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| CRAY > SEC Filings for CRAY > Form 10-Q on 5-Nov-2009 | All Recent SEC Filings |
5-Nov-2009
Quarterly Report
Preliminary Note Regarding Forward-Looking Statements
This quarterly report on Form 10-Q contains forward-looking statements that
involve risks and uncertainties, as well as assumptions that, if they never
materialize or prove incorrect, could cause our actual results to differ
materially from those expressed or implied by such forward-looking statements.
Forward-looking statements are based on our management's beliefs and assumptions
and on information currently available to them. In some cases you can identify
forward-looking statements by terms such as "may," "will," "should," "could,"
"would," "expect," "plans," "anticipates," "believes," "estimates," "projects,"
"predicts," and "potential," and similar expressions intended to identify
forward-looking statements, but the absence of these words does not mean that a
statement is not forward-looking. All statements other than statements of
historical fact are statements that could be deemed forward-looking statements,
and examples of forward-looking statements include any projections of earnings,
revenue or other results of operations or financial items; any statements of the
plans, strategies and objectives of management for future operations; any
statements concerning proposed new products, technologies or services; any
statements regarding future research and development or co-funding for such
efforts; any statements regarding future economic conditions or performance; and
any statements of belief and any statement of assumptions underlying any of the
foregoing. These forward-looking statements are subject to the safe harbor
created by Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. Our actual
results could differ materially from those anticipated in these forward-looking
statements for many reasons, including the risks faced by us and described in
"Item 1A. Risk Factors" in Part II and other sections of this report and our
other filings with the Securities and Exchange Commission. You should not place
undue reliance on these forward-looking statements, which apply only as of the
date of this report. You should read this report completely and with the
understanding that our actual future results may be materially different from
what we expect. We assume no obligation to update these forward-looking
statements, whether as a result of new information, future events, or otherwise.
Overview and Executive Summary
We design, develop, manufacture, market and service high performance
computing ("HPC") systems, commonly known as supercomputers. 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 demanding needs of the high-end
of the HPC market 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 interconnection network, system software and packaging capabilities that
enable our supercomputers to scale - that is, to continue to increase
performance as they grow in size. In addition, we have demonstrated expertise in
several processor technologies. Purpose-built for the supercomputer market, our
systems balance highly capable processors, highly scalable system software and
very high speed interconnect and communications capabilities.
Summary of First Nine Months of 2009 Results
Total revenue increased $68.3 million for the first nine months of 2009, from
$127.5 million to $195.8 million, compared to the first nine months of 2008,
primarily due to increased product revenue of $52.3 million, largely from Cray
XT systems and third-party equipment, and $16.0 million of increased service
revenue.
Loss from operations for the first nine months of 2009 was $3.1 million
compared to a loss from operations of $11.5 million for the same period in 2008,
due to increased gross profit of $14.5 million partially offset by a
$6.2 million increase in operating expenses. Operating expenses increased
primarily due to higher net research and development expenses due to
$2.3 million lower reimbursements recognized and $2.1 million higher stock-based
compensation, in large part due to the stock option repurchase tender offer
completed in the first quarter of 2009.
Net cash provided by operations was $19.2 million for the first nine months
of 2009 compared to net cash used in operations of $72.6 million for the first
nine months of 2008. Cash and short-term investment balances, including
restricted cash balances, were $67.8 million as of September 30, 2009 compared
to $80.4 million as of December 31, 2008, with the primary reason for the
reduction being the repurchase of $27.6 million of Notes in the second quarter
of 2009.
Market Overview and Challenges
Significant recent trends in the HPC industry include:
• The commoditization of HPC hardware, particularly processors and
interconnect systems,
• The growing commoditization of software, including plentiful building blocks and more capable open source software,
• Supercomputing with multi-core commodity processors causing increasing scalability requirements,
• Electrical power requirements becoming a design constraint and driver in total cost of ownership determinations,
• Increased micro-architectural diversity, including many-core processors with vector extensions and growing experimentation with accelerators, as the rate of per-core performance has decreased, and
• Data needs growing faster than computational needs.
Several of these trends have resulted in the expansion and acceptance of
lower-bandwidth cluster systems using processors manufactured by Intel, AMD and
others combined with commercially available commodity networking and other
components throughout the HPC market, especially in capacity, or throughput,
computing situations. These systems may offer higher theoretical peak
performance for equivalent cost, and "price/peak performance" is often the
dominant factor in HPC procurements outside of the high-end supercomputer market
segment. Vendors of such systems often put pricing pressure on us in competitive
procurements, even at times in larger procurements where "time to solution" is
of significant importance.
In the markets for larger systems costing significantly in excess of
$1 million, the use of commodity processors and networking components can result
in increasing data transfer bottlenecks as these components do not balance
processor power with network communication capability. With the arrival of
increasing processor core counts due to quad-core and soon many-core processors,
these unbalanced systems will typically have even lower productivity, especially
in larger systems running more complex applications. Vendors, including Cray,
have also begun to augment standard microprocessors with other processor types,
such as field programmable gate arrays and graphics processing units, in order
to increase computational power, further complicating programming models. In
addition, with increasing scale, bandwidth and processor core counts, large
computer systems use progressively higher amounts of power to operate and
require special cooling capabilities.
We believe we are well-positioned to meet the market's demanding needs, as we
concentrate our research and development efforts on the interconnect, system
software and packaging capabilities that enable our supercomputers to perform at
scale - that is, to continue to increase actual performance as systems grow ever
larger in size. We have demonstrated expertise in several processor
technologies. Further, we offer unique capabilities in high-speed, high
bandwidth system interconnect design, compiler technology, system software and
packaging capabilities. Our experience and capabilities across each of these
fronts are becoming ever more important, especially in larger procurements. We
expect to be in a comparatively advantageous position as larger many-core
processors become available and as multiple processing technologies become
integrated into single systems. In addition, we intend to expand our addressable
market by leveraging our technologies and customer base, the Cray brand and
industry trends by introducing complementary products and services to new and
existing customers, as demonstrated by our emphasis on Custom Engineering
projects and the introduction of our Cray CX family and Cray XT5m systems.
Our Goals and Strategy
Our goals are to become the leading provider of supercomputers in the HPC
market segments that we target and to have sustained annual profitability. Key
elements of our strategy to achieve these goals include:
Gain Share in Our Core Supercomputing 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 focused primarily on the mid-range and lower end of the HPC market where
lower bandwidth cluster systems dominate. We continue to be focused primarily on
the nearly $3 billion high-end supercomputing segment of the HPC market.
Expand Our Total Addressable Market. Over time, we will look to expand our
addressable market by leveraging our technologies and customer base, the Cray
brand and industry trends by introducing complementary products and services to
new and existing customers. We believe we have the opportunity to compete in a
broader portion of the HPC market as well as selective adjacent markets outside
of traditional HPC. Our expansion of our engineering services offerings,
including our Custom Engineering program, our Cray CX systems, our first
products based on Intel processors, and our Cray XT5m system, are three
initiatives to further this strategy.
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 suppliers and
customers with interests strongly aligned with ours. We will rely in part on
government funding for our research and development efforts. We intend to
execute on our product roadmap, supporting multiple processing technologies
within single, highly scalable systems.
Maintain Our 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.
In the future we intend to provide the HPC market with access to the best
processors, whether from Intel or AMD, that are available at any point in time.
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. The introduction of the Cray XT family and our
longer-term product roadmap, including our Intel initiative, are efforts to
increase product revenue. We also plan to increase our engineering services
offerings, which include our Custom Engineering team, and market new products,
such as the Cray CX and Cray XT5m systems, to increase revenue. Maintenance
service revenue is more constant in the short term and assists, in part, to
offset the impact that the variability in product revenue has on total revenue.
For the nine months ended September 30, 2009, both our product and service
revenue increased from the comparable 2008 period.
Gross profit margin. Our total gross profit margin and our product gross
profit margin for the first nine months of 2009 were 35% and 30%, respectively,
which reflect decreases from the respective 2008 levels of 43% and 44% due to a
large, low gross profit contract (on which $36 million was recognized in the
first quarter of 2009) and a $4.5 million charge in the third quarter of 2009
for estimated excess inventory from a last-time buy in 2008. We focus on
maintaining and improving our product gross profit margin over the long term,
which we believe is best achieved through product differentiation.
Operating expenses. Our operating expenses are driven largely by headcount,
the level of recognized co-funding for research and development and contracted
third-party research and development services. As part of our ongoing efforts to
control operating expenses, we monitor headcount levels in specific geographic
and operational areas. Operating expenses for the first nine months of 2009 were
approximately $6.2 million more than the first nine months of 2008 due primarily
to increased net research and development expense due to lower recognized
reimbursement amounts resulting from a delayed milestone in a co-funded
development contract.
Liquidity and cash flows. Due to the variability in product revenue and new
contracts, our cash position also varies from quarter-to-quarter and within a
quarter. We closely monitor our expected cash levels, particularly in light of
increased inventory purchases for large system installations and the risk of
delays in product shipments and acceptances and, longer-term, in product
development. Sustained profitability over annual periods is our primary
objective, which should improve our cash position.
Critical Accounting Policies and Estimates
This discussion, as well as disclosures included elsewhere in this quarterly
report on Form 10-Q, are based upon our Condensed Consolidated Financial
Statements, which have been prepared in accordance with GAAP. The preparation of
these financial statements requires us to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenue and expenses, and
related disclosure of contingencies. In preparing our financial statements in
accordance with GAAP, there are certain accounting policies that are
particularly important. These include revenue recognition, inventory valuation,
accounting for income taxes, research and development expenses and share-based
compensation. Our significant accounting policies are set forth in Note 2 to the
Consolidated Financial Statements included in our 2008 Form 10-K and should be
reviewed in conjunction with the accompanying Condensed Consolidated Financial
Statements and notes thereto as of September 30, 2009, as they are integral to
understanding our results of operations and financial condition in this interim
period. In some cases, these policies represent required accounting. In other
cases, they may represent a choice between acceptable accounting methods or may
require substantial judgment or estimation.
Additionally, we consider certain judgments and estimates to be significant,
including those relating to the fair value determination used in revenue
recognition, percentage of completion accounting, estimates of proportional
performance on co-funded engineering contracts and prepaid engineering services,
determination of inventory at the lower of cost or market, useful lives for
depreciation and amortization, determination of future cash flows associated
with impairment testing of long-lived assets, determination of the fair value of
stock options and other assessments of fair value, calculation of deferred
income tax assets, including our ability to utilize such assets, potential
income tax assessments and other contingencies. We base our estimates on
historical experience, current conditions and on other assumptions that we
believe to be reasonable under the circumstances. Actual results may differ
materially from these estimates and assumptions.
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. 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 consolidated statements of operations net of
any sales, use, value added or certain excise taxes imposed by governmental
authorities on specific sales transactions. In addition to the aforementioned
general policy, the following are our statements of policy with regard to
multiple-element arrangements and specific revenue recognition policies for each
major category of revenue.
Multiple-Element Arrangements. We commonly enter into transactions that
include multiple-element arrangements, which may include any combination of
hardware, maintenance and other services. 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 sales of our products, other than the
Cray CX system, upon customer acceptance of the system, when we have no
significant unfulfilled obligations stipulated by the contract that affect the
customer's 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. Revenue from sales of
our Cray CX products are generally recognized upon shipment when title and risk
of loss transfers to the customer.
Project Revenue. Revenue from contracts that require us to design, develop,
manufacture or modify complex HPC systems to a customer's specifications is
recognized using the percentage of completion method for long-term development
projects. 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 gross profit on a cumulative basis. To the 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.
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. Maintenance revenue 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 engineering services is recognized as services are
performed.
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.
Because the products we sell have high average sales prices and because a
high number of our prospective customers receive funding from U.S. or foreign
governments, it is difficult to estimate future sales of our products and the
timing of such sales. It also is difficult to determine whether the cost of our
inventories will ultimately be recovered through future sales. While we believe
our inventory is stated at the lower of cost or market and that our estimates
and assumptions to determine any adjustments to the cost of our inventories are
reasonable, our estimates may prove to be inaccurate. We have sold inventory
previously reduced in part or in whole to zero, and we may have future sales of
previously written-down inventory. We also may have additional expense to write
down inventory to its estimated market value. Adjustments to these estimates in
the future may materially impact our operating results. During the third quarter
of 2009, we recorded a charge of $4.5 million related to inventory in excess of
estimated future demand. This write-down related to a Cray custom-made inventory
component known as the Cray SeaStar purchased in 2008 under a last-time buy
procurement.
Accounting for Income Taxes
Deferred tax assets and liabilities are determined based on differences
between financial reporting and tax bases of assets and liabilities and
operating loss and tax credit carryforwards and are measured using the enacted
tax rates and laws that will be in effect when the differences and carryforwards
are expected to be recovered or settled. A valuation allowance for deferred tax
assets is provided when we estimate that it is more likely than not that all or
a portion of the deferred tax assets may not be realized through future
operations. This assessment is based upon consideration of available positive
and negative evidence, which includes, among other things, our 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. Estimated interest and penalties are recorded as a
component of interest expense and other expense, respectively.
As of September 30, 2009, we had approximately $136.0 million of net deferred
tax assets, against which we provided a $132.4 million valuation allowance,
resulting in a net deferred tax asset of $3.6 million. Our net deferred tax
assets relate primarily to certain foreign jurisdictions where we believe it is
more likely than not that such assets will be realized. During the three months
ended September 30, 2009, we reversed $1.1 million of the valuation allowance on
certain deferred income tax assets in Japan as we concluded it was more likely
than not these deferred income tax assets would be realized.
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 product features and expenses related to future product development.
Research and development costs are expensed as incurred, and may be offset by
co-funding from third parties. We may also enter into arrangements whereby we
make advance, non-refundable payments to a vendor to perform certain research
and development services. These payments are deferred and recognized over the
vendor's estimated performance period. During the three months ended
September 30, 2009, we amended a vendor agreement to settle outstanding
performance issues. We had made advance payments of $16.2 million to the vendor.
Under the terms of the amendment, we will receive a refund of $10.0 million of
amounts previously paid to the vendor and the right to receive rebates on future
purchases. We have estimated that the fair value of this rebate right is
$6.2 million which has been classified in "Other non-current assets" in the
Condensed Consolidated Balance Sheets. No gain or loss was recorded as a result
of this amendment.
Amounts to be received under co-funding arrangements with the U.S. government
are based on either contractual milestones or costs incurred. These co-funding
milestone payments are recognized in operations as performance is estimated to
be completed and are measured as milestone achievements occur or as costs are
incurred. These estimates are reviewed on a periodic basis and are subject to
change, including in the near term. If an estimate is changed, net research and
development expense could be impacted significantly.
We do not record a receivable from the U.S. government prior to completing
the requirements necessary to bill for a milestone or cost reimbursement.
Funding from the U.S. government is subject to certain budget restrictions and
milestones may be subject to completion risk, and as such, there may be periods
in which research and development costs are expensed as incurred for which no
reimbursement is recorded, as milestones have not been completed (as in our
third quarter of 2009) or the U.S. government has not funded an agreement.
We classify amounts to be received from funded research and development
projects as either revenue or a reduction to research and development expense,
based on the specific facts and circumstances of the contractual arrangement,
considering total costs expected to be incurred compared to total expected
funding and the nature of the research and development contractual arrangement.
In the event that a particular arrangement is determined to represent revenue,
the corresponding research and development costs are classified as cost of
revenue.
Share-based Compensation
We account for share-based compensation by estimating the fair value of
share-based compensation using the Black-Scholes option pricing model. We
utilize assumptions related to stock price volatility, stock option term and
. . .
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