Item 4. Controls and Procedures
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
For a discussion of legal proceedings, see “Note 11-Contingencies”10-Contingencies” in the Notes to Condensed Consolidated Financial Statements in this quarterly report on Form 10-Q.
You should carefully consider the risks described below together with all of the other information in this quarterly report on Form 10-Q and in our annual report on Form 10-K for the year ended December 31, 2017,2018, filed with the SEC on February 15, 2018.12, 2019. If any of these risks actually occur, our business, financial condition or operating results could be materially adversely affected and the trading price of our common stock could decline.
Our operating results fluctuate significantly and we may not achieve profitability in any given period. Our operating results are subject to significant fluctuations which make predicting revenue and operating results for any specific period very difficult, particularly because a material portion of product revenue recognized in any given quarter or year typically depends on a limited number of system sales expected for that quarter or year and product revenue generally depends on the timing of product acceptances by customers and contractual provisions affecting revenue recognition. Receiving less than anticipated customer orders, delays in achieving customer acceptances of installed systems, and recognizing revenue from a product transaction or transactions due to development or product delivery delays, customer site readiness delays, unexpected manufacturing delays or defects, not receiving components on time or at competitive prices, not receiving components with anticipated quality and performance, the inability of a system to meet performance requirements or targets, or other contractual obligations, among other factors, could have a material adverse effect on our operating results in any specific quarter or year, such as by reducing or delaying associated revenue, gross profit, and cash receipts from one quarter to another, or even from one year to another, particularly in the case of revenue expected to be realized in the fourth quarter of any year, as has happened in the past. In addition, because our revenue can be concentrated in particular quarters, often the fourth quarter, we generally do not expect to sustain profitability over successive quarters even if we are profitable for the year.
Although we recorded positive annual net income between 2010 and 2016, we recorded a net loss in 2017 and we2018 and expect to report a net loss in 20182019, and may well experience a net loss in any future year in addition to quarterly losses. Net income may fluctuate significantly as a result of many factors, including as a result of reduced revenue, gross margins, or significant investments we may make to grow our business which often require many years to come to fruition and may not be realized when expected, if at all. For example, we have incurred and anticipate continuing to incur significant expenditures in connection with ongoing investments in research and development. Due to the inherent difficulty in estimating costs associated with projects of this scale and nature, certain of the costs associated with these potential projects may be higher than estimated and it may take longer than expected to complete, if at all. In addition, while we were profitable in 2016, our revenue and profitability declined year over year in both 2016 and 2017, and our profitability declined year over year in 2016, 2017, and 2018, substantially driven by a slow-down in the segments of the high-end of the supercomputing market that we target. ItWhile we grew our revenue year over year in 2018, it is uncertain whether or when we will realize any significant benefit from a rebound in the segments of the high-end of the supercomputing market that we target or how strong or long-lived such a rebound will rebound and resume growing.be.
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:
our ability to secure sufficient orders at high enough gross margins for our next generation Cray XC and Cray CSShasta systems as well as upgrades and successor systems;
our ability to secure sufficient orders at high enough gross margins for our Cray XC and Cray CS systems, such asparticularly until our next generation “Shasta” system;Shasta systems are generally available;
successfully delivering and obtaining sufficient customer acceptances of ordered systems, including attached storage systems;
delays in delivery ofour ability to deliver upgraded or new systems in a timely manner, such as our ability to deliver our next generation “Shasta” system, longer than expected customer acceptance cycles or penalties resulting from system acceptance issues;Shasta systems by the fourth quarter of 2019, as currently planned;
revenue delays or losses due to customers postponing purchases as a result of delays in available budgets or waiting for the availability of future processors or upgraded or new systems, such as our next generation Shasta systems;
our ability to successfully integrate the ClusterStor product line, business and associated sales channel and longer than expected customer acceptance cycles or penalties resulting from system acceptance issues;
our ability to successfully generate revenue and profitability from sales of our storage, data analytics, and AI solutions;
our ability to successfully and timely design for, procure, and integrate competitive processors for our Cray XC, and Cray CS, and next generation Cray Shasta systems and upgrades and successor systems, such as our next generation “Shasta” system;
systems;
our expense levels, including research and development expense;
our ability to resolve and the costs incurred in connection with any actual or alleged issues with our products, including third-party components of such products, such as those that relate to product defects, such as the current “Meltdown” and “Spectre” processor vulnerabilities or intellectual property rights;secure additional government funding for future development projects;
our ability to efficiently scalecontinue to broaden our internal processescustomer base beyond our traditional customers;
the level of product gross profit contribution in any given period due to meet necessary peak requirementsvolume, competition, or product mix, particularly with the introduction of flexible commodity-based supercomputers, competitive factors, strategic transactions, product life cycle, currency fluctuations, tariffs, acceptance penalties, and growth in our business;component costs;
the level of revenue recognized in any given period, which is affected by the very high average sales prices and limited number of significant system sales and resulting potential acceptances in any quarter, the timing of product orders and acceptances by customers, and contractual provisions affecting the timing and amount of revenue recognition;
our ability to continue to broaden our customer base beyond our traditional customers;
our ability to secure additional government funding for future development projects;
the level of product gross profit contribution in any given period due to volume, competition or product mix, particularly with the introduction of flexible commodity-based supercomputers, competitive factors, strategic transactions, product life cycle, currency fluctuations, acceptance penalties and component costs;
the competitiveness of our products, services, and prices;
maintaining and successfully completing our capital and product development projects on schedule and within budgetary limitations;
our ability to efficiently scale our internal processes to meet necessary peak requirements and growth in our business; and
our ability to resolve and the costs incurred in connection with any actual or alleged issues with our products, including third-party components of such products, such as those that relate to product defects, such as the recent “Meltdown” and “Spectre” processor vulnerabilities or intellectual property rights;
the level and timing of maintenance contract renewals with existing customers; and
the terms and conditions of sale or lease for our products and services.
The receipt of orders and the timing of shipments and acceptances impacts our quarterly and annual results, including cash flows, and is affected by events outside our control, such as:
whether or when we will realize any significant benefit from a rebound in the segments of the high-end of the supercomputing market that we target which are currently experiencingor how strong or long-lived such a slow-down, rebound and resume growing;will be;
the timely availability of acceptable components, including, but not limited to, processors and memory, in sufficient quantities to meet customer delivery schedules and other customer commitments at a competitive cost and the identification of issues with already-delivered components, including processors, that require remediation and/or impact the performance of our products;
the timing and level of government funding and resources available for product acquisitions and research and development contracts, which have been, and may continue to be, adversely affected by the current global economic and fiscal uncertainties, increased governmental budgetary limitations, and disruptions in the operations of the United States and other governments;governments as has recently occurred;
competitor and supplier pricing strategies;
declining U.S. relations with foreign entities, including between the U.S. government and foreign governments, may make it more difficult or more expensive to sell U.S.-manufactured or U.S.-designed systems to those entities funded by governments, or in those countries;
currency fluctuations, international conflicts or economic crises, including the ongoing economic challenges in the United States, Japan and Europe, and fluctuations in oil prices that can affect the resources available to potential customers to purchase products;
new tariffs or taxes imposed on components and products sourced or manufactured outside of the United States;
the introduction or announcement of competitive or key industry supplier products;
price fluctuations or product shortages in the processors and other commodity electronics and memory markets;
the availability of adequate customer facilities to install and operate new Cray systems;
general economic trends, including changes in levels of customer capital spending; and
our customers’ ability to make future payments in accordance with contractual terms of their purchase or sales-type lease agreements.
Because of the numerous factors affecting our operating results, we may not achieve profitability on a quarterly or annual basis in the future. We anticipate that our quarterly results will fluctuate significantly, and include losses, even in years where we expect or achieve positive annual net income. Delays in theThe timing of availability of acceptable third-party components, product development, receipt of orders and product acceptances, issues with third-party component performance or reliability, reductions in outside funding for our research and development efforts, a reduction in the size in the segments of the high-end of the supercomputing market that we target, the level and timing of approved government fiscal budgets, and achieving contractual development milestones have had a substantial adverse effect on our past results and are expected to continue to have such an effect on our operating results in 20182019 and in future years.
Our business could be adversely affected by conditions affecting the HPC market.A substantial portion of our business depends on the demand for HPC products by large enterprise, the U.S. Government and foreign government customers and large enterprises, and we are dependent upon the overall economic health of the high-end of the supercomputing market, and on a relatively small number of customers and large procurements that make up that market. Demand for our products and services depends substantially upon the general demand for supercomputers and associated services, as well as technological needs in the data analytics, AI, and storage markets, which fluctuate based on numerous factors, including large-system purchase cycles, capital spending levels, political conditions and growth of our current and prospective customers. Moreover, the purchase of our products is often discretionary and may involve a significant commitment of capital and other resources. As a result, spending priorities for our current and future customers may vary and demand for our products and services may also fluctuate. For instance, while we were profitable in 2016, our revenue and profitability declined year over year in both 2016 and 2017 and our profitability declined year over year in 2016, 2017, and 2018, substantially driven by a slow-down in the segments of the high-end of the supercomputing market that we target, and whiletarget. While we believe that we have seen early signs of a recovery in the market, we believe that the overall downturn inthese segments of the market has continued into 2018.continue to be down from past years. It is uncertain whether or when these segments will recover fully from the ongoing downturn.this downturn, and because of long sales cycles there will be a delay between any recovery and when that recovery would be reflected in our revenue and other operating results. While we believe that the market’s long-term growth drivers remain intact, there is no assurance that these markets will continue to rebound and resume growing.or if any rebound will last. A prolonged slow-down infailure of these markets to recover strongly enough or in a sustained fashion could continue to harm our financial condition and results of operations.
If we are unable to successfully develop, sell and deliver our Cray XC systems and successor systems, such assuccessfully develop, sell, and deliver our next generation Shasta system,systems and successor systems, our operating results will be adversely affected. We expect that a substantial portion of our revenue in the foreseeable future will come from the sale of Cray XC systems and successor systems, such as our next generation Shasta system,systems and successor systems, including systems integrating future processors and accelerators where we are dependent upon third-party suppliers to deliver according to expected plans. The development efforts related to these systems are lengthy and technically challenging processes, and require a significant investment of capital, engineering, and other resources often years ahead of the time when we can be assured that they will result in competitive products. We may invest significant resources that may prove ultimately unsuccessful. The development process for our next generation “Shasta” systemShasta systems is particularly complex and challenging, and we are implementing new development techniques as part of our efforts to complete this significant project. Our efforts could be unsuccessful, the changes we are implementing could cause disruption to our development efforts, and unanticipated performance and/or development issues may require more engineers, time, or testing resources than are currently available. Given the breadth of our engineering challenges, changes in the market and technology and our limited engineering and technical personnel resources, we periodically review the anticipated contributions and expense of our product programs to determine their long-term viability, and we may substantially modify or terminate one or more development programs. We may not be successful in meeting our development schedules for technical reasons, including those related to our dependence on third-party suppliers of components such as processors and accelerators, and/or because of insufficient engineering resources, which could result in an uncompetitive product or cause a lack of confidence in our capabilities among our key customers. To the extent that we incur delays in completing the design, development, and production of hardware components, delays in development of requisite system software, cancellation of or changes to programs due to technical or economic infeasibility, inability to source acceptable third-party components such as processors and accelerators or investment in unproductive development efforts, our revenue, results of operations, and cash flows, and the reputation of such systems in the market, could be adversely affected.
In addition, many factors affect our ability to successfully sell and recognize revenue for these systems, including the following:
the level of product differentiation in our Cray XC systems and successor systems, such as our next generation Shasta system.systems and successor systems. We need to compete successfully against HPC systems from both large, established companies and smaller companies and demonstrate the value of our balanced, tightly integrated systems to our customers in a variety of markets;
whether potential customers delay purchases of our products because they decide to wait for successor systems or upgrades that we or our suppliers have announced or they believe will be available in the future, as we expect in 2019 following our announcement of our next generation Shasta systems but do not expect them to be available until at least the fourth quarter of 2019;
our ability to meet all customer requirements for acceptance. Even after a system has been delivered, we sometimes do not meet all of the contract requirements for customer acceptance and ongoing reliability of our systems within the provided-for acceptance period, which has resulted in contract penalties and delays in our ability to recognize revenue from system deliveries. Most often these penalties have adversely affected revenue and gross profit at the time of revenue recognition through the provision of additional equipment and services and/or service credits to satisfy delivery delays and performance shortfalls. The risk of contract penalties is increased when we bid for new
business prior to us or our suppliers completing development of new products and when we must estimate future system performance and costs, such as has been and will be required with our Cray XC systems, ClusterStor storage systems, and our next generation “Shasta”Shasta systems; and
our ability to source competitive, key components in appropriate quantities (to have enough to sell without ending up with excess inventory that can lead to obsolescence charges), in a timely fashion and with reasonable costs and terms and conditions, and that meet the performance criteria required; and
whether potential customers delay purchases of our products because they decide to wait for successor systems or upgrades that we or our suppliers have announced or they believe will be available in the future.required.
Failure to successfully develop and sell our Cray XC systems and successor systems, such asdevelop and sell our next generation Shasta system,systems and successor systems will adversely affect our operating results.
If our current and future products targeting markets outside of our traditional markets, primarily products targeting the data analytics, AI, and commercial markets, are not successful, our ability to grow or even maintain our revenues and achieve and sustain profitability will be adversely affected. Our ability to materially grow or even maintain our revenues and achieve and sustain profitability will be adversely affected if we are unable to generate sufficient revenue from products targeting markets outside of our traditional markets, including if those market segments do not grow significantly. We are currently focusing on data analytics, AI, and storage opportunities as well as the commercial market for all of our products. To grow outside our primary markets, we must successfully and in a cost-effective manner design and develop products utilizing technologies different from our traditional supercomputing products, compete successfully with many established companies and new entrants in these markets, win awards for new contracts, timely perform on existing contracts, develop our capability for broader market sales and business development, and successfully develop and introduce new solution-oriented offerings, notwithstanding that these are relatively new businesses for us and we do not have significant experience targeting these markets. Data analytics, AI, and storage and data management opportunities require significant monetary investments ahead of revenue, including product development efforts, adding experienced personnel and initiating new marketing and sales efforts and therefore may reduce net income in the short term even if ultimately successful in the longer term. As a result of our reliance on our traditional markets, the recent downturn in the high-end of the supercomputing market had a significant negative impact on our business and operating results. In addition, ifin our traditional markets we do notare reliant on large-system purchase cycles and on a relatively small number of potential customers. If we are unable to successfully integratetarget markets outside of our traditional markets, primarily products targeting the ClusterStor product linedata analytics, AI, and related business, including its more than 125 employees and contractors,commercial markets, our ability to generate revenue fromgrow or even maintain our storage business mayrevenues and achieve and sustain profitability will be adversely affected.
Our reliance on third-party suppliers poses significant risks to our operating results, business, and prospects. We rely upon third-party vendors, particularlysuch as Intel, AMD, NVIDIA, and Seagate to supply processors including graphics processing units and memory, and for most of the products, we sell and use service providers to co-develop key technologies. We purchase or subcontract the manufacturing of a majority of the hardware components for our high-end products, including integrated circuits, printed circuit boards, memory parts, hard disk drives and storage product enclosures, cables, and power supplies, on a sole or limited source basis to third-party suppliers.suppliers, including suppliers located in China. We use contract manufacturers to assemble certain important components for all of our systems. We also rely on third parties to supply keyimportant software and hardware capabilities, such as file systems, solution-specific servers, disk drives, and storage subsystems. Because specific components must be designed into our systems well in advance of initial deliveries of those systems, we are particularly reliant on our processor vendors particularly Intel, to deliver on the capabilities and pricing expected at the time we design key elements of the system and make binding
bids to customers. We are subject to substantial risks because of our reliance on these and other limited or sole source suppliers, including the following risks:
if a supplier does not provide components or systems that meet specifications in sufficient quantities and with acceptable performance, price, or quality on time or deliver when required, or delays future components or systems beyond anticipated delivery dates, then sales, production, delivery, acceptance, and revenue from our systems could be delayed and/or reduced and we could be subject to costly repair and/or delay costs and penalties even once delivered and accepted, which is currently happening and has happened multiple times in the past and has at times significantly lowered our revenue for a particular quarter or year;
if a supplier plans future processors that are made available in a way that encourages customers to delay purchases of our products because they decide to wait for successor systems or upgrades they believe will be available in the future or to purchase products with future processors from our competitors who are willing to take greater risk on delivery, our operating results will be adversely affected;
if a supplier, including those in China or who source components from China, provides us with hardware or software that contains bugs or other errors, defects, or security vulnerabilities, such as happened with the recent “Meltdown“Meltdown” and “Spectre” processor vulnerabilities, or is different from what we expected, our development projects and production systems may be adversely affected, through reduced performance or capabilities, additional design testing and verification efforts, including of required patches, re-spins of integrated circuits and/or development of replacement components, and the production and sales of our systems could be delayed, and systems installed at customer sites could require significant, expensive field component replacements or other remediation, and/or we might be required to pay penalties;penalties, and the trust customers and potential customers place in our products might be negatively affected;
if our relationship with a key supplier such as Intel, is adversely affected for any reason, such as due to competitive pressures or changes in company strategies and priorities, our ability to obtain components on competitive financial terms could be adversely affected;
if a supplier cannot provide a competitive key component, for example, due to inadequate performance or a prohibitive price, or eliminates key features from components, such as with the processors we design into our systems, our systems may be less competitive than systems using components with greater capabilities;
if an interruption of supply of our components, services, or capabilities occurs because a supplier changes its technology roadmap, suffers damage to its manufacturing facilities, decides to no longer provide those products or services, increases the price of those products or services significantly, or imposes reduced delivery allocations on its customers, it could take us a considerable period of time to identify and qualify alternative suppliers, to redesign our products as necessary, and to begin to manufacture the redesigned components or otherwise obtain those services or capabilities. In some cases, such as with key integrated circuits and memory parts or processors, we may not be able to redesign such components or find alternate sources that we could use in any realistic timeframe, if at all;
if a supplier plans future processors that are made available in a way that encourages customers to delay purchases of our products because they decide to wait for successor systems or upgrades they believe will be available in the future or to purchase products with future processors from our competitors who are willing to take greater risk on delivery, our operating results will be adversely affected;
if Cray systems at customer sites develop significant issues with third-party components, as has occurred in the past, the cost to Cray to repair or replace the components or otherwise address such issue may be material. If we are unable to effectively address such problem or a problem causes customer disruption, our relationship with our customers may also be harmed;
if a supplier of a component is subject to a claim that the component infringes a third-party’s intellectual property rights, as has happened with multiple suppliers, we may not be able to obtain necessary components or our cost to obtain such components could increase significantly;
if a key supplier is acquired or undergoes a significant business change, as has occurred in the past and is expected to occur this year with a supplier of interconnect technology, Mellanox, having entered into an agreement to be acquired by NVIDIA , the production and sales of our systems and services may be delayed or adversely affected, or our development programs may be delayed or may be impossible to complete;
if a supplier providing us with key research and development and design services or core technology components with respect to integrated circuit design, network communication capabilities, or software is late, fails to provide us with effective functionality, or loses key internal talent, our development programs may be delayed or prove to be impossible to complete; and
some of our key component and service suppliers are small companies with limited financial and other resources, and consequently may be more likely to experience financial and operational difficulties than larger, well-established companies, which increases the risk that they will be unable to deliver products as needed.
Delays in the availability of components with acceptable performance, features, and reliability or our inability to obtain such acceptable components in the quantities we need or at all, the discovery of issues with components after delivery and introduction into our products, and increases in prices and order lead times for certain components have occurred in the past. We have also experienced increased prices and/or delivery timelines of memory and other key components and have had to address the “Meltdown” and “Spectre” security vulnerabilities in processors included in our products. These types of issues have adversely affected our revenue and operating results in multiple prior periods, in some cases significantly, and could result in significant costs and/or effort to address. For instance, we expect that significant costs and efforts may be required to address in the “Meltdown” and “Spectre” processor vulnerabilities, which could adversely affect our future results.future.
If we are unable to compete successfully in the highly competitive HPC market, our business will not be successful. The market for HPC systems is very competitive. An increase in competitive pressures in our market or our failure to compete effectively may result in pricing reductions, reduced gross margins, and loss of market share and revenue. Many of our competitors are established well-known companies in the HPC market, including HPE, IBM, HPE, Lenovo, Dell/EMC, Huawei, NEC, Hitachi, Fujitsu, and Atos-Bull. Most of these competitors have substantially greater research, engineering, manufacturing, marketing, and financial resources than we do. In addition, certain Chinese companies are investing significantly in HPC and are becoming more aggressive and more competitive in the HPC global arena.
We also compete with systems builders and resellers of systems that are constructed from commodity components using processors manufactured and/or designed by Intel, ARM, AMD, NVIDIA, and others. These competitors include the companies named above, as well as smaller companies that benefit from the low research and development costs needed to assemble systems from commercially available commodity products. Such companies, because they can offer high peak performance per dollar, can put pricing pressure on us in certain competitive procurements. In addition, to the extent that Intel, AMD, NVIDIA, IBM, MARVEL, and other
processor suppliers develop processors with greater capabilities or at a lower cost than the processors we currently use in our products at any given time, our Cray XC systems may be at a competitive disadvantage to systems utilizing such other processors until we can design in, integrate, and secure competitive processors, if at all. Also, to the extent any component supplier successfully adds differentiating capabilities to their HPC products that compete with what we provide, such as Intel, we may experience greater competitive pressures.
Our growth initiatives in the data analytics, AI, and storage markets must also compete successfully with many established companies and new entrants, many of whom have significantly greater resources and brand recognition in these markets than we do.
Periodic announcements by our competitors of new HPC, storage, or data analytics systems or plans for future systems and price adjustments may reduce customer demand for our products. Many of our potential customers already own or lease high performance computer, storage, or data analytics systems. Some of our competitors have offered substantial discounts to potential customers. We have in the past been and may again be required to provide substantial discounts to make strategic sales, which may reduce or eliminate any gross profit on such transactions, or we may be required to provide lease financing for our products, which could result in a multi-year deferral of our receipt of cash and revenue for these systems. These developments limit our revenue and financial resources and reduce our ability to be profitable and grow.
The continuing commoditization of HPC hardware and software has resulted in increased pricing pressure and may adversely affect our operating results. The continuing commoditization of HPC hardware, such as processors, interconnects, storage, and other infrastructure, and the growing commoditization of software, including plentiful building blocks and more capable open source software, as well as the potential for integration of differentiated technology into already-commoditized components, has resulted in and may result in increased pricing pressure that may cause us to reduce our pricing in order to remain competitive, which can negatively impact our gross margins and adversely affect our operating results.
If the U.S. Government and other governments purchase, or fund the purchase of, fewer high-end supercomputers or delay such purchases, our revenue would be reduced and our operating results would be adversely affected. Historically, sales to the U.S. Government have represented the largest single market segment for supercomputer sales worldwide, including our products and services. In 2015, 2016, 2017, 2018, and the first three months of 2018,2019, approximately 47%, 47%53%, 53%28% and 25%50%, respectively, of our total revenue was derived from such sales. Our plans for the foreseeable future contemplate significant sales to the U.S. Government. Sales to the U.S. Government and other governments, including further sales pursuant to existing contracts, have been, and may continue to be, adversely affected by factors outside our control, such as by:
uncertainties relating to priorities of the current administration or adverse decisions by the current administration to reduce or eliminate budgets for governmental agencies or departments that purchase or fund the purchase of our products and services;
Congressional and executive branch decisions in addressing budget concerns and current policy;
disruptions in the operations of the U.S. Government, including impacts of the current administration and government “shutdowns” such as has occurred in the past and has recently occurred;
“sequestration”;
the downgrading of U.S. Government debt or the possibility of such action;
the political climate in the United States focusing on cutting or limiting budgets and its effect on government budgets;
the limits on federal borrowing capacity;
changes in procurement policies;
budgetary considerations, including Congressional delays in completing appropriation bills as has occurred in the past;
domestic crises, such as costs of addressing the damage associated with natural disasters; or
international political developments, such as the downgrading of European debt or the United Kingdom’s departure from the European Union; or
political efforts to limit the activities of U.S. intelligence community agencies, including proposed state legislation that would limit or even criminalize doing business with the U.S. National Security Agency for certain companies doing business with state governments.
Union.
In particular, the U.S. government has announced plans to procure multiple, large “exascale” systems for delivery in future years and provide funding for certain research and development efforts associated with those system deliveries. The U.S. government recently announced two of those exascale system awards, and that Cray was selected as a prime contractor or subcontractor to deliver those systems. If we are unable to complete or deliver those systems as expected or at all, or secure a sufficient portion of that developmentthe continuing funding for research and development of those exascale systems sales, our ability to grow in future years and our ability to offset research and development expenses leading up to those deliveries may be adversely affected. In addition, 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.
Changes in U.S. trade policy, including the imposition of tariffs and the resulting consequences, may harm our business. The U.S. government has adopted a new approach to trade policy and in some cases to renegotiate, or potentially terminate, certain existing bilateral or multi-lateral trade agreements. It has also imposed tariffs on certain components and products sourced or manufactured outside of the United States, most notably China, including, but not limited to, printed circuit board and related components, certain storage devices, and potentially certain microprocessors that are used in Cray systems. These measures may materially increase costs for goods imported into the United States, requiring us to materially increase prices to our customers which may reduce demand, or, if we are unable to increase prices, result in lowering our margin on products sold. In addition, certain foreign governments have imposed tariffs, taxes, and other limitations on products and services that are manufactured or designed in the United States in response to these new policies. These changes and related trade disputes could make it more difficult or costly for us to compete with our competitors outside the United States.
If we cannot retain, attract, and motivate key personnel, we may be unable to effectively implement our business plan. Our success depends in large part upon our ability to retain, attract, and motivate highly skilled management, development, marketing, sales, and service personnel. The loss of and failure to replace key technical management and personnel could adversely affect multiple development efforts, including those related to our next generation “Shasta” system.Shasta systems. 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. We have lost key personnel to other high technology companies, and many larger companies with significantly greater resources than us have aggressively recruited, and continue to aggressively recruit, key personnel. As part of our strategy to attract and retain key personnel, we may offer equity compensation through grants of stock options, restricted stock awards, or restricted stock units. Potential employees, however, may not perceive our equity incentives as attractive enough. In addition, due to the intense competition for qualified employees, we may be required to, and have had to, increase the level of compensation paid to existing and new employees, which could materially increase our operating expenses. In July 2017, we implemented a restructuring plan that included a reduction
Customers and other third parties may make statements speculating about or announcing the purchase, acceptance, or intention to complete purchases or acceptances of our workforceproducts, or the selection or award of government procurements, before such purchases, acceptances, or selection or awards are substantially certain, and these proposed purchases, acceptances, or selections or awards may not be completed when or as expected, if at all. From time to time, customers and other third parties may make statements speculating about or announcing a potential purchase of our products, or the selection or award of government procurements, before we have been selected or awarded a procurement, obtained an order for such purchases, or completed negotiations and signed a contract for the purchase of such products or relating to such procurement. In some instances, government and government-funded customers may announce possible purchases even before they have obtained the necessary budget to procure the products. As a result, these statements, postings, or announcements do not mean that we will ultimately be
able to secure the sale when or as expected or at all, or will be selected or awarded a procurement, for a number of reasons, including that it is not certain that the contract or order negotiations will be completed successfully or as expected or that the customer will be able to obtain the budget they hope for or expect. In addition, from time to time, customers and other third parties may have lost important talent and skill sets and may havemake statements speculating about or announcing the completion of an acceptance process of a more difficult time retaining and motivating those employeesdelivery system before such acceptance is completed or certain. As a result, these statements or announcements do not directly impacted bymean that we will ultimately be able to obtain the restructuringacceptance when or as well as attracting new employees.expected or recognize revenue.
We may infringe or be subject to claims that we infringe the intellectual property rights of others. We are and may in the future be subject to patent infringement and other intellectual property claims and lawsuits in various jurisdictions, and we cannot be certain that our products or activities do not violate the patents, trademarks, or other intellectual property rights of third-parties. Companies in the technology industry, and other patent, copyright, and trademark holders seeking to profit from royalties, own large numbers of patents, copyrights, trademarks, domain names, and trade secrets and frequently commence litigation based on allegations of infringement, misappropriation, or other violations of intellectual property or other rights. As we face increasing competition and gain an increasingly high profile, the intellectual property rights claims against us have grown and will likely continue to grow. For example, we are currentlyhave been involved in litigation with Raytheon Company (Raytheon) which is described in Note 11 - Contingencies 10, “Contingencies” in the Notes to our Condensed Consolidated Financial Statements in this quarterly report on Form 10-Q.
We intend to vigorously defend and prosecute these litigation matters and, based on our reviews to date, we believe we have valid defenses with respect to each of these matters. However, litigation is inherently uncertain, and any judgment or injunctive relief entered against us or any adverse settlement could materially and adversely impact our business, financial condition, operating results, and prospects. As a result of these or other intellectual property infringement claims, we could be required or otherwise decide that it is appropriate to:
pay third-party infringement claims;
discontinue manufacturing, using, or selling particular products subject to infringement claims;
discontinue using the technology or processes subject to infringement claims;
develop other technology not subject to infringement claims, which could be time-consuming and costly or may not be possible; and/or
license technology from third-parties, which license may not be available on commercially reasonable terms, or at all.
In addition, litigation can involve significant management time and attention and be expensive, as it has been with Raytheon, regardless of outcome. During the course of these litigation matters, there may be announcements of the results of hearings and motions, and other interim developments related to the litigation matters. If securities analysts or investors regard these announcements as negative, the market price of our common stock may decline.
If our cluster systems are not successful, our operating results could be adversely affected. Our cluster products were first introduced in late 2012. Cluster-based solutions face intense competition in the marketplace with buying decisions often driven by price, and if we cannot successfully sell these solutions with acceptable margins, our operating results will be adversely affected.
We have made and entered into in the past, and may make and enter into in the future, acquisitions or strategic transactions which could require significant management attention, disrupt our business, result in dilution to our shareholders, deplete our cash reserves, increase our business risks, and adversely affect our financial results. Acquisitions and strategic transactions, such as our recent2017 acquisition of the ClusterStor business from Seagate, involve numerous risks, including the following:
difficulties in successfully integrating the operations, systems, technologies, products, sales channels, manufacturing processes, offerings, and personnel of the acquired company or companies, assets, and/or business;
insufficient revenue, margin, or other benefits to offset increased expenses or other negative impacts associated with acquisitions or strategic transactions;
diversion of management’s attention from normal daily operations of the business and the challenges of managing larger and more widespread operations resulting from acquisitions or strategic transactions, including other customers of an acquired business;
potential difficulties in completing projects associated with in-process research and development intangibles;
difficulties in entering markets in which we have no or limited direct prior experience and where competitors in such markets have stronger market positions;
initial dependence on unfamiliar supply chains or relatively small supply partners;
the potential loss of key employees, customers, distributors, vendors, and other business partners of the companies or businesses we acquire following and continuing after announcement of any transaction; and
the potential to invest significant time and resources into a potential acquisition or strategic transaction that does not ultimately complete or close.
Acquisitions or strategic transactions may also cause us to:
use a substantial portion of our cash reserves or incur debt;
issue equity securities or grant equity incentives to acquired employees that would dilute our current shareholders’ percentage ownership;
assume or incur liabilities, including potentially unknown or underestimated liabilities;
record goodwill and non-amortizable intangible assets that are subject to impairment testing on a regular basis and potential periodic impairment charges;
incur amortization expenses related to certain intangible assets;
incur large and immediate write-offs and restructuring and other related expenses; or
become subject to intellectual property litigation or other litigation.
Acquisitions of high-technology companies, assets, and/or businesses are inherently risky and subject to many factors outside of our control, and no assurance can be given that our previously completed, currently planned, or future acquisitions or strategic transactions will be successful and will not materially adversely affect our business, operating results, or financial condition. Failure to manage and successfully integrate acquisitions could materially harm our business and operating results.
We maintain confidential and proprietary information on our computer networks and employ security measures designed to protect this information from unauthorized access. If our security measures are breached, we could lose proprietary data and may suffer economic losses. We maintain confidential information on our computer networks, including information and data that are proprietary to our customers and third parties, as well as to us. Although we have designed and employed and continue to enhance a multitude of security measures to protect this information from unauthorized access, security breaches may occur, and in the past have occurred, as a result of third-party action, including computer hackers, employee error, inherent hardware or software vulnerabilities (including in products or components sourced from suppliers in China), malfeasance, or otherwise. Security breaches canAny breach, malfeasance, or human or technological error could result in someone obtaining unauthorized access to our datadisclosure, modification, misuse, loss, or our customers’destruction of Cray, customer, supplier, or other third-party data, including our intellectual propertytrade secrets and other confidential business information. Because the techniques employed by hackers to obtain unauthorized access or to sabotage systems change frequently, we may be unable to anticipate these techniques or to implement adequate preventative measures. A security breach could result
in disclosure of our trade secrets or disclosure of confidential customer, supplier or employee data. If this should happen, we could be exposed to potentially significant legal liability, remediation expense, harm to our reputation, and other harm to our business.
As a global enterprise, the regulatory environment with respect to cybersecurity, privacy, and data protection is increasingly complex and may have impacts on the company’s business, including increased risk, costs, and expanded compliance obligations. The General Data Protection Regulation that came into force in the European Union in May 2018 will also cause us to incur additional compliance costs and potential financial or other exposure if we were found to fail to comply with such regulations.
We may not be able to protect our proprietary information and rights adequately. We rely on a combination of patent, copyright, trademark 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 adequately protect 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.
We are subject to market and financial risks due to our international operations that could adversely affect those operations or our profitability and operating results. Our international operations include sales and service offices in Europe, the Middle East, South America, Asia, Australia, and Canada. Our operations in countries outside of the United States, which accounted for approximately 64%29% of our total revenue for the first three months ended March 31, 2018,of 2019, expose us to greater risks associated with international sales and operations. Our profitability and international operations are, and will continue to be, subject to a number of risks and potential costs, including:
supporting multiple languages;
recruiting sales and technical support personnel internationally with the skills to sell and support our products and the potentially high cost related to employee separations;
complying with governmental regulations, including obtaining required import or export approval for our products;
additional tariffs, taxes, and penalties;
increased complexity and costs of managing international operations;
increased exposure to foreign currency exchange rate fluctuations;
trade protection measures and business practices that favor local competition, including as a result of recent measures and threats by the United States to levy tariffs on certain products;
risks and costs associated with employee-favorable labor laws in many foreign jurisdictions;
longer sales cycles and manufacturing lead times;
financial risks such as longer payment cycles and difficulties in collecting accounts receivable;
difficulties associated with repatriating cash generated or held abroad in a tax-efficient manner;
ineffective legal protection, including of intellectual property rights;
more complicated logistics and distribution arrangements;
additional taxes and penalties;
inadequate local infrastructure that could result in business disruptions;
global political and economic instability; and
other factors beyond our control such as natural disasters, terrorism, civil unrest, war, and infectious disease.
Our global operations are also subject to numerous U.S. and foreign laws and regulations, including those related to anti-corruption, tax, corporate governance, imports and exports, privacy and data security, financial and other disclosures, and labor relations. These laws and regulations are complex and may have differing, conflicting, and evolving legal standards, making compliance difficult and costly. If we or our employees, contractors, or agents violate these laws and regulations, we could be subject to fines, penalties, or criminal sanctions and may be prohibited from conducting business in one or more countries. Any violations, individually or in the aggregate, could have a material adverse effect on our operations and financial condition.
In addition, the United Kingdom gave formal notice of withdrawal from the European Union in March 2017. Consequently, the British government is currently negotiating the terms of the United Kingdom’s future relationship with the European Union.
The negotiated measures could potentially disrupt some of our target markets and jurisdictions in which we operate, including the United Kingdom and Germany, such as by adversely affecting tax benefits or liabilities in these or other jurisdictions or by restricting the movement of employees between the United Kingdom and other countries. Any such changes may adversely affect our operations and financial results.
Customers and other third parties may make statements speculating about or announcing the purchase, acceptance or intention to complete purchases or acceptances of our products before such purchases or acceptances are substantially certain, and these proposed purchases or acceptances may not be completed when or as expected, if at all. From time to time, customers and other third parties may make statements speculating about or announcing a potential purchase of our products before we have obtained an order for such purchases or completed negotiations and signed a contract for the purchase of such products. In some instances, government and government-funded customers may announce possible purchases even before they have obtained the necessary budget to procure the products. As a result, these statements, postings or announcements do not mean that we will ultimately be able to secure the sale when or as expected or at all as it is not certain that the contract or order negotiations will be completed successfully or as expected or that the customer will be able to obtain the budget they hope for or expect. In addition, from time to time, customers and other third parties may make statements speculating about or announcing the completion of an acceptance process of a delivery system before such acceptance is completed or certain. As a result, these statements or announcements do not mean that we will ultimately be able to obtain the acceptance when or as expected or recognize revenue.
We are subject to increasing government regulations and other requirements due to the nature of our business, which may adversely affect our business operations. In 2015, 2016, 2017, 2018, and the first three months of 2018,2019, approximately 47%, 47%53%, 53%28% and 25%50%, respectively, of our total revenue was derived from U.S. Government sales. In addition to normal business risks, our contracts with the U.S. government are subject to unique risks, some of which are beyond our control. Our contracts with the U.S. government are subject to particular risks, including:
The funding of U.S. government programs is subject to Congressional appropriations. Many of the U.S. government programs in which we participate may extend for several years; however, these programs are normally funded annually. Changes in U.S. strategy and priorities may affect our future procurement opportunities and existing programs. Long-term government contracts
and related orders are subject to cancellation, or delay, if appropriations for subsequent performance periods are not made. The termination of funding for existing or new U.S. government programs could result in a material adverse effect on our results of operations and financial condition.
The U.S. government may modify, curtail, or terminate its contracts with us. The U.S. government may modify, curtail, or terminate its contracts and subcontracts with us without prior notice at its convenience upon payment for work done and commitments made at the time of termination.done. Modification, curtailment, or termination of our major programs or contracts could have a material adverse effect on our results of operations and financial condition.
Our U.S. government contract costs are subject to audits by U.S. government agencies. U.S. government representatives may audit the costs we incur on ourcertain U.S. government contracts, including allocated indirect costs. Such audits could result in adjustments to our contract costs. Any costs found to be improperly allocated to a specific contract will not be reimbursed, and such costs already reimbursed must be refunded. If any audit uncovers improper or illegal activities or non-compliance with the terms of a specific contract, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines, and suspension or prohibition from doing business with the U.S. government.
Our business is subject to potential U.S. government inquiries and investigations. We may be subject to U.S. government inquiries and investigations of our business practices due to our participation in government contracts. Any such inquiry or investigation could potentially result in a material adverse effect on our results of operations and financial condition.
Our U.S. government business is also subject to specific procurement regulations and other requirements. These requirements, although customary in U.S. government contracts, increase our performance and compliance costs. These costs might increase in the future, reducing our margins, which could have a negative effect on our financial condition. Failure to comply with these regulations and requirements could lead to suspension or debarment, for cause, from U.S. government contracting or subcontracting for a period of time or the inability to participate in certain procurements and could have a negative effect on our reputation and ability to secure future U.S. government contracts.
U.S. export controls could hinder our ability to make sales to foreign customers and our future prospects. The U.S. government regulates the export of HPC systems such as our products. 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 certain foreign customers, eliminating an important source of potential revenue. Restrictions on the export of information needed to manufacture our products has in the past impacted and could in the future impact our ability to have certain products and components made in certain lower cost jurisdictions.
Our stock price is volatile. The trading price of our common stock is subject to significant fluctuations in response to many factors, including stock market trends and shareholder profile, our quarterly operating results, changes in analysts’ estimates or our outlook, our capital raising activities, announcements of technological innovations and customer contracts by us or our competitors, others in the industry or our customers, a significant aggressive seller or buyer, litigation activities, general economic conditions, and conditions in our industry. From January 1, 20172018 through March 31, 2018,2019, the closing sales price of our common stock on The Nasdaq Global Market ranged from $16.35$18.89 to $26.55$28.00 per share. Because our stock price has been volatile, investing in our common stock is risky.
We incorporate software licensed from third parties into the operating systems for our products as well as in our tools to design products and any significant interruption in the availability of these third-party software products or defects in these products could reduce the demand for our products or cause delay in development. The operating system as well as other software we develop for our supercomputers contains components that are licensed to us under open source software licenses. Our business could be disrupted if this software, or functional equivalents of this software, were either no longer available to us or no longer offered to us on commercially reasonable terms. In either case we would be required to redesign our operating system software to function with alternative third-party software, or develop these components ourselves, which would result in increased costs and could result in delays in product shipments. Our supercomputer systems utilize software system variants that incorporate Linux technology. The open source licenses under which we have obtained certain components of our operating system software may not be enforceable. Any ruling by a court that these licenses are not enforceable, or that Linux-based operating systems, or significant portions of them, may not be copied, modified, or distributed as provided in those licenses, would adversely affect our ability to sell our systems. In addition, as a result of concerns about the risks of litigation and open source software generally, we may be forced to protect our customers from potential claims of infringement. In any such event, our financial condition and results of operations may be adversely affected.
We also incorporate proprietary software from third parties, such as for file systems, job scheduling, and storage subsystems. We have experienced functional issues in the past with implementing such software with our supercomputer systems. In addition,
we may not be able to secure needed software systems on acceptable terms, or at all, which may make our systems less attractive to potential customers. These issues may result in lost revenue, additional expense by us, and/or loss of customer confidence.
The “conflict minerals” rule of the SEC has caused us to incur additional expenses, could limit the supply and increase the cost of certain metals used in manufacturing our products, and could make us less competitive in our target markets. The SEC requires public companies to disclose the origin, source, and chain of custody of specified minerals, known as conflict minerals, that are necessary to the functionality or production of products manufactured or contracted to be manufactured by us. Companies must obtain sourcing data from suppliers, engage in supply chain due diligence, and file annually with the SEC a specialized disclosure report on Form SD covering the prior calendar year. Implementation of our conflict minerals policy could limit our ability to source at competitive prices and to secure sufficient quantities of certain minerals used in the manufacture of our products, specifically tantalum, tin, gold, and tungsten, as the number of suppliers that provide conflict-free minerals may be limited. In addition, we have incurred, and may continue to incur, material costs associated with complying with the conflict minerals rule, such as costs related to the determination of the origin, source, and chain of custody of the minerals used in our products, the adoption of conflict minerals-related governance policies, processes, and controls, and possible changes to products or sources of supply as a result of such activities. Within our supply chain, we may not be able to sufficiently verify the origins of the relevant minerals used in our products through the data collection and due diligence procedures that we implement, which may harm our reputation.Furthermore, we may encounter challenges in satisfying those customers that require that all of the components of our products be certified as conflict free, and if we cannot satisfy these customers, they may choose a competitor’s products.We continue to investigate the presence of conflict materials within our supply chain.
We are required to evaluate our internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act of 2002 at the end of each fiscal year, and any adverse results from such future evaluations could result in a loss of investor confidence in our financial reports and have an adverse effect on our stock price. Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we are required to furnish a report by our management and a report by our independent registered public accounting firm on our internal control over financial reporting in our annual reports on Form 10-K as to whether we have any material weaknesses in our internal controls over financial reporting. Depending on their nature and severity, any future material weaknesses could result in our having to restate financial statements, could make it difficult or impossible for us to obtain an audit of our annual financial statements, or could result in a qualification of any such audit. In such events, we could experience a number of adverse consequences, including our inability to comply with applicable reporting and listing requirements, a loss of market confidence in our publicly available information, delisting from The Nasdaq Global Market, an inability to complete a financing, loss of other financing sources such as our line of credit, and litigation based on the events themselves or their consequences.
Our reported financial results may be adversely affected by changes in accounting principles generally accepted in the United States. Generally accepted accounting principles in the United States are subject to interpretation by the Financial
Accounting Standards Board, the SEC, and various bodies formed to promulgate and interpret appropriate accounting principles. A change in these principles or interpretations could have a significant effect on our reported financial results, and could affect the reporting of transactions completed before the announcement of a change.
U.S. federal income tax reform could adversely affect us. On December 22, 2017, the Tax Cuts and Jobs Act was signed into law, enacting a broad range of changes to the U.S. Internal Revenue Code. The Tax Cuts and Jobs Act, among other things, includes changes to U.S. federal tax rates, imposes significant additional limitations on the deductibility of interest and net operating losses, allows for the expensing of certain capital expenditures and puts into effect a number of changes impacting operations outside of the United States. In the fourth quarter of 2017, we reduced our deferred tax asset by approximately $28.9 million as a result. The Company will continue to assess the impact of the new tax legislation on its net deferred tax assets and liabilities and will continue to examine the impact this tax legislation may have on our business.
Provisions of our Restated Articles of Incorporation and Amended and Restated Bylaws could make a proposed acquisition of our business that is not approved by our Board of Directors more difficult. Provisions of our Restated Articles of Incorporation and Amended and Restated Bylaws could make it more difficult for a third-party to acquire us. These provisions could limit the price that investors might be willing to pay in the future for our common stock. For example, our Restated Articles of Incorporation and Amended and Restated Bylaws provide for:
removal of a director only in limited circumstances and only upon the affirmative vote of not less than two-thirds of the shares entitled to vote to elect directors;
the ability of our Board of Directors to issue up to 5,000,000 shares of preferred stock, without shareholder approval, with rights senior to those of the common stock;
no cumulative voting of shares;
the right of shareholders to call a special meeting of the shareholders only upon demand by the holders of not less than 30% of the shares entitled to vote at such a meeting;
the affirmative vote of not less than two-thirds of the outstanding shares entitled to vote on an amendment, unless the amendment was approved by a majority of our continuing directors, who are defined as directors who have either served as a director since August 31, 1995, or were nominated to be a director by the continuing directors;
special voting requirements for mergers and other business combinations, unless the proposed transaction was approved by a majority of continuing directors;
special procedures to bring matters before our shareholders at our annual shareholders’ meeting; and
special procedures to nominate members for election to our Board of Directors.
These provisions could delay, defer, or prevent a merger, consolidation, takeover, or other business transaction between us and a third-party that is not approved by our Board of Directors.
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Exhibit | | Exhibit Description | | Incorporated by Reference | | |
| | | | Form | | File No. | | Filing Date | | Exhibit/Annex | | Filed Herewith |
31.1 |
| | | | | | | | | | | | X |
31.2 |
| | | | | | | | | | | | X |
32.1* |
| | | | | | | | | | | | X |
101.INS XBRL Instance Document
101.SCH XBRL Taxonomy Extension Schema Document
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF XBRL Taxonomy Extension Definition Linkbase Document
101.LAB XBRL Taxonomy Extension Label Linkbase Document
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document
*This certification is deemed not filed for purposes of section 18 of the Exchange Act of 1934, as amended, or the Exchange Act, or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Act.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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| | CRAY INC. |
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Date: | May 1, 20187, 2019 | /S/ PETER J. UNGARO |
| | Peter J. Ungaro |
| | President and Chief Executive Officer |
| | |
Date: | May 1, 20187, 2019 | /S/ BRIAN C. HENRY |
| | Brian C. Henry |
| | Executive Vice President and Chief Financial Officer |
| | |
Date: | May 1, 20187, 2019 | /S/ CHARLES D. FAIRCHILD |
| | Charles D. Fairchild |
| | Vice President, Corporate Controller and Chief Accounting Officer |