Document/ExhibitDescriptionPagesSize 1: 10-K/A Amendment to Form 10-K HTML 499K
2: EX-23.2 Consent of Experts or Counsel HTML 7K
3: EX-31.1 Certification per Sarbanes-Oxley Act (Section 302) HTML 12K
4: EX-31.2 Certification per Sarbanes-Oxley Act (Section 302) HTML 12K
5: EX-32.1 Certification per Sarbanes-Oxley Act (Section 906) HTML 10K
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 if the Registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities
Act: Yes o No þ
Indicate by check mark if the Registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the
Act: Yes o No þ
Indicate by check mark whether the Registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been
subject to such filing requirements for the past
90 days: Yes þ No
o
Indicate by check mark 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
. þ
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, or a non-accelerated
filer. See definition of “accelerated filer and large
accelerated filer” in
Rule 12b-2
of the Exchange Act. (Check one):
Large accelerated
filer o Accelerated
filer þ Non-
accelerated o
Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the Exchange
Act) Yes o No þ
The aggregate market value of the Common Stock held by
non-affiliates of the Registrant as of June 30, 2006, was
approximately $224,200,000, based upon the closing price of
$9.95 per share reported for such date on the Nasdaq Global
Market System.
As of March 2, 2007, there were 32,397,023 shares of Common
Stock issued and outstanding.
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, 2007, are incorporated
by reference into Part III.
EXPLANATORY NOTE
We
are filing this Amendment No. 1 to our Annual Report on Form 10-K for the
year ended December 31, 2006 (the “2006 10-K”), filed on March 9, 2007, solely
to amend the Deloitte & Touche LLP Report of Independent Registered Public
Accounting Firm that appeared on page F-30 of our 2006 10-K.
The report of Deloitte & Touche LLP in our 2006 10-K referred to the
“accompanying consolidated balance sheet” of us and our subsidiaries as of
December 31, 2004 and our financial position at that date; under applicable SEC
rules, our 2006 10-K did not contain our consolidated balance sheet as of
December 31, 2004. The Deloitte & Touche LLP report contained in this
Amendment No. 1 to our 2006 10-K does not refer to our consolidated balance
sheet as of December 31, 2004, or our financial position at that date.
Although the sole change effected by this Amendment No. 1 is to amend the
Deloitte & Touche LLP report as described above, we have included in this
Amendment No. 1 all of Item 8, a revised consent of Deloitte & Touche LLP and
updated officer certifications, as required by Rule 12b-15 under the Securities
Exchange Act of 1934.
By this Amendment No. 1 we have not amended, except as described above, or
updated any information contained in our 2006 10-K as originally filed, and this
Amendment No. 1 to our 2006 10-K should be read in conjunction with our
filings made with the SEC subsequent to the filing of our 2006 10-K.
The Financial Statements are located following page 7.
3
QUARTERLY
FINANCIAL DATA
(Unaudited, in thousands, except per share data)
The following table presents unaudited quarterly financial
information for the two years ended December 31, 2006. In
the opinion of management, this information contains all
adjustments, consisting only of normal recurring adjustments,
necessary for a fair presentation thereof. Certain 2005
quarterly reclassifications have been made to conform to the
2006 presentation. The operating results are not necessarily
indicative of results for any future periods.
Quarter-to-quarter
comparisons should not be relied upon as indicators of future
performance.
The following data should be read in conjunction with
“Management’s Discussion and Analysis of Financial
Condition and Results of Operations” included elsewhere in
this Annual Report on
Form 10-K
and consolidated financial statements and related notes thereto.
2005
2006
For the Quarter Ended
3/31
6/30
9/30
12/31
3/31
6/30
9/30
12/31
Revenue
$
37,634
$
53,419
$
44,741
$
65,257
$
48,515
$
38,513
$
32,565
$
101,424
Cost of revenue
33,927
48,741
36,551
49,331
34,370
26,000
21,169
75,655
Gross margin
3,707
4,678
8,190
15,926
14,145
12,513
11,396
25,769
Research and development, net
13,032
13,427
6,472
8,780
7,215
6,371
9,692
5,764
Sales and marketing
6,599
7,574
5,778
5,857
4,985
5,682
4,924
6,386
General and administrative
4,267
4,607
3,617
3,654
5,594
4,600
4,134
4,457
Restructuring, severance and
impairment
(215
)
1,947
1,201
6,817
738
549
3
(39
)
Net income (loss)
(21,035
)
(23,796
)
(10,250
)
(9,227
)
(5,305
)
(7,173
)
(8,324
)
8,732
Net income (loss) per common share,
basic
$
(0.95
)
$
(1.08
)
$
(0.46
)
$
(0.42
)
$
(0.24
)
$
(0.32
)
$
(0.37
)
$
0.36
Net income (loss) per common share,
diluted
$
(0.95
)
$
(1.08
)
$
(0.46
)
$
(0.42
)
$
(0.24
)
$
(0.32
)
$
(0.37
)
$
0.33
Since the second half of 2004, we have reviewed our workforce
requirements in light of our operating results and engaged in
workforce reductions, particularly in second and fourth quarters
of 2005. The 2005 fourth quarter also reflects a
$4.9 million charge related to impairment of a core
technology intangible asset.
Diluted net income per common share for the fourth quarter of
2006 includes approximately 5 million equivalent shares for
outstanding employee stock options, warrants, unvested
restricted stock grants and shares issuable if the Notes were
converted. These items are antidilutive in any period with an
overall net loss. Additionally, the Notes’ fourth quarter
2006 interest expense and issuance fee amortization of $770,000
has been added back to net income to determine diluted net
income per common share under the if-converted method.
Our operating results are subject to quarterly fluctuations as a
result of a number of factors. See Item 1A. “Risk
Factors” above.
4
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Company has duly caused
this Amendment No. 1 to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Seattle, State of
Washington, on June 19, 2007.
CRAY INC.
By
/s/ Peter
J. Ungaro
Peter J. Ungaro
Chief Executive Officer and President
Pursuant to the requirements of the Securities Exchange Act of
1934, this Amendment No. 1 has been signed below by the following persons
on behalf of the Company and in the capacities indicated on
June 19, 2007.
Preferred Stock —
Authorized and undesignated, 5,000,000 shares; no shares
issued or outstanding
—
—
Common Stock and additional paid-in
capital, par value $.01 per share — Authorized,
75,000,000 shares; issued and outstanding, 22,743,377 and
32,236,888 shares, respectively
422,691
507,356
Exchangeable shares, no par
value — Unlimited shares authorized; 19,710 and no
shares outstanding, respectively
Cray Inc. (“Cray” or the “Company”) designs,
develops, manufactures, markets and services high performance
computer systems, commonly known as supercomputers. These
systems provide capability and capacity far beyond typical
server-based computer systems and address challenging scientific
and engineering computing problems.
In 2006, the Company incurred a net loss of $12.1 million
but generated $12.6 million in cash from operating
activities. Management’s plans project that the
Company’s current cash resources and cash to be generated
from operations in 2007 will be adequate to meet the
Company’s liquidity needs for at least the next twelve
months. These plans assume sales, shipment, acceptance and
subsequent collections from several large customers, as well as
cash receipts on new bookings.
NOTE 2
REVERSE
STOCK SPLIT
On June 6, 2006, the Company’s shareholders approved
an amendment to the Company’s articles of incorporation to
increase the number of authorized shares of common stock from
150 million to 300 million and also approved a
one-for-four
reverse stock split of the Company’s authorized and
outstanding common stock. These concurrent approvals resulted in
75 million authorized shares of the Company’s common
stock with a par value of $0.01 per share. The reverse
stock split was effective with respect to shareholders of record
at the opening of trading on June 8, 2006, and the
Company’s common stock began trading as adjusted for the
reverse stock split on that same day. As a result of the reverse
stock split, each four shares of common stock were combined into
one share of common stock and the total number of shares
outstanding was reduced from approximately 92 million
shares to approximately 23 million shares. The Company has
retroactively adjusted all share and per share information to
reflect the reverse stock split in the consolidated financial
statements and notes thereto, as well as throughout the rest of
this
Form 10-K
Report for all periods presented.
NOTE 3
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.
Reclassifications
Certain prior year amounts have been reclassified to conform
with the current year presentation. There has been no impact on
previously reported net income (loss) or shareholders’
equity.
Use of
Estimates
Preparation of financial statements in conformity with
accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions
that affect the amounts reported in the consolidated financial
statements and accompanying notes. These estimates are based on
management’s best knowledge of current events and actions
the Company may undertake in the future. Estimates are used in
accounting for, among other items, fair value determination used
in revenue recognition, percentage of completion accounting,
estimates of proportional performance on co-funded engineering
contracts, determination of inventory at the lower of cost or
market, useful lives for depreciation and amortization,
determination of future cash flows associated with impairment
testing for goodwill and long-lived assets, determination of the
fair value of stock options and
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
assessments of fair value, estimation of restructuring costs,
calculation of deferred income tax assets, potential income tax
assessments and other contingencies. The Company bases its
estimates on historical experience, current conditions and on
other assumptions that it believes to be reasonable under the
circumstances. Actual results could differ from those estimates.
Cash,
Cash Equivalents and Restricted Cash
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. The Company maintains cash and cash equivalent
balances with financial institutions that exceed federally
insured limits. The Company has not experienced any losses
related to these balances, and management believes its credit
risk to be minimal. The Company has pledged cash, cash
equivalents and other securities valued at $25 million as
required by its line of credit agreement, as described in
Note 14 — Convertible Notes Payable and
Lines of Credit.
Foreign
Currency Derivatives
From time to time the Company may utilize forward foreign
currency exchange contracts to reduce the impact of foreign
currency exchange rate risks. Forward contracts are cash flow
hedges of the Company’s foreign currency exposures and are
recorded at the contract’s fair value. The effective
portion of the forward contract is initially reported in
“Accumulated other comprehensive income,” a component
of shareholders’ equity, and when the hedged transaction is
recorded, the amount is reclassified into results of operations
in the same period. Any ineffectiveness is recorded to
operations in the current period. The Company measures hedge
effectiveness by comparing changes in fair values of the forward
contract and expected cash flows based on changes in the spot
prices of the underlying currencies. Cash flows from forward
contracts accounted for as cash flow hedges are classified in
the same category as the cash flows from the items being hedged.
Concentration
of Credit Risk
The Company currently derives a significant portion of its
revenue from sales of products and services to different
agencies of the U.S. government or commercial customers
primarily serving various agencies of the U.S. government.
See Note 17 — Segment Information for
additional information. Given the type of customers, the Company
does not believe its accounts receivable represent significant
credit risk.
Accounts
Receivable
Accounts receivable are stated at principal amounts and are
primarily comprised of amounts contractually due from customers
for products and services and amounts due from government
reimbursed research and development contracts. The Company
provides an allowance for doubtful accounts based on an
evaluation of customer account balances past due ninety days
from the date of invoicing. In determining whether to record an
allowance for a specific customer, the Company considers a
number of factors, including prior payment history and financial
information for the customer. The Company had no pledges nor any
restrictions on its accounts receivable balances at
December 31, 2006.
Fair
Values of Financial Instruments
The Company generally has the following financial instruments:
cash and cash equivalents, accounts receivable, accounts
payable, accrued liabilities and convertible notes payable. The
carrying value of cash and cash equivalents, accounts
receivable, accounts payable and accrued liabilities approximate
their fair value based on the short-term nature of these
financial instruments. The fair value of convertible notes
payable is based on quoted market prices. The Company’s
convertible notes payable are traded in a market with low
liquidity and are therefore subject to price volatility. As of
December 31, 2006 and 2005, the fair value of these
convertible notes payable was approximately $77 million and
$44 million, respectively, compared to their carrying value
of $80 million.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Inventories
Inventories are valued at cost (on a
first-in,
first-out basis) which is not in excess of estimated current
market prices. The Company regularly evaluates the technological
usefulness and anticipated future demand for various inventory
components and the expected use of the inventory. When it is
determined that these components do not function as intended, or
quantities on hand are in excess of estimated requirements, the
costs associated with these components are charged to expense.
The Company had no pledges nor any restrictions on any inventory
balances at December 31, 2006.
In connection with certain of its sales agreements, the Company
may receive used equipment from a customer. This inventory
generally will be recorded at no value based on the expectation
that the Company will not be able to resell or otherwise use the
equipment. In the event that the Company has a specific
contractual plan for resale at the date the inventory is
acquired, the inventory is recorded at its estimated fair value.
Property
and Equipment, net
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 18 months to seven years for
furniture, fixtures and computer equipment, and eight to
25 years for buildings and land improvements. Equipment
under capital lease is amortized over the lesser of the lease
term or its estimated useful life. Leasehold improvements are
amortized over the lesser of their estimated useful lives or the
term of the lease. The cost of software obtained or inventory
transferred for internal use is capitalized and depreciated over
their estimated useful lives, generally four years. The Company
had no pledges nor any restrictions on any of its net property
and equipment balance at December 31, 2006.
In accordance with American Institute of Certified Public
Accountants (“AICPA”) Statement of Position
(“SOP”)
98-1,
Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use, the Company may capitalize
certain costs associated with the implementation of software
developed for internal use. Costs capitalized primarily consist
of employee salaries and benefits allocated to the
implementation project. The Company capitalized no such costs in
2006 or 2005.
Service
Inventory
Service inventory is valued at the lower of cost or estimated
market and represents inventory used to support service and
maintenance agreements with customers. As inventory is utilized,
replaced items are returned and are either repaired or scrapped.
Costs incurred to repair inventory to a usable state are charged
to expense as incurred. Service inventory is recorded at cost
and is amortized over the estimated service life of the related
product platform (generally four years). The Company had no
pledges nor any restrictions on any service inventory balances
at December 31, 2006.
Goodwill
and Other Intangible Assets
In accordance with Statement of Financial Accounting Standards
(“FAS”) No. 142, Goodwill and Other Intangible
Assets, the Company tests goodwill for impairment on an
annual basis as of January 1, or if indicators of potential
impairment exist, using a fair-value based approach. The Company
currently has one operating segment and reporting unit. As such,
the Company evaluates impairment based on certain external
factors, such as its market capitalization. No impairment of
goodwill has been identified during any of the periods presented.
The Company capitalizes certain external legal costs incurred
for patent filings. The Company begins amortization of these
costs as each patent is awarded. Patents are amortized over
their estimated useful lives (generally five years). The Company
performs periodic review of its capitalized patent costs to
ensure that the patents have continuing value to the Company.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Impairment
of Long-Lived Assets
In accordance with FAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, management
tests long-lived assets to be held and used for recoverability
whenever events or changes in circumstances indicate that their
carrying amount may not be recoverable. No impairment of
intangible assets was recorded during 2006. As part of the 2004
OctigaBay Systems Corporation (“OctigaBay”)
acquisition, the Company assigned $6.7 million of value to
core technology. In December 2005 the Company announced plans to
further integrate its technology platforms, and combine the Cray
XD1 and the Cray XT3 products into a unified product offering.
The expected undiscounted cash flows from the product using the
core technology were not sufficient to recover the carrying
value of the asset. The Company performed a fair value
assessment similar to the original valuation and determined the
asset had no continuing value. The Company wrote off the
unamortized balance of its core technology intangible asset of
$4.9 million which is included in “Restructuring,
Severance and Impairment” in the accompanying 2005
Consolidated Statements of Operations. No impairment of
intangible assets was recorded during 2006 or 2004.
Revenue
Recognition
The Company recognizes revenue when it is realized or realizable
and earned. In accordance with the Securities and Exchange
Commission Staff Accounting Bulletin (“SAB”)
No. 104, Revenue Recognition in Financial
Statements, the Company considers revenue realized or
realizable and earned when it has persuasive evidence of an
arrangement, the product has been shipped or the services have
been provided to the customer, the sales price is fixed or
determinable, no significant unfulfilled Company obligations
exist, and collectibility is reasonably assured. The Company
records revenue in its Statements of Operations net of sales,
use, value added or certain excise taxes imposed by governmental
authorities on specific sales transactions. In addition to the
aforementioned general policy, the following are the specific
revenue recognition policies for each major category of revenue
and for multiple-element arrangements.
Products.The Company recognizes revenue from
its product lines as follows:
•
Cray X1/X1E and Cray XT3/XT4 Product
Lines:The Company recognizes revenue from
product sales upon customer acceptance of the system, when there
are no significant unfulfilled Company obligations stipulated by
the contract that affect the customer’s final acceptance,
the price is fixed or determinable and collection is reasonably
assured. A customer-signed notice of acceptance or similar
document is required from the customer prior to revenue
recognition.
•
Cray XD1 Product Line:The Company recognizes
revenue from product sales of Cray XD1 systems upon shipment to,
or delivery to, the customer, depending upon contract terms,
when there are no significant unfulfilled Company obligations
stipulated by the contract, the price is fixed or determinable
and collection is reasonably assured. If there is a contractual
requirement for customer acceptance, revenue is recognized upon
receipt of the notice of acceptance and when there are no
unfulfilled obligations.
Revenue from contracts that require the Company to design,
develop, manufacture or modify complex information technology
systems to a customer’s specifications is recognized using
the percentage of completion method for long-term development
projects under AICPA
SOP 81-1,
Accounting for Performance of Construction-Type and Certain
Production-Type Contracts. Percentage of completion is
measured based on the ratio of costs incurred to date compared
to the total estimated costs. Total estimated costs are based on
several factors, including estimated labor hours to complete
certain tasks and the estimated cost of purchased components or
services. Estimates may need to be adjusted from quarter to
quarter, which would impact revenue and margins on a cumulative
basis. To the extent the estimate of total costs to complete the
contract indicates a loss, such amount is recognized in full in
the period that the determination is made.
In 2004, the Company concluded that its Red Storm contract would
result in an estimated loss of $7.6 million. This amount
was charged to cost of product revenue. During 2005, the Company
increased the estimate of the loss
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
on the contract by $7.7 million (cumulative loss of
$15.3 million) due to additional hardware to be delivered
to satisfy contractual and performance issues. This amount was
also charged to cost of product revenue. As of December 31,2006 and 2005, the balance in the Red Storm loss contract
accrual was $157,000 and $5.7 million, respectively, and is
included in “Other Accrued Liabilities” on the
accompanying Consolidated Balance Sheets.
Services. Maintenance services are provided
under separate maintenance contracts with the Company’s
customers. These contracts generally provide for maintenance
services for one year, although some are for multi-year periods,
often with prepayments for the term of the contract. The Company
considers the maintenance period to commence upon installation
and acceptance of the product, which may include a warranty
period. The Company allocates a portion of the sales price to
maintenance service revenue based on estimates of fair value.
Revenue for the maintenance of computers is recognized ratably
over the term of the maintenance contract. Maintenance contracts
that are paid in advance are recorded as deferred revenue. The
Company considers fiscal funding clauses as contingencies for
the recognition of revenue until the funding is virtually
assured. Revenue from Cray Technical Services is recognized as
the services are rendered.
Multiple-Element Arrangements.The Company
commonly enters into transactions that include multiple-element
arrangements, which may include any combination of hardware,
maintenance, and other services. In accordance with Emerging
Issues Task Force Issue
No. 00-21,
Revenue Arrangements with Multiple Deliverables, when
some elements are delivered prior to others in an arrangement
and all of the following criteria are met, revenue for the
delivered element is recognized upon delivery and acceptance of
such item:
•
The element could be sold separately;
•
The fair value of the undelivered element is
established; and
•
In cases with any general right of return, the Company’s
performance with respect to any undelivered element is within
the Company’s control and probable.
If all of the criteria are not met, revenue is deferred until
delivery of the last element as the elements would not be
considered a separate unit of accounting and revenue would be
recognized as described above under the Company’s product
line or service revenue recognition policies. The Company
considers the maintenance period to commence upon installation
and acceptance of the product, which may include a warranty
period and accordingly allocates a portion of the sales price as
a separate deliverable which is recognized as service revenue
over the entire service period.
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 U.S. dollars at
year-end exchange rates, and revenue and expenses are translated
at average rates prevailing during the year. Translation
adjustments are included in accumulated other comprehensive
income (loss), 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 are included in the Consolidated Statements
of Operations. Aggregate transaction losses included in net loss
in 2006, 2005 and 2004 were $1.8 million,
$1.4 million, and $361,000, respectively.
Research
and Development
Research and development costs include costs incurred in the
development and production of the Company’s high
performance computing systems, costs incurred to enhance and
support existing software features and expenses related to
future product development. Research and development costs are
expensed as incurred, and may be offset by co-funding from the
U.S. government.
Amounts to be received under co-funding arrangements with the
U.S. government are based on either contractual milestones
or costs incurred. These co-funding milestone payments are
recognized as an offset to
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
research and development expenses as performance is estimated to
be completed and is measured as milestone achievements or as
costs are incurred. As of December 31, 2006 and 2005, the
Company had advance payment liabilities (milestones billed in
advance of amounts recognized) under co-funded research and
development arrangements of $21.5 million and
$1.5 million, respectively.
The Company does not record a receivable from the
U.S. government prior to completing the requirements
necessary to bill for a milestone or cost reimbursement. Funding
from the U.S. government is subject to certain budget
restrictions and as such, there may be periods in which research
and development costs are expensed as incurred for which no
reimbursement is recorded, as milestones have not been completed
or the U.S. government has not funded an agreement.
The Company classifies amounts to be received from funded
research and development projects as either revenue or a
reduction to research and development expense, based on the
specific facts and circumstances of the contractual arrangement,
considering total costs expected to be incurred compared to
total expected funding and the nature of the research and
development contractual arrangement. In the event that a
particular arrangement is determined to represent revenue, the
corresponding research and development costs are classified as
cost of revenue.
Income
Taxes
The Company accounts for income taxes under
FAS No. 109, Accounting for Income Taxes
(“FAS 109”). Deferred tax assets
and liabilities are determined based on temporary differences
between financial reporting and tax bases of assets and
liabilities, operating loss and tax credit carryforwards, and
are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to be recovered or
settled. Realization of certain deferred tax assets is dependent
upon generating sufficient taxable income in the appropriate
jurisdiction. The Company records a valuation allowance to
reduce deferred tax assets to amounts that are more likely than
not to be realized. The initial recording and any subsequent
changes to valuation allowances are based on a number of factors
(positive and negative evidence), as required by FAS 109.
The Company considers its actual historical results to have
stronger weight than other more subjective indicators when
considering whether to establish or reduce a valuation allowance.
Stock-Based
Compensation
On January 1, 2006, the Company adopted the fair value
recognition provisions of FAS No. 123(R), Share-Based
Payment, (“FAS 123R”). Prior to
January 1, 2006, the Company accounted for stock-based
payments under the recognition and measurement provisions of APB
Opinion No. 25, Accounting for Stock Issued to Employees
(“APB 25”), and related Interpretations, as
permitted by FAS No. 123, Accounting for Stock-Based
Compensation (“FAS 123”). In accordance with
APB 25, no compensation cost was required to be recognized
for options granted that had an exercise price equal to the
market value of the underlying common stock on the date of grant.
The Company adopted FAS 123R using the modified-prospective
transition method. Under that transition method, compensation
cost recognized for the year ended December 31, 2006
includes: (a) compensation cost for all share-based
payments granted prior to, but not yet vested as of
January 1, 2006, based on the grant-date fair value
estimated in accordance with the original provisions of
FAS 123, and (b) compensation cost for all share-based
payments granted subsequent to January 1, 2006, based on
the grant-date fair value estimated in accordance with the
provisions of FAS 123R. The financial results for the prior
periods have not been restated. The Company typically issues
stock options with a four-year vesting period (defined by
FAS 123R as the requisite service period), and no
performance or service conditions, other than continued
employment. The Company amortizes stock compensation cost
ratably over the requisite service period.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The fair value of unvested stock grants is based on the price of
a share of the Company’s common stock on the date of grant.
In determining the fair value of stock options, the Company uses
the Black-Scholes option pricing model that employs the
following key weighted average assumptions:
2004
2005
2006
Risk-free interest rate
4.2%
4.1%
4.5%
Expected dividend yield
0%
0%
0%
Volatility
82%
85%
73%
Expected life
6.9 years
4.6 years
4.0 years
Weighted average Black-Scholes
value of options granted
$15.00
$5.44
$6.00
The risk-free interest rate is based on the U.S. Treasury
yield curve in effect at the time of grant. The Company does not
anticipate declaring dividends in the foreseeable future.
Volatility is based on historical data. For the year ended
December 31, 2006, the expected term of an option was based
on the assumption that options will be exercised, on average,
about two years after vesting occurs, which approximates
historical exercise practices; for most options, 25% vest after
one year with the balance vesting monthly over the subsequent
three years. FAS 123R also requires that the Company
recognize compensation expense for only the portion of options
or stock units that are expected to vest. Therefore, management
applies an estimated forfeiture rate that is derived from
historical employee termination data and adjusted for expected
future employee turnover rates. The estimated forfeiture rate
applied for the year ended December 31, 2006 is 10%. If the
actual number of forfeitures differs from those estimated by
management, additional adjustments to compensation expense may
be required in future periods. The Company’s stock price
volatility, option lives and expected forfeiture rates involve
management’s best estimates at the time of such
determination, all of which impact the fair value of the option
calculated under the Black-Scholes methodology and, ultimately,
the expense that will be recognized over the life of the option.
The Company also has an employee stock purchase plan
(“ESPP”) which allows employees to purchase shares of
the Company’s common stock at 95% of the closing market
price on the fourth business day after the end of each offering
period. The ESPP is deemed non-compensatory and therefore is not
subject to the provisions of FAS 123R.
For 2006, the Company recognized $123,000 of additional
non-cash, share-based compensation expense due to the adoption
of FAS 123R, which increased the loss from operations and
net loss by such amount. This expense increased the
Company’s net loss per share for the year ended
December 31, 2006, by $.01, from $(0.52) to $(0.53).
If compensation cost for the Company’s stock option plans
and its ESPP had been determined based on the fair value at the
grant dates for awards under those plans in accordance with a
fair value based method of FAS 123, the Company’s net
loss and net loss per common share for the years ended
December 31, 2005 and 2004 would have been the pro forma
amounts indicated below (in thousands). For purposes of this pro
forma disclosure, the value of the options is amortized ratably
to expense over the options’ vesting periods. Because the
estimated value is determined as of the date of grant, the
actual value ultimately realized by the employee may be
significantly different.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
2004
2005
Net loss, as reported
$
(207,358
)
$
(64,308
)
Add:
Stock-based employee compensation
included in reported net loss, net of related tax effects
11,844
4,106
Less:
Amortized stock-based employee
compensation expense determined under fair value based method
for all awards, net of related tax effects
(19,423
)
(30,524
)
Pro forma net loss
$
(214,937
)
$
(90,726
)
Amortization of pro forma stock-based employee compensation
expense increased significantly in 2005 due to the actions taken
to accelerate vesting, as described in
Note 15 — Shareholders’
Equity — Stock Option Plans.
Pro forma basic and diluted net loss per common share for the
years ended December 31, 2005 and 2004 are as follows:
2004
2005
Basic and diluted net loss per
common share:
As reported
$
(9.95
)
$
(2.91
)
Pro forma
$
(10.31
)
$
(4.10
)
Shipping
and Handling Costs
Costs related to shipping and handling are included in
“Cost of Product Revenue” and “Cost of Service
Revenue” on the accompanying Consolidated Statements of
Operations.
Advertising
Costs
Marketing and sales expenses in the accompanying Consolidated
Statements of Operations include advertising expenses of
$871,000, $697,000, and $683,000 in 2006, 2005 and 2004,
respectively. The Company incurs advertising costs for
representation at certain trade shows, promotional events, sales
lead generation, as well as design and printing costs for
promotional materials. The Company expenses all advertising
costs as incurred.
Earnings
(Loss) Per Share (“EPS”)
Basic EPS is computed by dividing net income available to common
shareholders by the weighted average number of common shares,
including exchangeable shares but excluding unvested restricted
stock, outstanding during the period. Diluted EPS is computed by
dividing net income available to common shareholders by the
weighted average number of common and potential common shares
outstanding during the period, which includes the additional
dilution related to conversion of stock options, unvested
restricted stock and common stock purchase warrants as computed
under the treasury stock method and the common shares issuable
upon conversion of the outstanding convertible notes. For the
years ended December 31, 2006, 2005 and 2004, outstanding
stock options, unvested restricted stock, warrants, and shares
issuable upon conversion of the convertible notes are
antidilutive because of net losses, and as such, their effect
has not been included in the calculation of diluted net loss per
share. Potentially dilutive securities of 11.7 million,
12.1 million and 9.1 million, respectively, have been
excluded from the denominator in the computation of diluted EPS
for the years ended December 31, 2006, 2005 and 2004,
respectively, because they are antidilutive.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Accumulated
Other Comprehensive Income
Accumulated other comprehensive income, a component of
shareholders’ equity, consisted of the following at
December 31 (in thousands):
2004
2005
2006
Accumulated unrealized loss on
available-for-sale
investments
$
(24
)
$
—
$
—
Accumulated currency translation
adjustment
4,584
6,258
6,855
Accumulated other comprehensive
income
$
4,560
$
6,258
$
6,855
Recent
Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board
(“FASB”) issued Interpretation No. 48,
Accounting for Uncertainty in Income Taxes,
(“FIN 48”). FIN 48 clarifies the accounting
for uncertainty in income taxes and prescribes a recognition
threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected
to be taken in a tax return. FIN 48 is effective for fiscal
years beginning after December 15, 2006. The Company does
not expect the adoption of FIN 48 to be significant except
to provide additional disclosures about tax uncertainties.
In September 2006, the FASB issued FAS No. 157,
Fair Value Measurements (“FAS 157”).
FAS 157 defines fair value, establishes a framework for
measuring fair value and expands disclosures about fair value
measurements but does not require any new fair value
measurements. FAS 157 is effective for financial statements
issued for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years. The Company does
not expect the adoption of FAS 157 to have a significant
impact on its financial statements.
In September 2006, the FASB issued FAS No. 158,
Employers’ Accounting for Defined Benefit Pension and
Other Postretirement Plans, (“FAS 158”).
FAS 158 requires an employer to recognize the overfunded or
underfunded status of a defined benefit postretirement plan
(other than a multiemployer plan) as an asset or liability in
its balance sheet and to recognize changes in that funded status
in the year in which the changes occur through comprehensive
income. The Company adopted FAS 158 as of December 31,2006, and this adoption did not have a material impact on its
financial position.
In February 2007, the FASB issued FAS No. 159, The
Fair Value Option for Financial Assets and Financial
Liabilities, (“FAS 159”). FAS 159
permits entities to choose to measure many financial instruments
and certain other items at fair value. The objective is to
improve financial reporting by providing entities with the
opportunity to mitigate volatility in reported earnings caused
by measuring related assets and liabilities differently without
having to apply complex hedge accounting provisions.
FAS 159 is effective for financial statements issued for
fiscal years beginning after November 15, 2007. The Company
has not yet determined the impact of adopting FAS 159 on
the Company’s financial statements.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
NOTE 4
ACCOUNTS
RECEIVABLE, NET
Net accounts receivable consisted of the following at
December 31 (in thousands):
2005
2006
Trade accounts receivable
$
23,023
$
39,766
Unbilled receivables
12,340
4,045
Advance billings
19,894
1,078
55,257
44,889
Allowance for doubtful accounts
(193
)
(99
)
Accounts receivable, net
$
55,064
$
44,790
Unbilled receivables represent amounts where the Company has
recognized revenue in advance of the contractual billing terms.
Advance billings represent billings made based on contractual
terms for which no revenue has yet been recognized.
As of December 31, 2006 and 2005, accounts receivable
included $34.7 million and $41.6 million,
respectively, due from U.S. government agencies and
customers primarily serving the U.S. government. Of this
amount, $4.0 million and $12.0 million, respectively,
were unbilled, based upon contractual billing arrangements with
these customers.
NOTE 5
INVENTORY
A summary of inventory is as follows (in thousands):
As of December 31, 2006 and 2005, $17.7 million and
$48.7 million, respectively, of finished goods inventory
was located at customer sites pending acceptance. At
December 31, 2006 and 2005, $16.4 million and
$33.2 million, respectively, was related to a single
customer in each year. Revenue for 2006, 2005, and 2004 includes
$256,000, $2.1 million, and $498,000, respectively, from
the sale of refurbished inventory recorded at a zero cost basis.
In 2005, the amount consisted mainly of the sale of a
refurbished Cray T3E supercomputer, one of the Company’s
legacy systems.
During 2006, the Company wrote off $1.6 million of
inventory, primarily related to inventory on the Cray XT3
product line. During 2005, the Company wrote off
$5.8 million of inventory, primarily related to the Cray
X1E and Cray XD1 product lines. During 2004, the Company wrote
off $8.5 million of inventory, primarily related to the
Cray X1 product line.
The following table provides information about activity in
goodwill for the years ended December 31, 2006 and 2005,
respectively (in thousands):
2005
2006
Goodwill, at January 1
$
55,644
$
56,839
Foreign currency translation
adjustments and other
1,195
299
Goodwill, at December 31
$
56,839
$
57,138
In April 2004, the Company completed the acquisition of
OctigaBay, a privately-held development stage company located in
Burnaby, British Columbia, for $99.5 million and accounted
for the transaction under the purchase method of accounting.
Goodwill of approximately $39 million was recorded.
Additionally, in-process research and development of
$43.4 million was expensed in 2004.
Intangible assets as of December 31, 2006 and 2005
consisted of net capitalized patent costs of $1.4 million
and $1.1 million, respectively.
Amortization expense for 2006, 2005 and 2004 was $101,000,
$1.6 million, and $1.5 million, respectively.
Amortization decreased significantly for the year ended
December 31, 2006 as a result of the Company’s write
off of its core technology intangible asset in December 2005.
At December 31, 2006 and 2005, deferred revenue included
$19.0 million and $43.5 million, respectively, related
to a single customer in each year.
NOTE 10
RESTRUCTURING
AND SEVERANCE CHARGES
During 2006, the Company recognized net restructuring charges of
$1.3 million, which is included in “Restructuring,
Severance and Impairment” on the accompanying Consolidated
Statements of Operations, all of which originated from actions
arising during 2005. There were no new actions taken during 2006.
During 2005, the Company recognized restructuring charges of
$4.8 million, which is included in “Restructuring,
Severance and Impairment” on the accompanying Consolidated
Statements of Operations, net of adjustments for previously
accrued amounts. These restructuring charges were the result of
two actions taken during 2005, one of which was a worldwide
reduction in work force which was announced on June 27,2005, and affected employees in operations, sales and marketing.
The other action was a plan announced on December 12, 2005
to reduce nearly 65 full-time staff, principally based in
the Company’s Burnaby, British Columbia, Canada facility,
based upon Company plans to increase research and development
efficiencies, lower costs and integrate technology platforms,
and mainly affected employees in research and development.
During 2004, the Company recognized restructuring costs of
$8.2 million in “Restructuring, Severance and
Impairment” on the accompanying Consolidated Statements of
Operations, including a $196,000 compensation charge related to
the modification of stock options for certain individuals
affected by the restructuring. The $196,000 charge was recorded
directly to common stock. Substantially all of the restructuring
costs represent severance expenses for 131 terminated employees.
Activity related to the Company’s restructuring liability,
included in “Accrued Payroll and Related Expenses” on
the accompanying Consolidated Balance Sheets, during the years
ended December 31 is as follows (in thousands):
2004
2005
2006
Balance, January 1
$
3,069
$
4,690
$
3,582
Additional restructuring charge
8,077
5,092
1,284
Payments
(6,420
)
(5,724
)
(3,849
)
Adjustments to previously accrued
amounts
(91
)
(255
)
(33
)
Foreign currency translation
adjustment
55
(221
)
79
Total restructuring and severance
liability, December 31
4,690
3,582
1,063
Less long-term restructuring and
severance liability
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
NOTE 11
FOREIGN
CURRENCY DERIVATIVE
In order to reduce the impact of foreign currency exchange rate
risk related to a sales contract denominated in British pound
sterling, the Company entered into a forward contract on
February 6, 2006 with an original notional amount of
£15 million to hedge anticipated cash receipts on the
specific sales contract. During December 2006, the final cash
receipts were received and the hedge contract was settled. The
amount reclassified from Other Comprehensive Income (Loss) was a
$192,000 reduction to revenue. Prior to its designation as an
effective hedge on June 30, 2006, the Company recorded
losses of approximately $1.3 million in 2006, which are
included in “Other expense” in the accompanying
Consolidated Statement of Operations.
In January and February 2007, the Company entered into
additional forward contracts with notional amounts totaling
£37.8 million to hedge anticipated cash receipts on
another specific sales contract. These forward contracts were
designated as hedges in February 2007. These hedge contracts are
expected to be settled as cash receipts are received, with the
final cash receipts expected in late 2009.
NOTE 12
COMMITMENTS
AND CONTINGENCIES
The Company leases certain property and equipment under capital
leases pursuant to master equipment lease agreements and has
non-cancelable operating leases for facilities. Under the master
equipment lease agreements, the Company had fixed asset balances
of $7.7 million and $7.5 million as of
December 31, 2006 and 2005, respectively, net of
accumulated amortization of $6.7 million and
$5.4 million, respectively.
The Company has recorded rent expense under leases for buildings
or office space accounted for as operating leases in 2006, 2005
and 2004 of $3.5 million, $4.1 million and
$4.2 million, respectively.
As of December 31, 2006, the Company had no commitments
past 2012, except for principal and interest due on its
convertible notes payable described in Note 14 —
Convertible Notes Payable and Lines of Credit.
Minimum contractual commitments as of December 31, 2006,
were as follows (in thousands):
Capital
Operating
Development
Leases
Leases
Agreements
2007
$
32
$
3,215
$
12,922
2008
—
2,576
43
2009
—
793
—
2010
—
205
—
2011
—
205
—
Thereafter
—
22
—
Minimum contractual commitments
32
$
7,016
$
12,965
Less amount representing interest
(1
)
Recorded capital lease obligations
$
31
In its normal course of operations, the Company engages in
development arrangements under which it hires outside
engineering resources to augment its existing internal staff in
order to complete research and development projects, or parts
thereof. For the years ended December 31, 2006, 2005 and
2004, the Company incurred $23.9 million,
$20.3 million and $16.8 million, respectively, for
such arrangements.
In October 2005, the Company renegotiated one of its facility
leases to consolidate its floor space in its headquarters in
Seattle, Washington. The Company issued 17,500 shares of
common stock to the landlord, Merrill Place, LLC, for release
from certain of its operating lease obligations. The Company
charged $80,000, representing the fair value of the shares
issued, to “Restructuring, Severance and Impairment”
on the accompanying Consolidated Statements of Operations for
this issuance and related release from future obligations
In 2005 the Company and certain of its current and former
officers and directors were named as defendants in class actions
filed in the U.S. District Court for the Western District
of Washington alleging certain federal securities laws
violations in connection with certain of the Company’s
public statements and filings. The Court consolidated the
actions. On September 8, 2006, the Court entered judgment
in favor of the defendants dismissing the consolidated action
with prejudice.
In 2005 two derivative actions were filed, and later
consolidated, in the same Court against certain of the
Company’s current and former officers and directors,
asserting breach of fiduciary duty, abuse of control, gross
mismanagement, waste of corporate assets and unjust enrichment.
On September 8, 2006, the Court entered judgment in favor
of the defendants in the consolidated case, dismissing with
prejudice claims based on alleged insider trading and dismissing
without prejudice the remaining claims.
In December 2005, two derivative actions were filed in the
Superior Court of the State of Washington for King County
against certain of the Company’s current and former
officers and directors, and were later consolidated. The state
court derivative plaintiff asserted allegations substantially
similar to those asserted in the dismissed federal derivative
action. On July 28, 2006, the Company and the defendants
filed motions to dismiss the amended complaint. On
November 1, 2006, the Superior Court approved
plaintiff’s dismissal of this litigation without prejudice.
Other
From time to time the Company is subject to various other legal
proceedings that arise in the ordinary course of business or are
not material to the Company’s business. Additionally, the
Company is subject to income taxes in the U.S. and several
foreign jurisdictions and, in the ordinary course of business,
there are transactions and calculations where the ultimate tax
determination is uncertain. Although the Company cannot predict
the outcomes of these matters with certainty, the Company’s
management does not believe that the disposition of these
matters will have a material adverse effect on the
Company’s financial position, results of operations or cash
flows.
NOTE 13
INCOME
TAXES
Under FAS 109, Accounting for Income Taxes, income
taxes are recognized for the amount of taxes payable for the
current year and for the impact of deferred tax assets and
liabilities, which represent consequences of events that have
been recognized differently in the financial statements under
GAAP than for tax purposes. As of December 31, 2006, the
Company had federal net operating loss carryforwards of
approximately $290 million and gross federal research and
experimentation tax credit carryforwards of approximately
$12.6 million. The net operating loss carryforwards, if not
utilized, will expire from 2010 through 2026, and research and
development tax credits will expire from 2007 through 2026, if
not utilized.
Loss before provision for income taxes consists of the following
(in thousands):
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Deferred income taxes reflect the net tax effects of temporary
differences between the tax bases of assets and liabilities and
the corresponding financial statement amounts, operating loss,
and tax credit carryforwards. Significant components of the
Company’s deferred income tax assets and liabilities are as
follows (in thousands):
The net current deferred tax assets as of December 31, 2005
of $23,000 are included in “Prepaid Expenses and Other
Current Assets” on the accompanying Consolidated Balance
Sheets.
A summary of the changes to the valuation allowance on deferred
tax assets for the years ended December 31, 2006, 2005 and
2004 was increases of $3.8 million, $29.6 million and
$96.7 million, respectively. In September 2004, as a result
of substantial losses during the year and based on revised
projections indicating continued challenging operating results,
the Company established a valuation allowance of
$58.9 million. During 2003, the Company had reduced its
valuation allowance by $58.0 million.
Undistributed earnings of the Company’s foreign
subsidiaries are considered to be permanently reinvested;
accordingly, no provision for U.S. federal and state income
taxes has been provided thereon. Upon repatriation of those
earnings, in the form of dividends or otherwise, the Company
would be subject to both U.S. income taxes (subject to an
adjustment for foreign tax credits) and withholding taxes
payable to the various foreign countries. Determination of the
amount of unrecognized deferred U.S. income tax liability
is not practicable due to the complexities associated with this
hypothetical calculation.
NOTE 14 CONVERTIBLE
NOTES PAYABLE AND LINES OF CREDIT
In December 2004 the Company issued $80 million aggregate
principal amount of 3.0% Convertible Senior Subordinated
Notes due 2024 (“Notes”) in a private placement
pursuant to Rule 144A under the Securities Act of 1933, as
amended. These unsecured Notes bear interest at an annual rate
of 3.0%, payable semiannually on June 1 and December 1
of each year through the maturity date of December 1, 2024.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The Notes are convertible, under certain circumstances, into the
Company’s common stock at an initial conversion rate of
51.8001 shares of common stock per $1,000 principal amount
of Notes, which is equivalent to an initial conversion price of
approximately $19.31 per share of common stock (subject to
adjustment in certain events). Upon conversion of the Notes, in
lieu of delivering common stock, the Company may, at its
discretion, deliver cash or a combination of cash and common
stock.
The Notes are general unsecured senior subordinated obligations,
ranking junior in right of payment to the Company’s
existing and future senior indebtedness, equally in right of
payment with the Company’s existing and future indebtedness
or other obligations that are not, by their terms, either senior
or subordinated to the Notes and senior in right of payment to
the Company’s future indebtedness that, by its terms, is
subordinated to the Notes. In addition, the Notes are
effectively subordinated to any of the Company’s existing
and future secured indebtedness to the extent of the assets
securing such indebtedness and structurally subordinated to the
claims of all creditors of the Company’s subsidiaries.
Holders may convert the Notes during a conversion period
beginning with the mid-point date in a fiscal quarter to, but
not including, the mid-point date (or, if that day is not a
trading day, then the next trading day) in the immediately
following fiscal quarter, if on each of at least 20 trading days
in the period of 30 consecutive trading days ending on the first
trading day of the conversion period, the closing sale price of
the Company’s common stock exceeds 120% of the conversion
price in effect on that 30th trading day of such period.
The “mid-point dates” for the fiscal quarters are
February 15, May 15, August 15 and November 15.
Holders may also convert the Notes if the Company has called the
Notes for redemption or, during prescribed periods, upon the
occurrence of specified corporate transactions or a fundamental
change, in each case as described in the indenture governing the
Notes. As of December 31, 2006, 2005 and 2004, none of the
conditions for conversion of the Notes were satisfied.
The Company may, at its option, redeem all or a portion of the
Notes for cash at any time on or after December 1, 2007,
and prior to December 1, 2009, at a redemption price of
100% of the principal amount of the Notes plus accrued and
unpaid interest plus a make whole premium of $150.00 per
$1,000 principal amount of Notes, less the amount of any
interest actually paid or accrued and unpaid on the Notes prior
to the redemption date, if the closing sale price of the
Company’s common stock exceeds 150% of the conversion price
for at least 20 trading days in the 30-trading day period ending
on the trading day prior to the date of mailing of the
redemption notice. On or after December 1, 2009, the
Company may redeem for cash all or a portion of the Notes at a
redemption price of 100% of the principal amount of the Notes
plus accrued and unpaid interest. Holders may require the
Company to purchase all or a part of their Notes for cash at a
purchase price of 100% of the principal amount of the Notes plus
accrued and unpaid interest on December 1, 2009, 2014, and
2019, or upon the occurrence of certain events provided in the
indenture governing the Notes.
In connection with the issuance of the Notes, the Company
incurred $3.4 million of issuance costs, which primarily
consisted of investment banker fees, legal and other
professional fees. These costs are being amortized using the
effective interest method to interest expense over the five-year
period from December 2004 through November 2009. A total of
$683,000 and $676,000, respectively, was amortized into interest
expense during 2006 and 2005. The unamortized balance of these
costs was $2.0 million and $2.7 million, respectively,
as of December 31, 2006 and 2005, and is included in
“Other non-current assets” on the accompanying
Consolidated Balance Sheets.
Lines of
Credit
On December 29, 2006, the Company entered into a Credit
Agreement with Wells Fargo Bank, N.A., providing for a line of
credit for up to $25.0 million. The credit line replaces
the Company’s previous line of credit with Wells Fargo
Foothill, Inc. entered into in May 2005. The Credit Agreement
provides for a line of credit up to $25.0 million until
December 1, 2008. The Company is required to maintain a
pledged collateral account containing cash, cash equivalents and
other securities valued at not less than the maximum amount
allowed under the line of credit, currently $25.0 million.
The Company receives all interest and other earnings on the
collateral account until the
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Bank otherwise notifies the account holder and the Company. In
addition, the Company has covenants to maintain liquid assets
with an aggregate fair market value of not less than
$25.0 million. The Company designated $25.0 million of
its cash as restricted at December 31, 2006. The Credit
Agreement provides support for the Company’s existing
letters of credit, the balance of which was $190,000 as of
December 31, 2006. The available borrowing base under the
Credit Agreement is reduced by the amount of outstanding letters
of credit at that date. Therefore, the Company was eligible to
use $24.8 million of the line of credit as of
December 31, 2006.
On May 31, 2005, the Company entered into a
$30.0 million, two-year revolving line of credit agreement
with Wells Fargo Foothill, Inc. The Company capitalized
$1.3 million in fees, including the fair value of a
four-year warrant issued to the lender to purchase
50,000 shares of its common stock with an exercise price of
$6.60 per share, which was exercised on February 27,2007. That line of credit was collateralized by all of the
Company’s assets and pledges of the stock of its
subsidiaries. The agreement was replaced in December 2006 and
the remaining unamortized fee balance of $286,000 was charged to
interest expense on the accompanying Consolidated Statement of
Operations.
NOTE 15
SHAREHOLDERS’
EQUITY
Preferred Stock:The Company has
5,000,000 shares of undesignated preferred stock
authorized, and no shares of preferred stock outstanding.
Common Stock: On December 19, 2006, the
Company completed a public offering of 8,625,000 shares of
newly issued common stock at a public offering price of
$10.00 per share. The Company received net proceeds of
$81.3 million from the offering, after underwriting
discount and selling expenses. The Company expects to use the
net proceeds for general corporate purposes.
In 2004, the Company issued 1,890,221 shares of its common
stock and 1,210,105 exchangeable shares in connection with the
acquisition of OctigaBay.
Exchangeable Shares: Shares of exchangeable
stock were issued by one of the Company’s Nova Scotia
subsidiaries in connection with the April 2004 acquisition of
OctigaBay. No exchangeable shares were outstanding as of
December 31, 2006.
Shareholder Warrants: At December 31,2006, the Company had outstanding and exercisable warrants to
purchase an aggregate of 1,334,852 shares of common stock,
as follows:
On February 27, 2007, the warrant for 50,000 shares of
common stock was exercised, and the Company issued
25,194 shares in the net exercise transaction.
Restricted Stock: During 2006, the Company
issued an aggregate of 354,993 shares of restricted stock
to certain directors, executives and managers. The Company will
record approximately $3.6 million in stock compensation
expense for these issuances ratably over the vesting period,
which is generally two years for non-employee directors and four
years for officers and employees of the Company. In the fourth
quarter of 2005, the Company issued an aggregate of
491,250 shares of restricted stock to certain executives
and managers. These shares will become fully vested on
June 30, 2007. The Company recorded a deferred compensation
charge of $2.9 million for the issuance of these shares,
and will recognize compensation expense ratably over the
18-month
vesting period. As of December 31, 2006, $2.1 million
of expense has been recorded for these restricted stock
issuances, and an aggregate of $4.4 million remains to be
expensed over the respective vesting periods of the grants.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Stock Option Plans: As of December 31,2006, the Company had five active stock option plans that
provide shares available for option grants to employees,
directors and others. Options granted to employees under the
Company’s option plans generally vest over four years or as
otherwise determined by the plan administrator; however, options
granted during 2005 were generally granted with full vesting on
or before December 31, 2005, in order to avoid additional
expense related to the options under the implementation of
FAS 123R and to enhance short-term retention. Options to
purchase shares expire no later than ten years after the date of
grant.
On December 20, 2005, the Company announced a stock option
repricing for certain outstanding options as of that date, the
purpose of which was to reduce the number of new options needed
for grant at the same time, since the Company had a limited
number of shares available for such grant. A total of 318,565
options with original exercise prices from $14.52 to
$34.12 per share were repriced to an exercise price of
$5.96 per share, all of which were fully vested at the time
of repricing. Per the requirements of FIN No. 44,
Accounting for Certain Transactions Involving Stock
Compensation, the stock option modification resulted in
variable stock option accounting from the date of repricing
until the end of the year; however, because the closing price of
the Company’s common stock on December 31, 2005, was
less than the re-grant price, no compensation expense was
recorded.
Twice during 2005, the Board of Directors approved the
acceleration of the vesting of all unvested outstanding stock
options previously granted to employees and executive officers
under the Company’s stock option plans which exceeded
certain exercise price thresholds. In March 2005 the threshold
for accelerated vesting was all options with a per share
exercise price of $9.44 or higher (the market price of the
Company’s common stock on the date of the change), while in
May 2005 the threshold was all options with a per share exercise
price of $5.88 or greater (the market price of the
Company’s common stock on the date of the change). This
acceleration resulted in options to acquire approximately
1.2 million shares of the Company’s common stock
becoming immediately exercisable. Options granted to consultants
and to non-employee directors were not accelerated. All other
terms and conditions applicable to outstanding stock option
grants, including the exercise prices and numbers of shares
subject to the accelerated options, were unchanged. The
acceleration resulted in a charge to income of approximately
$1.1 million related to the deferred compensation of
previously unvested options granted as part of the OctigaBay
acquisition in April 2004. The acceleration eliminated future
compensation expense that the Company would have recognized in
its Consolidated Statements of Operations with respect to these
options upon the adoption of FAS 123R, on
January 1, 2006.
In connection with a restructuring plan announced in June 2005,
the Company amended the stock option grants for certain
terminated employees to extend the exercise period of vested
stock options, which is normally three months from the date of
termination. No compensation expense was recorded as the fair
market value of the Company’s stock (the closing market
price of the Company’s stock on the date of the change) was
less than the respective stock option exercise prices.
The weighted average exercise price of outstanding options at
December 31, 2005 includes the impact of the 2005 repricing
of 318,565 options, as described above.
The aggregate intrinsic value in the table above represents the
total pretax intrinsic value for all
“in-the-money”
options (i.e., the difference between the Company’s closing
stock price on the last trading day of 2006 and the exercise
price, multiplied by the number of shares) that would have been
received by the option holders had all option holders exercised
their options on December 31, 2006. This amount changes,
based on the fair market value of the Company’s stock.
Total intrinsic value of options exercised was $1.6 million
for the year ended December 31, 2006. Weighted average fair
value of options granted during the year ended December 31,2006 was $6.00 per share.
A summary of the Company’s unvested restricted stock grants
and changes during the years ended December 31 is as
follows:
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
As of December 31, 2006, the Company had $8.7 million
of total unrecognized compensation cost related to unvested
stock options and unvested restricted stock grants, which is
expected to be recognized over a weighted average period of
2.8 years.
Outstanding and exercisable options by price range as of
December 31, 2006, are as follows:
Outstanding Options
Exercisable Options
Weighted
Weighted
Weighted
Average
Average
Average
Range of Exercise
Number
Remaining
Exercise
Number
Exercise
Prices per Share
Outstanding
Life (Years)
Price
Exercisable
Price
$ 0.00 – $ 4.00
87,111
8.6
$
3.77
87,111
$
3.77
$ 4.01 – $ 8.00
789,160
6.9
$
6.25
780,863
$
6.24
$ 8.01 – $10.00
292,921
7.1
$
9.32
270,046
$
9.38
$10.01 – $12.00
1,092,908
8.5
$
10.67
403,008
$
10.87
$12.01 – $14.00
208,181
7.7
$
13.70
208,181
$
13.70
$14.01 – $16.00
534,145
6.6
$
15.15
534,145
$
15.15
$16.01 – $32.00
542,743
4.8
$
24.99
541,337
$
24.98
$32.01 – $54.75
320,246
5.9
$
39.37
320,196
$
39.37
$0.00 – $54.75
3,867,415
7.0
$
14.68
3,144,887
$
15.64
The following table (in thousands) sets forth the share-based
compensation cost resulting from stock options and unvested
stock grants recorded in the Company’s Consolidated
Statements of Operations for the years ended December 30,2006, 2005 and 2004. The 2006 expense represents expense as a
result of the adoption of FAS 123R. The 2005 and 2004
expense represents acquisition-related, share-based compensation
expense arising from the acquisition of OctigaBay in 2004.
2004
2005
2006
Cost of product revenue
$
—
$
—
$
60
Cost of service revenue
—
—
101
Research and development
5,068
3,444
386
Sales and marketing
2,837
579
334
General and administrative
3,229
13
1,218
Total share-based compensation
expense
$
11,134
$
4,036
$
2,099
Employee Stock Purchase Plan: In 2001, the
Company established an ESPP, which received shareholder approval
in May 2002. The maximum number of shares of the Company’s
common stock that employees could acquire under the 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 ESPP is 95% of the closing market
price on the fourth business day after the end of each offering
period. As of December 31, 2006 and 2005, 526,710 and
462,533 shares, respectively, had been issued under the
ESPP.
NOTE 16 BENEFIT
PLANS
401(k)
Plan
The Company has a retirement plan covering substantially all
U.S. employees that provides for voluntary salary deferral
contributions on a pre-tax basis in accordance with
Section 401(k) of the Internal Revenue Code of 1986, as
amended. Prior to 2005, the Company matched 25% of employee
contributions each calendar year, comprised of a 12.5% match of
employee contributions in cash 45 days after each quarter
and a 12.5% match determined annually by the Board of Directors
and payable in cash or common stock of the Company. The Company
eliminated its matching obligation as of June 30, 2005.
However, the Company reinstated its match for
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
2006 at 6.25% of total employee contributions, which was
satisfied in 2007 through issuance of common stock. The
Company’s 2006, 2005 and 2004 matching contribution
expenses were $347,000, $795,000 and $1.6 million,
respectively.
Pension
Plan
The Company’s German subsidiary maintains a defined benefit
plan. At December 31, 2006 and 2005, the Company recorded a
liability of $1.9 million and $1.7 million,
respectively, which approximates the excess of the projected
benefit obligation over plan assets of $671,000 and $599,000,
respectively. Plan assets are invested in insurance policies
payable to employees. Net pension expense was not material for
any period. Contributions to the plan are not expected to be
significant to the financial position of the Company. The
Company’s adoption of FAS 158, effective
December 31, 2006, did not have a material impact on the
financial position of the Company.
NOTE 17 SEGMENT
INFORMATION
FAS No. 131, Disclosure about Segments of an
Enterprise and Related Information
(“FAS 131”), establishes standards for
reporting information about operating segments and for related
disclosures about products, services and geographic areas.
Operating segments are identified as components of an enterprise
about which separate discrete financial information is available
for evaluation by the chief operating decision-maker, or
decision-making group, in making decisions regarding allocation
of resources and assessing performance. Cray’s chief
decision-maker, as defined under FAS 131, is the Chief
Executive Officer. During 2006, 2005 and 2004, Cray had one
operating segment.
Product and service revenue and long-lived assets classified by
significant country are as follows (in thousands):
Revenue attributed to foreign countries are derived from sales
to external customers. Revenue derived from U.S. government
agencies or commercial customers primarily serving the
U.S. government, and therefore under its control, totaled
approximately $105.4 million, $111.2 million and
$107.8 million in 2006, 2005 and 2004, respectively. In
2006, two customers accounted for an aggregate of approximately
33% of total revenue. In 2005, one customer contributed
approximately 18% of total revenue; in 2004, one customer
accounted for approximately 27% of total revenue. In 2006,
revenue in Korea accounted for 20% of total revenue, and revenue
in the United
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Kingdom accounted for 15% of total revenue. No single foreign
country accounted for more than 10% of the Company’s
revenue in either of the other years presented.
Goodwill makes up a significant portion of the long-lived asset
balances of the Company’s foreign subsidiaries. At
December 31, 2006 and 2005, goodwill comprised
$45.4 million and $45.1 million, respectively, or 92%
and 90%, respectively, of foreign long-lived asset balances.
NOTE 18 RESEARCH
AND DEVELOPMENT
The details for the Company’s net research and development
costs for the years ended December 31 are as follows (in
thousands):
Less: Amounts reimbursed or
included in cost of product revenue
(45,577
)
(54,546
)
(70,019
)
Net research and development
expenses
$
53,266
$
41,711
$
29,042
NOTE 19 INTEREST
INCOME (EXPENSE)
The detail of interest income (expense) for the years ended
December 31 is as follows (in thousands):
2004
2005
2006
Interest income
$
666
$
741
$
2,525
Interest expense
(301
)
(4,203
)
(4,620
)
Net interest income (expense)
$
365
$
(3,462
)
$
(2,095
)
Interest income is earned by the Company on cash and cash
equivalent balances, which are invested in highly liquid money
market funds.
Interest expense in both 2006 and 2005 consisted of
$2.4 million on the Notes in each year, $1.6 million
and $1.0 million, respectively, of amortization of
capitalized issuance costs, and $390,000 and $765,000,
respectively, of interest and fees on the line of credit with
Wells Fargo Foothill, Inc. Amortization of fees capitalized for
the line of credit increased in 2006 as the Company wrote off
all remaining capitalized costs when it changed lines of credit,
see Note 14 — Convertible Notes Payable
and Lines of Credit.
NOTE 20 RESTATEMENT
OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS
Subsequent to the issuance of the December 31, 2004
consolidated financial statements, the Company determined that
certain research and development costs were incorrectly charged
to one of its product development contracts in 2004. The
contract was accounted for under the percentage of completion
method of accounting. The error resulted in revenue being
recognized prematurely on the contract. Accordingly, the
accompanying 2004 consolidated financial statements have been
restated from the amounts previously reported to correct this
error. Additionally, the Company has reclassified the cash flow
impact of changes in restricted cash from financing activities
to investing activities.
Previously reported amount was increased by $5,068 to conform to
2005 financial statement presentation. Amount was reclassified
from Acquisition-related Compensation Expense.
We have audited the accompanying consolidated balance sheets of
Cray Inc. and Subsidiaries as of December 31, 2006 and
2005, and the related consolidated statements of operations,
shareholders’ equity and comprehensive income (loss), and
cash flows for the years then ended. These consolidated
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 the standards of the
Public Company Accounting Oversight Board (United States). 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, the consolidated financial statements referred
to above present fairly, in all material respects, the financial
position of Cray Inc. and Subsidiaries as of December 31,2006 and 2005, and the results of their operations and their
cash flows for the years then ended in conformity with
accounting principles generally accepted in the United States of
America.
Our audits were conducted for the purpose of forming an opinion
on the 2006 and 2005 basic consolidated financial statements
taken as a whole. The financial statement schedule listed in the
index at Item 15(a)(2) is presented for purposes of
additional analysis and is not a required part of the basic
consolidated financial statements. This schedule, for the years
ended December 31, 2006 and 2005, has been subjected to the
auditing procedures applied in the audits of the 2006 and 2005
basic consolidated financial statements and, in our opinion, is
fairly stated in all material respects in relation to the 2006
and 2005 basic consolidated financial statements taken as a
whole.
We have also audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
effectiveness of Cray Inc. and Subsidiaries’ internal
control over financial reporting as of December 31, 2006,
based on criteria established in Internal Control —
Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO), and our report
dated March 5, 2007, expressed an unqualified opinion on
management’s assessment of internal control over financial
reporting and an unqualified opinion on the effectiveness of
internal control over financial reporting.
As discussed in Note 3 to the consolidated financial
statements, Cray, Inc. and Subsidiaries adopted Statement of
Financial Accounting Standards No. 123(R),
“Share-Based Payment,” effective January 1, 2006.
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Cray Inc.
Seattle, Washington
We have audited the accompanying consolidated statements
of operations, shareholders’ equity and comprehensive
income (loss), and cash flows of Cray Inc. and subsidiaries (the “Company”) for the year
ended December 31, 2004. Our audit also included the financial statement schedule for the year
ended December 31, 2004, listed in the Index at Item 15. These financial statements and financial statement
schedule are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these
financial statements and financial statement schedule based on
our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). 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 also includes examining,
on a test basis, evidence supporting the amounts and disclosures
in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We
believe that our audit provides a reasonable basis for our
opinion.
In our opinion, such consolidated financial statements present
fairly, in all material respects, the results
of operations and cash flows of
the Company for the year ended December 31, 2004, in conformity with accounting principles generally
accepted in the United States of America. Also, in our opinion,
such financial statement schedule, when considered in relation
to the basic consolidated financial statements taken as a whole,
presents fairly in all material respects the information set
forth therein.
As discussed in Note 20, the accompanying financial
statements as of and for the year ended December 31, 2004,
have been restated.
