,832 |
|
|
|
44,889 |
|
Allowance for doubtful accounts |
|
|
(99 |
) |
|
|
(99 |
) |
|
|
|
|
|
|
|
Accounts receivable, net |
|
$ |
25,733 |
|
|
$ |
44,790 |
|
|
|
|
|
|
|
|
As of March 31, 2007, and December 31, 2006, accounts receivable included $13.4 million
and $34.7 million, respectively, due from U.S. government agencies and customers primarily
serving the U.S. government. Of this amount, $4.0 million was unbilled in each period, based
upon contractual billing arrangements with these customers.
The Company makes estimates of allowances for potential future uncollectible amounts
related to current period revenues of products and services. The allowance for doubtful
accounts is an estimate that considers actual facts and circumstances of individual
customers and other debtors, such as financial condition and historical payment trends.
Management evaluates the adequacy of the allowance utilizing a combination of specific
identification of potentially problematic accounts and identification of accounts that have
exceeded payment terms.
Note 6 Inventory
Inventory consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
|
2007 |
|
|
2006 |
|
Components and subassemblies |
|
$ |
11,873 |
|
|
$ |
22,536 |
|
Work in process |
|
|
11,107 |
|
|
|
15,310 |
|
Finished goods |
|
|
30,980 |
|
|
|
20,952 |
|
|
|
|
|
|
|
|
Total |
|
$ |
53,960 |
|
|
$ |
58,798 |
|
|
|
|
|
|
|
|
At both March 31, 2007, and December 31, 2006, the majority of finished goods inventory
was located at customer sites pending acceptance.
During the three months ended March 31, 2007, the Company wrote off $148,000 of
inventory, primarily related to scrap inventory on the Cray XT3 product and excess and
obsolete inventory on the Cray XD1 product. During the three months ended March 31, 2006,
the Company wrote off $117,000 of inventory, primarily related to scrap, excess and obsolete
inventory on the Cray XD1 product.
Note 7 Deferred Revenue
Deferred revenue consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
|
2007 |
|
|
2006 |
|
Deferred product revenue |
|
$ |
22,986 |
|
|
$ |
26,993 |
|
Deferred service revenue |
|
|
18,995 |
|
|
|
18,730 |
|
|
|
|
|
|
|
|
Total deferred revenue |
|
|
41,981 |
|
|
|
45,723 |
|
Less long-term deferred revenue |
|
|
(2,069 |
) |
|
|
(2,475 |
) |
|
|
|
|
|
|
|
Deferred revenue in current liabilities |
|
$ |
39,912 |
|
|
$ |
43,248 |
|
|
|
|
|
|
|
|
6
As of March 31, 2007, two customers combined accounted for approximately 50% of total
deferred revenue. As of December 31, 2006, total deferred revenue included $19.0 million of
deferred revenue related to a single customer.
Note 8 Restructuring and Severance Charges
During the three months ended March 31, 2006, the Company recognized restructuring and
severance charges of $738,000, all of which originated from actions arising during 2005;
there were no new actions taken during 2006 or 2007.
The current portion of restructuring and severance liability is included within
Accrued payroll and related expenses on the accompanying Condensed Consolidated Balance
Sheets. At March 31, 2007, none of the restructuring and severance liability was classified
as non-current. At March 31, 2006, $272,000 of the restructuring and severance liability
was classified in Other non-current liabilities. The activity related to restructuring
liability during the three months ended March 31, 2007 and 2006, was as follows (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
2007 |
|
|
2006 |
|
Balance, January 1 |
|
$ |
1,063 |
|
|
$ |
3,582 |
|
Payments |
|
|
(285 |
) |
|
|
(1,429 |
) |
Adjustments to previously accrued amounts |
|
|
10 |
|
|
|
107 |
|
Current period charges |
|
|
|
|
|
|
631 |
|
Foreign currency translation adjustment |
|
|
2 |
|
|
|
36 |
|
|
|
|
|
|
|
|
Total liability balance, March 31 |
|
|
790 |
|
|
|
2,927 |
|
Less long-term restructuring and severance liability |
|
|
|
|
|
|
(272 |
) |
|
|
|
|
|
|
|
Current restructuring and severance liability |
|
$ |
790 |
|
|
$ |
2,655 |
|
|
|
|
|
|
|
|
Note 9 Share-Based Compensation
The Company accounts for its share-based compensation under the provisions of FASB
Statement No. 123(R), Share-Based Payment, (FAS 123R).
The fair value of unvested stock grants is based on the price of a share of the
Companys common stock on the date of grant. The Company uses the Black-Scholes option
pricing model to estimate the fair value of its stock options. The following
weighted-average key assumptions were used to estimate the fair value of options granted in
the periods ended March 31, 2007 and 2006:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
March 31, |
|
|
2007 |
|
2006 |
Risk-free interest rate |
|
4.6% |
|
4.5% |
Expected dividend yield |
|
0% |
|
0% |
Volatility |
|
73% |
|
60% |
Expected life |
|
4.0 years |
|
4.5 years |
Weighted average Black-Scholes value of options granted |
|
$6.78 |
|
$4.45 |
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 adjusted historical data. The expected term of an option is based on
the assumption that options will be exercised, on average, about two years after vesting
occurs. FAS 123R also requires that the Company recognize 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 is 10%
for both quarters presented. 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, all of which
impact the fair value of the option calculated under the Black-Scholes methodology and,
ultimately, the expense that will be recognized over the life of the option. The Company
typically issues stock
7
options with a four-year vesting period (defined by FAS 123R as the requisite service
period). The Company amortizes stock compensation cost ratably over the requisite service
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 provisions of FAS 123R.
The following table sets forth the share-based compensation cost resulting from stock
options and unvested stock grants that is recorded in our Condensed Consolidated Statements
of Operations for the quarters ended March 31, 2007 and 2006 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
|
2007 |
|
|
2006 |
|
Cost of product revenue |
|
$ |
27 |
|
|
$ |
15 |
|
Cost of service revenue |
|
|
41 |
|
|
|
|
|
Research and development, net |
|
|
342 |
|
|
|
93 |
|
Sales and marketing |
|
|
137 |
|
|
|
105 |
|
General and administrative |
|
|
475 |
|
|
|
268 |
|
|
|
|
|
|
|
|
Total |
|
$ |
1,022 |
|
|
$ |
481 |
|
|
|
|
|
|
|
|
A summary of the Companys stock option activity and related information
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
Average |
|
|
|
|
|
|
|
|
|
|
Average |
|
|
Remaining |
|
|
Aggregate |
|
|
|
|
|
|
|
Exercise |
|
|
Contractual |
|
|
Intrinsic |
|
|
|
Options |
|
|
Price |
|
|
Term |
|
|
Value |
|
Outstanding at December 31, 2006 |
|
|
3,867,415 |
|
|
$ |
14.68 |
|
|
|
|
|
|
|
|
|
Grants |
|
|
17,000 |
|
|
|
11.75 |
|
|
|
|
|
|
|
|
|
Exercises |
|
|
(133,457 |
) |
|
|
7.99 |
|
|
|
|
|
|
|
|
|
Cancellations |
|
|
(100,500 |
) |
|
|
20.53 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at March 31, 2007 |
|
|
3,650,458 |
|
|
$ |
14.75 |
|
|
6.5 years |
|
$10.8 million |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at March 31, 2007 |
|
|
2,924,819 |
|
|
$ |
15.81 |
|
|
5.7 years |
|
$ 8.4 million |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Available for grant at March 31, 2007 |
|
|
2,402,523 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The aggregate intrinsic value in the table above 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 first quarter of 2007 and the exercise price,
multiplied by the number of shares) that would have been received by the option holders had
all option holders exercised their options on March 31, 2007. This amount changes, based on
the fair market value of the Companys stock. Total intrinsic value of options exercised
was $680,000 and $281,000, respectively, for the periods ended March 31, 2007 and 2006.
As of March 31, 2007 and 2006, the Company had $7.8 million and $2.5 million,
respectively, of total unrecognized compensation cost related to unvested stock options and
unvested restricted stock grants, which was expected to be recognized over a weighted
average period of 2.5 years and 1.4 years, respectively.
Note 10 Taxes
The Company recorded a tax provision of $365,000 and $269,000 for the three-month
periods ended March 31, 2007 and 2006, respectively. The expense recorded for both
three-month periods was primarily related to foreign and certain state income taxes payable.
In June 2006, the FASB issued its Interpretation No. 48 Accounting for Uncertainty in
Income Taxes an interpretation of FASB Statement 109 (FIN 48). FIN 48 establishes a
single model to address accounting for uncertain tax positions. FIN 48 clarifies the
accounting for income taxes by prescribing a minimum recognition
8
threshold a tax position is required to meet before being recognized in the financial
statements. FIN 48 also provides guidance on derecognition,
measurement, classification,
interest and penalties, accounting in interim periods, disclosure and transition. The
Company is subject to the provisions of FIN 48 as of January 1, 2007, and has analyzed its
filing positions in all of the federal, state, and international jurisdictions where it, or
its wholly-owned subsidiaries, are required to file income tax returns, as well as all open
tax years in these jurisdictions. Except for the tax years 2003 and 2004 with respect to its
wholly-owned subsidiarys income tax filings in the United Kingdom, no open periods in any
jurisdiction are currently under audit.
There was no financial statement impact from the adoption of FIN 48. As of January 1,
2007, the Company had recorded approximately $500,000 in liabilities related to unrecognized
tax benefits for uncertain income tax positions. Recognition of these tax benefits would
reduce the Companys effective tax rate. There have been no significant changes to these
amounts during the quarter ended March 31, 2007. Estimated interest and penalties are
recorded as a component of interest expense and other expense, respectively. Such amounts
are not material as of January 1, 2007 and March 31, 2007.
Note 11 Geographic Segment Information
SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information (SFAS
131), establishes standards for reporting information about operating segments and for
related disclosures about products, services and geographic areas. Operating segments are
identified as components of an enterprise about which separate discrete financial
information is available for evaluation by the chief operating decision-maker, or
decision-making group, in making decisions regarding allocation of resources and assessing
performance. Crays chief decision-maker, as defined under SFAS 131, 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, Europe, the Middle East, Japan, Australia, 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 |
|
Three months ended March 31, |
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
Product revenue |
|
$ |
27,235 |
|
|
$ |
31,428 |
|
|
$ |
6,425 |
|
|
$ |
2,841 |
|
|
$ |
33,660 |
|
|
$ |
34,269 |
|
Service revenue |
|
|
8,603 |
|
|
|
10,464 |
|
|
|
4,846 |
|
|
|
3,782 |
|
|
|
13,449 |
|
|
|
14,246 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue |
|
$ |
35,838 |
|
|
$ |
41,892 |
|
|
$ |
11,271 |
|
|
$ |
6,623 |
|
|
$ |
47,109 |
|
|
$ |
48,515 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue attributed to foreign countries is derived from sales to external customers.
Revenue derived from U.S. government agencies or commercial customers primarily serving the
U.S. government, and therefore under its control, totaled approximately $33.3 million and
$38.0 million for the three months ended March 31, 2007 and 2006, respectively.
There has been no material change in the balances of long-lived assets.
Note 12 Foreign Currency Derivatives
During the first quarter of 2007, the Company entered into three separate forward
contracts for a combined total of £37.8 million (British pound sterling) and 3.5
million (Euro) to hedge anticipated cash receipts on specific sales contracts, which are
expected to be received between the end of 2007 and 2009. At March 31, 2007, these three
forward contracts were designated as cash flow hedges. Prior to one of the forward
contracts designation as an effective cash flow hedge on February 15, 2007, the Company
recorded a gain of approximately $370,000 to Other income on its Condensed Consolidated
Statements of Operations. As of March 31, 2007, the fair values of these contracts was a
loss of $167,000, and unrecognized losses on the forward contracts have been recorded to
9
Accumulated other comprehensive income on the Companys Condensed Consolidated
Balance Sheet in the amount of $288,000. During the quarter, £5.0 million of the forward
contracts settled upon receipt of cash from the Companys customer, and therefore, as of
March 31, 2007, £32.8 million and 3.5 million were the notional amounts outstanding
on the Companys foreign currency derivatives.
10
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Preliminary Note Regarding Forward-Looking Statements
The information set forth in Managements Discussion and Analysis of Financial
Condition and Results of Operations below 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. All statements other than statements of
historical fact are statements that could be deemed forward-looking statements, including
any projections of earnings, revenue or other financial items; any statements of the plans,
strategies and objectives of management for future operations; any statements concerning
proposed new products, services or developments; any statements regarding future economic
conditions or performance; statements of belief and any statement of assumptions underlying
any of the foregoing. We assume no obligation to update these forward-looking statements.
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. Factors that could cause our actual results to differ materially from those expressed
or implied in the forward-looking statements are set forth in the discussion under Item 1A.
Risk Factors in Part II of this Report. The following discussion should also be read in
conjunction with the Consolidated Financial Statements and accompanying Notes thereto in
our Annual Report on Form 10-K for the fiscal year ended
December 31, 2006 (2006 Form 10-K), and the Condensed Consolidated Financial Statements and accompanying Notes
thereto in this Report.
Overview and Executive Summary
We design, develop, manufacture, market and service high performance computing (HPC)
systems, commonly known as supercomputers. Our supercomputer systems provide capability,
capacity and sustained performance far beyond typical server-based computer systems and
address challenging scientific and engineering 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 processing, interconnect and software capabilities that enable
our systems to scale that is, to continue to increase performance as our systems grow in
size. Purpose-built for the supercomputer market, our systems balance highly capable
processors, highly scalable software and very high speed interconnect and communications
capabilities.
In early 2006 we announced our Adaptive Supercomputing vision to expand the concept of
hybrid computing to a fully integrated view of both hardware and software supporting
multiple processing technologies within a single, highly scalable system. We believe that
our November 2006 $250 million award from the Defense Advanced Research Projects Agency
(DARPA) under its High Productivity Computing Systems (HPCS) program validates our
Adaptive Supercomputing vision. This award will co-fund our Cascade development project to
implement this vision.
Summary of 1st Quarter 2007 Results
Total revenue for the first three months of 2007 decreased by $1.4 million or 3% from
total revenue for the first three months of 2006 principally due to a period-over-period
decrease of nearly $8.0 million in revenue recognized on our low margin DARPA Phase II and
Red Storm projects. This decrease was offset in part by increased sales of $7.4 million of our Cray XT4 and
other HPC products.
Loss from operations improved to a loss of $1.9 million for the first three months of
2007, compared to a loss from operations of $4.4 million for the same period in 2006. The
improvement was primarily due to a $1.4 million increase in gross margin on first quarter
2007 sales and a reduction of $1.3 million in general and administrative costs over the
prior year period. Our net loss for the first quarter of 2007 was favorably impacted by
increased interest income in the period on higher cash and short-term investment balances.
11
Net cash provided by operations in the first quarter of 2007 was $6.3 million compared
to $23.9 million in the first three months of 2006. Cash, cash
equivalents, restricted cash and short-term investment balances
were $147.6 million and $140.3 million, respectively, as of
March 31, 2007 and December 31, 2006.
Market Overview and Challenges
The most significant trend in the HPC market is the continuing expansion and acceptance
of low-bandwidth cluster systems using processors manufactured by Intel, AMD, IBM and
others with commercially available commodity networking and other components throughout the
HPC market, especially in capacity computing situations. These systems may offer higher
theoretical peak performance for equivalent cost, and vendors of such systems often put
pricing pressure on us in competitive procurements, even at times in capability market
procurements.
To compete against these systems in the longer term, we need to incorporate greater
performance differentiation across our products. We believe we will have such
differentiation through our new vector-based product being developed in our BlackWidow
project and our new multithreaded Cray XMT system. These products, which focus initially on
a narrower market than our commodity processor products, are expected to be available in
late 2007 and 2008, respectively. One of our challenges is to broaden the markets for these
products. We must add greater performance differentiation to our high-bandwidth massively
parallel commodity processor-based products, such as the Cray XT4 and successor systems,
while balancing the business strategy trade-offs between using commodity parts, which are
available to our competitors, and proprietary components, which are both expensive and
time-consuming to develop but provide customers with higher levels of performance and
capability.
Our Strategy
Our goal is to become the leading provider of supercomputers in the markets that we
target. Key elements of our strategy include:
Gain Share in Our Core HPC Market. We intend to leverage our strong product portfolio,
product roadmap and brand recognition in the high end of the HPC market to gain market
share. We believe that most of our competitors are primarily focused on the lower end of the
HPC market where low-bandwidth cluster systems dominate. We plan to remain focused on the
capability and enterprise segments of the HPC market.
Maintain Focus on Execution and Profitability. We are committed to achieving sustained
profitability on an annual basis. We intend to continue to refine our product roadmap,
converge our technologies and development processes, improve our ability to deliver high
quality products on time and on budget and continue our commitment to financial discipline.
Extend Technology Leadership. We are an innovation driven company in a technology
driven market. We plan to maintain a technology leadership position by investing in research
and development and partnering with key customers with interests aligned strongly with ours.
We will rely in part on government funding for our research and development efforts. We
intend to execute on our product roadmap and implement our Adaptive Supercomputing vision to
realize the concept of supporting multiple processing technologies within a single, highly
scalable Linux-based system.
Expand Total Addressable Market. Over time, we intend to leverage our technologies,
customer base and Cray brand in new segments and expand our addressable market. We believe
we have the opportunity to compete in a broader portion of the HPC market as well as
selective markets outside of HPC.
12
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 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. Our new products scheduled for 2007 and 2008 and our longer-term Adaptive Supercomputing
vision are efforts to increase product revenue. Product revenue varies significantly from
quarter to quarter. Service revenue is more constant in the short run and assists, in part,
to offset the impact that the variability in product revenue has on total revenue.
Gross margins. Our overall product margins in the first quarter of 2007 were 30%, while
our overall margins, including service, were 33%. To be successful, we need to increase
product gross margins, which we believe is best achieved through increased product
differentiation. We also monitor service margins and have been proactive in reducing service
costs where possible. Recent increases in gross margins have led to improved operational
results.
Operating expenses. Our operating expenses are driven largely by headcount, contracted
research and development services and the level of co-funded research and development. As
part of our ongoing efforts to control operating expenses, we monitor headcount levels in
specific geographic and operational areas. During 2006 we received increased levels of
co-funding for our research and development projects. Our 2006 DARPA Phase III award is in
line with our long-term development path. This award likely will result in some increase in
gross and net research and development expenditures by us in future periods due to the size
of the overall program and the cost-sharing requirement on our part. Our overall operating
expenses significantly decreased in 2006 compared to 2005, especially in research and
development. Our first quarter 2007 operating expenses decreased by
$1.1 million from first quarter 2006 and, as a percent of
revenue, were 37%
compared to 38% for the same period in 2006.
Liquidity and cash flows. Due to the variability in product revenue, our cash position
also varies from quarter to quarter and within a quarter. We closely monitor our expected
cash levels, particularly in light of potential increased inventory purchases for large
system installations and the risk of delays in product shipments and acceptances and,
longer-term, in product development. Our common stock offering in late 2006 was consistent
with our goal to build our cash position to provide additional working capital and to
improve our operational and strategic flexibility while at the same time lowering the
business risk to shareholders. Sustained profitability over annual periods is our primary
objective, which should improve our cash position and shareholder value.
Critical Accounting Policies and Estimates
This discussion, as well as disclosures included elsewhere in this Quarterly Report on
Form 10-Q, is based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States of America
(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, goodwill, accounting for income taxes,
accounting for loss contracts, research and development expenses and share-based
compensation. Our relevant accounting policies are set forth in Note 3 to the Consolidated
Financial Statements included in our 2006 Form 10-K and should be reviewed in conjunction
with the accompanying condensed consolidated financial statements and notes thereto as of
March 31, 2007, 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.
13
Additionally, we consider certain judgments and estimates to be significant, including
those relating to the fair value determination used in revenue recognition, estimates of
proportional performance on co-funded engineering contracts, 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 for goodwill and long-lived assets,
determination of the fair value of stock options and assessments of fair value, estimation
of restructuring costs, percentage of completion accounting on the Red Storm contract,
calculation of deferred income tax 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 from these estimates and assumptions.
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
We recognize revenue when it is realized or realizable and earned. In accordance with
the Securities and Exchange Commission Staff Accounting Bulletin (SAB) No. 104, Revenue
Recognition in Financial Statements, we consider revenue realized or realizable and earned
when we have persuasive evidence of an arrangement, the product has been shipped or the
services have been provided to our customer, the sales price is fixed or determinable, no
significant unfulfilled obligations exist and collectibility is reasonably assured. We
record revenue in our 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. We commonly enter into transactions that include
multiple-element arrangements, which may include any combination of hardware, maintenance
and other services. In accordance with Emerging Issues Task Force Issue No. 00-21, Revenue
Arrangements with Multiple Deliverables, when some elements are delivered prior to others in
an arrangement and all of the following criteria are met, revenue for the delivered element
is recognized upon delivery and acceptance of such item:
|
|
|
The element could be sold separately; |
|
|
|
|
The fair value of the undelivered element is established; and |
|
|
|
|
In cases with any general right of return, our performance with respect
to any undelivered element is within our control and probable. |
If all of the criteria are not met, revenue is deferred until delivery of the last
element as the elements would not be considered a separate unit of accounting and revenue
would be recognized as described below under our product or service revenue recognition
policies. We consider the maintenance period to commence upon acceptance of the product,
which may include a warranty period and accordingly allocate a portion of the sales price as
a separate deliverable which is recognized as service revenue over the entire service
period.
Products.
We recognize revenue from product sales upon customer acceptance of the
system, when we have no significant unfulfilled obligations stipulated by the contract that
affect the customers final acceptance, the price is fixed or determinable and collection is
reasonably assured. A customer-signed notice of acceptance or similar document is typically
required from the customer prior to revenue recognition.
DARPA Phase II and Red Storm Project Revenue. Revenue from contracts that require us
to design, develop, manufacture or modify complex information technology systems to a
customers specifications is recognized using the percentage of completion method for
long-term development projects under American Institute of Certified Public Accountants
(AICPA) Statement of Position 81-1, Accounting for Performance of Construction-Type and
Certain Production-Type Contracts. Percentage of completion is measured based on the ratio
of costs incurred to date compared to the total estimated costs. Total estimated costs are
based on several factors, including estimated labor hours to complete certain tasks and the
estimated cost of purchased components or services. Estimates may need to be adjusted from
quarter to quarter, which would impact revenue and margins on a cumulative basis. To the
14
extent the estimate of total costs to complete the contract indicates a loss, such
amount is recognized in full in the period that the determination is made. Revenue from
these arrangements is included in Product Revenue on our accompanying Statements of
Operations. Funding under DARPA Phase III is reflected as reimbursed research and
development expense, and as such is deducted to arrive at net research and development
expenses as recorded on our Condensed Consolidated Statements of
Operations.
Services. Maintenance services are provided under separate maintenance contracts with
our customers. These contracts generally provide for maintenance services for one year,
although some are for multi-year periods, often with prepayments for the term of the
contract. We consider the maintenance period to commence upon acceptance of the product,
which may include a warranty period. We allocate a portion of the sales price to maintenance
service revenue based on estimates of fair value. Revenue for the maintenance of computers
is recognized ratably over the term of the maintenance contract. Maintenance contracts that
are paid in advance are recorded as deferred revenue. We consider fiscal funding clauses as
contingencies for the recognition of revenue until the funding is virtually assured. Revenue
from Cray Technical Services is recognized as the services are rendered.
Inventory Valuation
We record our inventory at the lower of cost or market. We regularly evaluate the
technological usefulness and anticipated future demand of 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. We
are nearing the end of the life cycle for the Cray XT3 and Cray XD1 systems and have made
certain estimates of the future demand for this product. These estimates are subject to risk
in the near term and could require a write-down of inventory if the actual demand is lower
than currently estimated.
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.
Goodwill
Approximately 18% of our total assets as of March 31, 2007 consisted of goodwill
resulting from our acquisition of the Cray Research business unit assets from Silicon
Graphics, Inc. (SGI) in 2000 and our acquisition of OctigaBay Systems Corporation in April
2004. We no longer amortize goodwill associated with the acquisitions, but we are required
to conduct ongoing analyses of the recorded amount of goodwill in comparison to its
estimated fair value. We currently have one operating segment and reporting unit. As such,
we evaluate any potential goodwill impairment by comparing our net assets against the market
value of our outstanding shares of common stock. We performed an annual impairment test
effective January 1, 2007, and determined that our recorded goodwill was not impaired.
The analysis of whether the fair value of recorded goodwill is impaired and the number
and nature of our reporting units involves a substantial amount of judgment. Future charges
related to the amounts recorded for goodwill could be material depending on future
developments and changes in technology and our business.
15
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. In
accordance with Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for
Income Taxes, 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 most
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. As
of March 31, 2007, we had approximately $139.4 million of deferred tax assets, of which
$138.7 million was fully reserved. The net deferred tax assets were generated in foreign
jurisdictions where we believe it is more likely than not that we will realize these assets
through future operations. For the three-month periods ended March 31, 2007 and 2006, we
recognized income tax expense of $365,000 and $269,000, respectively, related to taxes due
in foreign and certain state and local jurisdictions
On January 1, 2007, we implemented the provisions of FASB Interpretation No. 48,
Accounting for Uncertainty in Income Taxes (FIN 48). FIN 48 clarifies the accounting for
uncertainty in income taxes and prescribes a recognition threshold and measurement attribute
for the financial statement recognition and measurement of a tax position taken or expected
to be taken in a tax return. This adoption did not have a material impact on our financial
position.
Accounting for Loss Contracts
In accordance with our revenue recognition policy, certain production contracts are
accounted for using the percentage of completion accounting method. We recognize revenue
based on a measurement of completion comparing the ratio of costs incurred to date with
total estimated costs multiplied by the contract value. Inherent in these estimates are
uncertainties about the total cost to complete the project. If the estimate to complete
results in a loss on the contract, we will record the amount of the estimated loss in the
period the determination is made. On a regular basis, we update our estimates of total
costs. Changes to the estimate may result in a charge or benefit to operations. As of March
31, 2007, our estimate of loss on the Red Storm contract was consistent with our estimate of
such loss as of December 31, 2005 and 2006, which was a cumulative loss of $15.3 million, all of
which was recorded in prior periods. As of March 31, 2007 and December 31, 2006, the balance
in the Red Storm loss contract accrual account was $7,000 and $157,000, respectively, and is
included in Other accrued liabilities in the accompanying Condensed Consolidated Balance
Sheets.
Research and Development Expenses
Research and development costs include costs incurred in the development and production
of our hardware and software, costs incurred to enhance and support existing software
features and expenses related to future product development. Research and development costs
are expensed as incurred, and may be offset by co-funding from the U.S. government.
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 is measured as
milestone achievements occur or as costs are incurred. In 2006, certain of these co-funding
payments were recognized as product revenue. See Revenue
Recognition DARPA Phase II and Red Storm Project Revenue above.
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 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.
16
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.
Share-based Compensation
We account for share-based compensation in accordance with the provisions of FAS 123R.
Estimates of fair value of stock options are based upon 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.
Results of Operations
Revenue and Gross Margins
Our
product and service revenue and gross margins for the three months ended March 31 were (in thousands,
except for percentages):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2007 |
|
|
2006 |
|
Product revenue |
|
$ |
33,660 |
|
|
$ |
34,269 |
|
Less: Cost of product revenue |
|
|
23,577 |
|
|
|
26,677 |
|
|
|
|
|
|
|
|
Product gross margin |
|
$ |
10,083 |
|
|
$ |
7,592 |
|
|
|
|
|
|
|
|
Product gross margin percentage |
|
|
30% |
|
|
|
22% |
|
|
|
|
|
|
|
|
|
|
Service revenue |
|
$ |
13,449 |
|
|
$ |
14,246 |
|
Less: Cost of service revenue |
|
|
7,998 |
|
|
|
7,693 |
|
|
|
|
|
|
|
|
Service gross margin |
|
$ |
5,451 |
|
|
$ |
6,553 |
|
|
|
|
|
|
|
|
Service gross margin percentage |
|
|
41% |
|
|
|
46% |
|
|
|
|
|
|
|
|
|
|
Total revenue |
|
$ |
47,109 |
|
|
$ |
48,515 |
|
Less: Total cost of revenue |
|
|
31,575 |
|
|
|
34,370 |
|
|
|
|
|
|
|
|
Total gross margin |
|
$ |
15,534 |
|
|
$ |
14,145 |
|
|
|
|
|
|
|
|
Total gross margin percentage |
|
|
33% |
|
|
|
29% |
|
Product Revenue
Product revenue for the three months ended March 31, 2007 consisted of $33.7 million
primarily from sales of our Cray XT4 systems, but also includes sales
of our other HPC products.
Product revenue for the three months ended March 31, 2006 consisted of $26.3 million
primarily from our Cray XT3 systems, our Cray XD1 and Cray X1/X1E systems and other products
and $8.0 million from our low margin Red Storm and DARPA Phase II development projects.
Quarterly and annual results for 2007 will be affected by many factors, including the
timing and success of the Cray XT4 and BlackWidow product rollouts. The Cray XT4 system is
currently available and shipping, with an important upgrade to a quad-core Opteron processor
from AMD planned in late 2007. Planned re-spins of the BlackWidow and Cray XMT systems will
likely result in initial BlackWidow deliveries in late 2007 and initial Cray XMT system
deliveries in 2008. These changes in the anticipated timing of product availability have
impacted our outlook for 2007. While there continues to be a wide range of
potential outcomes for quarterly and annual results, we estimate the mid-point for the 2007
revenue range to be about $230 million. This estimate assumes a significant contribution
from quad-core Cray XT4 systems and upgrades, as well as a contribution from initial
BlackWidow sales. If we do not recognize any product revenue from our
quad-core Cray XT4 and initial BlackWidow systems in 2007, we expect our total 2007 revenue would be less than $200 million.
We anticipate as much as 50% of full-year product revenue could be
recognized in the fourth quarter, while second and third quarter results are expected to be
mixed, with the third quarter likely
17
benefiting from a very large product acceptance of about $40 million and the second
quarter potentially having minimal product revenue, resulting in
total revenue in the second quarter likely in the range of
$20 million to $25 million.
Service Revenue
Service revenue for the first three months of 2007 decreased by approximately $800,000,
from the same period in 2006, due to a high margin Cray Technical Services custom
engineering contract that ended in 2006.
While we expect our maintenance service revenue to stabilize over the next year, we may
have periodic revenue and margin declines as our older, higher margin service contracts end.
Our newer products will likely require less hardware maintenance and therefore generate less
maintenance revenue than our historic vector systems. Overall service revenue may decline in
2007 due to the end of a significant Cray Technical Services custom engineering contract in
2006.
Product Gross Margin
Product gross margin improved 8 percentage points to 30% for the first three months of
2007 compared to the same period in 2006. This increase in product gross margin was due to
improved margins on our Cray XT3, Cray XT4 and other products in the first quarter of 2007,
while product margins in the first quarter of 2006 were impacted adversely by low margin
development project revenue. If the effects of the low margin project revenue development
projects were excluded, adjusted product margins for the 2006 period would have been
approximately 27%.
With minimal low-margin, development-related product revenue expected in 2007 and some
expected benefit of new product introductions, we expect overall product gross margins to
increase in 2007 as compared to 2006 and to be in the low 30% range.
Service Gross Margin
At 41%, service gross margin was 5 percentage points lower in the first quarter of 2007
compared to the same period in 2006. The 2006 period benefited from high margin Cray
Technical Services revenue from a custom engineering contract, as described above, and our
2007 quarterly results were adversely impacted by slightly higher costs associated with
large system installations. Service gross margin percentage for 2007 is expected to decrease
somewhat from 2006 levels for the same reasons.
Operating Expenses
Research and Development
Our research and development expenses for the three months ended March 31 were (in
thousands, except for percentages):
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
|
|
Ended March 31, |
|
|
|
2007 |
|
|
2006 |
|
Gross research and development expenses |
|
$ |
22,531 |
|
|
$ |
26,073 |
|
Less: Amounts included in cost of product revenue |
|
|
(270 |
) |
|
|
(6,378 |
) |
Less: Reimbursed research and development
(excludes amounts in revenue) |
|
|
(14,381 |
) |
|
|
(12,480 |
) |
|
|
|
|
|
|
|
Net research and development expenses |
|
$ |
7,880 |
|
|
$ |
7,215 |
|
|
|
|
|
|
|
|
Percentage of total revenue |
|
|
17% |
|
|
|
15% |
|
Gross research and development expenses in the table above reflect all research
and development expenditures, including expenses related to our research and development
activities on the Red Storm and DARPA Phases II and III projects. Research and development
expenses on the Red Storm and DARPA Phase II projects are reflected in our Statements of
Operations as cost of product revenue, and government co-funding on our other projects,
including DARPA Phase III, is recorded in our Statements of Operations as reimbursed
research and development expense. Research and development expenses include personnel
expenses, depreciation, allocations for certain overhead expenses, software, prototype
materials and outside contracted engineering expenses.
18
For the three-month period ending March 31, 2007, net research and development expenses
increased slightly as compared to the same period in 2006 due principally to lower
government co-funding amounts recognized which were offset in part by lower gross research
and development expenses. Delays in completing milestones on the Cray XMT product as a
result of the additional required respin of the processor ASIC increased first quarter 2007
net research and development expenses and will likely impact the next few quarters as well.
When certain milestones are achieved, net research and development expenses in the quarter of
achievement could benefit.
We anticipate both gross research and development expenses and the total level of
government funding to increase in 2007, with net research and development expenses likely
higher than 2006 levels due to the cost-sharing portion of the DARPA Phase III award, with
possible further increases in net research and development expenses if the U.S. government
ceases co-funding on our BlackWidow or Cray XMT projects earlier than anticipated. We expect
that research and development co-funding, including amounts under the DARPA Phase III,
BlackWidow and Cray XMT funding agreements, will be recorded as a reduction to research and
development expense in 2007, based on contract-specific terms.
Other Operating Expenses
Our sales and marketing, general and administrative, and restructuring and severance
charges for the three months ended March 31 were (in thousands, except for percentages):
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
|
Ended March 31, |
|
|
2007 |
|
2006 |
Sales and marketing |
|
$ |
5,268 |
|
|
$ |
4,985 |
|
Percentage of total revenue |
|
|
11% |
|
|
|
10% |
|
General and administrative |
|
$ |
4,280 |
|
|
$ |
5,594 |
|
Percentage of total revenue |
|
|
9% |
|
|
|
12% |
|
Restructuring and severance |
|
$ |
10 |
|
|
$ |
738 |
|
Percentage of total revenue |
|
|
<1% |
|
|
|
2% |
|
Sales and Marketing. The increase in sales and marketing expenses for the three months
ended March 31, 2007, compared to the same period in 2006, was primarily due to an increase
in headcount. We expect that 2007 sales and marketing expenses could be higher than 2006
levels primarily due to increased headcount.
General and Administrative. The decrease in general and administrative costs for the
three months ended March 31, 2007 over the corresponding 2006 period was due to decreases in
expense for variable pay and retention compensation programs. Additionally, the 2006 period
was negatively impacted by accounting and legal costs related to the restatement of certain
2004 financial information. We expect overall 2007 general and administrative expenses to be
somewhat lower than 2006 expense levels.
Restructuring
and Severance. Restructuring and severance charges included
costs related to our efforts to reduce our overall cost structure by reducing headcount. In
the first quarters of 2007 and 2006, we continued to incur additional severance costs
related to our second and fourth quarter 2005 actions, though at decreasing levels, as those
actions are completed.
Other Income (Expense), net
For the three months ended March 31, 2007 and 2006, we recognized net other income of
$395,000 and net other expense of $41,000, respectively. Net other income for the three
months ended March 31, 2007 was principally the result of gains realized prior to a foreign
currency derivatives designation as an effective cash flow hedge, while net other expense
for the three months ended March 31, 2006 was principally the result of a loss in fair value
on a foreign currency derivative not designated as a cash flow hedge,
offset in part by net foreign
currency transaction gains.
Interest Income (Expense), net
Our interest income and interest expense for the three months ended March 31 were (in
thousands):
19
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
|
|
Ended March 31, |
|
|
|
2007 |
|
|
2006 |
|
Interest income |
|
$ |
1,835 |
|
|
$ |
485 |
|
Interest expense |
|
|
(802 |
) |
|
|
(1,093 |
) |
|
|
|
|
|
|
|
Net interest income (expense) |
|
$ |
1,033 |
|
|
$ |
(608 |
) |
|
|
|
|
|
|
|
Interest income increased significantly in the first quarter of 2007 compared to the
same period in 2006 as a result of higher average invested cash balances and higher
short-term interest rates. Higher invested cash balances were primarily a result of
proceeds from our December 2006 public offering.
Interest expense for the first three months of both 2007 and 2006 principally consisted
of $600,000 of interest on our Notes in each period and $172,000 and $338,000, respectively,
of non-cash amortization of capitalized issuance costs.
Taxes
We recorded tax expense of $365,000 and $269,000 for the three months ended March 31,
2007 and 2006, respectively. The tax expense recognized in both 2007 and 2006 reflects tax
expense for local, state and foreign tax jurisdictions.
Liquidity and Capital Resources
Cash, cash equivalents, restricted cash, short-term investments and accounts receivable
totaled $173.3 million at March 31, 2007, compared to $185.1 million at December 31, 2006;
cash, cash equivalents and restricted cash decreased by $24.2 million while short-term
investments increased by $31.5 million and accounts receivable decreased by $19.1 million.
At March 31, 2007, we had working capital of $139.6 million compared to $136.3 million at
December 31, 2006.
Net cash provided by operating activities for the three months ended March 31, 2007 was
$6.3 million compared to $23.9 million for the same period in 2006. For the three months
ended March 31, 2007, cash provided by operating activities was principally the result of
non-cash operating items included in net loss and decreases in accounts receivable and
inventory, which were slightly offset by decreases in accrued payroll and related expenses,
advance research and development payments, accounts payable and deferred revenue. Net cash
provided by operating activities for the three months ended March 31, 2006 consisted
primarily of decreases in accounts receivable and inventory and an increase in accounts
payable, partially offset by a decrease in deferred revenue.
Net cash used by investing activities was $31.7 million for the three months ended
March 31, 2007, compared to net cash used by investing activities of $757,000 for the
respective 2006 period. Net cash used by investing activities for the three months ended
March 31, 2007 consisted primarily of purchases of short-term investments. Net cash used by
investing activities for the three months ended March 31, 2006 consisted primarily of
purchases of property and equipment.
Net cash provided by financing activities was $1.2 million for the three months ended
March 31, 2007, compared to $702,000 for the respective 2006 period. The net cash provided
by financing activities for both periods resulted primarily from cash received from the
exercise of stock options and the issuance of common stock through our employee stock
purchase plan. In both years, these proceeds were partially offset by principal payments on
capital leases.
Over the next twelve months, our significant cash requirements will relate to
operational expenses, consisting primarily of personnel costs, costs of inventory and spare
parts, outside engineering expenses, particularly as we continue development of our Cray XT4
and successor systems and internally fund a portion of the expenses on our Cascade project
pursuant to the DARPA Phase III award, interest expense and acquisition of property and
equipment. As of March 31, 2007, our remaining fiscal year 2007 capital budget for property
and equipment was approximately $14 million. In addition, we lease certain equipment used in
our operations under operating or capital
20
leases in the normal course of business. The following table summarizes our contractual
cash obligations as of March 31, 2007 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amounts Committed by Year |
|
|
|
|
|
|
|
Less than |
|
|
1-3 |
|
|
3-5 |
|
|
|
|
Contractual Obligations |
|
Total |
|
|
1 year |
|
|
years |
|
|
years |
|
|
Thereafter |
|
Development agreements |
|
$ |
18,536 |
|
|
$ |
16,349 |
|
|
$ |
2,187 |
|
|
$ |
|
|
|
$ |
|
|
Operating leases |
|
|
6,206 |
|
|
|
2,405 |
|
|
|
3,369 |
|
|
|
409 |
|
|
|
23 |
|
|
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Total contractual cash obligations |
|
$ |
24,742 |
|
|
$ |
18,754 |
|
|
$ |
5,556 |
|
|
$ |
409 |
|
|
$ |
23 |
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|
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We have $80.0 million of outstanding Convertible Senior Subordinated Notes (Notes)
which are due in 2024. These Notes bear interest at 3.0% ($2.4 million per year, or $600,000
on a quarterly basis) and holders of these Notes may require us to purchase these Notes on
December 1, 2009, December 1, 2014 and December 1, 2019, or upon the occurrence of certain
events provided in the indenture governing the Notes. Additionally, we have a two-year
cash-secured revolving line of credit for up to $25.0 million, which expires in December
2008. No amounts were outstanding under this line as of March 31, 2007. As of the same date,
we were eligible to borrow $24.8 million against this line of credit; the borrowing
limitation relates to restrictions from an outstanding letter of credit. We are required to
maintain $25 million of restricted cash in connection with our line of credit agreement.
In our normal course of operations, we have development arrangements under which we
engage outside engineering resources to work on our research and development projects. For
the three-month periods ended March 31, 2007 and 2006, we incurred $4.1 million and $7.0
million, respectively, for such arrangements.
At any particular time, our cash position is affected by the timing of cash receipts
for product sales, maintenance contracts, government co-funding for research and development
activities and our payments for inventory, resulting in significant fluctuations in our cash
balance from quarter-to-quarter and within a quarter. Our principal sources of liquidity are
our cash and cash equivalents, short-term investments, operations and credit facility. Even
assuming acceptances and payment for large new systems to be sold and the benefit from our
restructuring activities and other recent cost reduction efforts, our cash flow from
operations is likely to be negative for 2007 as a whole, largely to support working capital
requirements, although a wide range of results is possible. With the proceeds of our
December 2006 public offering, and the near term expected cash flow from our DARPA Phase III
award, we do not anticipate borrowing from our credit line and we expect our cash resources
to be adequate for at least the next twelve months.
We have been focusing on expense controls, negotiating sales contracts with advance
partial payments where possible, implementing tighter purchasing and manufacturing processes
and improving working capital management in order to maintain adequate levels of cash.
Additionally, the adequacy of our cash resources is dependent on the amount and timing of
government funding as well as our ability to sell our products, particularly the Cray XT4,
BlackWidow and Cray XMT systems, with adequate margins. Beyond the next twelve months, the
adequacy of our cash resources will largely depend on our success in re-establishing
profitable operations and positive operating cash flows on a sustained basis. See Item 1A.
Risk Factors in Part II below.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to financial market risks, including changes in interest rates and
equity price fluctuations.
Interest Rate Risk: We invest our available cash in 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. Investments in both
fixed-rate and floating-rate interest earning instruments carry a degree of interest rate
risk. Fixed-rate securities may have their fair market value adversely affected due to a
rise in interest rates, while floating-rate securities may produce less income than expected
if interest rates fall. Due in part to these factors, our future investment income may fall
short of expectations due to changes in interest rates or we may suffer losses in principal
if forced to sell securities, which have declined in market value due to changes in interest
rates. At March 31, 2007, we held a portfolio of highly liquid investments, all of which
were to mature in a range between less than 90 days and up to two years from the date of
initial investment.
21
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. During the first
quarter of 2007, we entered into three separate forward exchange contracts with notional
amounts totaling £37.8 million (British pound sterling) and 3.5 million (Euro) to
hedge anticipated cash receipts on specific sales contracts against the risk of foreign
exchange rate changes between the time that the related contracts were signed and when the
cash receipts are expected to be received. Our foreign maintenance contracts are 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 March 31, 2007, a 10% change in foreign exchange
rates could impact our annual earnings and cash flows by
approximately $1.5 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 March 31, 2007 that our disclosure controls and procedures
were effective such that the information required to be disclosed in our Securities and
Exchange Commission (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 March 31,
2007 that have materially affected or are reasonably likely to materially affect our
internal control over financial reporting.
Item 4T. Controls and Procedures
Not applicable.
PART II. OTHER INFORMATION
Item 1A. Risk Factors
The following factors should be considered in evaluating our business, operations,
prospects and common stock as they may affect our future results and financial condition and
they may affect an investment in our securities.
Our operating results may fluctuate significantly and we may not achieve profitability
in any given period. Our operating results are subject to significant fluctuations due to
the factors listed below, which make estimating revenue and operating results for any
specific period very difficult, particularly as the product revenue recognized in any given
quarter may depend on a very limited number of system sales planned for that quarter, the
timing of product acceptances by customers and contractual provisions affecting revenue
recognition. For example, we expect a substantial portion of our potential product revenue
in the first three quarters of 2007 to come from a few principal transactions, and a
significant portion of our product revenue in late 2007 to come from upgrades to our Cray
XT4 system utilizing quad-core AMD Opteron processors with new
scalable system software, and initial deliveries of
our Cray BlackWidow system, all of which are currently in development. We anticipate that as
much as 50% of full-year product revenue could be recognized in the fourth quarter, while
second and third quarter results are expected
22
to be mixed, with the third quarter likely benefiting from a very large product
acceptance of about $40 million and the second quarter potentially having minimal product
revenue. Delays in recognizing revenue from any of those transactions due to not achieving
product acceptances, contractual provisions or for other reasons, could
have a material adverse effect on our operating results for those quarters, and could shift
associated revenue, margin and cash receipts into a subsequent quarter or fiscal year.
We experienced net losses in each full year of our development-stage operations prior
to 2002. For 2002 we had net income of $5.4 million and for 2003 we had net income of $63.2
million, including an income tax benefit of $42.2 million substantially all of which came
from the reversal of a valuation allowance against deferred tax assets. For 2004 we had a
net loss of $207.4 million, including an expense for in-process research and development of
$43.4 million and an income tax expense of $59.1 million, of which $58.9 million related to
the establishment of a valuation allowance against deferred tax assets. For 2005 we had a
net loss of $64.3 million; for 2006 we had a net loss of $12.1 million, with net losses in
the first three quarters of the year offsetting net income in the fourth quarter; and for
the first quarter of 2007, we had a net loss of $841,000.
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:
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successfully selling the Cray XT4 system, including upgrades and
successor systems, and new products based on our BlackWidow project and Cray
XMT system, and the timing and funding of government purchases, especially
in the United States; |
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the level of revenue recognized in any given period, particularly with
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 of revenue recognition; |
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the level of product margin contribution in any given period due to
product mix, strategic transactions, product life cycle and component costs; |
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the level and timing of maintenance contract renewals with existing customers; |
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maintaining our product development projects on schedule and within budgetary limitations; |
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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; |
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our expense levels, including research and development net of government
funding, which may be affected by the level and timing of such funding; |
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the terms and conditions of sale or lease for our products; and |
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the impact of expensing our share-based compensation under FAS 123R. |
The timing of orders and shipments impact our quarterly and annual results and are
affected by events outside our control, such as:
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the timely availability of acceptable components in sufficient quantities
to meet customer delivery schedules; |
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the timing and level of government funding for product acquisitions and
research and development contracts; |
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the availability of adequate customer facilities to install and operate new Cray systems; |
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general economic trends, including changes in levels of customer capital spending; |
23
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the introduction or announcement of competitive products; |
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currency fluctuations, international conflicts or economic crises; and |
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the receipt and timing of necessary export licenses. |
Because of the numerous factors affecting our revenue and results of operations, we
cannot assure our investors that we will have net income on a quarterly or annual basis in
the future. We anticipate that our quarterly results will vary significantly, and include
losses. Delays in product development, receipt of orders or product acceptances could have a
substantial adverse effect on our quarterly and full year results in 2007 and in future
years.
Failure to sell Cray XT4 systems in planned quantities and at expected gross margins
could adversely affect revenue and operating results in 2007 and future periods. We expect
that a substantial majority of our product revenue in 2007 will come from a limited number
of sales of Cray XT4 systems in the United States and overseas. We shipped the first Cray
XT4 system in late November 2006, and we received the first customer acceptance of a Cray
XT4 system in the first quarter of 2007. We will require timely availability of quad-core
AMD Opteron processors in the second half of 2007 and timely completion of scalable system
software for large systems if we are to receive product acceptances planned for the fourth
quarter of 2007. We also face significant margin pressure for our Cray XT4 system from
competitors. If we do not sell these systems in planned quantities and at expected margins,
our 2007 revenue and operating results would be adversely affected.
In order to command higher margins in 2007 and beyond, we need increased performance
differentiation from our competitors in our Cray XT4 and future Baker massively parallel
products. The market for such products is larger but is replete with low bandwidth cluster
systems offered by larger competitors with significant resources and smaller companies with
minimal research and development expenditures. Potential customers may be able to meet their
computing needs through the use of such systems, and are willing to accept lower capability
and less accurate modeling in return for lower acquisition costs. Vendors of such systems,
because they can offer high peak performance per dollar, put pricing pressure on us in
certain competitive procurements. Our long-term success may be adversely affected if we are
not successful in demonstrating the value of our balanced high bandwidth systems with the
capability of solving challenging problems quickly to a market beyond our core of customers,
largely certain agencies of the U.S. and other governments, that require systems with the
performance and features we offer.
Our inability to complete the development of our BlackWidow and Cray XMT supercomputer systems
would adversely affect our revenue and operating results in 2007 and future periods. Our 2007 plan
initially contemplated product revenue and gross margin from sales of our BlackWidow and our Cray
XMT systems. These systems are still in development and, with required respins of integrated
circuits for both of these products, we do not expect initial deliveries of the BlackWidow system
until late 2007 and initial deliveries of the Cray XMT system until 2008. These hardware and
software development efforts are lengthy and technically challenging processes. We may incur
additional delays in successfully completing the design and production of these hardware
components, including several custom integrated circuits and network components; in detecting and
correcting, if possible, design errors in such integrated circuits and components; and/or in
developing requisite system software, integrating and stabilizing the full systems. Any of these
delays will make it difficult for us to develop the BlackWidow system in time for revenue
recognition during 2007 and could result in additional delays in the availability of the Cray XMT
system. The delays in the BlackWidow and Cray XMT system development have adversely impacted our
expected 2007 operating results and any such additional delay in the availability of the BlackWidow
system will adversely impact our 2007 operating results even further. Delays in product
availability of initial systems can impact future revenue as anticipated follow-on purchases of
these systems may be reduced or delayed.
If we lose government support for development of our supercomputer systems, our net
research and development expenditures and capital requirements would increase and our
ability to conduct research and development would decrease. A few government agencies and
research laboratories fund a significant portion of our development efforts, including our
Cascade project through the DARPA HPCS program and our BlackWidow and Cray XMT projects
through other agencies; this funding significantly reduces our reported level of net
research and development expenses. DARPAs financial commitments are subject to
Congressional and federal inter-agency action. Our development projects for our BlackWidow
and multithreaded projects are expected to be funded through September 2007 but the timing
of current funding as well as future funding for these projects may be at risk. Any delay of
funding could result in significant quarterly fluctuations in research and development
expense. Agencies of the U.S. government historically have facilitated the development of,
and have constituted a market for, new and enhanced very high performance computer systems.
U.S. government agencies may delay or decrease funding of our
24
future product development efforts due to product development delays, a change of
priorities, international political developments, overall budgetary considerations or for
any other reason. Any delay or decrease in other governmental support would cause an
increased need for capital, increase significantly our research and development expenditures
and adversely impact our operating results and our ability to implement our product roadmap.
Our reliance on third-party suppliers poses significant risks to our business and
prospects. We subcontract the manufacture of a majority of the hardware components for all
of our 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 our components for all of our systems. We also
rely on third parties to supply key capabilities, such as file systems and storage
subsystems. We are subject to substantial risks because of our reliance on limited or sole
source suppliers. For example:
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if a supplier does not provide components that meet our specifications in
sufficient quantities on time, then production and sales of our systems
would be delayed, adversely affecting revenue and cash flow these risks
are accentuated during steep production ramp periods as we introduce new or
successor products; |
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if an interruption of supply of our components occurs, because of a
significant problem with a supplier providing parts that later prove to be
defective or because a single-source supplier imposes allocations on its
customers, decides to no longer provide those components to us or increases
the price of those parts significantly, it could take us a considerable
period of time to identify and qualify alternative suppliers, to redesign
our products as necessary and to begin manufacture of the redesigned
components. In some cases, we may not be able to redesign such components.
Defective components may need to be replaced, which may result in increased
costs and obsolete inventory. See also the Risk Factor captioned, We have
placed last-time buy decisions affecting our current products, which
may adversely affect our revenue and operating results, below; |
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if a supplier cannot provide a competitive key component, our systems may
be less competitive than systems using components with greater capability;
and |
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some of our key 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. |
Our Cray XT4 and successor systems utilize AMD Opteron processors as will planned
upgrade and successor products. Our performance in the fourth quarter of 2007 depends
substantially on the timely availability of quad-core Opteron processors from AMD, and a
delay in availability of these processors could have a material adverse effect on our
revenue, earnings and cash flow for 2007. To the extent that Intel, IBM or other processor
suppliers develop processors with greater capabilities, even for a short time, our systems,
including upgrades and successor products, may be at a competitive disadvantage to systems
utilizing such other processors. Our BlackWidow system is based on custom integrated
circuits manufactured for us by Texas Instruments, Inc. while our Cray XMT system is based
on custom integrated circuits manufactured for us by Taiwan Semiconductor Manufacturing
Company. If any of our integrated circuit suppliers suffers delays or cancels the
development of enhancements to its processors, our product revenue would be adversely
affected. Changing our product designs to utilize another suppliers integrated circuits
would be a costly and time-consuming process.
Our products must meet demanding specifications. For example, integrated circuits must
perform reliably at high frequencies to meet acceptance criteria. From time to time during
the last three years, we incurred significant delays in the receipt of key components which
delayed product shipments and acceptances. The delays in product shipments and acceptances
adversely affected revenue and margins in those years, and, to the extent that we experience
similar problems in the future, such delays may adversely affect 2007 and future revenue and
margins.
Failure to overcome the technical challenges of completing the development of our
supercomputer systems on our product roadmap would adversely affect our revenue and
operating results in subsequent years. In addition to developing the BlackWidow system for
general availability and scalable system software for quad-core Cray XT4 systems in the
second half of 2007, we continue work on our product roadmap,
including the Cray XMT system, the
Baker project as the successor to the Cray XT4 system and our Cascade program under the
DARPA HPCS Phase III award to implement our Adaptive Supercomputing vision. These hardware
and software development efforts are lengthy and technically challenging processes, and
require a significant investment of capital, engineering and other resources. Our
engineering and technical personnel resources are limited. Unanticipated performance and/or
development issues may require more engineers, time or testing resources than are currently
available. Engineering resources directed to solving current issues may adversely affect the
timely development of successor or future products. Given the breadth of our engineering
challenges and our limited resources, we periodically review the anticipated contributions
and expense of our product programs to determine their long-term viability. We may not be
successful in meeting our development schedules for technical reasons and/or because of
insufficient hardware and software 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 or uncover stability issues, whether for software
or hardware, our revenue, results of operations and cash flows, and the reputation of such
systems in the market could be adversely affected. Future sales of our products may be
adversely affected by any of these factors. We have suffered significantly from product
delays in the past that adversely affected our financial performance, and we continue to
incur some stability issues typical of new large installations. We
recently announced development delays for both our BlackWidow project and
Cray XMT system. We
may incur additional development delays
and stability issues in 2007 and subsequent years, which could adversely affect our revenue
and operating results in those periods.
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 a
significant market for supercomputers, including our products. From January 1, 2001, through
December 31, 2003, approximately 81% of our aggregate product revenue was
25
derived from sales to various agencies of the U.S. government; in 2004, 2005, 2006 and
the first quarter of 2007, approximately 81%, 55%, 45% and 79%, respectively, of our product
revenue was derived from such sales. Our 2007 and future plans contemplate significant sales
to U.S. government agencies. Sales to government agencies may be affected by factors outside
our control, such as changes in procurement policies, budgetary considerations, 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.
Phase III of the DARPA HPCS program will affect our operations. Our proposal for Phase
III of the DARPA HPCS program was accepted on November 21, 2006, for the development of our
Cascade project. This award calls for the delivery of prototype systems by late 2010, and
provides for a contribution by DARPA to us of up to $250 million payable over approximately
four years, assuming we meet ten milestones, of which to date we have
met one. If we do not
meet any of the remaining milestones, our cash flows would be adversely impacted and our
product development programs would be at risk. DARPAs future financial commitments are
subject to subsequent Congressional and federal inter-agency action, and our Cascade
development efforts would be adversely impacted if DARPA did not receive expected funding or
decided to terminate the program before completion. We must contribute at least $125 million
towards the projects total development cost; failure to do so would result in a lower level
of DARPA contribution and could result in a termination of the contract. This award likely
will result in increased net research and development expenditures by us for the
cost-sharing portion of the program and adversely affect our cash flow, particularly in the
later years of the program.
The achievement of our business plan is highly dependent on increased product revenue
and margins. Product revenue in recent years has been adversely affected by delays in
product shipments due to development delays, including system software development for large
systems, and at times by the availability of key components from third-party vendors. System
stability issues typical of new large systems previously have affected the timing of system
acceptances, which adversely affects our revenue, results of operations and cash flows. In
the past, product margins have been adversely impacted by competitive pressures, lower
volumes than planned and higher than anticipated manufacturing variances, including scrap,
rework and excess and obsolete inventory. We sometimes do not meet all of the contract
requirements for customer acceptance of our systems, which have resulted in contract
penalties. Most often these penalties adversely affect the gross margin on a sale through
the provision of additional equipment and services to satisfy delivery delays and
performance shortfalls, although there is the risk of contract defaults and product return.
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. To improve our
26
financial performance, we need to limit negative manufacturing variances, contract
penalties and other charges that adversely affect product margin.
We have placed last-time buy decisions affecting our current products, which may
adversely affect our revenue and operating results. We placed a last-time buy order in the
first quarter of 2007 for a key component for our Cray XT4 and Cray XMT systems. Such
last-time buy orders and inventory purchases were placed before we could know all possible
sales prospects for these products. In determining last-time buy orders and inventory
purchases, we either may have estimated too low, in which case we limited the number of
possible sales of products and reduced potential revenue, perhaps substantially, or we may
have estimated too high, and may incur inventory obsolescence charges. Either way, our
operating results could be adversely affected. These last-time buy decisions adversely
impact short-term cash flow and increase inventory because the items are paid for well in
advance of customer revenue. For example, since September 2006 we have placed orders for
approximately $8.5 million of certain components for which we expect delivery in 2007 but do
not expect to sell the major part of the products containing these components until sometime
in 2008.
If we are unable to compete successfully in the HPC market, our revenue will decline.
The performance of our products may not be competitive with the computer systems offered by
our competitors. Many of our competitors are established companies well known in the HPC
market, including IBM, NEC, Hewlett-Packard, SGI, Dell, 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, IBM and others. These competitors include the previously named
companies as well as smaller firms that benefit from the low research and development costs
needed to assemble systems from commercially available commodity products. These companies
have capitalized on developments in parallel processing and increased computer performance
in commodity-based networking and cluster systems. While these companies products are more
limited in applicability and scalability, they have achieved growing market acceptance. They
offer significant peak/price performance on larger problems lacking complexity. 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 use from AMD, our Cray XT4 systems and successor products may be at a competitive
disadvantage to systems utilizing such other processors.
Internationally we compete primarily with IBM, Hewlett-Packard, Sun Microsystems, Bull
S.A., SGI and NEC. While the first five companies offer large systems based on commodity
processors, NEC also offers vector-based systems with a large suite of ported application
programs. As in the United States, commodity HPC suppliers can offer systems with
significantly better peak/price performance.
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 very high performance computer systems. Some of our
competitors may offer trade-in allowances or substantial discounts to potential customers,
and engage in other aggressive pricing tactics, and we have not always been able to match
these sales incentives. We have in the past and may again be required to provide substantial
discounts to make strategic sales, which may reduce or eliminate any positive margin 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.
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. A
breakthrough in technology could make low 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.
27
Our stock price is volatile. The stock market has been and is subject to price and
volume fluctuations that particularly affect the market prices for small capitalization,
high technology companies like us. The trading price of our common stock is subject to
significant fluctuations in response to many factors, including our quarterly operating
results (particularly if they are less than our or analysts previous estimates), changes in
analysts estimates, our capital raising activities, announcements of technological
innovations by us or our competitors and general conditions in our industry.
If we cannot retain, attract and motivate key personnel, we may be unable to
effectively implement our business plan. Our success also depends in large part upon our
ability to retain, attract and motivate highly skilled management, technical, 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. As part of
our strategy to attract and retain personnel, we offer equity compensation through stock
options and restricted stock grants. However, potential employees 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.
Lower than anticipated sales of new supercomputers and the termination of maintenance
contracts on older and/or decommissioned systems may reduce our service revenue and margins
from maintenance service contracts. Our HPC systems are typically sold with maintenance
service contracts. These contracts generally are for annual periods, although some are for
multi-year periods, and provide a predictable revenue base. Our revenue from maintenance
service contracts declined from approximately $95 million in 2000 to approximately $42
million in 2005 while increasing to approximately $50 million in 2006. We expect that 2007
maintenance service revenue may decline from this level. We may have periodic revenue and
margin declines as our older, higher margin service contracts are ended and newer, lower
margin contracts are established, based on the timing of system withdrawals from service.
Adding service personnel to new locations when we win contracts where we have previously had
no presence and servicing installed products if we discover defective components in the
field create additional pressure on service margins.
Expansion of our Technical Services efforts could reduce our service margins. We plan
to expand our capabilities to deliver Cray Technical Services in 2007 through the addition
of experienced managers and personnel and marketing of these services. These services
usually are rendered on a project-by-project basis. To the extent that we incur additional
expenses in this effort prior to receiving additional revenue, our service margins will be
adversely affected.
The adoption of FAS 123R has and will continue to adversely affect our operating
results and may adversely affect the market price of our common stock. We have used
share-based compensation, primarily stock options and an employee stock purchase plan, as a
key component in our employee compensation. In previous years we granted stock options to
each new employee and to all employees on an annual basis, and in 2005 we vested almost all
existing stock options. For 2003 through 2005, as we have reported in the notes to our
financial statements, we estimated that our stock option and employee stock purchase
programs, as then structured, would have added approximately $7 million to $26 million of
additional non-cash expense annually. These estimates were based on use of the Black-Scholes
valuation method, which provides significantly different values depending on certain
assumptions. Beginning in 2006, in light of the adoption of FAS 123R, we awarded option and
stock awards to a limited number of new employees and granted options and restricted stock
to less than a majority of employees, almost all with four-year vesting periods. We also
changed the purchase price under our employee stock purchase plan to 95% of the closing
market price on the fourth business day after the end of each offering period in order to
designate the plan as non-compensatory, and thereby avoid expense which would have otherwise
been incurred under FAS 123R. We recorded approximately $1.0 million as non-cash
compensation expense in the first quarter of 2007 and $2.1 million for all of 2006 for stock
options and restricted stock grants, and we anticipate that this amount will increase in
future years. We do not know how analysts and investors will react to the additional expense
recorded in our statements of operations rather than disclosed in the notes thereto, and
thus such additional expense may adversely affect the market price of our common stock.
28
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 or to 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.
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.
We incorporate software licensed from third parties into the operating systems for our
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. 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 alternate third-party
software, or develop these components ourselves, which would result in increased costs and
could result in delays in product shipments. Furthermore, we might be forced to limit the
features available in our current or future operating system software offerings. Our Cray
XT4 and successor systems utilize software system variants that incorporate Linux
technology. The SCO Group, Inc. has filed and threatened to file lawsuits against companies
that operate Linux for commercial purposes, alleging that such use of Linux infringes its
rights. 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 this
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 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. These issues, if
repeated, may result in additional expense by us in integrating this software more fully
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 on our
internal control over financial reporting in our Annual Reports on Form 10-K. Such report
must contain, among other items, an assessment of the effectiveness of our internal control
over financial reporting as of the end of the fiscal year, including a statement as to
whether or not our internal control over financial reporting is effective. This assessment
must include disclosure of any material weaknesses in our internal control over financial
reporting identified by management. Such report must also contain a statement that our
independent registered public accounting firm has issued an attestation report on
managements assessment of such internal control.
We received favorable opinions from our independent registered public accounting firm
and we reported no material weaknesses for 2005 and 2006; for 2004, however, we reported
material weaknesses and received a disclaimed attestation report. Each year, we must
continue to monitor and assess our internal control over financial reporting and determine
whether we have any material weaknesses. 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, loss of financing sources such as our line of
credit, and litigation based on the events themselves or their consequences.
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Our indebtedness may adversely affect our financial strength. In December 2004 we sold
$80.0 million in aggregate principal amount of our 3.0% Convertible Senior Subordinated
Notes due 2024 (the Notes). Holders may require us to purchase all or a part of their
Notes for cash at a purchase price of 100% of the principal amount of the Notes plus accrued
and unpaid interest on December 1, 2009, 2014, or 2019, or upon the occurrence of certain
events provided in the indenture governing the Notes. As of March 31, 2007 we had no other
outstanding indebtedness for money borrowed and no material equipment lease obligations. We
have a $25.0 million cash secured credit facility which supports the issuance of letters of
credit and forward currency contracts. As of March 31, 2007, we had approximately $24.8
million available to borrow under this credit facility. Our current credit facility
constitutes senior debt with respect to the Notes. We may incur additional indebtedness for
money borrowed, which may include borrowing under new credit facilities or the issuance of
new debt securities. Over time, the level of our indebtedness could, among other things:
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increase our vulnerability to general economic and industry conditions,
including recessions; |
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require us to use cash from operations to service our indebtedness,
thereby reducing our ability to fund working capital, capital expenditures,
research and development efforts and other expenses; |
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limit our flexibility in planning for, or reacting to, changes in our
business, including merger and acquisition opportunities; |
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place us at a competitive disadvantage compared to competitors that have
less indebtedness; and |
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limit our ability to borrow additional funds that may be needed to
operate and expand our business. |
We may not have the funds necessary to purchase the Notes upon a fundamental change or
other purchase date and our ability to purchase the Notes in such events may be limited. On
December 1, 2009, December 1, 2014 or December 1, 2019, holders of the Notes may require us
to purchase their Notes for cash. In addition, holders may also require us to purchase their
Notes upon a fundamental change, as defined in the indenture governing the Notes, which
includes among other matters a change of control. Our ability to repurchase the Notes in
such events may be limited by law and by the terms of other indebtedness, including the
terms of senior indebtedness, we may have outstanding at the time of such events. While our
existing credit facility does not prohibit us from repurchasing any of the Notes, any
subsequent credit facility may include such a covenant or a requirement for prior written
consent from the lender. If we do not have sufficient funds, we will not be able to
repurchase the Notes tendered to us for purchase. If a repurchase event occurs, we may
require third-party financing to repurchase the Notes, but we may not be able to obtain that
financing on favorable terms or at all. Our failure to repurchase tendered Notes at a time
when the repurchase is required by the indenture would constitute a default under the
indenture. In addition, a default under the indenture would constitute a default under our
existing senior secured credit facility and could lead to defaults under other existing and
future agreements governing our indebtedness. In these circumstances, the subordination
provisions in the indenture governing the Notes may limit or prohibit payments to Note
holders. If, due to a default, the repayment of the related indebtedness were to be
accelerated after any applicable notice or grace periods, we may not have sufficient funds
to repay the indebtedness or repurchase the Notes.
We will require a significant amount of cash to repay our indebtedness and to fund
planned capital expenditures, research and development efforts and other corporate expenses.
Our ability to make payments on our indebtedness, including the potential repurchase of the
Notes in December 2009, and to fund planned capital expenditures, research and development
efforts and other corporate expenses will depend on our future operating performance and on
economic, financial, competitive, legislative, regulatory and other factors. Many of these
factors are beyond our control. Our business may not generate sufficient cash from
operations and future borrowings may not be available to us in an amount sufficient to
enable us to pay our indebtedness, including the Notes, or to fund our other needs.
If we are unable to generate sufficient cash to enable us to pay our indebtedness, we
may need to pursue one or more alternatives, such as reducing our operating expenses,
reducing or delaying capital expenditures or research and development, selling assets,
raising additional equity capital and/or debt, and seeking legal protection from our
creditors.
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Any reduction in operating expenses, reduction or delay in capital expenditures, or
sale of assets may materially and adversely affect our future revenue prospects. In
addition, we may not be able to raise additional equity capital or debt on commercially
reasonable terms or at all. Any of the above actions may not provide sufficient cash to
repay our indebtedness, including the Notes. In addition, our issuance of additional equity
or debt that is convertible into equity could dilute our existing shareholders.
New environmental rules in Europe and other jurisdictions may adversely affect our
operations. In 2006 members of the European Union (EU) and certain other European
countries have begun implementing the Restrictions on Hazardous Substances (RoHS)
Directive, which prohibits or limits the use in electrical and electronic equipment of the
following substances: lead, mercury, cadmium, hexavalent chromium, polybrominated biphenyls,
and polybrominated diphenyl ethers. After July 1, 2006, a company shipping products that do
not comply with RoHS to the EU or such other European countries could have its products
detained and could be subject to penalties. We did not ship any Cray X1E or Cray XD1 systems
to Europe after July 1, 2006, because of these restrictions, and we are working with our
suppliers to assure RoHS compliance with respect to our other products. We believe we are
RoHS-compliant with our Cray XT4 system which began shipping in the fourth quarter of 2006
and our BlackWidow and Cray XMT systems which we plan to ship in late 2007 and 2008. If a
regulatory authority determines that one of our products is not RoHS-compliant, we will have
to redesign and requalify certain components to meet RoHS requirements, which could result
in increased engineering expenses, shipment delays, penalties and possible product
detentions or seizures.
A separate EU Directive on Waste Electrical and Electronic Equipment (WEEE) was
scheduled to become effective in August 2005, but many EU member states have delayed its
implementation. Under the WEEE Directive, companies that put electrical and electronic
equipment on the EU market must register with individual member states, mark their products,
submit annual reports, provide recyclers with information about product recycling, and
either recycle their products or participate in or fund mandatory recycling schemes. In
addition, some EU member states require recycling fees to be paid in advance to ensure funds
are available for product recycling at the end of the products useful life or
de-installation. We have begun to mark our products as required by the WEEE Directive and
are registering with those EU member states where our products are sold. Each EU member
state is responsible for implementing the WEEE Directive and some member states have not yet
established WEEE registrars or established or endorsed the recycling schemes required by the
WEEE Directive. We are monitoring implementation of the WEEE Directive by the member states.
Compliance with the WEEE Directive could increase our costs and any failure to comply with
the WEEE Directive could lead to monetary penalties.
Other jurisdictions are considering adoption of rules similar to the RoHS and WEEE
regulations. To the extent that any such rules differ from the RoHS and WEEE regulations,
they may result in additional expense for us to redesign and requalify our products, and may
delay us from shipping products into such jurisdictions.
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.
A substantial number of our shares are eligible for future sale and may depress the
market price of our common stock and may hinder our ability to obtain additional financing.
As of March 31, 2007, we had outstanding:
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32,432,747 shares of common stock; |
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1,284,852 shares of common stock issuable upon exercise of warrants; |
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3,650,458 shares of common stock issuable upon exercise of options, of
which options to 2,924,819 shares of common stock were then exercisable; and |
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Notes convertible into an aggregate of 4,144,008 shares of common stock
or, under certain circumstances specified in the indenture governing the
Notes, a maximum of 5,698,006 shares of common stock. |
Almost all of our outstanding shares of common stock may be sold without substantial
restrictions, with certain exceptions including 846,243 shares held by Board members,
executive officers and key managers that may be forfeited and are restricted against
transfer until vested. The restrictions on 511,733 of these
shares lapse in June 2007.
Almost all of the shares of common stock that may be issued on exercise of the warrants
and options will be available for sale in the public market when issued, subject in some
cases to volume and other limitations. The warrants outstanding at March 31, 2007, consisted
of warrants to purchase 1,284,852 shares of common stock, with an exercise price of $10.12
per share, expiring on June 21, 2009. The Notes are not now convertible, and only become
convertible upon the occurrence of certain events specified in the indenture governing the
Notes. Sales in the public market of substantial amounts of our common stock, including
sales of common stock issuable upon the exercise or conversion of warrants, options and
Notes, may depress prevailing market prices for the common stock. Even the perception that
sales could occur may impact market prices adversely. The existence of outstanding warrants,
options and Notes may prove to be a hindrance to our future financings. Further, the holders
of warrants, options and Notes may exercise or convert them for shares of common stock at a
time when we would otherwise be able to obtain additional equity capital on terms more
favorable to us. Such factors could impair our ability to meet our capital needs. We also
have authorized 5,000,000 shares of undesignated preferred stock, although no shares of
preferred stock currently are outstanding.
Provisions of our Restated Articles of Incorporation and Bylaws could make a proposed
acquisition 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:
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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; |
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the ability of our board of directors to issue preferred stock, without
shareholder approval, with rights senior to those of the common stock; |
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no cumulative voting of shares; |
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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; |
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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; |
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special voting requirements for mergers and other business combinations,
unless the proposed transaction was approved by a majority of continuing
directors; |
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special procedures to bring matters before our shareholders at our annual
shareholders meeting; and |
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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.
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Item 6. Exhibits
31.1 |
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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 |
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31.2 |
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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 |
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32.1 |
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Certificate pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002 |
Items 1, 2, 3, 4 and 5 of Part II are not applicable and have been omitted.
33
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.
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CRAY INC.
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May 7, 2007 |
/s/ PETER J. UNGARO
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Peter J. Ungaro |
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Chief Executive Officer and President |
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/s/ BRIAN C. HENRY
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Brian C. Henry |
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Chief Financial Officer |
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/s/ KENNETH D. ROSELLI
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Kenneth D. Roselli |
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Chief Accounting Officer |
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