1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ___________ TO ____________.
COMMISSION FILE NUMBER: 0-26820
CRAY INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
WASHINGTON 93-0962605
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
411 FIRST AVENUE SOUTH, SUITE 600,
SEATTLE, WASHINGTON 98104-2860
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (206) 701-2000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE EXCHANGE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE EXCHANGE ACT:
COMMON STOCK, $.01 PAR VALUE
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the past 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days: Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
The aggregate market value of the Common Stock held by non-affiliates of
the Registrant as of March 19, 2001 was approximately $65,600,000, based upon
the last sale price of $1.78 reported for such date on the Nasdaq National
Market System.
As of March 19, 2001, there were 39,375,541 shares of Common Stock issued
and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement to be delivered to shareholders in connection
with the Registrant's Annual Meeting of Shareholders to be held on May 16, 2001,
are incorporated by reference into Part III.
2
CRAY INC
FORM 10-K
FOR FISCAL YEAR ENDED DECEMBER 31, 2000
INDEX
Page
----
PART I
Item 1. Business 3
Item 2. Properties 20
Item 3. Legal Proceedings 20
Item 4. Submission of Matters to a Vote of Security Holders 20
Item E.O. Executive Officers of the Company 21
PART II
Item 5. Market for the Company's Common Equity and Related Stockholder
Matters 23
Item 6. Selected Financial Data 24
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 24
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 29
Item 8. Financial Statements and Supplementary Data 30
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 31
PART III
Item 10. Directors and Executive Officers of the Company 32
Item 11. Executive Compensation 32
Item 12. Security Ownership of Certain Beneficial Owners and Management 32
Item 13. Certain Relationships and Related Transactions 32
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 33
2
3
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains forward-looking statements that
involve risks and uncertainties, as well as assumptions that, if they never
materialize or prove incorrect, could cause our results to differ materially
from those expressed or implied by such forward-looking statements. All
statements other than statements of historical fact are statements that could be
deemed forward-looking statements, including any projections of earnings,
revenues, or other financial items; any statements of the plans, strategies, and
objectives of management for future operations; any statements concerning
proposed new products, services, or developments; any statements regarding
future economic conditions or performance; statements of belief and any
statement of assumptions underlying any of the foregoing.
The risks, uncertainties and assumptions referred to above include the
timely development, production and acceptance of products and services and their
features; the level of governmental support for supercomputers; our dependency
on third-party suppliers to build and deliver necessary components; our need for
additional credit and financial facilities; the challenge of managing asset
levels, including inventory; the difficulty of keeping expense growth at modest
levels while increasing revenue; our ability to retain and motivate key
employees; and other risks that are described from time to time in our
Securities and Exchange Commission reports, including but not limited to the
items discussed in "Factors That Could Affect Future Results" set forth in
"Business" in Item 1 below in this report, and in subsequently filed reports. We
assume no obligation to update these forward-looking statements.
GENERAL
On April 1, 2000, we acquired the operating assets of the Cray Research
business unit from Silicon Graphics, Inc. ("SGI"), and changed our corporate
name from Tera Computer Company to Cray Inc. With that acquisition we changed
from a development stage company with 125 employees (almost all located in
Seattle, Washington), limited revenue and one product under development, to a
company with nearly 900 employees located in over 20 countries, ongoing sales of
supercomputer systems with several products in development, major manufacturing
operations, an established service organization and substantial inventory. For
these reasons, period to period comparisons that include periods prior to April
1, 2000, are not indicative of future results. Discussions that relate to
periods prior to April 1, 2000, refer to our operations as Tera Computer Company
and discussions relating to periods after April 1, 2000, refer to our combined
operations as Cray Inc.
PART I
ITEM 1. BUSINESS
INTRODUCTION
We design, build, sell and service high performance computer systems,
commonly known as supercomputers. We have leading edge technology, multiple
product platforms, nearly 900 employees, a substantial worldwide installed base
of computers, major manufacturing and
3
4
service capabilities and extensive global customer relationships. We believe
that our current products and those under development represent the future of
supercomputing.
We were incorporated under the laws of the State of Washington in December
1987. Our corporate headquarters offices are located at 411 First Avenue South,
Suite 600, Seattle, Washington, 98104-2860, and our telephone number is (206)
701-2000.
PRODUCT OFFERINGS AND THE HIGH PERFORMANCE COMPUTER MARKET
Since the pioneering Cray 1(R) system arrived in 1976,
supercomputers--defined simply as the most powerful class of computers at any
point in time--have contributed substantially to the advancement of knowledge
and the quality of human life. Problems of major economic, scientific and
strategic importance typically are addressed by supercomputers years before
becoming tractable on less-capable systems. For scientific applications, the
increased need for computing power has been driven by highly challenging
problems that can be solved only through numerically intensive computation. For
engineering applications, high performance computers boost productivity and
decrease the time to market for companies and products in a broad range of
industries. The U.S. Government has recognized that the continued development of
high performance computer systems, which typically sell for mutiple millions of
dollars each, is of critical importance to the economic, scientific and
strategic competitiveness of the United States.
In conjunction with some of the world's most creative scientific and
engineering minds, these formidable tools already have made automobiles safer
and more fuel-efficient; located new deposits of oil and gas; saved lives and
property by predicting severe storms; created new materials and life-saving
drugs; powered advances in electronics and visualization; safeguarded national
security; and unraveled mysteries ranging from protein-folding mechanisms to the
shape of the universe.
Applications promising future competitive and scientific advantage create a
demand for more supercomputer power--10 to 1,000 times greater than anything
available today, according to users. Automotive companies are targeting
increased passenger cabin comfort, improved safety and handling. Aerospace firms
envision more-efficient planes and space vehicles. The petroleum industry wants
to "see" subsurface phenomena in greater detail. Urban planners hope to ease
traffic congestion. Integrated digital imaging and virtual surgery--including
simulated sense of touch--are high on the wish list in medicine. The sequencing
of the human genome promises to open an era of burgeoning research and
commercial enterprise in the life sciences.
Our customized supercomputer products provide high bandwidth and other
capabilities needed for exploiting new and existing market opportunities. Among
supercomputer vendors, we offer the largest variety of products in order to
address the broadest range of customer requirements and market segments.
4
5
Vector Supercomputer Systems. For certain important classes of scientific
and industrial applications, vector supercomputer systems remain unequaled.
Starting in 1976, Cray Research pioneered the use of vector systems in a variety
of market sectors. Vector systems typically use a moderate number (one to 64) of
custom processors, each of which is two to 100 times faster in practice than the
fastest commercially available microprocessors at any time. Earlier, vector
systems effectively were the only type of system available and therefore
dominated the supercomputer market. In the past decade, supercomputers employing
alternative designs ("architectures"), including the Cray T3E(TM) highly
parallel system and others, have emerged to capture substantial marketshare.
Today, increasingly powerful vector systems remain an important market factor
and are typically reserved for the most demanding class of applications and
workloads. Our vector systems include unique features, traditionally employed by
classified government customers, that in preliminary tests have demonstrated
substantial performance advantages over microprocessor-based systems for
mainstream problem solving in the emerging bioninformatics market. The same
unique, hard-to-replicate features will be included in our forthcoming Cray
MTA-2 systems.
The Cray SV1ex(TM) system, scheduled for availability in mid-2001, provides
substantial enhancements to the predecessor Cray SV1(TM) product. These
enhancements elevate this product line from a successful upgrade path for
midrange and prior-generation high-end Cray vector supercomputers, to a product
that for important, non-bandwidth-intensive applications is expected to perform
well as current high-end systems. The system's clock rate, at 500 megahertz, is
the fastest of any currently available supercomputer, vector or non-vector; and
the Cray SV1ex system's cachebased memory, unique among vector supercomputers,
significantly improves performance for problems that make good use of cache
memory. The targeted selling focus for the SV1ex systems is 8 to 64 gigaflops
(billions of calculations per second), with typical selling prices ranging from
$1 million to $2 million. We expect to sell some Cray SV1ex systems larger than
64 gigaflops.
In February 2001 we signed an agreement with NEC Corporation to distribute
and service NEC SX-5(TM) vector supercomputers and their successors. This
agreement provides us with exclusive distribution and servicing rights in the
United States, Canada and Mexico, and non-exclusive rights in the rest of the
world. The SX-5 computers are the world's current best-selling high-end,
high-bandwidth vector supercomputers, with a strong installed base in industry,
government and academia. Current duties under a U.S. anti-dumping ruling
effectively prohibit the importation of these computers into the U.S. We have
requested that the U.S. Government remove these duties. Assuming that these
duties are removed as expected, we plan on marketing NEC SX-5 series computers
to customers with a need for high-end, high-bandwidth vector supercomputers,
particularly in the United States. The targeted selling focus for the SX-5
supercomputers will be from 10 to 160 gigaflops, with expected selling prices
ranging from $1.5 million to $15 million.
Microprocessor-based Highly Parallel Systems. In recent years highly
parallel supercomputer products have captured substantial market share by
providing greater performance and price/performance on a range of applications
for which vector supercomputers are less well suited. Highly parallel
supercomputers typically link together tens, hundreds or thousands of
5
6
standard microprocessors to act either concurrently on multiple tasks, or in
concert on a single computationally-intensive task. In these systems, each
processor typically is directly connected to its own private ("distributed" or
"local") memory and the programmer must manage the movement of data among memory
units. As a result, computer systems relying on this architecture can be
difficult to program and are most suited for applications that can be
partitioned easily into discrete tasks that do not need to communicate often
with each other and do not require the high memory and interconnect system
bandwidth of supercomputers such as the forthcoming Cray SV2(TM), NEC SX-5 and
Cray MTA-2 systems.
The Cray T3E system, introduced in 1996 and able to employ up to 2,048
processors, is widely recognized as the first technically and commercially
successful highly parallel system. The Cray T3E holds the world record for
actual ("sustained") performance on a real application and was named
"Supercomputer Product of the Year" for the year 2000 by the readers of
Scientific Computing & Instrumentation magazine. We expect continued strong
demand for T3E systems in 2001, driven by the product's proven superiority among
highly parallel systems in handling large, complex applications and workloads.
In May 2000 we sold an 816-processor T3E system upgrade to the U.S. Army High
Performance Computing Research Center for $18.5 million. In August 2000, we sold
the first enhanced Cray T3E-1350 system, totaling 136 processor, to Phillips
Petroleum Company. We recently sold and installed a T3E system with teraflop
capacity to the U.S. Department of Defense for approximately $21 million.
In January 2001, we announced plans to introduce the Cray SuperCluster(R)
series, a product line designed to extend the leadership of the Cray T3E system
while exploiting commercially available third-party technologies to a greater
degree. With the SuperCluster system, we plan to address market demand for COTS
(commercial-off-the-shelf) clusters with higher capabilities than those
available today, especially by leveraging the approximately $45 million software
investment that has made the Cray T3E system the most scalable, usable system in
its category. In addition to our own significant software contribution, we plan
to use leading commercial off-the-shelf components, including Alpha processor
technology from API Networks, advanced Linux system software and the highly
scalable Myrinet cluster-interconnect network from Myricom. Over the next two
years, we plan to add advanced data center management capabilities to the
SuperCluster operating system, leveraging the Cray T3E software investment.
Target markets for the SuperCluster systems include government, scientific
research and select industries, such as petroleum and the life sciences. Unlike
our vector and multithreaded architecture products, the SuperCluster is aimed at
scalar applications and workloads, and at the growing number of customers and
new prospects considering microprocessor-based COTS clusters. The SuperCluster
is targeted for first customer ship in the second half of 2001.
Cray SV2 System. We are currently developing the revolutionary Cray SV2
system, which incorporates in its design both vector processing capabilities
from the long line of Cray Research vector systems, and highly parallel
capabilities analogous to those of our T3E system. The SV2 is an "extreme
performance" supercomputer aimed at the high end of the vector processing market
and the high end of the market for highly parallel systems. The SV2 has been
under development since 1997, and first customer ship is scheduled for the
second half of 2002.
6
7
Our expected selling focus for the SV2 is 200 gigaflops to multiple tens of
teraflops (trillions of calculations per second). The U.S. Government is
providing substantial funding support for the development of the SV2 system and
conducts rigorous progress reviews on a quarterly basis. Our SV2 development has
satisfactorily completed all quarterly reviews to date.
Multithreading Systems. Tera Computer Company was originally formed to
pursue a significant breakthrough in high-performance computing by developing a
scalable, uniform shared memory, latency tolerant system that utilizes a
multithreaded architecture and a high bandwidth interconnection system. In the
past year we have been heavily engaged in reimplementing the MTA system from
gallium arsenide technology to more-mainstream CMOS (complementary metal-oxide
silicon) technology. In January 2001 we announced a $5.4 million contract from
Logicon, a Northrup Grumman company, to deliver a 28-processor, all-CMOS MTA-2
system to the Naval Research Laboratory in the fourth quarter of 2001, with
substantial upgrade options over a four-year period. The Naval Research
Laboratory plans to make this system available for investigative purposes to its
own researchers and to the Department of Defense national research community.
With the MTA-2 system, we are targeting customers in the defense community, in
scientific research--including burgeoning new life sciences field such as
bioinformatics, and in advanced imaging. The MTA-2 is aimed at new applications
not well served by vector or highly parallel systems, such as dynamically
adaptive meshes, data sorting and problems benefiting from advanced scalability,
large uniform shared memory and easier parallel programming. The MTA-2 has shown
a significant performance advantage, for example, on so-called Monte Carlo codes
used in a wide range of sectors, from nuclear physics to medicine to finance.
SOFTWARE
We offer UNIX-based operating systems, compiler software and diagnostic
tools. We currently support multiple operating systems, including UNICOS/mk(TM)
in the T3E, UNICOS(TM) in the SV1 and earlier vector processing systems, a
UNIX-based system called MTX(TM) for the Cray MTA system. The SuperCluster
operating system will be based on open-source version of LINUX with extensions
to support high performance computing in a production environment, while the SV2
operating system will be UNIX-based with common UNICOS extensions. The NEC SX-5
systems and its successors use NEC's SUPER-UX(TM) operating system, which is
also based on UNIX.
We continue to design and build highly optimizing programming environments,
performance management diagnostic software products that allow our customers to
obtain maximum benefit from our systems. In addition to supporting third-party
applications, we also research advanced algorithms and other approaches to
improving application performance. We also purchase or license software
technologies from third parties when necessary to provide appropriate support to
our customers, while focusing on our own resources where we add the highest
value.
7
8
MAINTENANCE AND SUPPORT
Our extensive world-wide maintenance and support systems provide us with a
competitive advantage. Our employees providing these services include field
service engineers, product and applications specialists and product support
engineers. They are usually based at customer sites. We currently have
approximately 100 support personnel in the field in the U.S., another 100
support personnel in other countries and 90 employees providing central support
services based in Chippewa Falls, Wisconsin, including extensive data center
operations.
Support services are provided under separate maintenance contracts with our
customers. These contracts generally provide for support services on an annual
basis, although some cover multiple years. While most customers pay support
monthly, others pay on a quarterly or annual basis. In the nine months of our
combined operations in 2000, our support revenues exceeded $71 million. At
year-end we had deferred support revenue in excess of $15 million representing
prepaid support.
SALES AND MARKETING
We primarily sell our system products through our direct sales force which
operates throughout the United States and in all significant international
markets. We serve smaller international markets through representatives and
distributors.
We have 60 sales staff, including sales representatives, sales managers,
pre-sale analysts and administrative personnel located in the United States and
28 sales staff located internationally.
Information with respect to our international operations and export sales
is set forth in Note 14 to the Consolidated Financial Statements included in
Part II, Item 8 of this Form 10-K. No single end-user customer accounted for 10%
or more of our revenue for each of the last three years, but agencies of the
United States government, both directly and indirectly through system
integrators and other resellers, accounted for approximately 54% of our 2000
revenue.
RESEARCH AND DEVELOPMENT
We are committed to leadership in the high performance computer market. Our
leadership depends on successful development and introduction of new products
and enhancements to existing products. Prior to April 2000, our primary research
and development activity was the design of the hardware components and software
required for our MTA system. Since April 2000 we have continued development of
the MTA system, the development of the enhancements to the Cray T3E system and
Cray SV1 series leading to the SV1ex, and the development of the SV2 system. We
expect that the SuperCluster system will involve software development with
minimal hardware engineering, and we do not anticipate any development
expenditures on the NEC SX-5 and successor SX systems
8
9
Our research and development expenses, net of governmental funding, were
$13.7 million in 1998, $15.2 million in 1999 and $48.4 million in 2000 (of which
$43.9 was spent in the nine months of combined operations). These amounts
represent 687%, 720% and 41% (including 37% in the nine months of combined
operations), respectively, of total revenue. While we will be required to
continue to devote a substantial portion of our resources to research and
development activities, our goal is to have research and development expenses
represent approximately 15 -- 18% of revenue. We expect to achieve this goal
primarily by increasing revenue while holding research and development
expenditures to modest increases.
MANUFACTURING
While we design many of the hardware components for all of our products, we
subcontract the manufacture of these components, including integrated circuits,
printed circuit boards, flex circuits, memory modules, machined enclosures and
support structures, cooling systems, high performance cables and other items to
third-party suppliers. Our strategy is to avoid the large capital commitment and
overhead associated with establishing full-scale manufacturing facilities and to
maintain the flexibility to adopt new technologies as they become available
without the risk of equipment obsolescence. We perform final system integration
and testing, and design and maintain our system software internally.
Our manufacturing facilities are located in Chippewa Falls, Wisconsin. We
maintain a development and support capability in Seattle, Washington. At
December 31, 2000, we had 160 full-time employees in manufacturing, with 137
located in Chippewa Falls, Wisconsin.
Our systems incorporate components that are available from one or limited
sources. Key components that are sole-sourced include our integrated circuits,
flex circuits and memory products. We have chosen to deal with sole sources in
these cases because of specific technologies, economic advantages and other
factors. We also have sole or limited sources for less critical components, such
as peripherals, power supplies and chassis. Reliance on single or limited source
vendors involves several risks, including the possibility of shortages of key
components, long lead times, reduced control over delivery schedules and changes
in direction by vendors.
COMPETITION
The high performance computer market is intensely competitive. The barriers
to entry are high, as is the cost of remaining competitive. Our competitors can
be divided into two general categories: established companies that are
well-known in the high performance computer market and new entrants capitalizing
on developments in architecture or techniques to increase computer performance
through linking together clusters or networks of micro processor based systems
- -- servers, workstations or personal computers.
9
10
Participants in the market include IBM, Fujitsu, Ltd., Hitachi, Ltd., and
NEC Corporation. To date, the Japanese suppliers, as a group, have been largely
unsuccessful in the U.S. high performance computer market but have been enjoying
success in foreign markets. Once our distribution agreement with NEC becomes
effective, we will have exclusive rights to market NEC vector processing
supercomputers in North America; we have non-exclusive rights to market these
computers elsewhere, which means we would be competing with NEC in the rest of
the world. We compete with these companies by offering systems with superior
performance, coupled with our excellent post-sale service capabilities and
established customer relationships.
A number of companies, including IBM, Silicon Graphics, Inc., Hitachi,
Ltd., Fujitsu, Ltd., Sun Microsystems, Inc., Hewlett-Packard Corporation and
Compaq Computer Corporation, offer clusters or other highly parallel systems for
the high performance market. While our T3E system competes primarily on
performance, we expect that our SuperCluster system will compete on
price/performance, more extensive software capabilities and superior post-sale
service.
Each of our competitors named above has substantially greater engineering,
manufacturing, marketing and financial resources than we do.
INTELLECTUAL PROPERTY
We attempt to protect our trade secrets and other proprietary rights
through formal agreements with our employees, customers, suppliers and
consultants, and through patent protection. Although we intend to protect our
rights vigorously, there can be no assurance that our contractual and other
security arrangements will be successful. There can be no assurance that such
arrangements will not be terminated or that we will be able to enter into
similar arrangements on favorable terms if required in the future. In addition
if such agreements were breached, there can be no assurance that we would have
adequate remedies for any breach. Although we have not been a party to any
material intellectual property litigation, third parties may assert proprietary
rights claims covering certain of our products and technologies.
We have a number of patents relating to our hardware and software systems.
We license certain patents and other intellectual property from Silicon
Graphics, Inc., as part of our acquisition of the Cray Research operations.
These licenses contain restrictions on use of the underlying technology,
generally limiting the use to historic Cray products, vector processor computers
and the Cray SV2 system. Our general policy is to seek patent protection for
those inventions and improvements likely to be incorporated into our products
and services or to give us a competitive advantage. While we believe our patents
and applications have value, no single patent is in itself essential to us as a
whole or to any of our key products. Any of our proprietary rights could be
challenged, invalidated or circumvented and may not provide significant
competitive advantage.
There can be no assurance that the steps we take will be adequate to
protect or prevent the misappropriation of our intellectual property.
Litigation may be necessary in the future to enforce patents we obtain, and to
protect copyrights, trademarks, trade secrets and know-how we own. Such
litigation, if necessary, could result in substantial expense to us and a
diversion of our efforts.
EMPLOYEES
As of December 31, 2000, we employed 886 employees (compared to 123 at the
end of 1999 as Tera Computer Company) on a full-time basis, of whom 303 were in
development and
10
11
engineering, 160 were in manufacturing, 88 were in sales and marketing, 290 in
field service and 45 were in administration. We also employed 57 individuals on
a part-time or temporary basis or as interns. We have no collective bargaining
agreement with our employees. We have never experienced a work stoppage and
believe that our employee relations are excellent.
FACTORS THAT COULD AFFECT FUTURE RESULTS
The following factors should be considered in evaluating our business,
operations and prospects and may affect our future results and financial
condition.
LACK OF CUSTOMER ORDERS FOR OUR EXISTING SV1 AND T3E PRODUCTS AND OUR INABILITY
TO SELL OUR PRODUCTS AT EXPECTED PRICES WOULD ADVERSELY AFFECT OUR PROSPECTS. We
will depend on sales of our current products, the Cray SV1 series and T3E
systems, for significant product revenue in 2001. To obtain these sales, we need
to assure our customers of product performance and our ability to service these
products. Most of our potential customers already own or lease very
high-performance computer systems. Some of our competitors may offer trade-in
allowances or substantial discounts to potential customers, and we may not be
able to match these sales incentives. We may be required to provide discounts to
make sales or to provide lease financing for our products, which would result in
a deferral of our receipt of cash for such systems. These developments would
limit our revenue and resources and would adversely affect our profitability and
operations.
OUR INABILITY TO OVERCOME THE TECHNICAL CHALLENGES OF COMPLETING THE DEVELOPMENT
OF OUR SYSTEMS COULD CAUSE OUR BUSINESS TO FAIL. We expect that our success in
2002 and following years depends upon completing the development of the
SuperCluster, the MTA-2 and the SV2 systems. These development efforts are
lengthy and technically challenging processes, and require a significant
investment of capital, engineering and other resources. Delays in completing the
design of the hardware components or software of these systems or in integrating
the full systems could materially and adversely affect our business and results
of operations. We are dependent on our vendors to manufacture components for our
systems, and few companies can meet our design requirements. Their inability to
manufacture our components to our designs will adversely affect the completion
of these products. From time to time during the development process we have had,
and in the future we may have, to redesign certain components because of
previously unforeseen design flaws. We also may find certain flaws, or "bugs,"
in our system software which require correction. Redesign work may be costly and
cause delays in the development of these systems, and could affect adversely
their success as commercial products.
11
12
LACK OF GOVERNMENT SUPPORT FOR SUPERCOMPUTER SYSTEMS WOULD ADVERSELY AFFECT OUR
BUSINESS AND INCREASE OUR CAPITAL REQUIREMENTS. We have targeted U.S. and
foreign government agencies and research laboratories as important sales
prospects for all of our products. In addition, a few of these agencies fund a
portion of our development efforts. The U.S. government historically has
facilitated the development of, and has constituted a market for, new and
enhanced very high- performance computer systems. The failure of U.S. and
foreign government agencies to purchase additional very high-performance
computer systems or to continue to fund these development efforts, due to lack
of funding, change of priorities or for any other reason, would materially and
adversely affect our results of operations and increase our need for capital.
PROPOSALS AND PURCHASES BASED ON THEORETICAL PEAK PERFORMANCE ADVERSELY AFFECT
OUR PROSPECTS. Our high-performance systems are designed to provide high actual
sustained performance on difficult computational problems. Many of our
competitors offer systems with higher theoretical peak performance numbers,
although their actual sustained performance frequently is a small fraction of
their theoretical peak performance. Nevertheless, many requests for proposals,
primarily from governmental agencies in the U.S. and elsewhere, have criteria
based on theoretical peak performance. Until these criteria are changed, we are
foreclosed from bidding or proposing our systems on such proposals, which
adversely affects our revenue potential.
FAILURE TO OBTAIN RENEWAL OF SERVICE CONTRACTS WOULD ADVERSELY AFFECT OUR
REVENUES AND EARNINGS. High-performance computer systems are typically sold with
maintenance service contracts. These contracts generally are for annual periods,
although some are for multi-year periods. We have been performing most of the
services under the existing SGI maintenance contracts as a sub-contractor to SGI
and are in the process of novating these contracts to us. As these contracts
expire, we need to sell new maintenance service contracts to these customers. A
significant portion of these contracts include prepaid service amounts. If
customers do not renew their maintenance service contracts with us, our
revenues, earnings and cash resource would be adversely affected.
OUR RELIANCE ON THIRD-PARTY SUPPLIERS POSES SIGNIFICANT RISKS TO OUR BUSINESS
AND PROSPECTS. We subcontract the manufacture of substantially all of our
hardware components for all of our products, including integrated circuits,
printed circuit boards, flex circuits and power supplies, on a sole or limited
source basis to third-party suppliers. The SuperCluster system will be built
entirely from commercial off-the-shelf components on a sole-source basis. In
addition we use a contract manufacturer to assemble our SV1 and T3E components,
and plan to do so for our MTA-2 and SV-2 systems also.
12
13
We are exposed to substantial risks because of our reliance on these and
other limited or sole source suppliers. For example:
- - if a reduction or interruption of supply of our components occurred, it
could take us a considerable period of time to identify and qualify
alternative suppliers to redesign our products as necessary and to
recommence manufacture of the redesigned components;
- - if we were ever unable to locate a supplier for a component, we would be
unable to assemble and deliver our products;
- - one or more suppliers may make strategic changes in their product lines,
which may result in the delay or suspension of manufacture of our
components or systems; and
- - some of our key suppliers are small companies with limited financial and
other resources, and consequently may be more likely to experience
financial difficulties than larger, well- established companies.
THE ABSENCE OF THIRD-PARTY APPLICATION SOFTWARE COULD ADVERSELY AFFECT OUR
ABILITY TO MAKE COMMERCIAL SALES OF OUR NEW SYSTEMS. In order to make sales in
the automotive, aerospace, chemistry and other engineering and commercial
markets, we must be able to attract independent software vendors to port their
software application programs so that they will run on our systems. The
relatively low volume of supercomputer sales makes it difficult for us to
attract these vendors. We also modify and rewrite third-party software
applications to run on our systems and so facilitate the expansion of our
potential markets. There can be no assurance that we will be able to induce
independent software vendors to rewrite their applications, or that we will
successfully rewrite third-party applications for use on our systems.
FAILURE TO OBTAIN CREDIT FACILITIES MAY RESTRICT OUR OPERATIONS. While we have
obtained a secured credit facility based on domestic accounts receivables and
maintenance revenue, we are seeking additional credit facilities, such as bank
lines of credit, vendor credit and capitalized equipment lease lines. The
absence of a consistent record of revenue and earnings makes obtaining such
facilities more difficult; if we obtain such facilities, they may have high
interest rates, contain restrictions on our operations and require security.
Failure to obtain such credit facilities may limit our planned operations and
our ability to acquire needed infrastructure and other capital items and would
adversely affect our cash reserves and increase our need for capital.
OUR QUARTERLY PERFORMANCE MAY VARY SIGNIFICANTLY AND COULD CAUSE OUR STOCK PRICE
TO BE VOLATILE. One or a few system sales may account for a substantial
percentage of our quarterly and annual revenue. This is due to the high average
sales price of our products, particularly the Cray T3E system, and the expected
high average sales prices for our MTA-2 and SV2 systems, and the timing of
purchase orders and product acceptances. Because a number of our prospective
customers receive funding from the U.S. or foreign governments, the timing of
orders from such customers may be subject to the
13
14
appropriation and funding schedules of the relevant government agencies. The
timing of orders and shipments also could be affected by other events outside
our control, such as:
- - changes in levels of customer capital spending;
- - the introduction or announcement of competitive products;
- - the availability of components;
- - timing of the receipt of necessary export licenses; or
- - currency fluctuations and international conflicts or economic crises.
Because of these factors, revenue, net income or loss and cash flow are
likely to fluctuate significantly from quarter to quarter.
THE COST OF SERVICE OF THE T90 INSTALLED BASE WILL ADVERSELY AFFECT OUR
EARNINGS. Certain components in the T90 vector computers sold by SGI prior to
our acquisition of the Cray Research operations have an unusually high failure
rate. The cost of servicing the T90 computers exceeds the related service
revenue. We are continuing to take action that commenced prior to the
acquisition to address this problem, and have recorded a warranty reserve to
provide for anticipated future losses on the T90 maintenance service contracts.
OUR UNCERTAIN PROSPECTS FOR EARNINGS COULD ADVERSELY AFFECT AN INVESTMENT IN US.
While we have had a substantial increase in revenue with the acquisition of the
Cray business operations, whether we will continue to achieve earnings will
depend upon a number of factors, including:
- - our ability to market and sell our existing products, the SV1 and T3E, and
complete the development of the SV1ex, SuperCluster, MTA-2, and SV2
systems;
- - the level of revenue in any given period;
- - the cost of servicing the T90 installed base;
- - the terms and conditions of sale or lease for our products; and
- - our expense levels, particularly for research and development and
manufacturing and service costs.
U.S. EXPORT CONTROLS COULD HINDER OUR ABILITY TO MAKE SALES TO FOREIGN CUSTOMERS
AND OUR FUTURE PROSPECTS. The U.S. Government regulates the export of
high-performance computer systems such as our products. Delay or
14
15
denial in the granting of any required licenses could adversely affect our
ability to make sales to certain foreign customers, thereby eliminating an
important source of potential revenue.
A SUBSTANTIAL NUMBER OF OUR SHARES ARE ELIGIBLE FOR FUTURE SALE AND COULD
DEPRESS MARKET PRICES OF OUR STOCK AND HINDER OUR ABILITY TO OBTAIN ADDITIONAL
FINANCING. Sale of a substantial number of our shares of common stock in the
public market or the prospect of such sales could materially and adversely
affect the market price of our common stock. As of December 31, 2000, we had
outstanding:
- - 35,280,785 shares of common stock;
- - warrants to purchase 14,801,096 shares of common stock;
- - 8% Convertible Promissory Notes due March 31, 2001, in the principal amount
of $494,291, convertible at $5.00 per share into 98,858 shares of common
stock; and
- - stock options to purchase an aggregate of 8,224,005 shares of common stock,
of which 2,428,813 options were then exercisable.
Almost all of our outstanding shares of common stock may be sold without
substantial restrictions. All of the shares purchased under the options are
available for sale in the public market, subject in some cases to volume and
other limitations.
Sales in the public market of substantial amounts of our common stock,
including sales of common stock issuable upon the exercise of warrants and
options, could depress prevailing market prices for the common stock. Even the
perception that such sales could occur may impact market prices.
In addition, the existence of outstanding warrants and options may prove to
be a hindrance to our future equity financings. Further, the holders of the
warrants and options may exercise them at a time when we would otherwise be able
to obtain additional equity capital on terms more favorable to us. Such factors
could materially and adversely affect our ability to meet our capital needs.
ADDITIONAL FINANCINGS MAY BE DILUTIVE TO EXISTING SHAREHOLDERS. Over the next
twelve months our significant cash requirements relate to operational expenses,
consisting primarily of personnel costs, costs of inventory and third-party
engineering expenses, and acquisition of capital goods. We expect that
anticipated product sales and maintenance services over the next twelve months
will generate positive cash flow. We secured a $15 million credit facility in
March 2001, and expect that the NEC distribution agreement will be completed in
the second quarter of 2001, at which time NEC will invest $25 million in us. At
any particular time, given the high average selling price of our products, our
capital position is impacted by the timing of particular product sales, and the
receipt of prepaid maintenance. In addition delays in the completion of the
SV1ex system and the development of the MTA-2 and SuperCluster systems, all
planned to be completed in 2001, or delays in the SV2 development program may
require additional capital earlier than planned. In order to provide sufficient
working capital and
15
16
enhance our capital position, we may raise additional equity and/or debt capital
through utilization of our shelf registration statement covering $20 million of
common stock, private placements and/or enhanced credit facilities. Financings
may not be available to us when needed or, if available, may not be available on
satisfactory terms and may be dilutive to our shareholders.
WE MAY BE UNABLE TO ATTRACT, RETAIN AND MOTIVATE KEY PERSONNEL, AND AS A RESULT
WE MAY NOT BE ABLE TO GROW AS WE EXPECT OR EFFECTIVELY IMPLEMENT OUR BUSINESS
PLAN. Our success also depends in large part upon our ability to attract, retain
and motivate highly skilled management, technical and marketing and sales
personnel. Competition for highly skilled management, technical, marketing and
sales personnel is intense, and we may not be successful in attracting and
retaining such personnel. In particular we have an ongoing project to add
software developers to assist our development efforts. We have no employment
contracts with any of our employees.
OUR STOCK PRICE MAY BE VOLATILE. The trading price of our common stock is
subject to significant fluctuations in response to, among other factors:
- - changes in analysts' estimates;
- - our future capital raising activities;
- - announcements of technological innovations by us or our competitors; and
- - general conditions in the high-performance computer industry.
In addition, the stock market has been and is subject to price and volume
fluctuations that particularly affect the market prices for small
capitalization, high technology companies like ourselves.
WE MAY NOT BE ABLE TO KEEP UP WITH RAPID TECHNOLOGICAL CHANGE. Our market is
characterized by rapidly changing technology, accelerated product obsolescence
and continuously evolving industry standards. Our success will depend upon our
ability to enhance our current products, to complete development of the
SuperCluster, the MTA-2 and the SV2 systems and to develop successor systems in
the future. We will need to introduce new products and features in a timely
manner to meet evolving customer requirements. We may not succeed in these
efforts. Our business and results of operations will be materially and adversely
affected if we incur delays in developing our products or if such products do
not gain broad market acceptance. In addition, products or technologies
developed by others may render our products or technologies noncompetitive or
obsolete.
WE MAY BE UNABLE TO COMPETE SUCCESSFULLY IN THE HIGH- PERFORMANCE COMPUTER
MARKET. The performance of our products may not be competitive with the computer
systems offered by our competitors, and we may not compete successfully over
time against new entrants or innovative competitors at the lower end of the
16
17
market. Furthermore, periodic announcements by our competitors of new
high-performance computer systems and price adjustments may materially and
adversely affect customer demand for our products.
Our competitors are established companies that are well known in the
high-performance computer market, including IBM, Sun Microsystems, Compaq
Computer, Hewlett-Packard, Silicon Graphics, NEC Corporation, Fujitsu and
Hitachi. Each of these competitors has broader product lines and substantially
greater research, engineering, manufacturing, marketing and financial resources
than we do.
In addition we compete with new entrants capitalizing on developments in
parallel processing and increased computer performance through networking and
clustering systems. To date, these products have been limited in applicability
and scalability and can be difficult to program. A breakthrough in architecture
or software technology could make parallel systems more attractive to potential
customers. Such a breakthrough would materially and adversely affect our ability
to sell our products and the receipt of revenue.
WE MAY NOT BE ABLE TO PROTECT OUR PROPRIETARY INFORMATION AND RIGHTS ADEQUATELY.
We rely on a combination of patent, copyright and trade secret protection,
non-disclosure agreements and licensing arrangements to establish, protect and
enforce our proprietary information and rights. We have a number of patents and
have additional applications pending. There can be no assurance, however, that
patents will be issued from the pending applications or that any issued patents
will protect adequately those aspects of our technology to which such patents
will relate. Despite our efforts to safeguard and maintain our proprietary
rights, we cannot be certain that we will succeed in doing so or that our
competitors will not independently develop or patent technologies that are
substantially equivalent or superior to our technologies.
Although we are not a party to any present litigation regarding proprietary
rights, third parties may assert intellectual property claims against us in the
future. Such claims, if proved, could materially and adversely affect our
business and results of operations. In addition, even meritless claims would
require management attention and would cause us to incur significant expense to
defend.
The laws of certain countries do not protect intellectual property rights
to the same extent or in the same manner as do the laws of the United States.
Although we continue to implement protective measures and intend to defend our
proprietary rights vigorously, these efforts may not be successful.
OUR ABILITY TO BUILD CERTAIN PRODUCTS IS LIMITED BY OUR AGREEMENT WITH SGI,
WHICH MAY LIMIT OUR ABILITY TO COMPETE WITH SGI AND OTHER COMPANIES. The
Technology Agreement pursuant to which we acquired and licensed patent, know-how
and other intellectual property rights from SGI contains restrictions on our
ability to develop certain products, including specified successors to the T3E
17
18
system, and restrictions on the use of other technology, such as SGI's IRIX
operating system in the SV2.
IT MAY BECOME MORE DIFFICULT TO SELL OUR STOCK IN THE PUBLIC MARKET. Our common
stock is quoted on the Nasdaq National Market. In order to remain listed on this
market, the Company must meet Nasdaq's listing maintenance standards. If the bid
price of our common stock falls below $5.00 for an extended period, or we are
unable to continue to meet Nasdaq's standards for any other reason, our common
stock could be delisted from the Nasdaq National Market. If our common stock
were delisted, we likely would seek to list the common stock on the Nasdaq
SmallCap Market or for quotation on the American Stock Exchange or a regional
stock exchange. However, listing or quotation on these markets or exchanges
could reduce the liquidity for our common stock. If our common stock were not
listed or quoted on another market or exchange, trading of our common stock
would be conducted in our over-the-counter market on an electronic bulletin
board established for unlisted securities or in what are commonly referred to as
the "pink sheets." As a result, an investor would find it more difficult to
dispose of, or to obtain accurate quotations for the price of, the common stock.
In addition, a delisting from the Nasdaq National Market and failure to obtain
listing or quotation on such other market or exchange would subject our
securities to so-called "penny stock" rules that impose additional sales
practice and market-making requirements on broker-dealers who sell and/or make a
market in such securities. Consequently, removal from the Nasdaq National Market
and failure to obtain listing or quotation on another market or exchange could
affect the ability or willingness of broker-dealers to sell and/or make a market
in our common stock and the ability of purchasers of our common stock to sell
their securities in the secondary market. In addition, if the market price of
our common stock falls to below $5.00 per share, we may become subject to
certain penny stock rules even if our common stock is still quoted on the Nasdaq
National Market. While such penny stock rules should not affect the quotation of
our common stock on the Nasdaq National Market, such rules may further limit the
market liquidity of our common stock and the ability of investors to sell our
common stock in the secondary market.
PROVISIONS IN OUR AGREEMENT WITH SILICON GRAPHICS MAKE IT MORE DIFFICULT FOR
SPECIFIED COMPANIES TO ACQUIRE US. The Asset Purchase Agreement with SGI
pursuant to which we purchased the Cray Research business assets contains
provisions restricting our ability to transfer the Cray Research business
assets. Sales of these assets to Hewlett-Packard, Sun Microsystems, IBM, Compaq
Computer, NEC or Gores Technology Group, or their affiliates, are prohibited
until the earlier of March 31, 2003 or if SGI were sold. In addition, we must
give SGI a right of first refusal for any sale of these assets to other
purchasers for such period or earlier, if over a period of four fiscal quarters
the revenue from product sales of Cray products is less than 50% of our total
revenue.
18
19
PROVISIONS OF OUR ARTICLES AND BYLAWS COULD MAKE A PROPOSED ACQUISITION THAT IS
NOT APPROVED BY OUR MANAGEMENT MORE DIFFICULT. Provisions of our Restated
Articles of Incorporation and Restated Bylaws could make it more difficult for a
third party to acquire us. These provisions could limit the price that investors
might be willing to pay in the future for our common stock. For example, our
Articles and Bylaws provide for:
- - a staggered Board of Directors, so that only three of nine directors are
elected each year;
- - removal of a director only for cause and only upon the affirmative vote of
not less than two-thirds of the shares entitled to vote to elect directors;
- - the issuance of preferred stock, without shareholder approval, with rights
senior to those of the common stock;
- - no cumulative voting of shares;
- - calling a special meeting of the shareholders only upon demand by the
holders of not less than 30% of the shares entitled to vote at such a
meeting;
- - amendments to the Restated Articles of Incorporation require the
affirmative vote of not less than two-thirds of the outstanding shares
entitled to vote on the amendment, unless the amendment was approved by a
majority of "continuing directors" (as that term is defined in our
Articles);
- - special voting requirements for mergers and other business combinations,
unless the proposed transaction was approved by a majority of continuing
directors;
- - special procedures must be followed in order to bring matters before our
shareholders at our annual shareholders' meeting; and
- - special procedures must be followed in order for nominating members for
election to the Board of Directors.
WE DO NOT ANTICIPATE DECLARING ANY DIVIDENDS. We have never paid any dividends
on our common stock and we intend to continue our policy of retaining any
earnings to finance the development and expansion of our business.
19
20
ITEM 2. PROPERTIES
The Company's principal properties are as follows:
Approximate
Location of Property Uses of Facility Square Footage
- -------------------- ----------------- --------------
Chippewa Falls, Wisconsin Manufacturing, 222,000
engineering, development,
service, and warehouse
Seattle, Washington Executive offices, MTA 85,000
hardware and software
development
Mendota Heights, Minnesota Hardware and software 40,000
development, sales and
marketing operations
We lease the properties described above except that we own 179,000 square
feet of manufacturing, office and warehouse space in Chippewa Falls, Wisconsin.
We also lease a total of approximately 10,654 square feet primarily for
sales and service offices in various domestic locations. In addition, various
foreign sales and service subsidiaries have leased an aggregate of approximately
22,720 square feet of office space. We believe our facilities are adequate to
meet our needs in 2001.
ITEM 3. LEGAL PROCEEDINGS
We are not a party to any legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our shareholders during the fourth
quarter of 2000.
20
21
ITEM E.O. EXECUTIVE OFFICERS OF THE COMPANY
Our executive officers as of March 19, 2001, were as follows:
NAME AGE POSITION
---- --- --------
Burton J. Smith 60 Chief Scientist and Director
James E. Rottsolk 56 Chief Executive Officer, President and Chairman
Rene' G. Copeland 53 Vice President - Sales and Marketing
Kenneth W. Johnson 58 Vice President - Finance, Chief
Financial Officer, and Secretary
David R. Kiefer 52 Vice President - Hardware Development
Brian D. Koblenz 40 Vice President - Software Development
Gerald E. Loe 51 Vice President - Worldwide Service
John D. Neale 59 Vice President - Human Resources
Douglas C. Ralphs 42 Vice President - Controller
Katherine L. Rowe 44 Vice President - Manufacturing
Richard M. Russell 56 Vice President - International
Burton J. Smith is one of our co-founders and has been our Chief Scientist
and a Director since our inception in 1987. He is a recognized authority on high
performance computer architecture and programming languages for parallel
computers, and is the principal architect of the MTA system. Mr. Smith was a
Fellow of the Supercomputing Research Center (now Center for Computing
Sciences), a division of the Institute for Defense Analyses, from 1985 to 1988.
He was honored in 1990 with the Eckert-Mauchly Award given jointly by the
Institute for Electrical and Electronic Engineers and the Association for
Computing Machinery, and was elected a Fellow of both organizations in 1994. Mr.
Smith received S.M., E.E. and Sc.D. degrees from the Massachusetts Institute of
Technology.
James E. Rottsolk is one of our co-founders and has served as our Chief
Executive Officer, President and a Director since our inception in 1987. He
became Chairman of the Board in December 2000. Prior to 1987, Mr. Rottsolk
served as an executive officer with several high technology start-up companies.
Mr. Rottsolk received a B.A. degree from St. Olaf College and A.M. and J.D.
degrees from the University of Chicago.
Rene' G. Copeland joined us as Vice President -- Sales and Marketing in
February 2000. From 1998 to joining us, Mr. Copeland worked at IBM, where he
served as the Manager of the World-Wide Manufacturing Segment for the RS6000 SP
Supercomputer. Prior to joining IBM, Mr. Copeland held a variety of senior
management, marketing and sales positions at Silicon Graphics, Inc., and Cray
Research, Inc. Mr. Copeland graduated from the U.S. Military Academy at West
Point with a B.S. Electrical Engineering, and received a M.B.A. from the
University of Chicago.
Kenneth W. Johnson joined us in September 1997 as Vice President - Finance,
Chief Financial Officer and Secretary. Prior to joining us, Mr. Johnson
practiced law in Seattle for twenty years with Stoel Rives LLP and predecessor
firms, where his practice emphasized corporate finance. Mr. Johnson received an
A.B. degree from Stanford University and a J.D. degree from Columbia University
Law School.
Brian D. Koblenz served as our Group Leader, Languages and Compilers, from
1990 until May 1994, when he assumed his present position as Vice President --
Software Development. Prior to joining us, Mr. Koblenz was Principal Software
Engineer at Digital Equipment Corporation from 1986 to 1989. He was lead
designer of Digital's high performance vector
21
22
FORTRAN compiler and participated in the Alpha architecture and VAX
vectorization efforts. He received a B.S. from the University of Vermont and a
M.S. from the University of Washington.
David R Kiefer joined us as Vice President - Hardware Engineering in April
2000. From 1996 to 2000, Mr. Kiefer was Director of Hardware Engineering at the
Cray Research operations of Silicon Graphics, Inc. Prior to joining Silicon
Graphics, he held a variety of engineering and engineering management positions
with Univac and Cray Research, Inc. Mr. Kiefer received his B.S. in Electrical
Engineering from the University of Wisconsin.
Gerald E. Loe joined us in 1992 as Vice President - Hardware Engineering
and Manufacturing. He was named Vice President -- Hardware Engineering in 1996,
and Vice President -- Worldwide Service in April 2000. Prior to joining us, he
was Vice President of Operations at Siemens Quantum Inc., a high-end radiology
ultrasound company, from 1989 to 1992. Mr. Loe received a B.S.M.E. from the
Massachusetts Institute of Technology and a M.B.A. from Harvard Business School.
John D. Neale joined us as Vice President -- Human Resources in December
2000. He served in various positions with Battelle Memorial Institute in
Columbus, Ohio, from 1988 to 2000, most recently as Director of Human Resources.
From 1974 to 1988, Mr. Neale held various managerial positions with components
of General Electric Co. He received a Masters in Industrial Relations at the
University of Wisconsin and his undergraduate degree at St. Francis College in
Ft. Wayne, Indiana.
Douglas C. Ralphs joined us as Vice President -- Corporate Controller in
November 2000. He was chief financial officer at Interpoint, Inc. from 1998
until he joined us, and held various financial management positions at Itron,
Inc. from 1989 to 1998, serving as treasurer from 1997 to 1998. He previously
held financial positions with Hewlett-Packard Co. and Morrison Knudsen. He
received a M.B.A. from the University of Chicago and a B.A. from Boise State
University.
Katherine L. Rowe joined us as Director of Manufacturing in 1994 and was
named Vice President - Manufacturing in 1996. Prior to joining us, Ms. Rowe was
an Engineering Manager at ELDEC Corporation, an aerospace electronics company,
and was Manufacturing Manager and Project Manager in new product development at
Physio-Control Corporation, a medical electronics company. She received her S.M.
from Massachusetts Institute of Technology and her B.S.M.E. from Purdue
University.
Richard M. Russell joined us as Director of New Business Development in
1995 and was named Vice President - Marketing in March 1998. In February 2000 he
was appointed Vice President -- International. Prior to joining us, he worked in
a variety of sales and marketing positions at several high technology companies,
including Cray Research, Inc. from 1976 through 1990 and Kendall Square Research
Corporation from 1991 through 1994. Mr. Russell was educated in England.
22
23
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is traded on the Nasdaq National Market under the symbol
CRAY; prior to April 1, 2000, our stock traded under the symbol TERA. On March
19, 2001, we had 39,375,541 shares of common stock outstanding that were held by
763 holders of record. We have not paid cash dividends on our common stock. We
currently anticipate that we will retain all available funds for use in our
business and do not anticipate paying any cash dividends on our common stock in
the foreseeable future. In addition our credit facilities restrict our ability
to pay cash dividends.
The quarterly high, low and closing sales prices of our common stock for the
periods indicated are as follows:
1999 2000
------------------------------- ---------------------------------
High Low Close High Low Close
------ ------- ----- ------ ------- -------
First Quarter 9 3/4 4 7 1/4 11 1/2 4 1/8 6 7/16
Second Quarter 7 4 1/2 5 1/2 6 7/8 3 3 7/16
Third Quarter 6 3/16 2 7/8 4 1/8 7 5/8 3 9/32 4 15/32
Fourth Quarter 5 5/8 2 15/16 4 1/2 4 1/2 1 1/8 1 1/2
On March 19, 2001, the closing sale price for the common stock was $1.78. These
quotations reflect inter-dealer prices, without retail mark-up, mark-down or
commission, and may not represent actual transactions.
23
24
ITEM 6. SELECTED FINANCIAL DATA
Financial data for fiscal year 2000 in the following table includes nine months
of activity of the Cray Research business acquired on April 1, 2000.
(In thousands, execpt for per share amounts and statistical data)
Years Ended December 31, 1996 1997 1998 1999 2000
-------- -------- -------- -------- ---------
Operating Data:
Product Revenue $ $ $ 1,274 $ 1,794 $ 46,617
Service Revenue 714 320 71,455
Cost of Product Revenue 3,759 15,165 32,505
Cost of Service Revenue 584 273 34,077
Research and Development 10,319 13,142 13,664 15,216 48,426
Net Loss (12,077) (15,755) (19,803) (34,532) (25,388)
Comprehensive Loss (18,806) (18,672) (20,736) (34,647) (25,516)
Net Loss per Common Share $ (3.53) $ (2.13) $ (1.70) $ (1.74) $ (0.78)
Weighted Average
Outstanding Shares 5,321 8,785 12,212 19,906 32,699
Balance Sheet Data:
Cash and Cash Equivalents $ 929 $ 13,329 $ 3,162 $ 10,069 $ 4,626
Working Capital (22) 14,342 7,269 9,208 (28,205)
Warranty Reserves, Long-term Portion 14,285
Capital Leases, Long-term Portion 114 532 573 390 284
Notes Payable, Long-term Portion 1,022 254
Total Assets 4,617 20,859 20,288 23,410 136,193
Redeemable Securities 9,478
Shareholders' Equity 1,128 6,368 11,889 14,307 36,147
Statistical Data:
Number of Full-time Employees 61 84 109 123 886
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
PRELIMINARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
The information set forth in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" below includes "forward- looking
statements" within the meaning of Section 21E of the Securities Exchange Act of
1934, and is subject to the safe harbor created by that Section. Factors that
realistically could cause results to differ materially from those projected in
the forward looking statements are set forth in this section and under "Business
- --Factors That Could Affect Future Results." The following discussion should
also be read in conjunction with the Financial Statements and accompanying Notes
thereto.
24
25
OVERVIEW
We design, develop, market and service high-performance computer systems,
commonly known as supercomputers. We presently market two computer systems, the
Cray SV1 and T3E, and provide maintenance services to the world-wide installed
base of these and earlier models of Cray computers. We are developing
enhancements to the Cray SV1, and we are developing three new computer systems,
the MTA-2, based on our multithreaded architecture system, the Super Cluster, a
highly parallel system using leading commercial off-the-shelf components, and
the SV2, which will combine elements of the SV1 and T3E computers.
In 2000 we largely were involved in the separation of the Cray Research
operations from those of SGI and integrating them with our own. This process
included establishing separate network, communications and other infrastructure
services, reconstituting the marketing and sales operations, setting up
subsidiary operations for international sales and services, implementing new
operational policies and procedures, and identifying and filling openings in
management, administration and other areas.
We have experienced net losses in each year of operations. We incurred net
losses of approximately $25.4 million in 2000, $34.5 million in 1999 and $19.8
million in 1998.
We recognize revenue from sales of our computer systems upon acceptance by
the customer, although depending on sales contract terms, revenue may be
recognized when title passes upon shipment or may be delayed until funding is
certain. We recognize service revenue from the maintenance of our computer
systems ratably over the term of each maintenance agreement.
Factors that should be considered in evaluating our business, operations and
prospects and that may affect our future results and financial condition are set
forth above, beginning on page 11.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998.
With the acquisition of the Cray Research business unit on April 1, 2000,
period-to-period comparisons of our operating results that include periods prior
to the acquisition are not indicative of results for any future period.
REVENUE. We had revenue from product sales of $46.6 million for 2000, up
from $1.8 million in 1999 and $1.3 million in 1998. Product revenue represented
39% of total revenues for 2000 and consisted primarily of $19.1 million for our
SV1 product line and $27.3 million for our T3E product line. 1999 revenues
included $1.7 million from the upgrade of the MTA system at the San Diego
Supercomputer Center ("SDSC") to eight processors, and 1998 revenues included
$1.3 million from the sale of the two-processor MTA system to SDSC, our first
revenue as Tera Computer Company from product sales.
25
26
We had service revenue of $71.5 million for 2000, up from $320,000 in 1999
and $714,000 in 1998. Services are provided under separate maintenance contracts
with our customers. These contracts generally provide for maintenance services
for one year, although some are for multi-year periods. The overall increase in
service revenue is due to the acquisition of the Cray product line and related
service business in April 2000. We expect service revenue to decline slowly over
the next year or so as older systems are withdrawn from service and then to
stabilize as our new systems are placed in service. Service revenue represented
61% of total revenues for 2000.
OPERATING EXPENSES. Cost of product revenue was $32.5 million for 2000,
$15.2 million for 1999 and $3.8 million for 1998. Cost of product revenue for
2000 represented 70% of product revenue for 2000. The high cost of product
revenue in 2000 is due to the age of the SV1 and T3E product lines and inventory
adjustments for SV1 and MTA gallium arsenide parts. Cost of product revenue was
high in 1999 and 1998 as a percentage of the revenue due to the inclusion of
manufacturing costs and inventory adjustments relating to the MTA product line
and favorable pricing terms provided to our first MTA customer.
Cost of service revenue was $34.1 million for 2000, $273,000 for 1999 and
$584,000 for 1998. Cost of service revenue for 2000 was net of $18.4 of warranty
reserve utilization. Cost of service revenue represented 48% of service revenues
for 2000.
Research and development expenses reflect our costs associated with the
enhancements to the Cray SV1 and T3E systems and the development of the MTA and
SV2 systems, including related software development. These costs also include
personnel expenses, allocated overhead and operating expenses, software,
materials and engineering expenses, including payments to third parties. These
costs are offset in part by governmental development funding. Net research and
development expenses were $48.4 million in 2000, $15.2 million for 1999 and
$13.7 million for 1998. Research and development expenses in 2000 represented
41% of revenue. We expect that research and development expenses will decrease
slightly in 2001, with increases in engineering personnel, principally software
engineers, being offset by decreases in third-party non-recurring engineering
expenses as we complete development of the MTA-2 and SV-2 systems. In subsequent
years, unless we obtain additional governmental development funding to replace
funding for projects as they are completed, the net amount of research and
development expenditures will increase. Over time, with receipt of increased
revenue from products currently under development and sales of the NEC SX-5
series of computers, we expect research and development expenses to decrease as
a percentage of overall revenue.
Marketing and sales expense were $14.4 million in 2000, $2.5 million in 1999
and $1.8 million in 1998. The increase in these expenses for 2000 over 1999 was
due to the acquisition of the Cray Research business unit, which required us to
re-establish the Cray sales and customer support staff and increase expenditures
in connection with sales and marketing, benchmarks and development of third
party applications software. The increase in these expenses for 1999 over 1998
was due largely to higher wages and operating costs.
General and administrative expenses were $7.0 million for 2000, $3.1
million in 1999 and $2.1 million in 1998. The increase in these expenses for
2000 over 1999 was due to the
26
27
acquisition of the Cray Research operations, which required us to add managerial
and administrative staff and increases in legal, accounting and consulting
expenses in connection with establishing foreign operations and implementing new
accounting systems. The increase in 1999 expenses over 1998 was due largely to
higher wages, and operating costs associated with being a publicly owned
company. General and administrative expenses are expected to increase as we
complete our administrative staffing, but should decline as a percentage of
revenue.
We incurred amortization expense of $5.2 million in 2000 primarily related
to the goodwill and intangible assets from the acquisition of the Cray Research
business unit.
INTEREST INCOME (EXPENSE). Interest income was $690,000 for 2000, $537,000
for 1999, and $366,000 for 1998, reflecting the Company's increased cash
position due to the sales of equity securities in the first quarter of 2000, and
in 1999 and 1998.
Interest expense was $2.4 million for 2000, $815,000 for 1999 and $189,000
for 1998. The increase in 2000 was largely due to imputed interest expense of
$1.4 million for 2000 on the non-interest bearing note issued to SGI, a non-cash
interest expense of approximately $336,000 associated with the value of the
conversion feature of certain investor promissory notes, a non-cash expense of
$200,000 for the value of warrants issued in conjunction with investor
promissory notes and $92,000 of interest paid on a line of credit. The increase
in 1999 was largely due to a non-cash interest expense of approximately $278,000
associated with the value of the conversion feature of certain convertible
promissory notes issued in the first quarter of 1999. The 1999 results also
include a non-cash expense for the value of detachable warrants issued in
conjunction with convertible promissory notes, of which $249,000 was recognized
upon conversion in the second quarter of 1999.
TAXES. We made a provision of $831,000 for international income taxes in
2000. As of December 31, 2000, we had net operating loss carry-forwards of
approximately $119.4 million which expire in years 2003 through 2020, if not
utilized.
PREFERRED STOCK. In the second quarter of 1999, all of our outstanding
preferred stock was converted to common stock. The dividends for 1998 were
accrued on our Series A Convertible Preferred Stock, and were higher than that
accrued during the comparable period of 1999 because we had more shares of
Preferred Stock then outstanding.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents totaled $4.6 million at December 31, 2000
compared to $10.1 million at December 31, 1999. Restricted cash balances, which
serve as collateral for capital
27
28
equipment loans and leases, totaled $761,000 at December 31, 2000, and $1.1
million at December 31, 1999.
Net cash provided by operating activities was $5.1 million for the year
ended December 31, 2000, compared to net cash used of $26.3 million in 1999. On
a pro forma basis, in the nine months subsequent to the Cray acquisition we had
net cash provided by operating activities of $13.7 million. For 2000, net
operating cash flows were primarily attributed to increases in depreciation and
amortization, accounts payable and deferred revenue offset in part by increases
in accounts receivable and warranty reserves.
Net cash used in investing activities was approximately $57.4 million for
the year ended December 31, 2000, compared to $427,000 for 1999. In 2000, we
paid a total of $50.2 million to SGI to acquire the Cray Research business unit.
We also spent $5.8 million on fixed assets, primarily consisting of computer
hardware and software and electronic test equipment.
Net cash provided by financing activities was $47.0 million for the year
ended December 31, 2000, compared to $33.6 million for 1999. In 2000, we raised
$25.2 million in a private placement of 5.2 million shares of common stock and
$8.9 million from the exercise of common stock warrants. We also raised $12.5
million through the issuance of promissory notes to two investors, retiring $4.2
million of these notes by year-end through conversion into common stock.
Subsequent to December 31, 2000, we have paid the remaining $8.3 million
principal amount and interest through sales of common stock to the investors.
Over the next twelve months our significant cash requirements relate to
operational expenses, consisting primarily of personnel costs, costs of
inventory and third-party engineering expenses, and acquisition of property and
equipment. These expenses include our commitments to acquire components and
manufacturing and engineering services. We expect that anticipated product sales
and maintenance services over the next twelve months will generate positive cash
flow from operations. We secured a $15 million credit facility in March 2001,
and expect that the NEC distribution agreement will be completed in the second
quarter of 2001, at which time NEC will invest $25 million in us. At any
particular time, given the high average selling price of our products, our cash
position is affected by the timing of product sales and the receipt of prepaid
maintenance revenue. In addition, delays in the development of the SV1ex, MTA-2
and SuperCluster systems, all planned to be completed in the next twelve months,
and the SV2 system may require additional capital earlier than planned. While we
believe our cash resources will be adequate for the next 12 months, we may need
to raise additional equity and/or debt capital through our shelf registration
statement, private placements and/or enhanced credit facilities. If we are
successful in our product development and market conditions were favorable, we
may wish to consider financings to enhance our cash position and working capital
position. Financings may not be available to us when needed or, if available,
may not be available on satisfactory terms and may be dilutive to our
shareholders.
RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board issued SFAS No. 133, Accounting
for Derivative Instruments and Hedging Activities, in June 1998, which is
effective for the
28
29
Company beginning January 1, 2001. SFAS No. 133 requires that all derivative
instruments be recorded on the balance sheet at their fair value. Changes in the
fair value of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designed as part of a
hedge transaction and, if it is, the type of hedge transaction. Since we do not
currently hold any derivative instruments, SFAS No. 133 is not expected to have
any impact on the consolidated financial statements.
In December 1999, the United States Securities and Exchange Commission
(SEC) released Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in
Financial Statements, which was required to be adopted in the Company's fourth
fiscal quarter of 2000. SAB No. 101 provides guidance on revenue recognition and
the SEC staff's views on the application of accounting principles to selected
revenue recognition issues. The adoption of SAB No. 101 did not have a material
impact on the consolidated financial statements.
In March 2000, the FASB issued Interpretation No. 44 (FIN 44), Accounting
for Certain Transactions Involving Stock Compensation--an Interpretation of
Accounting Principles Board (APB) Opinion No. 25, which addresses certain
accounting issues which arose under the previously established accounting
principles relating to stock-based compensation. The adoption of this
interpretation did not have a material effect on the Company's consolidated
financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Substantially all of our cash equivalents and marketable securities are
held in money market funds or commercial paper of less than 90 days that is held
to maturity. Accordingly, we believe that the market risk arising from our
holdings of these financial instruments is minimal. We sell our products
primarily in North America, but with significant sales in Asia and Europe. As a
result, our financial results could be affected by factors such as changes in
foreign currency exchange rates or weak economic conditions in foreign markets.
Our products are generally priced in U.S. dollars, and a strengthening of the
dollar could make our products less competitive in foreign markets. While we
commonly sell products with payments in U.S. dollars, our product sales
contracts occasionally call for payment in foreign currencies and to the extent
we do so, we are subject to foreign currency exchange risks. We believe that a
10% change in foreign exchange rates would not have a material impact on the
financial statements. Our foreign maintenance contracts are paid in local
currencies and provide a natural hedge against local expenses. To the extent
that we wish to repatriate any of these funds to the United States, however, we
are subject to foreign exchange risks. We do not hold any derivative instruments
and have not engaged in hedging transactions.
29
30
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS*
Consolidated Balance Sheets at December 31, 1999 and December 31, 2000................. F1
Consolidated Statements of Operations and Comprehensive Loss
for each of the three years in the period ended December 31, 2000............... F2
Consolidated Statements of Shareholders' Equity for each of the three years in the
period ended December 31, 2000.................................................. F3
Consolidated Statements of Cash Flows for each of the three years in the
period ended December 31, 2000.................................................. F4
Notes to Consolidated Financial Statements............................................. F5
Independent Auditors' Report........................................................... F22
- ----------
* The Financial Statements are located following page 38.
30
31
QUARTERLY FINANCIAL DATA
(in thousands, except per share data)
The following table presents unaudited quarterly financial information for
the two years ended December 31, 2000. In the opinion of management, this
information contains all adjustments, consisting only of normal recurring
adjustments, necessary for a fair presentation thereof. The operating results
are not necessarily indicative of results for any future periods.
1999 2000
-------------------------------------------- --------------------------------------------
For the Quarter Ended 3/31 6/30 9/30 12/31 3/31 6/30 9/30 12/31
------- ------- -------- ------- ------- ------- -------- --------
Revenue $ 661 $ 260 $ 850 $ 343 $ 43 $50,973 $ 33,688 $ 33,368
Cost of Sales 3,017 1,785 9,039 1,597 2,029 27,503 18,426 18,624
Gross margin (2,356) (1,525) (8,189) (1,254) (1,986) 23,470 15,262 14,744
Research and Development 3,033 3,686 4,752 3,745 4,483 13,865 13,272 16,806
Marketing and Sales 632 545 611 729 768 2,822 4,397 6,378
General and Administrative 465 638 551 1,437 1,101 1,898 1,645 2,389
Net Loss (6,811) (6,672) (13,934) (7,115) (8,005) 2,661 (6,097) (13,947)
Comprehensive loss (6,881) (6,717) (13,934) (7,115) (8,005) 2,661 (6,097) (13,875)
Net Income (Loss) Per Common
Share, Basic and Diluted $ (0.47) $ (0.40) $ (0.59) $ (0.29) $ (0.27) $ 0.08 $ (0.18) $ (0.41)
The Company's future operating results may be subject to quarterly
fluctuations as a result of a number of factors, including the timing of
deliveries of the Company's products. See "Business -- Factors That Could Affect
Future Results." Quarter-to-quarter comparisons should not be relied upon as
indicators of future performance.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
31
32
PART III
Certain information required by Part III is omitted from this Report as we will
file a definitive proxy statement for the Annual Meeting of Shareholders to be
held on May 16, 2001, pursuant to Regulation 14A (the "Proxy Statement") not
later than 120 days after the end of the fiscal year covered by this Report, and
certain information included in the Proxy Statement is incorporated herein by
reference. Only those sections of the Proxy Statement which specifically address
the items set forth herein are incorporated by reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
Information with respect to our Directors may be found under the captions
"The Board of Directors" and "Election of Three Directors" in our Proxy
Statement. Such information is incorporated herein by reference. Information
with respect to Executive Officers may be found beginning on page 21 above,
under the caption "The Executive Officers of the Company." Information with
respect to compliance with Section 16(a) of the Exchange Act by the persons
subject thereto may be found under the caption "Information About Our Common
Stock Ownership" in the Proxy Statement and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information in the Proxy Statement set forth under the captions "How We
Compensate Directors," "How We Compensate Executive Officers," "The Board of
Directors" and "The Committees of the Board" is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information in the Proxy Statement set forth under the caption
"Information About Our Common Stock Ownership" is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information set forth under the caption "Certain Transactions" in the
Proxy Statement is incorporated herein by reference.
32
33
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES,
AND REPORTS ON FORM 8-K
(a) EXHIBIT LISTING
2.1 Asset Purchase Agreement between Silicon Graphics, Inc. and the
Company, dated as of March 1, 2000(3)
2.2 Amendment No. 1 to the Asset Purchase Agreement between Silicon
Graphics, Inc., and the Company, dated as of March 31, 2000(3)
2.3 Technology Agreement between Silicon Graphics and the Company,
effective as of March 31, 2000(4)
2.4 Services Contract Agreement between Silicon Graphics, Inc. and the
Company, dated as of March 31, 2000(4)
2.5 Transition Services Agreement between Silicon Graphics, Inc., and
the Company, dated as of March 31, 2000(4)
3.1 Restated Articles of Incorporation(1)
3.2 Restated Bylaws
10.1 1988 Stock Option Plan(2)
10.2 1993 Stock Option Plan(2)
10.3 1995 Stock Option Plan(2)
10.4 1995 Independent Director Stock Option Plan(2)
10.5 1999 Stock Option Plan(5)
10.6 2000 Non-Executive Stock Option Plan(5)
10.7 Lease Agreement between Merrill Place, LLC and the Company, dated
November 21, 1997(6)
10.8 Agreement between CIT Group/Business Credit, Inc. and the Company,
dated June 29, 2000(1)
10.9 Fab I Building Lease Agreement between Union Semiconductor
Technology Corporation and the Company, dated as of June 30,
2000.
10.10 Conference Center Lease Agreement between Union Semiconductor
Technology Corporation and the Company, dated as of June 30, 2000.
10.11 Mendota Heights Office Lease Agreement between the Teachers
Retirement System of the State of Illinois and the Company,
dated as of August 10, 2000.
23.1 Independent Auditors' Consent
- ----------
(1) Incorporated by reference to the Company's Report on Form 10-Q as filed
with the Commission on August 14, 2000.
(2) Incorporated by reference to Form SB-2 Registration Statement, Registration
No. 33-95460-LA, as filed with the Commission on August 3, 1995.
(3) Incorporated by reference to the Company's Report on Form 8-K, as filed
with the Commission on April 17, 2000
33
34
(4) Incorporated by reference to the Company's Report on Form 8-K, as filed
with the Commission on May 15, 2000
(5) Incorporated by reference to the Company's Registration Statement on Form
S-8, Registration No. 333-57970, as filed with the Commission on March 30,
2001
(6) Incorporated by reference to the Company's Report on Form 10-K, as filed
with the Commission for the fiscal year ended December 31, 1997.
(b) REPORTS ON FORM 8-K
We filed no reports on Form 8-K in the fourth quarter of 2000.
34
35
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the Company
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized in the City of Seattle, State of Washington, on March 30, 2001.
CRAY INC.
By JAMES E. ROTTSOLK
---------------------------------------
James E. Rottsolk
Chief Executive Officer and President
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of Company and in the capacities indicated on
March 30, 2001.
Signature Title
--------- -----
By JAMES E. ROTTSOLK Chief Executive Officer,
--------------------------------- President and Chairman of
James E. Rottsolk the Board of Directors
By BURTON J. SMITH Chief Scientist and Director
---------------------------------
Burton J. Smith
By KENNETH W. JOHNSON Chief Financial Officer
---------------------------------
Kenneth W. Johnson
By DOUGLAS C. RALPHS Chief Accounting Officer
---------------------------------
Douglas C. Ralphs
By DAVID N. CUTLER Director
---------------------------------
David N. Cutler
By DANIEL J. EVANS Director
---------------------------------
Daniel J. Evans
By KENNETH W. KENNEDY Director
---------------------------------
Kenneth W. Kennedy
By STEPHEN C. KIELY Director
---------------------------------
Stephen C. Kiely
35
36
By WILLIAM A. OWNES Director
---------------------------------
William A. Owens
By: TERREN S. PEIZER Director
---------------------------------
Terren S. Peizer
By DEAN D. THORNTON Director
---------------------------------
Dean D. Thornton
36
37
EXHIBIT INDEX
2.1 Asset Purchase Agreement between Silicon Graphics, Inc. and the
Company, dated as of March 1, 2000(3)
2.2 Amendment No. 1 to the Asset Purchase Agreement between Silicon
Graphics, Inc., and the Company, dated as of March 31, 2000(3)
2.3 Technology Agreement between Silicon Graphics and the Company,
effective as of March 31, 2000(4)
2.4 Services Contract Agreement between Silicon Graphics, Inc. and the
Company, dated as of March 31, 2000(4)
2.5 Transition Services Agreement between Silicon Graphics, Inc., and
the Company, dated as of March 31, 2000(4)
3.1 Restated Articles of Incorporation(1)
3.2 Restated Bylaws
10.1 1988 Stock Option Plan(2)
10.2 1993 Stock Option Plan(2)
10.3 1995 Stock Option Plan(2)
10.4 1995 Independent Director Stock Option Plan(2)
10.5 1999 Stock Option Plan(5)
10.6 2000 Non-Executive Stock Option Plan(5)
10.7 Lease Agreement between Merrill Place, LLC and the Company, dated
November 21, 1997(6)
10.8 Agreement between CIT Group/Business Credit, Inc. and the Company,
dated June 29, 2000(1)
10.9 Fab I Building Lease Agreement between Union Semiconductor
Technology Corporation and the Company, dated as of June 30,
2000.
10.10 Conference Center Lease Agreement between Union Semiconductor
Technology Corporation and the Company, dated as of June 30, 2000.
10.11 Mendota Heights Office Lease Agreement between the Teachers
Retirement System of the State of Illinois and the Company,
dated as of August 10, 2000.
23.1 Independent Auditors' Consent
- ----------
(1) Incorporated by reference to the Company's Report on Form 10-Q as filed
with the Commission on August 14, 2000.
(2) Incorporated by reference to Form SB-2 Registration Statement, Registration
No. 33-95460-LA, as filed with the Commission on August 3, 1995.
(3) Incorporated by reference to the Company's Report on Form 8-K, as filed
with the Commission on April 17, 2000
37
38
(4) Incorporated by reference to the Company's Report on Form 8-K, as filed
with the Commission on May 15, 2000
(5) Incorporated by reference to the Company's Registration Statement on Form
S-8, Registration No. 333-57970, as filed with the Commission on March 30,
2001
(6) Incorporated by reference to the Company's Report on Form 10-K, as filed
with the Commission for the fiscal year ended December 31, 1997.
38
39
CRAY INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
December 31, December 31,
1999 2000
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 10,069 $ 4,626
Restricted cash 1,132 761
Accounts receivable 641 25,159
Inventory, net 4,513 23,637
Prepaid expenses and other assets 544 2,835
--------- ---------
Total current assets 16,899 57,018
Property and equipment, net 5,829 25,535
Spares inventory, net 21,139
Goodwill and intangible assets, net 186 29,578
Other assets 496 2,923
--------- ---------
TOTAL $ 23,410 $ 136,193
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,366 $ 16,247
Accrued payroll and related expenses 2,147 12,028
Accrued loss on purchase commitment 6,006
Other accrued liabilities 209 6,574
Deferred revenue 68 17,666
Current portion of warranty reserves 17,996
Current portion of obligations under capital leases 612 349
Current portion of notes payable 289 8,357
--------- ---------
Total current liabilities 7,691 85,223
Warranty reserves 14,285
Obligations under capital leases 390 284
Notes payable 1,022 254
Commitments and contingencies
Shareholders' equity:
Common Stock, par $.01 - Authorized, 100,000 shares;
issued and outstanding, 25,212 and 35,250 shares 111,443 158,799
Accumulated deficit (97,136) (122,524)
Accumulated other comprehensive income:
Cumulative currency translation adjustment (128)
--------- ---------
14,307 36,147
--------- ---------
TOTAL $ 23,410 $ 136,193
========= =========
See accompanying notes.
F-1
40
CRAY INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(in thousands, except per share data)
Years ended December 31,
-----------------------------------
1998 1999 2000
-------- -------- ---------
Revenue:
Product $ 1,274 $ 1,794 $ 46,617
Service 714 320 71,455
-------- -------- ---------
Total revenue 1,988 2,114 118,072
-------- -------- ---------
Operating expenses:
Cost of product revenue 3,759 15,165 32,505
Cost of service revenue 584 273 34,077
Research and development 13,664 15,216 48,426
Marketing and sales 1,830 2,517 14,365
General and administrative 2,131 3,091 7,033
Amortization of goodwill and intangible assets 5,217
-------- -------- ---------
Total operating expenses 21,968 36,262 141,623
-------- -------- ---------
Loss from operations (19,980) (34,148) (23,551)
Other income (expense), net (106) 675
Interest income (expense), net 177 (278) (1,681)
-------- -------- ---------
Loss before income taxes (19,803) (34,532) (24,557)
Provision for income taxes 831
-------- -------- ---------
Net loss (19,803) (34,532) (25,388)
Preferred stock dividend (468) (115)
Amortization of preferred stock discount (465)
-------- -------- ---------
Net loss for common shareholders (20,736) (34,647) (25,388)
Other comprehensive income:
Currency translation adjustment (128)
-------- -------- ---------
Comprehensive loss $(20,736) $(34,647) $ (25,516)
======== ======== =========
Basic and diluted net loss per common share $ (1.70) $ (1.74) $ (0.78)
======== ======== =========
Weighted average shares outstanding, basic
and diluted 12,212 19,906 32,699
======== ======== =========
See accompanying notes.
F-2
41
CRAY INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands)
Series B Convertible
Preferred Stock Common Stock
--------------------- ------------------------
Number of Number of
Shares Amount Shares Amount
--------- ------ --------- --------
BALANCE, January 1, 1998 $ 11,248 $ 49,168
Exercise of stock options 153 220
Exercise of warrants 433 125
Issuance of shares under Employee
Stock Purchase Plan 30 271
Issuance of common stock for
leasehold improvements 176 1,314
Issuance of common stock for services 3 27
Common stock issued in private placement 800 8,000
Issuance of common stock for
prepaid rent 13 97
Conversion of Series A preferred shares 1,342 9,478
Issuance of Series B preferred stock,
net of issuance costs of $326 6 5,674
Issuance of common stock for
accrued dividends 6 45
Preferred stock dividend
Net loss
------ ------ ------ --------
BALANCE, December 31, 1998 6 5,674 14,204 68,745
Issuance of shares under Employee
Stock Purchase Plan 55 270
Preferred stock dividend distributed
in common stock 36 190
Common stock issued in private
placement, net of issuance costs
of $1,378 7,685 33,148
Beneficial conversion feature in notes
and interest expense recognized on
convertible warrants 595
Conversion of Series B preferred shares (6) (5,674) 1,275 5,559
Issuance of shares under Company
401(k) Plan 36 144
Exercise of stock options 112 55
Exercise of warrants 1,375 14
Options issued for services 77
Warrants issued for services 602
Common stock issued in exchange for notes 434 2,046
Net loss
------ ------ ------ --------
BALANCE, December 31, 1999 25,212 111,443
Issuance of shares under Employee
Stock Purchase Plan 179 754
Cash received on subscribed common stock 900
Common stock issued in private
placement, net of issuance costs
of $1,847 5,227 24,287
Beneficial conversion feature in notes
and interest expense of $200 recognized
on options 1,283
Common stock issued in exchange
for notes, net of issuance costs of $294 1,671 3,906
Issuance of shares under Company
401(k) Plan 14 92
Exercise of stock options 69 182
Exercise of warrants 1,878 8,885
Options issued for services 156
Warrant issued for services 211
Issuance of common stock to SGI 1,000 6,700
Other comprehensive income:
Cumulative currency translation adjustment
Net loss
------ ------ ------ --------
BALANCE, December 31, 2000 $ 35,250 $158,799
====== ====== ====== ========
Preferred Currency
Stock Accumulated Translation
Dividend Deficit Adjustment Total
---------- ----------- ------------ ---------
BALANCE, January 1, 1998 $ $ (42,801) $ 6,367
Exercise of stock options 220
Exercise of warrants 125
Issuance of shares under Employee
Stock Purchase Plan 271
Issuance of common stock for
leasehold improvements 1,314
Issuance of common stock for services 27
Common stock issued in private placement 8,000
Issuance of common stock for
prepaid rent 97
Conversion of Series A preferred shares 9,478
Issuance of Series B preferred stock,
net of issuance costs of $326 5,674
Issuance of common stock for
accrued dividends 45
Preferred stock dividend 75 75
Net loss (19,803) (19,803)
------ --------- ------ ---------
BALANCE, December 31, 1998 75 (62,604) 11,890
Issuance of shares under Employee
Stock Purchase Plan 270
Preferred stock dividend distributed
in common stock (75) 115
Common stock issued in private
placement, net of issuance costs
of $1,378 33,148
Beneficial conversion feature in notes
and interest expense recognized on
convertible warrants 595
Conversion of Series B preferred shares (115)
Issuance of shares under Company
401(k) Plan 144
Exercise of stock options 55
Exercise of warrants 14
Options issued for services 77
Warrants issued for services 602
Common stock issued in exchange for notes 2,046
Net loss (34,532) (34,532)
------ --------- ------ ---------
BALANCE, December 31, 1999 (97,136) 14,307
Issuance of shares under Employee
Stock Purchase Plan 754
Cash received on subscribed common stock 900
Common stock issued in private
placement, net of issuance costs
of $1,847 24,287
Beneficial conversion feature in notes
and interest expense of $200 recognized
on options 1,283
Common stock issued in exchange
for notes, net of issuance costs of $294 3,906
Issuance of shares under Company
401(k) Plan 92
Exercise of stock options 182
Exercise of warrants 8,885
Options issued for services 156
Warrant issued for services 211
Issuance of common stock to SGI 6,700
Other comprehensive income:
Cumulative currency translation adjustment (128) (128)
Net loss (25,388) (25,388)
------ --------- ------ ---------
BALANCE, December 31, 2000 $ $(122,524) $ (128) $ 36,147
====== ========= ====== =========
See accompanying notes.
F-3
42
CRAY INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1999, AND 2000
(in thousands)
1998 1999 2000
-------- -------- --------
Operating activities
Net loss $(19,803) $(34,532) $(25,388)
Adjustments to reconcile net loss to
net cash used by operating activities:
Depreciation and amortization 803 1,881 14,349
Amortization of goodwill and intangible assets 5,217
Loss on disposal of assets 3,289
Imputed interest on non interest bearing note 1,437
Beneficial conversion feature of notes payable 595 336
Non-cash warrant and option expense 602 567
Inventory write down 6,589
Cash provided (used) by changes in operating assets
and liabilities, net of effects of the Cray Research acquisition:
Accounts receivable (279) 78 (20,483)
Inventory (5,955) (2,047) 2,681
Other assets (837) 467 (2,416)
Accounts payable 3,332 (501) 11,587
Other accrued liabilities (49) 5,331
Accrued payroll and related expenses (169) 603 6,032
Warranty reserves (15,053)
Deferred revenue 19 49 17,598
-------- -------- --------
Net cash provided by (used by) operating activities (22,889) (26,265) 5,084
Investing activities
Cash used for acquisition (51,585)
Purchases of property and equipment (2,076) (427) (5,835)
-------- -------- --------
Net cash used by investing activities (2,076) (427) (57,420)
Financing activities
Restricted cash (1,132) 371
Related party (receivable)/payments 61 (34) (129)
Issuance of notes payable 1,900 12,500
Issuance of common stock 8,860 33,488 26,033
Proceeds from exercise of options 55 182
Proceeds from exercise of warrants 8,885
Principal payments on bank note (71) (253)
Sale of preferred stock 5,674
Capital leases 203 (607) (568)
-------- -------- --------
Net cash provided by financing activities 14,798 33,599 47,021
-------- -------- --------
Effect of foreign exchange rate changes on
cash and cash equivalents (128)
Net increase (decrease) in cash and cash equivalents (10,167) 6,907 (5,443)
Cash and cash eqivalents
Beginning of period 13,329 3,162 10,069
-------- -------- --------
End of period $ 3,162 $ 10,069 $ 4,626
======== ======== ========
Supplemental disclosure of cash flow information:
Cash paid for interest $ 202 $ 174 $ 347
Non-cash investing and financing activities
Inventory reclassified to property and equipment 1,191 5,233
Common stock issued for acquisition of business 6,700
Fixed asset additions through common stock 1,314 164
Fixed asset additions through notes payable 933
Fixed asset additions through capital leases 493 199
Note payable converted to common stock 2,045 4,200
Accounts payable converted to notes 594
Stock dividends 250 190
Beneficial conversion feature on notes payable 1,083
See accompanying notes.
F-4
43
CRAY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
($ TABLES IN THOUSANDS)
NOTE 1 DESCRIPTION OF BUSINESS
Cray Inc. ("Cray" or the "Company") (formerly "Tera Computer
Company") designs, develops, markets and services high-performance
computer systems, commonly known as supercomputers. The Company
presently markets two computer systems, the Cray SV1 and T3E, and
provides maintenance services to the installed base of these and
earlier models of Cray computers. The Company is developing
enhancements to the Cray SV1, and is developing three new computer
systems, the MTA-2, based on the Company's multithreaded
architecture system; the SuperCluster, a highly parallel system
using leading commercial off-the-shelf components; and the SV2,
which will combine elements of the SV1 and T3E computers.
The Company has a net loss of $25.4 million for the year ended
December 31, 2000. Management's plans project sufficient cash flows
to finance its planned operations for the next twelve months. In
addition, subsequent to December 31, 2000, the Company entered in to
$15 million financing agreement. (See Note 15 -- Subsequent Events).
The Company also plans on finalizing a distribution agreement with
NEC, which will provide an equity investment of $25 million.
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ACCOUNTING PRINCIPLES
The consolidated financial statements and accompanying notes are
prepared in accordance with accounting principles generally accepted
in the United States of America.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries. Intercompany balances and
transactions have been eliminated. Investments in affiliates which
are not majority owned are reported using the equity method.
BUSINESS COMBINATIONS
For business combinations that have been accounted for under the
purchase method of accounting, the Company includes the results of
operations of the acquired business from the date of acquisition.
Net assets of the companies acquired are recorded at their fair
value at the date of acquisition. The excess of the purchase price
over the fair value of tangible net assets acquired is included in
goodwill and intangible assets in the accompanying consolidated
balance sheets.
F-5
44
USE OF ESTIMATES
Preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect
the amounts reported in the financial statements and accompanying
notes. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of highly liquid financial
instruments that are readily convertible to cash and have original
maturities of three months or less at the time of acquisition.
RESTRICTED CASH
Restricted cash consists of cash equivalents that serve as
collateral pursuant to lease and indebtedness agreements entered
into in 1999 for the acquisition of capital equipment.
GOODWILL AND INTANGIBLE ASSETS
Goodwill and intangible assets are amortized on a straight-line
basis over five years.
FAIR VALUES OF FINANCIAL INSTRUMENTS
At December 31, 2000, the Company had the following financial
instruments: cash and cash equivalents, accounts receivable,
accounts payable, accrued liabilities and notes payable. The
carrying value of cash and cash equivalents, accounts receivable,
accounts payable, accrued liabilities and notes payable approximates
their fair value based on the liquidity of these financial
instruments or based on their short-term nature.
REVENUE RECOGNITION
Cray generally recognizes revenue from product sales upon customer
acceptance; however, depending on sales contract terms, revenue may
be recognized upon shipment, or delayed until funding is definite.
Service revenues from the maintenance of computers are recognized
ratably over the term of the maintenance contract. Funds from
maintenance contracts that are paid in advance are recorded as
deferred revenue.
FOREIGN CURRENCY TRANSLATION
The functional currency of the Company's foreign subsidiaries is the
local currency. Assets and liabilities of foreign subsidiaries are
translated into US dollars at year-end exchange rates, and revenues
and expenses are translated at average rates prevailing during the
year. Translation adjustments are included in accumulated other
comprehensive loss and as a separate component of shareholders'
equity. Transaction gains and losses arising from transactions
denominated in a currency other than the functional currency of the
entity involved, which have been insignificant, are included in the
consolidated statements of operations.
F-6
45
RESEARCH AND DEVELOPMENT
Research and development costs include costs incurred in the
development and production of the Company's hardware and software,
costs incurred to enhance and support existing software features and
expenses related to future implementations of systems. Research and
development costs are expensed as incurred. Statement of Financial
Accounting Standards (SFAS) No. 86, Accounting for the Costs of
Computer Software to Be Sold, Leased, or Otherwise Marketed,
requires the capitalization of certain software product costs after
technological feasibility of the software is established. Due to the
relatively short period between the technological feasibility a
product and completion of product development and the insignificance
of related costs incurred during this period, no software
development costs were capitalized.
INVENTORIES
Inventories are valued at the lower of cost (first-in, first-out) or
market (LCM). The Company regularly evaluates the technological
usefulness of various inventory components. When it is discovered
that previously inventoried components do not function as intended
in a fully operational system, the costs associated with these
components are expensed.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost less accumulated
depreciation and amortization. Depreciation is calculated on a
straight-line basis over the estimated useful lives of the related
assets, ranging from three to seven years. Equipment under capital
leases is depreciated over the lease term. Leasehold improvements
are amortized over the lesser of their estimated useful lives or the
term of the lease.
SPARES INVENTORY
Spares inventory is stated at cost, less accumulated depreciation.
Depreciation on spares inventory is computed using the straight-line
method over the estimated useful lives of three or four years.
IMPAIRMENT OF LONG-LIVED ASSETS
Pursuant to SFAS No. 121, management periodically evaluates
long-lived assets, consisting primarily of property and equipment
and goodwill and intangible assets, to determine whether there has
been any impairment of these assets and the appropriateness of their
remaining useful lives. The Company evaluates impairment whenever
events or changes in circumstances indicate that the carrying amount
of the Company's assets might not be recoverable. Accordingly,
during 2000, the Company recorded an impairment loss of $3.3 million
on certain obsolete fixed assets included in cost of product sales
in the Consolidated Statement of Operations and Comprehensive Loss.
F-7
46
INCOME TAXES
The Company accounts for income taxes under SFAS No. 109, Accounting
for Income Taxes. Deferred tax assets and liabilities are determined
based on differences between financial reporting and tax bases of
assets and liabilities and are measured using the enacted tax rates
and laws that will be in effect when the differences are expected to
reverse. The Company provides a valuation allowance, if necessary,
to reduce deferred tax assets to their estimated realizable value.
RECLASSIFICATIONS
Certain prior-year amounts have been reclassified to conform with
the current-year presentation.
NET LOSS PER SHARE
Basic and diluted net loss per share is computed based on the
weighted average number of shares of common stock outstanding.
Net loss per share has been computed in accordance with SFAS No.
128, Earnings per Share. Under the provisions of SFAS No. 128, basic
net loss per share is computed by dividing the net comprehensive
loss for the period by the weighted average number of common shares
outstanding. Common stock equivalent shares related to stock
options, warrants and shares subject to repurchase are excluded from
the calculation as their effect is antidilutive. Accordingly, basic
and diluted net loss per share are equivalent.
SEGMENT INFORMATION
The Company has organized and managed its operations in a single
operating segment providing global sales and service of high
performance computers. See note 14 -- Segment Information.
WARRANTY RESERVE
Certain components in the T90 vector computers sold by Silicon
Graphics Inc. ("SGI") prior to the Company's acquisition of the Cray
Research operations have an unusually high failure rate. The cost of
servicing the T90 computers exceeds the related service revenues.
The Company is continuing to take action that commenced prior to the
acquisition to address this problem, and has recorded a reserve to
provide for anticipated future losses on the T90 maintenance service
contracts. Included in warranty reserves at December 31, 2000, is an
accrual of $31.5 million for estimated losses on service contracts
covering the Cray Business' T90 product line. The reserve is
calculated as the excess of estimated service costs over estimated
service revenues for the term of the related contracts. Estimated
service costs include cost of repair parts, direct costs of service,
indirect labor, and overhead allocations based on management
estimates of time dedicated to service T-90 contracts. Stated
contract terms are adjusted for management estimates of when T-90
products will be replaced before the expiration of the service
contract term. A summary of warranty reserve is as follows (in
thousands):
F-8
47
Balance Balance
December 31, 2000 2000 December 31,
1999 Additions Deductions 2000
------------ --------- ----------- ------------
Warranty Reserve $ -- $47,461 $(15,180) $32,281
==== ======= ======== =======
RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities, in
June 1998, which is effective for the Company beginning January 1,
2001. SFAS No. 133 requires that all derivative instruments be
recorded on the balance sheet at their fair value. Changes in the
fair value of derivatives are recorded each period in current
earnings or other comprehensive income, depending on whether a
derivative is designed as part of a hedge transaction and, if it is,
the type of hedge transaction. Since the Company does not currently
hold any derivative instruments, SFAS No. 133 is not expected to
have any impact on the consolidated financial statements.
In December 1999, the United States Securities and Exchange
Commission (SEC) released Staff Accounting Bulletin (SAB) No. 101,
Revenue Recognition in Financial Statements, which was required to
be adopted in the Company's fourth fiscal quarter of 2000. SAB No.
101 provides guidance on revenue recognition and the SEC staff's
views on the application of accounting principles to selected
revenue recognition issues. The adoption of SAB No. 101 did not have
a material impact on the consolidated financial statements.
In March 2000, the FASB issued Interpretation No. 44 (FIN 44),
Accounting for Certain Transactions Involving Stock Compensation--an
Interpretation of Accounting Principles Board (APB) Opinion No. 25,
which addresses certain accounting issues which arose under the
previously established accounting principles relating to stock-based
compensation. The adoption of this interpretation did not have a
material effect on the Company's consolidated financial statements.
F-9
48
NOTE 3 PROPERTY AND EQUIPMENT, NET
A summary of property and equipment is as follows (in thousands):
December 31,
-----------------------
1999 2000
-------- --------
Land $ $ 139
Building 8,130
Furniture and equipment 736 1,504
Computer equipment 8,458 28,754
Leasehold improvements 1,974 2,309
-------- --------
11,168 40,836
Accumulated depreciation (5,339) (15,301)
-------- --------
Property and equipment, net $ 5,829 $ 25,535
======== ========
NOTE 4 INVENTORY, NET
A summary of inventory is as follows (in thousands):
December 31,
-----------------------
1999 2000
-------- --------
Components and subassemblies $ 8,044 $ 14,884
Work in process 806 10,148
Finished goods 1,137 936
-------- --------
9,987 25,968
LCM adjustment (5,474) (2,331)
-------- --------
Inventory, net $ 4,513 $ 23,637
======== ========
Balance Balance
December 31, 2000 2000 December 31,
1999 Additions Deductions 2000
------------- ---------- ----------- -------------
LCM adjustment $5,474 $3,200 $(6,343) $2,331
====== ====== ======== ======
F-10
49
NOTE 5 SPARES INVENTORY, NET
A summary of spares inventory is as follows (in thousands):
December 31,
-------------------
1999 2000
----- --------
Spares inventory $ -- $ 27,697
Accumulated depreciation -- (6,558)
----- --------
Spares inventory, net $ -- $ 21,139
===== ========
NOTE 6 ACQUISITION
The Company acquired certain assets of the Cray Research business
unit from Silicon Graphics, Inc. ("SGI") on April 1, 2000, in
exchange for cash of $15.0 million, the issuance of one million
shares of common stock valued at $6.7 million, and the issuance of a
$35.3 million non-interest bearing promissory note. Commencing April
1, 2000, the Company has included the results of operations of the
Cray Research business unit in its consolidated results of
operations.
The Company has accounted for this transaction under the purchase
method of accounting in accordance with the APB Opinion No. 16.
Under the purchase method of accounting, the purchase price was
allocated to the assets acquired and liabilities assumed based on
their estimated fair values.
The following table summarizes the purchase accounting for the
acquisitions (in thousands):
Current and long term assets $ 80,165
Goodwill and intangible assets 34,906
Liabilities assumed (58,223)
--------
Net assets acquired 56,848
Less: acquisition costs (1,326)
--------
Purchase price $ 55,522
========
The following table presents the results of operations of the
Company on a pro forma basis. These results are based on the
individual historic results of the Company and the Cray Research
business unit and reflect adjustments to give effect to the
acquisitions as if they had occurred at the beginning of the periods
presented (in thousands):
F-11
50
December 31,
----------------------
1999 2000
-------- --------
(unaudited)
Revenue $287,771 $183,820
======== ========
Net income $ 31,536 $ 5,142
======== ========
Basic and diluted net income per common share $ 1.51 $ 0.16
======== ========
Weighted average shares used to compute
basic and diluted net income per common share 20,906 32,949
======== ========
NOTE 7 RELATED PARTY TRANSACTIONS
During 2000, the Company accepted promissory notes in the aggregate
principal amount of $326,000 as collateral for payment by the
Company of option exercises and federal income taxes due from the
exercise of employee stock options. These notes replaced promissory
notes in the aggregate principal amount of $341,000 originally
issued during 1999. The notes are due and payable in twelve months
and bear interest at a rate of 5.74% per year. These notes and the
unpaid accrued interest are secured by a pledge of shares of Cray's
common stock. The Company's rights to payment are not limited to
such security. The options exercised under these notes are
considered to be variable employee stock options under current
accounting literature. Accordingly, compensation is recognized to
the extent the fair value of the Company's stock exceeds the
options' exercise price.
The Company also has an unsecured promissory note in the aggregate
principal amount of $138,000 from the Chief Executive Officer of the
Company. The note is due and payable on March 31, 2001, including
accrued interest at a rate of 9.5%. The Company recorded interest
income of $1,100 for year ended December 31, 2000, on the note. The
note was paid in full on February 6, 2001.
The Company paid fees of $1.8 million as part of a private placement
completed in February 2000 to a company whose Chairman, CEO and
principal shareholder is one of the Company's directors.
As part of a common stock purchase agreement in October and December
2000 (See Note 12 -- Shareholders' Equity) the Company has accrued
fees of $294,000 to a company whose Chairman, CEO and principal
shareholder is one of the Company's directors.
NOTE 8 LEASE AGREEMENTS
The Company leases certain property and equipment under capital
leases pursuant to master equipment lease agreements. Under such
agreements, the Company has acquired computer and other equipment in
the amount of $1,856,000 and $2,114,000, for which $1,023,000 and
$1,550,000 of accumulated depreciation was recorded as of December
31, 1999, and 2000, respectively.
F-12
51
Minimum lease commitments are (in thousands):
Capital Operating
leases leases
------ --------
2001 $403 $ 3,474
2002 218 3,529
2003 88 3,013
2004 5 3,083
2005 2,929
Thereafter 8,251
---- -------
714 $24,279
=======
Less amounts representing interest (81)
----
$633
====
Rent expense for 1998, 1999, and 2000 was $961,000, $1,929,000 and
$2,520,000, respectively.
NOTE 9 COMMITMENTS
The Company is contractually committed to acquire components, and
manufacturing and engineering services totaling $16.3 million.
Commitments are for goods and services to be provided to Cray by
either specific dates or by achieving milestones identified in the
contracts.
NOTE 10 FEDERAL INCOME TAXES
Due to continued losses from operations, there has been no provision
for federal income taxes for any period. The provision for income
taxes consisted of (in thousands):
December 31,
----------------------
1998 1999 2000
----- ---- ----
Federal:
Current $ $ $
Deferred
State:
Current
Deferred
Foreign:
Current 831
Deferred
---- ---- ----
Total provision for income taxes $ $ $831
==== ==== ====
F-13
52
The Company did not pay any income taxes in 1998,1999 and 2000 due
to losses from operations. In 2000, the company purchased the assets
of the Cray Research business unit from SGI. Consequently, this is
the Company's first year with foreign income tax liabilities.
Loss before provision for income taxes consisted of (in thousands):
December 31,
------------------------------------
1998 1999 2000
-------- ------- -------
United States $(19,803) $(34,532) $(27,219)
International 1,831
-------- -------- --------
$(19,803) $(34,532) $(25,388)
======== ======== ========
The following table reconciles the federal statutory income tax rate
to the Company's effective tax rate.
1998 1999 2000
------ ------ ------
Federal income tax rate -34.00% -34.00% -34.00%
State taxes
Foreign taxes 3.27%
Other 0.82%
Effect of net operating loss
carryfoward and valuation allowance 33.18% 34.00% 34.00%
------ ------ ------
Effective income tax rate 3.27% 0.00% 0.00%
====== ====== ======
Deferred income taxes reflect the net tax effects of temporary
differences between the tax basis of assets and liabilities and the
corresponding financial statement amounts. Significant components of
the Company's deferred income tax assets are as follows:
F-14
53
1999 2000
-------- --------
Warranty reserve $ 68 $ 10,976
Inventory reserve 1,862 699
Accrued compensation 246 735
Stock issued for services 231
Fixed assets 123 3,340
Research and experimentation 3,022 4,541
Net operating loss carryfowards 29,986 40,587
State tax loss carryfowards 1,577 1,500
-------- --------
Net deferred tax assets 37,115 62,378
Valuation allowance for deferred tax assets (37,115) (62,378)
-------- --------
Deferred tax balance $ $
======== ========
As of December 31, 1998, 1999 and 2000, the Company had federal net
operating loss carryforwards of approximately $60.7 million, $88.3
million and $119.4 million, respectively. The Company also had
federal research and experimentation tax credit carryforwards of
approximately $2.5 million, $3.0 million and $4.5 million,
respectively. The net operating loss credit carryforwards will
expire at various dates beginning in 2003 through 2020 if not
utilized. The utilization of the federal net operating loss and
credit carryforwards are subject to annual limitations due to
ownership changes of stock in prior years.
The Company has fully reserved its deferred tax assets. Management
believes sufficient uncertainty exists regarding the realizability
of the deferred tax assets such that a full valuation allowance is
required. The net change in the valuation allowance during the years
ended December 31, 1999 and 2000 was $13.0 million and $25.3
million, respectively.
F-15
54
NOTE 11 NOTES PAYABLE
Notes payable consists of the following at December 31, 1999 and
2000 (in thousands except origional principal and discount amounts):
1999 2000
-------- --------
Note payable to bank, dated August 31, 1999,
original principal of $544,000, interest at 10.48%,
due August 31, 2002, secured by equipment $ 492 $ 323
Note payable to bank, dated October 7, 1999,
original principal of $389,000, interest at 8.71%,
due October 7, 2002, secured by equipment 370 249
Convertible note payable to vendor, dated March 25, 1999,
original principal of $494,000, interest at 8.00%,
due March 31, 2001, unsecured, net of remaining discount of
$45,000 and $8,000 for 1999 and 2000, respectively 449 486
Notes payable to investors, dated October 18, 2000,
original principal of $7,500,000, interest at 6.00%,
due February 1, 2001, unsecured. (Note 12) 3,300
Notes payable to investors, dated December 12, 2000,
original principal of $5,000,000, interest at 6.00%,
due April 3, 2001, unsecured, net of discount
of $747,000. (Note 12) 4,253
-------- --------
1,311 8,611
Less current portion (289) (8,357)
-------- --------
Total long-term notes payable $ 1,022 $ 254
======== ========
The aggregate maturities of notes payable for the years 2001 through
2002 are as follows: $8,357,000 and $254,000.
The Company has an unused $5,000,000 revolving credit agreement. The
agreement contains a minimum tangible net capital covenant with
which the Company was not in compliance at December 31, 2000.
Subsequent to December 31, 2000, the Company has entered into a new
credit agreement. See note 15 -- Subsequent Events.
NOTE 12 SHAREHOLDERS' EQUITY
COMMON STOCK PURCHASE AGREEMENTS: In October and December 2000, the
Company agreed to issue shares of common stock to certain investors
covered by the Company's
F-16
55
shelf registration statement and to apply the purchase price for the
shares against repayment of principal and interest on certain notes
payable. Through December 2000, the Company repaid $4.2 million of
the notes by delivering an aggregate of 1,671,094 shares of common
stock at an average price of $2.51 per share, which reflects an 8%
discount from the daily volume weighted average trading price for
the Company's stock. Unless the Company prepays the notes, it will
repay the remaining $8.3 million of the notes by issuing additional
shares of common stock to the investors, using a 9% discount from
the average of the daily volume weighted average trading prices over
the period from the first week of January through March 2001.
SHAREHOLDER WARRANTS: At December 31, 2000, the Company had
outstanding and exercisable warrants to purchase an aggregate of
14,801,096 shares of common stock, as follows:
Shares of Exercise Price Expiration
Common Stock per share Date of Warrants
------------- -------------- ------------------
90,488 $6.00 December 31, 2001
97,208 $6.00 February 28, 2002
282,500 $3.94 April 21, 2002
7,311,055 $4.72 June 21, 2002
155,000 $4.50 June 25, 2002
87,500 $6.00 December 23, 2002
80,672 $4.72 September 28, 2003
100,000 $6.00 January 20, 2004
200,000 $4.72 March 9, 2004
25,000 $5.16 March 9, 2004
1,111,111 $4.72 March 9, 2004
100,000 $6.00 March 30, 2004
14,829 $5.00 March 31, 2004
5,801 $6.00 November 7, 2005
524 $6.00 May 21, 2006
5,139,408 $2.53 June 21, 2009
----------
14,801,096
==========
For expense recorded in the three years ended December 31, 2000,
warrants were valued at their fair values using the Black-Scholes
model based on the volatility of the Company's stock, the
contractual life of the warrants, and the risk-free rate of return.
As part of a financing completed on June 21, 1999, the Company
issued a warrant to a director of the Company, in exchange for cash
of $200,000, exercisable for a minimum of 1,591,723 shares of common
stock. In 2000, the number of shares subject to this warrant
increased to 10% of the Company's issued and outstanding shares, on
a fully diluted basis, with certain limited exceptions to 5,139,408
shares.
STOCK OPTION PLANS: The Company has six stock option plans that
provide for option grants to employees, directors and others. Four
of these plans, the 1988 Employee
F-17
56
Stock Option Plan, the 1993 Employee Stock Option Plan, the 1995
Employee Stock Option Plan, and the 1995 Independent Director Stock
Option Plan were terminated by the Board of Directors in 1995 and
1999. Options granted under the Company's option plans generally
vest over four years or as otherwise determined by the plan
administrator. Options to purchase shares expire no later than ten
years after the date of grant.
A summary of Cray's stock option activity and related information
follows:
Outstanding
Weighted Weighted
Average Average
Options Exercise Options Exercise
Outstanding Price Exercisable Price
----------- ------------ ----------- ---------
Balance, January 1, 1998 2,035,905 $4.37 931,309 $3.25
Granted 742,090 8.44
Exercised (153,234) 1.43
Canceled (41,725) 6.61
---------
Balance, December 31, 1998 2,583,036 5.68 1,158,125 4.15
Granted 1,320,439 5.17
Exercised (107,513) 0.56
Canceled (100,616) 4.65
---------
Balance, December 31, 1999 3,695,346 5.68 1,158,125 5.29
Granted 4,924,513 5.48
Exercised (69,479) 2.69
Canceled (326,375) 5.16
---------
Balance, December 31, 2000 8,224,005 $5.61 2,428,813 $5.59
=========
Available for grant at
December 31, 2000 6,535,839
=========
Outstanding and exercisable options by price range as of December
31, 2000 are as follows:
Options Outstanding Options Exercisable
- ------------------------------------------------------------ ----------------------
Weighted Weighted Weighted
Range of Average Average Average
Exercise Price Number Remaining Exercise Number Exercise
Per Share Outstanding Life (Years) Price Exercisable Price
---------------- ----------- ------------ -------- ----------- --------
$ 0.35 - $ 3.00 256,782 5.3 $1.89 148,448 $ 1.64
3.01 - 6.00 5,445,424 8.3 4.88 1,574,596 5.11
6.01 - 9.00 2,512,799 8.5 7.54 699,769 7.44
9.01 - 12.00 -- -- -- -- --
12.01 - 15.00 9,000 7.3 13.69 6,000 13.69
--------------- --------- --- ----- --------- ------
$ 0.35 - $15.00 8,224,005 8.3 $5.61 2,428,813 $ 5.59
=============== ========= === ===== ========= ======
In 1996, the Company established an Employee Stock Purchase Plan
(1996 ESPP). The maximum number of shares of the Company's common
stock that employees may
F-18
57
acquire under the 1996 ESPP is 1,000,000 shares. Eligible employees
are permitted to acquire shares of the Company's common stock
through payroll deductions not exceeding 15% of base wages. The
purchase price per share under the 1996 ESPP is the lower of (a) 85%
of the fair market value of the Company's Common Stock at the
beginning of each six month offering period or (b) the fair market
value of the Common Stock at the end of each six month offering
period.
FAIR VALUE INFORMATION: The Company applies APB Opinion No. 25,
Accounting for Stock Issued to Employees and related Interpretations
in accounting for its stock option and purchase plans. Had
compensation cost for the Company's stock option plans and its stock
purchase plan been determined based on the fair value at the grant
dates for awards under those plans consistent with the method of
SFAS No. 123, Accounting for Stock-Based Compensation, the Company's
net loss for common stock and net loss per common share for the
years ended December 31, 1998, 1999, and 2000 would have been
increased to the pro forma amounts indicated below:
Net loss for common shareholders (in thousands):
1998 1999 2000
-------- -------- --------
As reported $(20,736) $(34,647) $(25,388)
Pro forma $(22,933) $(37,444) $(41,971)
Basic and diluted net loss per common share:
1998 1999 2000
-------- -------- --------
As reported $ (1.70) $ (1.74) $ (0.78)
Pro forma $ (1.88) $ (1.88) $ (1.28)
The weighted average Black-Scholes value of options granted under
the stock option plans during 1998, 1999, and 2000 was $9.35, $4.42,
and $5.29. Fair values were estimated as of the dates of grant using
the Black-Scholes option-pricing model with the following
weighted-average assumptions: no dividend yield, expected volatility
of 94%, 85 % and 98% for 1998, 1999, and 2000, respectively,
risk-free interest rate of 5.7%, 5.4%, and 5.2% for 1998, 1999 and
2000, respectively, and an expected term of 9.6, 8.4, and 8.4 years
for 1998, 1999, and 2000, respectively.
NOTE 13 401(k) PLAN
The Company has a defined contribution retirement plan covering
substantially all employees that provides for voluntary salary
deferral contributions on a pre-tax basis in accordance with Section
401(k) on the Internal Revenue Code of 1986, as amended. The Company
may make voluntary matching contributions in amounts determined
F-19
58
annually by the Board of Directors. Defined contribution pension
expense was $139,000, $183,000 and $713,000 for 1998, 1999, and
2000, respectively.
NOTE 14 SEGMENT INFORMATION
SFAS No. 131, Disclosure about Segments of an Enterprise and Related
Information, establishes standards for reporting information about
operating segments and for related disclosures about products and
services and geographic areas. Operating segments are identified as
components of an enterprise about which separate discrete financial
information is available for evaluation by the chief operating
decision-maker, or decision-making group, in making decisions on
allocating resources and assessing performance. Cray's chief
decision-maker, as defined under SFAS No. 131, is the Chief
Executive Officer and the executive management team. As of December
31, 2000, Cray operates in one business segment: global sales and
service of high performance computers.
Revenue from U.S. Government agencies or commercial customers
primarily serving the U.S. Government totaled approximately
$63.4 million in 2000.
The Company's significant operations outside the United States
include sales and service offices in Europe, the Middle East, and
Africa (EMEA), Japan, and Asia Pacific (Australia, Korea, China and
Taiwan). Intercompany transfers between operating segments and
geographic areas are primarily accounted for at prices that
approximate arm's length transactions.
Geographic revenue and long-lived assets related to operations as of
and for the year ended December 31, 2000, were as follows:
United Asia
States EMEA Japan Pacific Total
------- ------- ------- ------- -------
Product revenue $46,617 $ -- $ -- $ -- $46,617
======= ======= ======= ======= =======
Service revenue $43,926 $17,706 $ 7,015 $ 2,808 $71,455
======= ======= ======= ======= =======
Long lived assets $69,009 $ 5,245 $ 3,406 $ 1,515 $79,175
======= ======= ======= ======= =======
No prior year comparative information has been presented as the
Company did not have significant operations outside the United
States prior to the Cray Research acquisition on April 1, 2000.
NOTE 15 SUBSEQUENT EVENTS
In February 2001 the Company signed a distribution agreement with
NEC Corporation to distribute and service NEC SX-5 vector processor
computers and its successors. This
F-20
59
agreement provides the Company with exclusive distribution and
servicing in the United States, Canada and Mexico, and non-exclusive
rights in the rest of the world. Current duties under the U.S.
anti-dumping laws effectively prohibit the importation of these
computers into the U.S. The Company has requested that the U.S.
Government remove these duties. Assuming these duties are removed as
expected, the Company plans on marketing NEC SX-5 series computers
to customers and industries with a need for significant performance
improvements, particularly in the United States. As part of the
agreement, NEC will invest $25 million of cash in Cray, in exchange
for 3,125,000 non-voting, preferred shares, convertible into Cray
common stock at a fixed conversion price of $8.00 per share.
In March 2001, the Company entered into a credit agreement with
Foothill Capital Corporation. This line of credit replaced the
Company's existing credit agreement in place at December 31, 2000.
The credit agreement makes available $15 million through March 2004.
The credit agreement provides $7.5 million of borrowings in the form
of a revolving line of credit based on eligible domestic and foreign
product accounts receivable, and $7.5 million of borrowings in the
form of a term loan. Borrowings under the credit agreement are
secured by property, plant and equipment and bear interest at the
prime rate plus 2% for the revolving line of credit and at the prime
rate plus 3.25% for the term loan. The credit agreement contains
financial covenants relating to tangible net worth, EBITDA and
domestic service revenue.
F-21
60
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Cray Inc.
Seattle, Washington
We have audited the accompanying consolidated balance sheets of Cray Inc. (the
Company) as of December 31, 2000 and 1999, and the related consolidated
statements of operations, shareholders' equity, and cash flows for each of the
three years in the period ended December 31, 2000. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of Cray Inc. as of December 31, 2000 and 1999,
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 2000, in conformity with accounting
principles generally accepted in the United States of America.
DELOITTE & TOUCHE LLP
Seattle, Washington
February 9, 2001
(March 28, 2001 as to Note 15)
F-22