Item 1. Unaudited Condensed Consolidated Financial Statements
CRAY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited and in thousands, except share data)
|
|
|
|
|
|
|
|
|
|
June 30,
2018
|
|
December 31,
2017
|
ASSETS
|
|
|
|
Current assets:
|
|
|
|
Cash and cash equivalents
|
$
|
142,157
|
|
|
$
|
137,326
|
|
Restricted cash
|
1,300
|
|
|
1,964
|
|
Short-term investments
|
—
|
|
|
6,997
|
|
Accounts and other receivables, net
|
113,138
|
|
|
162,034
|
|
Inventory
|
148,153
|
|
|
186,307
|
|
Prepaid expenses and other current assets
|
23,134
|
|
|
25,015
|
|
Total current assets
|
427,882
|
|
|
519,643
|
|
|
|
|
|
Long-term restricted cash
|
1,030
|
|
|
1,030
|
|
Long-term investment in sales-type lease, net
|
16,409
|
|
|
23,367
|
|
Property and equipment, net
|
37,880
|
|
|
36,623
|
|
Goodwill
|
14,182
|
|
|
14,182
|
|
Intangible assets other than goodwill, net
|
3,760
|
|
|
4,345
|
|
Other non-current assets
|
18,536
|
|
|
19,567
|
|
TOTAL ASSETS
|
$
|
519,679
|
|
|
$
|
618,757
|
|
|
|
|
|
LIABILITIES AND SHAREHOLDERS’ EQUITY
|
|
|
|
Current liabilities:
|
|
|
|
Accounts payable
|
$
|
16,758
|
|
|
$
|
57,207
|
|
Accrued payroll and related expenses
|
16,994
|
|
|
18,546
|
|
Other accrued liabilities
|
10,885
|
|
|
9,471
|
|
Customer contract liabilities
|
58,575
|
|
|
80,119
|
|
Total current liabilities
|
103,212
|
|
|
165,343
|
|
|
|
|
|
Long-term customer contract liabilities
|
32,917
|
|
|
38,622
|
|
Other non-current liabilities
|
12,823
|
|
|
14,495
|
|
TOTAL LIABILITIES
|
148,952
|
|
|
218,460
|
|
|
|
|
|
Shareholders’ equity:
|
|
|
|
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 40,815,172 and 40,464,963 shares, respectively
|
639,782
|
|
|
633,408
|
|
Accumulated other comprehensive income
|
1,946
|
|
|
915
|
|
Accumulated deficit
|
(271,001
|
)
|
|
(234,026
|
)
|
TOTAL SHAREHOLDERS’ EQUITY
|
370,727
|
|
|
400,297
|
|
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
|
$
|
519,679
|
|
|
$
|
618,757
|
|
The accompanying notes are an integral part of these condensed consolidated financial statements
CRAY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited and in thousands, except per share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Revenue:
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
83,379
|
|
|
$
|
51,531
|
|
|
$
|
127,833
|
|
|
$
|
72,659
|
|
Service
|
|
36,824
|
|
|
35,604
|
|
|
71,964
|
|
|
73,507
|
|
Total revenue
|
|
120,203
|
|
|
87,135
|
|
|
199,797
|
|
|
146,166
|
|
Cost of revenue:
|
|
|
|
|
|
|
|
|
Cost of product revenue
|
|
65,274
|
|
|
39,515
|
|
|
99,319
|
|
|
54,266
|
|
Cost of service revenue
|
|
17,122
|
|
|
19,277
|
|
|
35,719
|
|
|
39,748
|
|
Total cost of revenue
|
|
82,396
|
|
|
58,792
|
|
|
135,038
|
|
|
94,014
|
|
Gross profit
|
|
37,807
|
|
|
28,343
|
|
|
64,759
|
|
|
52,152
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
Research and development, net
|
|
29,382
|
|
|
17,325
|
|
|
59,274
|
|
|
49,965
|
|
Sales and marketing
|
|
15,218
|
|
|
15,247
|
|
|
30,883
|
|
|
29,900
|
|
General and administrative
|
|
5,624
|
|
|
7,205
|
|
|
11,403
|
|
|
16,002
|
|
Restructuring
|
|
—
|
|
|
—
|
|
|
476
|
|
|
—
|
|
Total operating expenses
|
|
50,224
|
|
|
39,777
|
|
|
102,036
|
|
|
95,867
|
|
Loss from operations
|
|
(12,417
|
)
|
|
(11,434
|
)
|
|
(37,277
|
)
|
|
(43,715
|
)
|
|
|
|
|
|
|
|
|
|
Other income, net
|
|
430
|
|
|
155
|
|
|
48
|
|
|
1,197
|
|
Interest income, net
|
|
667
|
|
|
897
|
|
|
1,380
|
|
|
1,775
|
|
Loss before income taxes
|
|
(11,320
|
)
|
|
(10,382
|
)
|
|
(35,849
|
)
|
|
(40,743
|
)
|
Income tax benefit (expense)
|
|
370
|
|
|
3,542
|
|
|
(109
|
)
|
|
14,688
|
|
Net loss
|
|
$
|
(10,950
|
)
|
|
$
|
(6,840
|
)
|
|
$
|
(35,958
|
)
|
|
$
|
(26,055
|
)
|
|
|
|
|
|
|
|
|
|
Basic net loss per common share
|
|
$
|
(0.27
|
)
|
|
$
|
(0.17
|
)
|
|
$
|
(0.89
|
)
|
|
$
|
(0.65
|
)
|
Diluted net loss per common share
|
|
$
|
(0.27
|
)
|
|
$
|
(0.17
|
)
|
|
$
|
(0.89
|
)
|
|
$
|
(0.65
|
)
|
|
|
|
|
|
|
|
|
|
Basic weighted average shares outstanding
|
|
40,616
|
|
|
40,051
|
|
|
40,527
|
|
|
40,022
|
|
Diluted weighted average shares outstanding
|
|
40,616
|
|
|
40,051
|
|
|
40,527
|
|
|
40,022
|
|
The accompanying notes are an integral part of these condensed consolidated financial statements
CRAY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited and in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Net loss
|
|
$
|
(10,950
|
)
|
|
$
|
(6,840
|
)
|
|
$
|
(35,958
|
)
|
|
$
|
(26,055
|
)
|
Other comprehensive income (loss), net of tax:
|
|
|
|
|
|
|
|
|
Unrealized gain on available-for-sale investments
|
|
9
|
|
|
77
|
|
|
7
|
|
|
94
|
|
Foreign currency translation adjustments
|
|
(1,185
|
)
|
|
(170
|
)
|
|
(1,159
|
)
|
|
440
|
|
Unrealized gain (loss) on cash flow hedges
|
|
2,306
|
|
|
(615
|
)
|
|
1,074
|
|
|
(1,174
|
)
|
Reclassification adjustments on cash flow hedges included in net loss
|
|
633
|
|
|
38
|
|
|
1,109
|
|
|
38
|
|
Other comprehensive income (loss)
|
|
1,763
|
|
|
(670
|
)
|
|
1,031
|
|
|
(602
|
)
|
Comprehensive loss
|
|
$
|
(9,187
|
)
|
|
$
|
(7,510
|
)
|
|
$
|
(34,927
|
)
|
|
$
|
(26,657
|
)
|
The accompanying notes are an integral part of these condensed consolidated financial statements
CRAY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited and in thousands)
|
|
|
|
|
|
|
|
|
|
Six Months Ended
June 30,
|
|
2018
|
|
2017
|
Operating activities:
|
|
|
|
Net loss
|
$
|
(35,958
|
)
|
|
$
|
(26,055
|
)
|
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
|
|
|
|
Depreciation and amortization
|
8,269
|
|
|
7,893
|
|
Share-based compensation expense
|
6,134
|
|
|
5,058
|
|
Deferred income taxes
|
(239
|
)
|
|
(14,811
|
)
|
Other
|
(145
|
)
|
|
637
|
|
Cash provided (used) due to changes in operating assets and liabilities:
|
|
|
|
Accounts and other receivables
|
46,484
|
|
|
124,479
|
|
Long-term investment in sales-type lease, net
|
6,673
|
|
|
4,577
|
|
Inventory
|
32,755
|
|
|
(68,472
|
)
|
Prepaid expenses and other assets
|
(617
|
)
|
|
799
|
|
Accounts payable
|
(40,264
|
)
|
|
11,618
|
|
Accrued payroll and related expenses and other liabilities
|
3,777
|
|
|
(3,088
|
)
|
Customer contract liabilities
|
(27,049
|
)
|
|
(977
|
)
|
Net cash provided by (used in) operating activities
|
(180
|
)
|
|
41,658
|
|
Investing activities:
|
|
|
|
Sales/maturities of available-for-sale investments
|
7,000
|
|
|
15,000
|
|
Purchases of available-for-sale investments
|
—
|
|
|
(94,902
|
)
|
Cash received in strategic transaction
|
1,584
|
|
|
—
|
|
Purchases of property and equipment
|
(3,275
|
)
|
|
(13,588
|
)
|
Net cash provided by (used in) investing activities
|
5,309
|
|
|
(93,490
|
)
|
Financing activities:
|
|
|
|
Proceeds from issuance of common stock through employee stock purchase plan
|
—
|
|
|
365
|
|
Purchase of employee restricted shares to fund related statutory tax withholding
|
(2,569
|
)
|
|
(1,514
|
)
|
Proceeds from exercises of stock options
|
1,792
|
|
|
90
|
|
Net cash used in financing activities
|
(777
|
)
|
|
(1,059
|
)
|
Effect of foreign exchange rate changes on cash, cash equivalents and restricted cash
|
(185
|
)
|
|
1,281
|
|
Net increase (decrease) in cash, cash equivalents and restricted cash
|
4,167
|
|
|
(51,610
|
)
|
Cash, cash equivalents and restricted cash:
|
|
|
|
Beginning of period
|
140,320
|
|
|
224,617
|
|
End of period
|
$
|
144,487
|
|
|
$
|
173,007
|
|
|
|
|
|
Supplemental disclosure of cash flow information:
|
|
|
|
Cash paid for income taxes
|
$
|
401
|
|
|
$
|
990
|
|
Non-cash investing and financing activities:
|
|
|
|
Inventory transfers to fixed assets and service spares
|
$
|
5,503
|
|
|
$
|
887
|
|
The following is a reconciliation of cash, cash equivalents and restricted cash reported within the Condensed Consolidated Balance Sheets that sum to the total of the same such amounts shown in the Condensed Consolidated Statements of Cash Flows:
|
|
|
|
|
|
|
|
|
|
June 30,
2018
|
|
December 31,
2017
|
Cash and cash equivalents
|
$
|
142,157
|
|
|
$
|
137,326
|
|
Restricted cash (1)
|
1,300
|
|
|
1,964
|
|
Long-term restricted cash (1)
|
1,030
|
|
|
1,030
|
|
Total cash, cash equivalents and restricted cash
|
$
|
144,487
|
|
|
$
|
140,320
|
|
|
|
(1)
|
Restricted cash primarily associated with certain letters of credit to secure customer prepayments and other customer related obligations.
|
The accompanying notes are an integral part of these condensed consolidated financial statements
CRAY INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1— Basis of Presentation
In these notes, the Company and its wholly-owned subsidiaries are collectively referred to as the “Company.” In the opinion of management, the accompanying Condensed Consolidated Balance Sheets, Statements of Operations, Statements of Comprehensive Loss, and Statements of Cash Flows have been prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP, for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. Management believes that all adjustments (consisting of normal recurring adjustments) considered necessary for fair presentation have been included. Interim results are not necessarily indicative of results for a full year. The information included in this quarterly report on Form 10-Q should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements and notes thereto included in the Company’s annual report on Form 10-K for the fiscal year ended
December 31, 2017
.
The Company’s revenue, results of operations and cash balances are likely to fluctuate significantly from quarter to quarter. These fluctuations are due to such factors as the high average sales prices and limited number of sales of the Company’s products, the timing of purchase orders and product deliveries, the revenue recognition accounting policy of generally not recognizing product revenue until customer acceptance and other contractual provisions have been fulfilled and the timing of payments for product sales, maintenance services, government research and development funding and purchases of inventory. Given the nature of the Company’s business, its revenue, receivables and other related accounts are likely to be concentrated among a relatively small number of customers.
Principles of Consolidation
The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All material intercompany accounts and transactions have been eliminated.
Use of Estimates
The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the amounts reported in the Company’s condensed consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates.
Revenue Recognition
On January 1, 2018, the Company adopted the new accounting standard ASC 606, Revenue from Contracts with Customers, which superseded nearly all existing revenue recognition guidance under GAAP, to all contracts using the modified retrospective method. The comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods. Adoption of the new standard did not have a material impact on the Company’s net
loss
during the first
six
months of 2018. The Company expects the impact of the adoption of the new standard to be immaterial to its net income on an ongoing basis.
The Company’s performance obligations are satisfied over time as work is performed or at a point in time. The majority of the Company’s revenue is recognized at a point in time when products are accepted, installed or delivered. Most of the Company’s revenue is derived from long-term contracts that can span several years. Revenue is recognized when performance obligations under the terms of a contract with the customer are satisfied; generally, this occurs with the transfer of control of the Company’s systems or services. In general, this does not occur until the products have been shipped or services provided to the customer, risk of loss has transferred to the customer, and, where applicable, a customer acceptance has been obtained. Revenue is measured as the amount of consideration the Company expects to receive in exchange for transferring goods or providing services. Sales, value add, and other taxes that the Company collects concurrent with revenue-producing activities are excluded from revenue. Incidental items that are immaterial in the context of the contract are recognized as expense.
To determine the proper revenue recognition method for contracts, the Company evaluates whether two or more contracts should be combined and accounted for as one single contract and whether the combined or single contract should be accounted for as more than one performance obligation. Contracts are often modified to account for changes in contract specifications and requirements. To determine the proper revenue recognition method for contract modifications, the Company evaluates whether the contract modification should be accounted for as a separate contract, part of an existing contract, or termination of an existing contract and the creation of a new contract. This evaluation requires significant judgment and the decision to combine a group of contracts or separate the combined or single contract into multiple performance obligations could change the amount of revenue and profit recorded in a given period. For contracts with multiple performance obligations, the Company allocates the contract’s
transaction price to each performance obligation using the Company’s estimate of the standalone selling price of each distinct good or service in the contract.
The Company determines the transaction price by reviewing the established contractual terms and other relevant information. Contracts can include penalty clauses and contracts with government customers may not be fully funded, both of which represent variable consideration. Generally, the Company includes both the funded and unfunded portions of a contract with a government customer in the transaction price, as most often it is deemed the contract will become fully funded. The Company also assesses the likelihood of certain penalties that would result in contract price reductions and, if deemed probable, the transaction price is adjusted.
The majority of the Company’s contracts include multiple promised goods and services, which are assessed at contract inception. Each distinct good or service is identified as a performance obligation, which may be an individual good or service or a bundle of goods or services. In order to determine whether the promises are distinct, the Company assesses the use of its products and services by its customers to determine whether the customer can benefit from the good or service on its own or from other readily available resources, and whether the promised transfer of goods or services is separately identifiable from other promises in the contract.
The majority of the Company’s revenues are from product solutions which include supercomputers, storage, and data analytics systems, each of which are usually separate performance obligations. Revenue is recognized when obligations under the terms of a contract with a customer are satisfied. Product revenue is typically recognized upon customer acceptance, or upon installation or delivery if formal acceptance is not required. Service revenue is typically recognized over time and consists mainly of system maintenance, analyst services, and engineering services, each of which are usually separate performance obligations. System maintenance commences upon customer acceptance or installation, depending on the contract terms, and revenue is recognized ratably over the remaining term of the maintenance contract. On-site analysts provide specialized services to customers, the revenue for which is recognized ratably over the contract period. Service revenue is recognized on a straight-line basis over the service period as the services are available continuously to the customer. Revenue from engineering services can be recognized as services are performed or as milestones are achieved, depending on the terms of the contract and nature of services performed. If, in a contract, the customer has an option to acquire additional goods or services, that option gives rise to a performance obligation if the option provides a material right to the customer that it would not receive without entering into that contract. Revenue from purchase options can be recognized as those future goods or services are transferred or when the option expires.
The Company performs an assessment to determine whether a significant financing component is present in a contract. If a contract is determined to include a significant financing component, the interest rate used in the calculation is based on the prevailing interest rates at contract inception and the entity’s creditworthiness. When the period between providing a good or service to the customer is expected to be less than one year from payment, the Company applies the practical expedient and does not adjust the consideration for the effects of a significant financing component.
Occasionally, the Company’s contracts include noncash consideration. This typically consists of returned parts when a system is upgraded or de-installed. Noncash consideration is measured at contract inception at estimated fair value.
The total transaction price is allocated to each performance obligation identified in the contract based on its relative standalone selling price. The Company does not have directly observable standalone selling prices for the majority of its performance obligations due to a relatively small number of customer contracts that differ in system size and contract terms which can be due to infrequently selling each performance obligation separately, not pricing products within a narrow range, or only having a limited sales history, such as in the case of certain advanced and emerging technologies. When a directly observable standalone selling price is not available, the Company estimates the standalone selling price. In determining the estimated standalone selling price, the Company uses the cost to provide the product or service plus a margin, or considers other factors. When using cost plus a margin, the Company considers the total cost of the product or service, including customer-specific and geographic factors as appropriate. The Company also considers the historical margins of the product or service on previous contracts and several other factors including any changes to pricing methodologies, competitiveness of products and services, and cost drivers that would cause future margins to differ from historical margins.
The Company sometimes offers discounts to its customers. As these discounts are offered on bundles of goods and services, the discounts are applied to all performance obligations in the contract on a pro-rata basis.
The following table provides information about contract receivables, contract assets, and contract liabilities from contracts with customers (in thousands) and includes both short-term and long-term portions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30,
2018
|
|
December 31, 2017
|
|
Change
|
Contract receivables
|
|
$
|
111,300
|
|
|
$
|
167,346
|
|
|
$
|
(56,046
|
)
|
Contract assets
|
|
8,303
|
|
|
9,321
|
|
|
(1,018
|
)
|
Contract liabilities
|
|
91,492
|
|
|
118,741
|
|
|
(27,249
|
)
|
Generally, billing occurs subsequent to product revenue recognition and payment is expected within 30 days, resulting in contract assets. Contract receivables consist of amounts billed to customers and include the Company's investment in a sales type lease, a portion of which is due beyond one year. Contract assets primarily relate to the Company's rights to consideration for work completed but not billed where right to payment is not just subject to the passage of time. Contract assets become contract receivables when the rights become unconditional. The Company sometimes receives advances or deposits from customers before revenue is recognized, resulting in customer contract liabilities (formerly deferred revenue). These assets and liabilities are reported on the Condensed Consolidated Balance Sheet on a contract-by-contract basis at the end of each reporting period. The Company’s payment terms vary from contract to contract. Contracts may require payment before, at or after the Company’s performance obligations have been satisfied. The
decrease
in the Company's contract asset balance for the
six months ended June 30, 2018
is primarily due to transfers of amounts from contract assets to contract receivables that were included in the contract assets balance at the beginning of the period, partially offset by the addition of new contract assets.
For the
six
month period ended
June 30, 2018
, the Company recognized
$49.9 million
in revenues from the contract liability balance at the beginning of the period.
The Company’s incremental direct costs of obtaining a contract come primarily from sales commissions, a portion of which are paid upon contract signing. These commissions are generally capitalized upon payment and expensed at the time of revenue recognition. These deferred commissions are included in prepaid expenses in the Condensed Consolidated Balance Sheet. As of
June 30, 2018
and
December 31, 2017
, the Company had
$2.0 million
and
$1.3 million
, respectively, of deferred commissions. For the
three and six months ended June 30, 2018
, the Company recognized
$1.5 million
and
$2.6 million
, respectively, in commissions expense. For the
three and six months ended June 30, 2017
, the Company recognized
$1.2 million
and
$1.7 million
, respectively, in commissions expense.
The following data presents the Company's operating segment revenues disaggregated by primary geographic market, which is determined based on a customer's geographic location (in thousands). Regions represent Europe, the Middle East, and Africa (EMEA); Asia-Pacific and Japan; and the United States, Canada, and Latin America (Americas). Revenues were reduced by
$0.6 million
and
$1.1 million
related to hedging losses for the
three and six months ended June 30, 2018
, respectively, which do not represent revenues recognized from contracts with customers.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Americas
|
|
EMEA
|
|
Asia Pacific & Japan
|
|
Total
|
Three Months Ended June 30, 2018
|
|
|
|
|
|
|
|
|
Supercomputing
|
|
$
|
44,318
|
|
|
$
|
14,148
|
|
|
$
|
43,305
|
|
|
$
|
101,771
|
|
Storage and Data Management
|
|
6,876
|
|
|
3,268
|
|
|
2,817
|
|
|
12,961
|
|
Maintenance and Support
|
|
21,117
|
|
|
7,752
|
|
|
5,425
|
|
|
34,294
|
|
Engineering Services and Other
|
|
5,189
|
|
|
58
|
|
|
224
|
|
|
5,471
|
|
Elimination of inter-segment revenue
|
|
(21,117
|
)
|
|
(7,752
|
)
|
|
(5,425
|
)
|
|
(34,294
|
)
|
Total revenue
|
|
$
|
56,383
|
|
|
$
|
17,474
|
|
|
$
|
46,346
|
|
|
$
|
120,203
|
|
|
|
|
|
|
|
|
|
|
|
|
Americas
|
|
EMEA
|
|
Asia Pacific & Japan
|
|
Total
|
Six Months Ended June 30, 2018
|
|
|
|
|
|
|
|
|
Supercomputing
|
|
$
|
64,927
|
|
|
$
|
22,806
|
|
|
$
|
69,904
|
|
|
$
|
157,637
|
|
Storage and Data Management
|
|
14,914
|
|
|
7,444
|
|
|
11,356
|
|
|
33,714
|
|
Maintenance and Support
|
|
41,663
|
|
|
15,241
|
|
|
10,224
|
|
|
67,128
|
|
Engineering Services and Other
|
|
7,910
|
|
|
118
|
|
|
418
|
|
|
8,446
|
|
Elimination of inter-segment revenue
|
|
(41,663
|
)
|
|
(15,241
|
)
|
|
(10,224
|
)
|
|
(67,128
|
)
|
Total revenue
|
|
$
|
87,751
|
|
|
$
|
30,368
|
|
|
$
|
81,678
|
|
|
$
|
199,797
|
|
The Company’s remaining performance obligations reflect the deliverables within contracts with customers that will have revenue recognized in a future period (this may also be referred to as backlog). Due to the nature of the Company’s business and the size of individual transactions, forecasting the timing and total amount of revenue recognition is subject to significant uncertainties. As of
June 30, 2018
, the Company has an aggregate of
$465 million
in remaining performance obligations stemming from a mixture of system contracts with their related service obligations and other service obligations. Included in this balance are
$0.5 million
in gains resulting from hedged foreign currency transactions, which offset the related increase in revenue from currency fluctuations. These gains will be reclassified from accumulated other comprehensive income to revenue in the period the related transactions are recognized as revenue. These obligations are anticipated to be recognized as revenue over approximately the next
six years
. The Company estimates that about
80%
of these obligations are expected to be recognized as revenue in the next
18 months
, with the remainder thereafter.
Note 2— New Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers: Topic 606 (ASU 2014-09) to supersede nearly all existing revenue recognition guidance under GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, it is possible more judgment and estimates may be required within the revenue recognition process than required under prior GAAP, including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. The new guidance also requires additional disclosures and several terminology changes, such as amounts previously referred to as deferred revenue now being referred to as customer contract liabilities. The Company adopted ASU 2014-09 at the beginning of the first quarter of 2018 using the modified retrospective method. No cumulative effect adjustment was required to be recorded for this change in accounting as the Company determined the impact of the change to not be material. The comparative information for the
three and six months ended June 30, 2017
, and as of December 31, 2017 has not been restated and continues to be reported under the accounting standards in effect for those periods. The effect of initially applying the new revenue standard had an immaterial effect on the Company’s financial statements. Adoption of the new standard did not have a material impact on the Company’s net
loss
during the first
six
months of 2018. The Company expects the impact of the adoption of the new standard to be immaterial to its net income on an ongoing basis.
In January 2016, FASB issued Accounting Standards Update No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities: Topic 825 (ASU 2016-01). The updated guidance enhances the reporting model for financial instruments, which includes amendments to address aspects of recognition, measurement, presentation and disclosure. The Company adopted ASU 2016-01 at the beginning of the first quarter of 2018. Adoption of ASU 2016-01 did not have a material impact on the Company’s consolidated financial statements.
In February 2016, FASB issued Accounting Standards Update No. 2016-02, Leases: Topic 842 (ASU 2016-02), that replaces existing lease guidance. The new standard is intended to provide enhanced transparency and comparability by requiring lessees to record right-of-use assets and corresponding lease liabilities on the balance sheet. Under the new guidance, leases will continue to be classified as either finance or operating, with classification affecting the pattern of expense recognition in the Consolidated Statements of Operations. Lessor accounting is largely unchanged under ASU 2016-02. Adoption of ASU 2016-02 is required for fiscal reporting periods beginning after December 15, 2018, including interim reporting periods within those fiscal years with early adoption being permitted. The new standard requires application with a modified retrospective approach to each prior reporting period presented with various optional practical expedients. While the Company expects adoption to lead to a material increase in the assets and liabilities recorded on its Consolidated Balance Sheet, the Company is still evaluating the overall impact on its consolidated financial statements.
In August 2016, FASB issued Accounting Standards Update No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (ASU 2016-15). The updated guidance clarifies how companies present and classify certain cash receipts and cash payments in the statement of cash flows. The Company adopted ASU 2016-15 at the beginning of the first quarter of 2018. Adoption of ASU 2016-15 did not have a material impact on the Company’s consolidated financial statements.
In November 2016, FASB issued Accounting Standards Update No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (ASU 2016-18), which amends ASC 230 to add or clarify guidance on the classification and presentation of restricted cash in the statement of cash flows. The amended guidance requires that amounts that are deemed to be restricted cash and restricted cash equivalents be included in the cash and cash-equivalent balances in the statement of cash flows. A reconciliation between the consolidated balance sheet and the statement of cash flows must be disclosed when the consolidated balance sheet includes more than one line item for cash, cash equivalents, restricted cash, and restricted cash equivalents. The guidance also requires that changes in restricted cash and restricted cash equivalents that result from transfers between cash, cash equivalents, and restricted cash and restricted cash equivalents should not be presented as cash flow activities in the statement of cash flows. An entity with a material balance of amounts generally described as restricted cash and restricted cash equivalents must disclose information about the nature of the restrictions. The Company adopted ASU 2016-18 at the beginning of the first quarter of 2018. Restricted cash amounts have been combined with the cash and cash equivalent balances in the Condensed Consolidated Statement of Cash Flows for each period presented. Adoption of ASU 2016-18 did not have a material impact on the Company’s consolidated financial statements.
In August 2017, FASB issued Accounting Standards Update No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities (ASU 2017-12). The new standard simplifies and expands the eligible hedging strategies for financial and nonfinancial risks. It also enhances the transparency of how hedging results are presented and disclosed. Further, the new standard provides partial relief on the timing of certain aspects of hedge documentation and eliminates the requirement to recognize hedge ineffectiveness separately in earnings. Adoption of ASU 2017-12 is required for fiscal reporting periods beginning after December 15, 2018, including interim reporting periods within those fiscal years with early adoption being permitted. The Company is currently evaluating the potential impact of the pending adoption of ASU 2017-12 on its consolidated financial statements.
In February 2018, FASB issued Accounting Standards Update No. 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (ASU 2018-02). The new standard amends ASC 220 to allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the “Tax Cuts and Jobs Act” and requires entities to provide certain disclosures regarding stranded tax effects. Adoption of ASU 2018-02 is required for fiscal reporting periods beginning after December 15, 2018, including interim reporting periods within those fiscal years with early adoption being permitted. The Company does not expect the adoption of ASU 2018-02 to have a material impact on its consolidated financial statements.
Note 3— Fair Value Measurement
Based on the observability of the inputs used in the valuation techniques used to determine the fair value of certain financial assets and liabilities, the Company is required to provide the following information according to the fair value hierarchy. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values.
In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities. Fair values determined by Level 2 inputs utilize observable inputs other than Level 1 prices, such as quoted prices
for similar assets or liabilities, quoted prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the related assets or liabilities. Fair values determined by Level 3 inputs are unobservable data points for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. The following table presents information about the Company’s financial assets and liabilities that have been measured at fair value as of
June 30, 2018
, and indicates the level within the fair value hierarchy of the valuation inputs utilized to determine such fair value (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Description
|
|
Fair Value
as of
June 30,
2018
|
|
Quoted
Prices in
Active
Markets
(Level 1)
|
|
Significant
Other
Observable
Inputs
(Level 2)
|
Assets:
|
|
|
|
|
|
|
Cash, cash equivalents and restricted cash
|
|
$
|
144,487
|
|
|
$
|
144,487
|
|
|
$
|
—
|
|
Foreign currency exchange contracts (1)
|
|
3,522
|
|
|
—
|
|
|
3,522
|
|
Assets measured at fair value at June 30, 2018
|
|
$
|
148,009
|
|
|
$
|
144,487
|
|
|
$
|
3,522
|
|
Liabilities:
|
|
|
|
|
|
|
Foreign currency exchange contracts (2)
|
|
197
|
|
|
—
|
|
|
197
|
|
Liabilities measured at fair value at June 30, 2018
|
|
$
|
197
|
|
|
$
|
—
|
|
|
$
|
197
|
|
|
|
(1)
|
Included in “Prepaid expenses and other current assets” and “Other non-current assets” on the Company’s Condensed Consolidated Balance Sheets.
|
|
|
(2)
|
Included in “Other accrued liabilities” and “Other non-current liabilities” on the Company’s Condensed Consolidated Balance Sheets.
|
Foreign Currency Derivatives
The Company may enter into foreign currency derivatives to hedge future cash receipts on certain sales transactions that are payable in foreign currencies.
As of
June 30, 2018
and
December 31, 2017
, the Company had outstanding foreign currency exchange contracts that were designated and accounted for as cash flow hedges of anticipated future cash receipts on sales contracts payable in foreign currencies. The outstanding notional amounts were approximately (in millions):
|
|
|
|
|
|
|
|
|
|
June 30,
2018
|
|
December 31, 2017
|
Euros (EUR)
|
|
0.8
|
|
|
2.1
|
|
Japanese Yen (JPY)
|
|
1,006.7
|
|
|
4,345.6
|
|
Canadian Dollars (CAD)
|
|
54.4
|
|
|
56.0
|
|
New Zealand Dollars (NZD)
|
|
—
|
|
|
16.2
|
|
The Company had hedged foreign currency exposure related to these designated cash flow hedges of approximately
$52.1 million
and
$96.3 million
as of
June 30, 2018
and
December 31, 2017
, respectively.
As of
June 30, 2018
and
December 31, 2017
, the Company had outstanding foreign currency exchange contracts that had been dedesignated for the purposes of hedge accounting treatment. The Company dedesignates cash flow hedges when the receivable related to the hedged cash flow is recorded. The outstanding notional amounts were approximately (in millions):
|
|
|
|
|
|
|
|
June 30,
2018
|
|
December 31, 2017
|
British Pounds (GBP)
|
22.2
|
|
|
26.1
|
|
Euros (EUR)
|
3.1
|
|
|
4.7
|
|
Swiss Francs (CHF)
|
—
|
|
|
2.6
|
|
Canadian Dollars (CAD)
|
0.2
|
|
|
0.3
|
|
Japanese Yen (JPY)
|
2,260.0
|
|
|
—
|
|
The foreign currency exposure related to these contracts was approximately
$57.2 million
as of
June 30, 2018
and
$46.9 million
as of
December 31, 2017
. Unrealized gains or losses related to these dedesignated contracts are recorded in other income
(loss) in the Condensed Consolidated Statements of Operations and are generally offset by foreign currency adjustments on related receivables. These foreign currency exchange contracts are considered to be economic hedges.
Cash receipts associated with the foreign currency exchange contracts are expected to be received from 2018 through 2022, during which time the revenue on the associated sales contracts is expected to be recognized, or in the case of receivables denominated in a foreign currency, the receivables balances will be collected. Any gain or loss on hedged foreign currency will be recognized
at the time of customer acceptance, or
in the case of receivables denominated in a foreign currency,
over the period during which hedged receivables denominated in a foreign currency are outstanding.
Fair values of derivative instruments designated as cash flow hedges (in thousands):
|
|
|
|
|
|
|
|
|
|
Balance Sheet Location
|
|
Fair Value
as of
June 30,
2018
|
|
Fair Value
as of
December 31,
2017
|
Prepaid expenses and other current assets
|
|
$
|
488
|
|
|
$
|
546
|
|
Other accrued liabilities
|
|
—
|
|
|
(129
|
)
|
Other non-current liabilities
|
|
(126
|
)
|
|
(1,907
|
)
|
Total fair value of derivative instruments designated as cash flow hedges
|
|
$
|
362
|
|
|
$
|
(1,490
|
)
|
Fair values of derivative instruments not designated as cash flow hedges (in thousands):
|
|
|
|
|
|
|
|
|
|
Balance Sheet Location
|
|
Fair Value
as of
June 30,
2018
|
|
Fair Value
as of
December 31,
2017
|
Prepaid expenses and other current assets
|
|
$
|
1,625
|
|
|
$
|
1,252
|
|
Other non-current assets
|
|
1,409
|
|
|
1,453
|
|
Other accrued liabilities
|
|
(71
|
)
|
|
(395
|
)
|
Total fair value of derivative instruments not designated as cash flow hedges
|
|
$
|
2,963
|
|
|
$
|
2,310
|
|
Note 4— Accumulated Other Comprehensive Income
The following table shows the impact on product revenue of reclassification adjustments from accumulated other comprehensive income resulting from hedged foreign currency transactions recorded by the Company for the
three and six months ended June 30, 2018 and 2017
(in thousands). The reclassification adjustments decreased product revenue for the
three and six months ended June 30, 2018 and 2017
.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
|
|
|
|
|
|
|
|
|
Gross of tax reclassifications
|
|
$
|
(633
|
)
|
|
$
|
(64
|
)
|
|
$
|
(1,109
|
)
|
|
$
|
(64
|
)
|
Net of tax reclassifications
|
|
$
|
(633
|
)
|
|
$
|
(38
|
)
|
|
$
|
(1,109
|
)
|
|
$
|
(38
|
)
|
The following tables show the changes in accumulated other comprehensive income by component for the
three and six months ended June 30, 2018 and 2017
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, 2018
|
|
|
Unrealized Loss on Investments
|
|
Foreign Currency Translation Adjustments
|
|
Unrealized Gain (Loss) on Cash Flow Hedges
|
|
Accumulated Other Comprehensive Income
|
Beginning balance
|
|
$
|
(9
|
)
|
|
$
|
1,637
|
|
|
$
|
(1,445
|
)
|
|
$
|
183
|
|
Current-period change, net of tax
|
|
9
|
|
|
(1,185
|
)
|
|
2,939
|
|
|
1,763
|
|
Ending balance
|
|
$
|
—
|
|
|
$
|
452
|
|
|
$
|
1,494
|
|
|
$
|
1,946
|
|
|
|
|
|
|
|
|
|
|
Income tax expense (benefit) associated with current-period change
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, 2017
|
|
|
Unrealized Gain on Investments
|
|
Foreign Currency Translation Adjustments
|
|
Unrealized Gain (Loss) on Cash Flow Hedges
|
|
Accumulated Other Comprehensive Income
|
Beginning balance
|
|
$
|
17
|
|
|
$
|
2,711
|
|
|
$
|
122
|
|
|
$
|
2,850
|
|
Current-period change, net of tax
|
|
77
|
|
|
(170
|
)
|
|
(577
|
)
|
|
(670
|
)
|
Ending balance
|
|
$
|
94
|
|
|
$
|
2,541
|
|
|
$
|
(455
|
)
|
|
$
|
2,180
|
|
|
|
|
|
|
|
|
|
|
Income tax expense (benefit) associated with current-period change
|
|
$
|
51
|
|
|
$
|
20
|
|
|
$
|
(384
|
)
|
|
$
|
(313
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, 2018
|
|
|
Unrealized Loss on Investments
|
|
Foreign Currency Translation Adjustments
|
|
Unrealized Gain (Loss) on Cash Flow Hedges
|
|
Accumulated Other Comprehensive Income
|
Beginning balance
|
|
$
|
(7
|
)
|
|
$
|
1,611
|
|
|
$
|
(689
|
)
|
|
$
|
915
|
|
Current-period change, net of tax
|
|
7
|
|
|
(1,159
|
)
|
|
2,183
|
|
|
1,031
|
|
Ending balance
|
|
$
|
—
|
|
|
$
|
452
|
|
|
$
|
1,494
|
|
|
$
|
1,946
|
|
|
|
|
|
|
|
|
|
|
Income tax expense (benefit) associated with current-period change
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, 2017
|
|
|
Unrealized Gain on Investments
|
|
Foreign Currency Translation Adjustments
|
|
Unrealized Gain (Loss) on Cash Flow Hedges
|
|
Accumulated Other Comprehensive Income
|
Beginning balance
|
|
$
|
—
|
|
|
$
|
2,101
|
|
|
$
|
681
|
|
|
$
|
2,782
|
|
Current-period change, net of tax
|
|
94
|
|
|
440
|
|
|
(1,136
|
)
|
|
(602
|
)
|
Ending balance
|
|
$
|
94
|
|
|
$
|
2,541
|
|
|
$
|
(455
|
)
|
|
$
|
2,180
|
|
|
|
|
|
|
|
|
|
|
Income tax expense (benefit) associated with current-period change
|
|
$
|
63
|
|
|
$
|
195
|
|
|
$
|
(757
|
)
|
|
$
|
(499
|
)
|
Note 5— Loss Per Share ("EPS")
Basic EPS is computed by dividing net loss available to common shareholders by the weighted average number of common shares, excluding unvested restricted stock, outstanding during the period. Diluted EPS is computed by dividing net loss 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 unvested restricted stock units as computed under the treasury stock method.
For the
three and six months ended June 30, 2018 and 2017
, outstanding stock options, unvested restricted stock and unvested restricted stock units were antidilutive because of the net losses and, as such, their effect has not been included in the calculation
of basic or diluted net loss per share. For the
three and six months ended June 30, 2018 and 2017
, potential gross common shares of
3.0 million
and
3.2 million
, respectively, were antidilutive and not included in computing diluted EPS. An additional
0.5 million
and
0.6 million
performance vesting restricted stock and performance vesting restricted stock units were excluded from the computation of potential common shares for the
three and six months ended June 30, 2018 and 2017
, respectively, because the conditions for vesting had not been met as of the balance sheet date.
Note 6— Investments
The Company’s investments in debt securities with maturities at purchase greater than three months are classified as “available-for-sale.” Changes in fair value are reflected in other comprehensive income (loss). The carrying amounts of the Company’s investments in available-for-sale securities as of
December 31, 2017
are shown in the table below (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized Loss
|
|
|
|
|
Cost
|
|
|
Fair Value
|
Short-term available-for-sale securities
|
|
$
|
7,007
|
|
|
$
|
(10
|
)
|
|
$
|
6,997
|
|
Note 7— Accounts and Other Receivables, Net
Net accounts and other receivables consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
June 30,
2018
|
|
December 31, 2017
|
Trade accounts receivable
|
|
$
|
84,513
|
|
|
$
|
131,151
|
|
Current contract assets
|
|
6,067
|
|
|
9,321
|
|
Advance billings
|
|
1,865
|
|
|
3,569
|
|
Short-term investment in sales-type lease
|
|
12,082
|
|
|
10,684
|
|
Other receivables
|
|
8,638
|
|
|
7,337
|
|
|
|
113,165
|
|
|
162,062
|
|
Allowance for doubtful accounts
|
|
(27
|
)
|
|
(28
|
)
|
Accounts and other receivables, net
|
|
$
|
113,138
|
|
|
$
|
162,034
|
|
Contract assets 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 revenue has not been recognized.
As of
June 30, 2018
and
December 31, 2017
, accounts receivable included
$39.0 million
and
$45.3 million
, respectively, that resulted from sales to the U.S. government and system acquisitions primarily funded by the U.S. government (“U.S. Government”). Of these amounts,
$1.0 million
and
$2.1 million
were unbilled and included in contract assets as of
June 30, 2018
and
December 31, 2017
, respectively, based upon contractual billing arrangements with these customers. As of
June 30, 2018
,
two
non-U.S. Government customers accounted for
30%
of total accounts and other receivables. As of
December 31, 2017
,
two
non-U.S. Government customers accounted for
38%
of total accounts and other receivables.
Note 8— Sales-type Lease
The Company has a sales-type lease with one non-U.S. Government customer, under which it will receive quarterly payments over the term of the lease, which expires in September 2020. The lease is denominated in British Pounds and the Company has entered into certain foreign currency exchange contracts that act as an economic hedge for the foreign currency exposure associated with this arrangement.
The following table shows the components of the net investment in the sales-type lease as of
June 30, 2018
and
December 31, 2017
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
June 30,
2018
|
|
December 31, 2017
|
Total minimum lease payments to be received
|
|
$
|
33,971
|
|
|
$
|
42,268
|
|
Less: executory costs
|
|
(4,574
|
)
|
|
(6,831
|
)
|
Net minimum lease payments receivable
|
|
29,397
|
|
|
35,437
|
|
Less: unearned income
|
|
(906
|
)
|
|
(1,386
|
)
|
Net investment in sales-type lease
|
|
28,491
|
|
|
34,051
|
|
Less: long-term investment in sales-type lease
|
|
(16,409
|
)
|
|
(23,367
|
)
|
Investment in sales-type lease included in accounts and other receivables
|
|
$
|
12,082
|
|
|
$
|
10,684
|
|
As of
June 30, 2018
, minimum lease payments for each of the succeeding three fiscal years are as follows (in thousands):
|
|
|
|
|
|
2018 (less than 1 year)
|
|
$
|
7,553
|
|
2019
|
|
15,105
|
|
2020
|
|
11,313
|
|
Total minimum lease payments to be received
|
|
$
|
33,971
|
|
Note 9— Inventory
Inventory consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
June 30,
2018
|
|
December 31, 2017
|
Components and subassemblies
|
|
$
|
34,263
|
|
|
$
|
37,219
|
|
Work in process
|
|
45,589
|
|
|
59,456
|
|
Finished goods
|
|
68,301
|
|
|
89,632
|
|
Total
|
|
$
|
148,153
|
|
|
$
|
186,307
|
|
Finished goods inventory of
$66.0 million
and
$48.1 million
was located at customer sites pending acceptance as of
June 30, 2018
and
December 31, 2017
, respectively. At
June 30, 2018
,
two
customers accounted for
$55.0 million
of finished goods inventory, and at
December 31, 2017
,
two
customers accounted for
$67.7 million
of finished goods inventory.
The Company did not write off any inventory during the
three and six months ended June 30, 2018 and 2017
.
Note 10— Customer Contract Liabilities
Liabilities from contracts with customers consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
June 30,
2018
|
|
December 31, 2017
|
Contract liability - product
|
|
$
|
7,055
|
|
|
$
|
22,245
|
|
Contract liability - service
|
|
84,437
|
|
|
96,496
|
|
Total contract liabilities
|
|
91,492
|
|
|
118,741
|
|
Less: long-term contract liabilities
|
|
(32,917
|
)
|
|
(38,622
|
)
|
Current contract liabilities
|
|
$
|
58,575
|
|
|
$
|
80,119
|
|
As of
June 30, 2018
and
December 31, 2017
, the U.S. Government accounted for
$25.9 million
and
$32.5 million
, respectively, of total customer contract liabilities. As of
June 30, 2018
and
December 31, 2017
,
no
non-U.S. Government customers accounted for more than
10%
of total customer contract liabilities.
Note 11— Contingencies
The Company is subject to patent lawsuits brought by Raytheon Company, or Raytheon. The first suit was brought by Raytheon on September 25, 2015 in the Eastern District of Texas (Civil Action No. 2:15-cv-1554) asserting infringement of
four
patents owned by Raytheon.
Two
of the originally asserted patents relate to computer hardware alleged to be encompassed by Cray’s current and past products (the “Hardware Patents”), and the
two
remaining asserted patents relate to features alleged to be
performed by certain third-party software that Cray optionally includes as part of its product offerings (the “Software Patents”). A second suit was brought by Raytheon on April 22, 2016 in the Eastern District of Texas (Civil Action No. 2:16-cv-423) asserting infringement of
five
patents owned by Raytheon. In this second suit, all
five
asserted patents relate to features alleged to be performed by certain third-party software that Cray optionally includes as part of its product offerings. On September 21, 2017, the United States Court of Appeals for the Federal Circuit granted Cray’s petition for writ of mandamus and overturned the trial court’s determination that venue in the first action was proper in the Eastern District of Texas, and accordingly on April 5, 2018, the trial court ordered that the first action should be transferred to the Western District of Wisconsin as had been requested by Cray, which was effective on April 30, 2018 (Civil Action No. 3:18-cv-00318-wmc). After transfer, Raytheon indicated its desire to withdraw its claims for infringement of the Hardware Patents. Accordingly, the Wisconsin court, upon joint motion of the parties, has dismissed with prejudice the counts related to the Hardware Patents, and Raytheon has served on the Company and filed with the court covenants not to sue for infringement of the Hardware Patents. The Wisconsin court has also scheduled summary judgment proceedings on the remaining two counts, relating to the Software Patents, and trial has been set for June 3, 2019. The Texas court, upon joint motion of the parties, has also transferred the second action to the Northern District of California (Civil Action No. 3:18-cv-03388-RS). Per joint motion of the parties, the California court has stayed the second action pending resolution of the first action. The Company is vigorously defending these actions. The probable outcome of either litigation cannot be determined, nor can the Company estimate a range of potential loss. Based on its review of the matters to date, the Company believes that it has valid defenses and claims in each of the
two
lawsuits. As a result, the Company considers the likelihood of a material loss related to these matters to be remote.
Note 12— Share-Based Compensation
The Company accounts for its share-based compensation based on an estimate of fair value of the grant on the date of grant.
In determining the fair value of stock options, the Company uses the Black-Scholes option pricing model. The following key weighted average assumptions were employed in the calculation for the three and
six
month periods ended
June 30, 2018
and
June 30, 2017
:
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Risk-free interest rate
|
|
2.85%
|
|
1.61%
|
|
2.85%
|
|
1.61%
|
Expected dividend yield
|
|
—%
|
|
—%
|
|
—%
|
|
—%
|
Volatility
|
|
48.93%
|
|
54.19%
|
|
48.93%
|
|
54.20%
|
Expected life
|
|
4.0 years
|
|
4.0 years
|
|
4.0 years
|
|
4.0 years
|
Weighted average Black-Scholes value of options granted
|
|
$11.13
|
|
$7.76
|
|
$11.13
|
|
$7.75
|
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. The expected life of an option is based on the assumption that options will be exercised, on average, about
two
years after vesting occurs. The Company recognizes compensation expense for only the portion of options 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 to the Company’s stock option grants during the
three and six months ended June 30, 2018 and 2017
was
8.0%
. 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, which impact the fair value of the option calculated under the Black-Scholes methodology and, ultimately, the expense that will be recognized over the vesting period or requisite service period of the option. The Company typically issues stock options with a
four
year vesting period (the requisite service period) and amortizes the fair value of stock options (stock compensation cost) ratably over the requisite service period.
A summary of the Company’s year-to-date stock option activity and related information follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
Options
|
|
Weighted
Average
Exercise
Price
|
|
Weighted
Average
Remaining
Contractual
Term
|
Outstanding at December 31, 2017
|
|
2,034,474
|
|
|
$
|
17.26
|
|
|
|
Grants
|
|
168,803
|
|
|
$
|
27.10
|
|
|
|
Exercises
|
|
(192,814
|
)
|
|
$
|
9.30
|
|
|
|
Canceled and forfeited
|
|
(64,527
|
)
|
|
$
|
26.75
|
|
|
|
Outstanding at June 30, 2018
|
|
1,945,936
|
|
|
$
|
18.59
|
|
|
5.7
|
Exercisable at June 30, 2018
|
|
1,430,360
|
|
|
$
|
16.57
|
|
|
4.6
|
Available for grant at June 30, 2018
|
|
2,618,570
|
|
|
|
|
|
As of
June 30, 2018
, there was
$14.8 million
of aggregate intrinsic value of outstanding stock options, including
$13.4 million
of aggregate intrinsic value of exercisable stock options. Intrinsic value 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 its
second
quarter of
2018
and the exercise price, multiplied by the number of shares of common stock underlying the stock options) that would have been received by the option holders had all option holders exercised their options on
June 30, 2018
. During the
three and six months ended June 30, 2018
, stock options covering
20,699
and
192,814
shares of common stock, respectively, with a total intrinsic value of
$0.3 million
and
$2.7 million
, respectively, were exercised. During the
three and six months ended June 30, 2017
, stock options covering
3,376
and
13,523
shares of common stock, respectively, with a total intrinsic value of
$49 thousand
and
$0.2 million
, respectively, were exercised.
The fair value of unvested restricted stock and unvested restricted stock units is based on the market price of a share of the Company’s common stock on the date of grant and is amortized over the vesting period.
A summary of the Company’s unvested restricted stock grants and changes during the
six months ended June 30, 2018
is as follows:
|
|
|
|
|
|
|
|
|
|
|
Service Vesting Restricted Shares
|
|
|
Shares
|
|
Weighted
Average
Grant Date
Fair Value
|
Outstanding at December 31, 2017
|
|
112,325
|
|
|
$
|
24.09
|
|
Granted
|
|
28,469
|
|
|
$
|
27.10
|
|
Forfeited
|
|
(680
|
)
|
|
$
|
26.26
|
|
Vested
|
|
(85,595
|
)
|
|
$
|
23.05
|
|
Outstanding at June 30, 2018
|
|
54,519
|
|
|
$
|
27.02
|
|
The estimated forfeiture rate applied to the Company’s restricted stock grants during the
three and six months ended June 30, 2018 and 2017
, was
8.0%
. The aggregate fair value of restricted stock vested during the
three and six months ended June 30, 2018
, was
$1.9 million
and
$2.0 million
, respectively. The aggregate fair value of restricted stock vested during the
three and six months ended June 30, 2017
, was
$2.3 million
and
$2.4 million
, respectively.
A summary of the Company’s unvested restricted stock unit grants and changes during the
six months ended June 30, 2018
is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service Vesting Restricted Stock Units
|
|
Performance Vesting Restricted Stock Units
|
|
Total Restricted Stock Units
|
|
|
Units
|
|
Weighted
Average
Grant Date
Fair Value
|
|
Units
|
|
Weighted
Average
Grant Date
Fair Value
|
|
Units
|
|
Weighted Average Grant Date Fair Value
|
Outstanding at December 31, 2017
|
|
988,023
|
|
|
$
|
21.29
|
|
|
482,485
|
|
|
$
|
30.13
|
|
|
1,470,508
|
|
|
$
|
24.19
|
|
Granted
|
|
294,203
|
|
|
$
|
26.61
|
|
|
—
|
|
|
$
|
—
|
|
|
294,203
|
|
|
$
|
26.61
|
|
Forfeited
|
|
(41,116
|
)
|
|
$
|
21.97
|
|
|
—
|
|
|
$
|
—
|
|
|
(41,116
|
)
|
|
$
|
21.97
|
|
Vested
|
|
(228,564
|
)
|
|
$
|
22.41
|
|
|
—
|
|
|
$
|
—
|
|
|
(228,564
|
)
|
|
$
|
22.41
|
|
Outstanding at June 30, 2018
|
|
1,012,546
|
|
|
$
|
22.55
|
|
|
482,485
|
|
|
$
|
30.13
|
|
|
1,495,031
|
|
|
$
|
25.00
|
|
The estimated forfeiture rate applied to the Company’s service vesting restricted stock unit grants during the
three and six months ended June 30, 2018 and 2017
, was
8.0%
. The aggregate fair value of restricted stock units vested during the
three and six months ended June 30, 2018
, was
$4.7 million
and
$5.1 million
, respectively. The aggregate fair value of restricted stock units vested during the
three and six months ended June 30, 2017
, was
$1.5 million
and
$1.6 million
, respectively. Restricted stock units are not outstanding shares and do not have any voting or dividend rights. At the time of vesting, a share of common stock representing each restricted stock unit vested will be issued by the Company. The performance vesting restricted stock units are subject to performance measures that are currently not considered “probable” of attainment and as such, no compensation cost has been recorded for these units. The performance measures are based on Company performance for fiscal years 2018 and 2019.
Including performance-based equity awards, the Company had
$36.3 million
of total unrecognized compensation cost related to unvested stock options, unvested restricted stock and unvested restricted stock units as of
June 30, 2018
. Excluding the
$14.5 million
of unrecognized compensation cost related to unvested restricted stock units that are subject to performance measures that are currently not considered “probable” of attainment, unrecognized compensation cost is
$21.8 million
. No compensation expense is recognized for unvested restricted stock units subject to performance measures that are not considered “probable” of attainment. Unrecognized compensation cost related to unvested stock options and unvested non-performance-based restricted stock is expected to be recognized over a weighted average period of
3.1
years.
The following table sets forth the gross share-based compensation cost resulting from stock options, unvested restricted stock and unvested restricted stock units that were recorded in the Company’s Condensed Consolidated Statements of Operations for the
three and six months ended June 30, 2018 and 2017
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Cost of product revenue
|
|
$
|
110
|
|
|
$
|
76
|
|
|
$
|
216
|
|
|
$
|
116
|
|
Cost of service revenue
|
|
103
|
|
|
69
|
|
|
200
|
|
|
135
|
|
Research and development, net
|
|
1,101
|
|
|
907
|
|
|
1,961
|
|
|
1,798
|
|
Sales and marketing
|
|
744
|
|
|
315
|
|
|
1,478
|
|
|
1,200
|
|
General and administrative
|
|
1,134
|
|
|
940
|
|
|
2,279
|
|
|
1,809
|
|
Total
|
|
$
|
3,192
|
|
|
$
|
2,307
|
|
|
$
|
6,134
|
|
|
$
|
5,058
|
|
Note 13— Taxes
The Company’s effective tax rates for the
three and six months ended June 30, 2018 and 2017
were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Effective tax rates
|
|
3%
|
|
34%
|
|
—%
|
|
36%
|
The difference between the expected statutory tax rate of
21%
and the actual tax rates of
3%
and
0%
for the
three and six months ended June 30, 2018
, respectively, was attributable to the Company’s decision to continue to provide a full valuation allowance against the Company’s U.S. federal deferred tax assets offset, in part, by foreign taxes. The primary reason for the
difference between the expected statutory tax rate of
35%
and the actual tax rates of
34%
and
36%
for the
three and six months ended June 30, 2017
, respectively, was the Company’s research and development tax credit and other permanent items.
On December 22, 2017, the President of the United States signed into law H.R. 1, “An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018” (the “Tax Cuts and Jobs Act”). ASC Topic 740, Accounting for Income Taxes, requires companies to recognize the effect of tax law changes in the period of enactment. The Tax Cuts and Jobs Act made significant changes to existing U.S. tax law, including, but not limited to, a permanent reduction to the U.S. federal corporate income tax rate from 35% to 21% and the imposition of a one-time tax on deferred foreign income (“Repatriation Transition Tax”). Given the significance of the Tax Cuts and Jobs Act, the FASB issued Accounting Standards Update No. 2018-05, Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118 that recognized that a company’s review of the income tax effects attributable to the enactment of the Tax Cuts and Jobs Act may be incomplete at the time financial statements were issued for the reporting period that included the date of enactment and allowed a company to record provisional amounts during a one year measurement period. During the measurement period, income tax effects attributable to the enactment of the Tax Cuts and Jobs Act can be adjusted and recognized, as a discreet item in the applicable reporting period, as information becomes available, prepared or analyzed. The measurement period is deemed to have ended when the company has obtained, prepared and analyzed the information necessary to finalize its accounting. During the year ended December 31, 2017 the Company recorded provisional tax expense, in the amount of
$0.3 million
, attributable to the Repatriation Transition Tax and provisional tax expense, in the amount of
$0.3 million
, as a result of the Company’s decision to no longer consider the undistributed earnings of its foreign subsidiaries to be permanently reinvested outside of the U.S. As of
June 30, 2018
, the Company has not had sufficient time to obtain, prepare and analyze historical tax returns, financial statements and related accounts that is required to finalize its accounting with respect to the items for which provisional tax expense was recorded.
As of
June 30, 2018
, the Company continued to provide a full valuation allowance against its U.S. federal deferred tax assets and against the majority of its deferred tax assets arising in state and foreign jurisdictions as the realization of such assets is not considered to be more likely than not at this time. In a future period, the Company’s assessment of the realizability of its deferred tax assets and therefore the appropriateness of the valuation allowance could change based on an assessment of all available evidence, both positive and negative in that future period. If the Company’s conclusion about the realizability of its deferred tax assets and therefore the appropriateness of the valuation allowance changes in a future period, the Company could record a substantial tax benefit in its Condensed Consolidated Statements of Operations when that occurs.
Note 14— Segment Information
The Company has the following reportable segments: Supercomputing, Storage and Data Management, Maintenance and Support, and Engineering Services and Other. The Company’s reportable segments represent components of the Company for which separate financial information is available that is utilized on a regular basis by the Chief Executive Officer, who is the Chief Operating Decision Maker, in determining how to allocate the Company’s resources and evaluate performance. The segments are determined based on several factors, including the Company’s internal operating structure, the manner in which the Company’s operations are managed, client base, similar economic characteristics and the availability of separate financial information.
Supercomputing
Supercomputing includes a suite of highly advanced, tightly integrated and cluster supercomputer systems which are used by large research and engineering centers in universities, government laboratories, and commercial institutions. Supercomputing also includes the ongoing maintenance of these systems as well as system analysts.
Storage and Data Management
Storage and Data Management offers Cray DataWarp and ClusterStor (formerly branded Sonexion), as well as other third-party storage products and their ongoing maintenance as well as system analysts.
Maintenance and Support
Maintenance and Support provides ongoing maintenance of Cray supercomputers, big data storage and analytics systems, as well as system analysts.
Engineering Services and Other
Included within Engineering Services and Other are the Company’s analytics and artificial intelligence businesses and Custom Engineering.
The following table presents revenues and gross margins for the Company’s operating segments for the
three and six months ended June 30, 2018 and 2017
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Revenue:
|
|
|
|
|
|
|
|
|
Supercomputing
|
|
$
|
101,771
|
|
|
$
|
64,772
|
|
|
$
|
157,637
|
|
|
$
|
95,015
|
|
Storage and Data Management
|
|
12,961
|
|
|
15,744
|
|
|
33,714
|
|
|
31,289
|
|
Maintenance and Support
|
|
34,294
|
|
|
31,045
|
|
|
67,128
|
|
|
60,782
|
|
Engineering Services and Other
|
|
5,471
|
|
|
6,619
|
|
|
8,446
|
|
|
19,862
|
|
Elimination of inter-segment revenue
|
|
(34,294
|
)
|
|
(31,045
|
)
|
|
(67,128
|
)
|
|
(60,782
|
)
|
Total revenue
|
|
$
|
120,203
|
|
|
$
|
87,135
|
|
|
$
|
199,797
|
|
|
$
|
146,166
|
|
|
|
|
|
|
|
|
|
|
Gross Profit:
|
|
|
|
|
|
|
|
|
Supercomputing
|
|
$
|
29,051
|
|
|
$
|
20,164
|
|
|
$
|
47,172
|
|
|
$
|
31,823
|
|
Storage and Data Management
|
|
5,316
|
|
|
5,728
|
|
|
12,349
|
|
|
12,219
|
|
Maintenance and Support
|
|
17,871
|
|
|
14,759
|
|
|
32,946
|
|
|
28,577
|
|
Engineering Services and Other
|
|
3,440
|
|
|
2,451
|
|
|
5,238
|
|
|
8,110
|
|
Elimination of inter-segment gross profit
|
|
(17,871
|
)
|
|
(14,759
|
)
|
|
(32,946
|
)
|
|
(28,577
|
)
|
Total gross profit
|
|
$
|
37,807
|
|
|
$
|
28,343
|
|
|
$
|
64,759
|
|
|
$
|
52,152
|
|
Revenue and cost of revenue is the only discrete financial information the Company prepares for its segments. Other financial results or assets are not separated by segment.
The Company’s geographic operations outside the United States include sales and service offices in Europe and the Middle East, South America, Asia Pacific and Canada. Service revenue includes engineering services which can vary significantly from period to period. The following data represents the Company’s revenue for the United States and all other countries, which is determined based upon a customer’s geographic location (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
Other Countries
|
|
Total
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Three months ended June 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
Product revenue
|
|
$
|
31,155
|
|
|
$
|
38,826
|
|
|
$
|
52,224
|
|
|
$
|
12,705
|
|
|
$
|
83,379
|
|
|
$
|
51,531
|
|
Service revenue
|
|
22,470
|
|
|
24,641
|
|
|
14,354
|
|
|
10,963
|
|
|
36,824
|
|
|
35,604
|
|
Total revenue
|
|
$
|
53,625
|
|
|
$
|
63,467
|
|
|
$
|
66,578
|
|
|
$
|
23,668
|
|
|
$
|
120,203
|
|
|
$
|
87,135
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
Other Countries
|
|
Total
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Six months ended June 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
Product revenue
|
|
$
|
38,172
|
|
|
$
|
52,141
|
|
|
$
|
89,661
|
|
|
$
|
20,518
|
|
|
$
|
127,833
|
|
|
$
|
72,659
|
|
Service revenue
|
|
44,231
|
|
|
51,202
|
|
|
27,733
|
|
|
22,305
|
|
|
71,964
|
|
|
73,507
|
|
Total revenue
|
|
$
|
82,403
|
|
|
$
|
103,343
|
|
|
$
|
117,394
|
|
|
$
|
42,823
|
|
|
$
|
199,797
|
|
|
$
|
146,166
|
|
Sales to the U.S. Government totaled approximately
$42.5 million
and
$61.4 million
for the
three and six months ended June 30, 2018
, respectively, compared to approximately
$57.4 million
and
$91.6 million
for the
three and six months ended June 30, 2017
, respectively. For the
six months ended June 30, 2018
,
one
non-U.S. Government customer in Japan accounted for
17%
of total revenue. For the
six months ended June 30, 2018
, total revenue in Japan accounted for
26%
of total revenue. For the
six months ended June 30, 2017
,
no
non-U.S. Government or international customer accounted for more than
10%
of total revenue.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Preliminary Note Regarding Forward-Looking Statements
This quarterly report on Form 10-Q contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they never materialize or if they prove incorrect, could cause our actual results to differ materially from those expressed or implied by such forward-looking statements. Forward-looking statements are based on our management’s beliefs and assumptions and on information currently available to them. In some cases you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “would,” “expect,” “plans,” “anticipates,” “believes,” “continue,” “estimates,” “projects,” “predicts” and “potential” and similar expressions, but the absence of these words does not mean that a statement is not forward-looking. All statements other than statements of historical fact are statements that could be deemed forward-looking statements, and examples of forward-looking statements include any projections of earnings, revenue or other results of operations or financial results; any statements of the plans, strategies, objectives and beliefs of our management; any statements concerning proposed new products, technologies or services such as our next generation “Shasta” system; any statements regarding potential new markets or applications for our products; any statements regarding the impact and effects of the acquisition of Seagate’s ClusterStor line of business; any statements regarding technological developments or trends; any statements regarding future research and development or co-funding for such efforts; any statements regarding future market and economic conditions; any statements regarding the expected vesting of our performance-based equity awards; and any statements of assumptions underlying any of the foregoing. These forward-looking statements are subject to the safe harbor created by Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the risks faced by us and described in Item 1A. Risk Factors in Part II and other sections of this report and our other filings with the U.S. Securities and Exchange Commission, or SEC. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this report. You should read this report completely and with the understanding that our actual future results may be materially different from what we expect. We assume no obligation to update these forward-looking statements, whether as a result of new information, future events, or otherwise, except as otherwise required by law.
Overview
We focus on designing, developing, manufacturing, marketing and servicing computing products that magnify and enhance human capital, foster innovation and create competitive advantages. That means our products are aimed primarily at the high-end of the high performance computing (HPC) and data analytics and artificial intelligence (AI) markets - the segments populated by the pioneers, executives and entrepreneurs leading their industries in both the private and public sectors. These products include compute systems commonly known as supercomputers, and storage, data analytics and AI solutions. We offer them individually, integrated into a complete solution or hosted in the cloud, depending on a customer’s need. We also provide related software and system maintenance, support, and engineering services. Our customers include domestic and foreign government and government-funded entities, academic institutions and commercial companies. We provide customer-focused solutions based on four main models: (1) tightly integrated supercomputing designed throughout for scalability and sustained performance; (2) customizable cluster supercomputing based on highest-performance industry-standard components; (3) robust high-performance storage solutions; and (4) integrated solutions for large-scale analytics and AI applications. All of our solutions also emphasize total cost of ownership, scalable performance and data center flexibility as key features. Our continuing strategy is to gain market share by extending our technology leadership and differentiation and expanding our share and addressable market in areas where we can leverage our experience and technology, such as in AI applications and data analytics. We also meet diverse customer requirements by combining supercomputing, cluster supercomputing, and data analytics and AI into unique offerings that work in a workflow-driven datacenter environment.
Summary of First
Six
Months of
2018
Results
Total revenue
increase
d by
$53.6 million
for the first
six
months of
2018
compared to the first
six
months of
2017
, from
$146.2 million
to
$199.8 million
, due to higher product revenue. Product revenue was
$55.2 million
higher in the first
six
months of
2018
compared to the first
six
months of
2017
, driven by several large product acceptances during the first
six
months of
2018
.
Net
loss
for the first
six
months of
2018
was
$36.0 million
compared to net
loss
of
$26.1 million
for the same period in
2017
. The increase in net loss was primarily driven by a decrease in income tax benefit of
$14.8 million
for the first
six
months of
2018
compared to the first
six
months of
2017
and an increase of
$9.3 million
in net research and development expense due to lower reimbursements. These amounts were partially offset by the increase in revenue discussed above.
Net cash
used in
operating activities was
$0.2 million
for the first
six
months of
2018
compared to net cash
provided by
operating activities of
$41.7 million
for the first
six
months of
2017
. Net cash
used in
operating activities for the first
six
months of
2018
was primarily driven by the net loss, adjusted for non-cash expenses, of
$21.9 million
, a decrease in our accounts payable balance of
$40.3 million
due to the timing of payments to vendors, largely in connection with inventory purchases in the fourth quarter of 2017 and a decrease in customer contract liabilities of
$27.0 million
. These amounts were largely offset by collections
from customers that resulted in a decrease of
$46.5 million
in accounts and other receivables and a decrease of
$32.8 million
in inventory due to customer acceptances of systems that were delivered during the first
six
months of
2018
.
Market Overview and Challenges
Significant trends in the HPC industry include:
|
|
•
|
convergence of traditional supercomputing modeling simulation with big data analytics and AI;
|
|
|
•
|
supercomputing with many-core commodity processors driving increasing scalability requirements;
|
|
|
•
|
increased micro-architectural diversity, including increased usage of many-core processors and accelerators (such as graphics processors or GPU’s), as the rate of increases in per-core performance slows;
|
|
|
•
|
data I/O and storage capacity needs growing faster than computational needs;
|
|
|
•
|
the rise of AI along using machine learning and deep learning algorithms which utilize HPC technologies for performance and scale;
|
|
|
•
|
technology innovations in memory and storage allowing for faster data access such as high bandwidth memory, NVRAM, SSDs and flash devices;
|
|
|
•
|
the increasing commoditization of HPC hardware, particularly processors and system interconnects;
|
|
|
•
|
the growing concentration of very large suppliers of key computing, memory and storage components in the industry;
|
|
|
•
|
the growing commoditization of software, including more capable open source software;
|
|
|
•
|
electrical power and system cooling requirements becoming a design constraint and driver in total cost of ownership determinations;
|
|
|
•
|
increasing use of AI and analytics technologies (Hadoop, Spark, NoSQL and Graph) in both the HPC and big data markets;
|
|
|
•
|
increased adoption of cloud computing as a solution for loosely-coupled HPC applications;
|
|
|
•
|
much higher memory costs during the past year; and
|
|
|
•
|
significant variability in market demand for supercomputers from quarter-to-quarter and year-to-year.
|
Several of these trends have recently impacted the growth rate and related improvements in price-performance of products in the industry and has contributed to the expansion and acceptance of loosely-coupled cluster systems using processors manufactured by Intel, AMD and others combined with commercially available, commodity networking and other components, particularly in the middle and lower portions of the supercomputing market. These systems may offer higher theoretical peak performance for equivalent cost, and “price/peak performance” is sometimes the dominant factor in HPC procurements. Vendors of such systems often put pricing pressure on us, resulting in lower margins in competitive procurements.
In the market for the largest, and most scalable systems, those often costing in excess of $10 million, the use of generally available network components can result in increasing data transfer bottlenecks as these components do not balance processor power with network communication and system software capability. With increasing processor core counts due to new many-core processors, these unbalanced systems will typically have lower productivity, especially in larger systems running more complex applications. We and others augment standard microprocessors with other processor types, such as graphics processing units, in order to increase computational power, further complicating programming models. In addition, with increasing scale, bandwidth and processor core counts, large computer systems use progressively higher amounts of power to operate and require special cooling capabilities.
To position ourselves to meet the market’s demanding needs, we concentrate our research and development efforts on technologies that enable our supercomputers to perform at scale - that is, to continue to increase actual performance as systems and applications grow ever larger in size - and in areas where we can leverage our core expertise in other markets whose applications demand these tightly coupled architectures. We also invest relatively significantly in next-generation technology to successfully and uniquely address the challenges of “Exascale computing” (systems with exaflops-levels of performance). In addition, we have demonstrated expertise in system and performance software for several processor architectures. We expect to be in a comparatively advantageous position as larger many-core processors become available and as multiple processing technologies become integrated into single systems in heterogeneous environments. In addition, we have continued to expand our addressable market by leveraging
our technologies, customer base, the Cray brand and by introducing complementary products and services to new and existing customers, as demonstrated by our emphasis on strategic initiatives, such as big data analytics, AI and storage.
In analytics and AI, we are developing and delivering high performance data discovery, advanced analytics, machine learning and deep learning solutions. These solutions compete with open source software, running on commodity cluster or cloud systems. Although these competitive systems have low acquisition costs, the total cost of ownership (TCO) is driven up by management, power, efficiency and scaling challenges. We concentrate our efforts on developing solutions that minimize the TCO, delivering faster time-to-solution and advanced capabilities that are key drivers for many of our data analytics and AI customers. We support open source technologies such as Hadoop, Spark and Jupyter Notebook to design large-scale data analytics stacks that simplify analyses of scientific and commercial application and Python and R, distributed Dask, BigDL, TensorFlow and TensorBoard for advanced AI solutions.
In storage, we are developing and delivering high value products for the high performance parallel storage market. Our 2017 transaction with Seagate enhances our capabilities in storage and data management. Our storage products are primarily positioned to enable tight integration of storage with computing solutions and/or utilize parallel file processing technologies and facilitate storage across multiple data tiers. We support open source parallel file systems and protocols such as Lustre.
We have also expanded our addressable market by providing cluster systems and solutions to the supercomputing market that allow us to offer flexible platforms to incorporate best of breed components to allow customers to optimize the system to fit their unique requirements.
Key Performance Indicators
Our management monitors and analyzes several key performance indicators in order to manage our business and evaluate our financial and operating performance, including:
Revenue.
Product revenue generally constitutes the major portion of our revenue in any reporting period and, for the reasons discussed in this quarterly report on Form 10-Q or in our annual report on Form 10-K for the year ended
December 31, 2017
, is subject to significant variability from period to period and is difficult to forecast. In the short term, we closely review the status of customer proposals, customer contracts, product shipments, installations and acceptances in order to forecast revenue and cash receipts. In the longer-term, we monitor the status of the pipeline of product sales opportunities and product development cycles. We believe product revenue growth measured over several quarters is a better indicator of whether we are achieving our objective of growth and increased market share in the supercomputing market. The Cray XC and Cray CS products, along with our longer-term product roadmap are efforts to increase product revenue. We have increased our business and product development efforts in big data analytics, AI and storage and data management. Service revenue related to our maintenance offerings is subject to less variations in the short term and may assist, in part, to offset the impact that the variability in product revenue has on total revenue.
Gross profit margin.
Gross profit margin is impacted by the level of revenue, different customer requirements, competitive considerations, product type and our cost to build and deliver our products and services. Our services tend to carry higher gross profit margins than our products. We often bid contracts and commit to future system performance where certain key components are not available in the market at the time of bid and/or whose price might change from what was expected. While we have significant experience doing so, such actions are inherently risky and can impact our gross profit margin significantly in any period. For example, memory prices have more than doubled in less than a year which has had a significant impact on our reported product gross profit margin. To mitigate this and other similar risks, we monitor the cost of components, manufacturing, and installation of our products. In assessing our service gross profit margin, we monitor headcount levels and third-party costs.
Operating expenses.
Our operating expenses are driven primarily by headcount and compensation expense, including variable incentive compensation and contracted third-party research and development services. As part of our ongoing expense management efforts, we continue to monitor headcount levels in specific geographic and operational areas. With the recent reduction in revenue levels, we reduced the size of our workforce in 2017. However, the 2017 transaction with Seagate has partially offset this reduction but should help increase revenue and improve storage gross profit.
Liquidity and cash flows.
Due to the variability in product revenue, new contracts, acceptance and payment terms, our cash position also varies significantly from quarter-to-quarter and within a quarter. We monitor our expected cash levels, particularly in light of increased inventory purchases for large system installations and the risk of delays in product shipments, customer acceptances and, in the long-term, product development. Cash receipts generally lag customer acceptances.
Results of Operations
We adopted Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers : Topic 606 (ASU 2014-09) at the beginning of the first quarter of 2018. Adoption of ASU 2014-09 did not have a material impact on our results of operations or the comparability of the current and prior periods presented below.
Our revenue, results of operations and cash balances fluctuate significantly from period-to-period. These fluctuations are due to such factors as the strength or weakness of the HPC market, high average sales prices and limited number of sales of our products with variable gross margin levels, the timing of purchase orders and product deliveries, the availability of components, the revenue recognition accounting policy of generally not recognizing product revenue until customer acceptance and other contractual provisions have been fulfilled, the timing of payments for product sales, maintenance services, government research and development funding, the impact of the timing of new products on customer orders, and purchases of inventory during periods of inventory build-up. As a result of these factors, revenue, gross margin, expenses, cash, receivables, inventory and other related financial statement items have in the past varied, and are expected to continue to vary, significantly from quarter-to-quarter and year-to-year.
Revenue and Gross Profit Margins
Our revenue, cost of revenue and gross profit margin for the
three and six months ended June 30, 2018 and 2017
, respectively, were (in thousands, except for percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Product revenue
|
|
$
|
83,379
|
|
|
$
|
51,531
|
|
|
$
|
127,833
|
|
|
$
|
72,659
|
|
Less: Cost of product revenue
|
|
65,274
|
|
|
39,515
|
|
|
99,319
|
|
|
54,266
|
|
Product gross profit
|
|
$
|
18,105
|
|
|
$
|
12,016
|
|
|
$
|
28,514
|
|
|
$
|
18,393
|
|
Product gross profit margin
|
|
22
|
%
|
|
23
|
%
|
|
22
|
%
|
|
25
|
%
|
Service revenue
|
|
$
|
36,824
|
|
|
$
|
35,604
|
|
|
$
|
71,964
|
|
|
$
|
73,507
|
|
Less: Cost of service revenue
|
|
17,122
|
|
|
19,277
|
|
|
35,719
|
|
|
39,748
|
|
Service gross profit
|
|
$
|
19,702
|
|
|
$
|
16,327
|
|
|
$
|
36,245
|
|
|
$
|
33,759
|
|
Service gross profit margin
|
|
54
|
%
|
|
46
|
%
|
|
50
|
%
|
|
46
|
%
|
Total revenue
|
|
$
|
120,203
|
|
|
$
|
87,135
|
|
|
$
|
199,797
|
|
|
$
|
146,166
|
|
Less: Total cost of revenue
|
|
82,396
|
|
|
58,792
|
|
|
135,038
|
|
|
94,014
|
|
Total gross profit
|
|
$
|
37,807
|
|
|
$
|
28,343
|
|
|
$
|
64,759
|
|
|
$
|
52,152
|
|
Total gross profit margin
|
|
31
|
%
|
|
33
|
%
|
|
32
|
%
|
|
36
|
%
|
Product Revenue
Product revenue for the
three and six months ended June 30, 2018 and 2017
was primarily from sales of our Cray XC and Cray CS supercomputing systems, and ClusterStor storage systems. Product revenue was
$31.8 million
higher for the
three months ended June 30, 2018
, compared to the
three months ended June 30, 2017
and
$55.2 million
higher for the
six months ended June 30, 2018
, compared to the
six months ended June 30, 2017
, driven by several large product acceptances during the first
six
months of
2018
.
Service Revenue
Service revenue was
$1.2 million
higher for the
three months ended June 30, 2018
, compared to the
three months ended June 30, 2017
and
$1.5 million
lower for the
six months ended June 30, 2018
, compared to the
six months ended June 30, 2017
. Our maintenance revenue increased by
$3.2 million
and
$6.3 million
, respectively, over the prior year periods, driven by our larger installed system base, including the benefit from longer lifetimes of installed systems due to the slowdown in acquisitions of new replacement systems. Over the same periods, engineering services revenue, which varies significantly from period to period, decreased by $2.0 million and $7.9 million, respectively, driven by the completion of several engineering services contracts that we recognized revenue on during the first
six
months of
2017
.
Cost of Product Revenue and Product Gross Profit
Cost of product revenue
increase
d by
$25.8 million
for the
three months ended June 30, 2018
compared to the
three months ended June 30, 2017
, and
increase
d by
$45.1 million
for the
six months ended June 30, 2018
compared to the
six months ended June 30, 2017
, due mainly to higher product revenue. For the
three months ended June 30, 2018
, product gross profit margin
decrease
d
1
percentage point to
22%
from
23%
in the same period in
2017
. For the
six months ended June 30, 2018
, product gross profit margin
decrease
d
3
percentage points to
22%
from
25%
in the same period in
2017
. Product gross profit margins in the first six months of 2018 and 2017 were below our target margins. In the third quarter of 2017, it was determined that a large contract with product deliveries scheduled in the first and second quarters of 2018 would be performed at a loss. The loss is attributable in part to higher component costs, predominantly for memory, changes in the configuration of the system from the time of bid,
and changes in the exchange rate. We recorded the full amount of the loss in the third quarter of 2017 and no material gross profit on the accepted systems and related services in the first and second quarters of 2018, which negatively impacted gross profit margin for both periods. One relatively large sale to a U.S. Government customer in the second quarter of 2017 significantly contributed to the lower gross profit margin for both prior year periods. Product gross profit margin in any one period may not be indicative of future results as product gross profit margin can vary significantly between contracts for many reasons.
Cost of Service Revenue and Service Gross Profit
For the
three months ended June 30, 2018
, cost of service revenue
decrease
d by
$2.2 million
compared to the same period in
2017
. For the
six months ended June 30, 2018
, cost of service revenue
decrease
d by
$4.0 million
compared to the same period in
2017
. For the
three and six months ended June 30, 2018
, a lower percentage of our total service revenue was from engineering services which typically carry higher costs. Service gross profit margin for the
three months ended June 30, 2018
increase
d
8
percentage points to
54%
compared to
46%
in the same period in
2017
. Service gross profit margin for the
six months ended June 30, 2018
increase
d
4
percentage points to
50%
compared to
46%
in the same period in
2017
. For the
three and six months ended June 30, 2018
, a lower percentage of our total service revenue was from engineering services which typically carry a lower gross profit margin. Over the same periods, gross profit margins on our maintenance business also increased due to a higher leverage of fixed costs.
Research and Development Expenses
Research and development expenses for the
three and six months ended June 30, 2018 and 2017
, respectively, were (in thousands, except for percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Gross research and development expenses
|
|
$
|
36,244
|
|
|
$
|
33,791
|
|
|
$
|
74,280
|
|
|
$
|
71,802
|
|
Less: Amounts included in cost of revenue
|
|
(708
|
)
|
|
(2,999
|
)
|
|
(1,555
|
)
|
|
(7,559
|
)
|
Less: Reimbursed research and development (excludes amounts in cost of revenue)
|
|
(6,154
|
)
|
|
(13,467
|
)
|
|
(13,451
|
)
|
|
(14,278
|
)
|
Net research and development expenses
|
|
$
|
29,382
|
|
|
$
|
17,325
|
|
|
$
|
59,274
|
|
|
$
|
49,965
|
|
Percentage of total revenue
|
|
24
|
%
|
|
20
|
%
|
|
30
|
%
|
|
34
|
%
|
Gross research and development expenses in the table above reflect all research and development expenditures. Research and development expenses include personnel expenses, depreciation, allocations for certain overhead expenses, software, prototype materials and third party contract engineering expenses.
For the
three and six months ended June 30, 2018
, gross research and development expenses increased by
$2.5 million
over the prior year comparative periods. For the
three months ended June 30, 2018
, third party costs increased by $1.8 million over the prior year comparative period, driven primarily by expenditures under co-funding arrangements for which we will be at least partially reimbursed. For the
six months ended June 30, 2018
, non-incentive-based compensation costs increased by $2.1 million over the prior year comparative period due to increased average headcount. Incentive and share-based compensation expense increased by $1.4 million for the same six month period.
Net research and development expenses
increase
d by
$12.1 million
and
$9.3 million
for the
three and six months ended June 30, 2018
, respectively, compared to the same periods in 2017, primarily driven by the level and timing of reimbursements for research and development related to new development projects, primarily our next generation “Shasta” system, as well as lower amounts included in cost of revenue. We anticipate that reimbursed research and development will continue to vary significantly from period to period but will remain at relatively high levels over the next couple of years as a result of these projects. The amount and timing of research and development costs related to engineering development contracts and the level of reimbursement from third parties for research and development projects varies significantly from period to period, often due to the timing of milestone acceptances, and can have a significant impact on net reported research and development expense in any period.
Sales and Marketing and General and Administrative Expenses
Our sales and marketing and general and administrative expenses for the
three and six months ended June 30, 2018 and 2017
, respectively, were (in thousands, except for percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Sales and marketing
|
|
$
|
15,218
|
|
|
$
|
15,247
|
|
|
$
|
30,883
|
|
|
$
|
29,900
|
|
Percentage of total revenue
|
|
13
|
%
|
|
17
|
%
|
|
15
|
%
|
|
20
|
%
|
General and administrative
|
|
$
|
5,624
|
|
|
$
|
7,205
|
|
|
$
|
11,403
|
|
|
$
|
16,002
|
|
Percentage of total revenue
|
|
5
|
%
|
|
8
|
%
|
|
6
|
%
|
|
11
|
%
|
Sales and Marketing
.
Sales and marketing expense for the
three months ended June 30, 2018
was largely in line with the prior year comparative period with increased commissions and incentive compensation being offset by a decrease in marketing programs costs. Sales and marketing expense for the
six months ended June 30, 2018
increase
d by
$1.0 million
from the same period in
2017
, primarily driven by an increase in commissions resulting from higher revenue and an increase in incentive compensation.
General and Administrative
. General and administrative expense for the
three months ended June 30, 2018
decrease
d by
$1.6 million
from the same period in
2017
. General and administrative expense for the
six months ended June 30, 2018
decrease
d by
$4.6 million
from the same period in
2017
. The
decrease
in general and administrative expense for the
three and six months ended June 30, 2018
was primarily attributable to a decrease in legal costs compared to the same periods in 2017, related to our ongoing litigation with Raytheon, which is described in Note 11, “Contingencies” in the Notes to our Condensed Consolidated Financial Statements in this quarterly report on Form 10-Q. Due to our ongoing litigation with Raytheon, legal expenses may vary over the next several quarters.
Other Income (Expense), net
For the
three and six months ended June 30, 2018
, we recognized net other income of
$0.4 million
and
$48 thousand
, respectively, compared to net other income of
$0.2 million
and
$1.2 million
, respectively, for the same periods in
2017
. Net other income and expense for the
three and six months ended June 30, 2018 and 2017
included gains and losses from foreign currency transactions, investments and disposals of assets.
Interest Income, net
Our interest income and interest expense for the
three and six months ended June 30, 2018 and 2017
, respectively, were (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Interest income
|
|
$
|
669
|
|
|
$
|
906
|
|
|
$
|
1,369
|
|
|
$
|
1,792
|
|
Interest expense
|
|
(2
|
)
|
|
(9
|
)
|
|
11
|
|
|
(17
|
)
|
Interest income, net
|
|
$
|
667
|
|
|
$
|
897
|
|
|
$
|
1,380
|
|
|
$
|
1,775
|
|
Interest income is earned on cash and cash equivalents, investment balances and the investment in sales-type lease.
Taxes
Our effective tax rates were approximately
3%
and
0%
for the
three and six months ended June 30, 2018
, respectively, compared to
34%
and
36%
for the
three and six months ended June 30, 2017
, respectively. The difference between the expected statutory tax rate of
21%
and the actual tax rates of
3%
and
0%
for the
three and six months ended June 30, 2018
, respectively, was attributable to our decision to continue to provide a full valuation allowance against our U.S. federal deferred tax assets offset, in part, by foreign taxes. The primary reason for the difference between the expected statutory tax rate of
35%
and the actual tax rates of
34%
and
36%
for the
three and six months ended June 30, 2017
, respectively, was our research and development tax credit and other permanent items.
New Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers: Topic 606 (ASU 2014-09) to supersede nearly all existing revenue recognition guidance under
GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, it is possible more judgment and estimates may be required within the revenue recognition process than required under prior GAAP, including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. The new guidance also requires additional disclosures and several terminology changes, such as amounts previously referred to as deferred revenue now being referred to as customer contract liabilities. We adopted ASU 2014-09 at the beginning of the first quarter of 2018 using the modified retrospective method. The comparative information for the
three and six months ended June 30, 2017
, and as of December 31, 2017 has not been restated and continues to be reported under the accounting standards in effect for those periods. The effect of initially applying the new revenue standard had an immaterial effect on our financial statements. Adoption of the new standard did not have a material impact on our net
loss
during the first
six
months of 2018. We expect the impact of the adoption of the new standard to be immaterial to our net income on an ongoing basis.
In January 2016, FASB issued Accounting Standards Update No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities: Topic 825 (ASU 2016-01). The updated guidance enhances the reporting model for financial instruments, which includes amendments to address aspects of recognition, measurement, presentation and disclosure. We adopted ASU 2016-01 at the beginning of the first quarter of 2018. Adoption of ASU 2016-01 did not have a material impact on our consolidated financial statements.
In February 2016, FASB issued Accounting Standards Update No. 2016-02, Leases: Topic 842 (ASU 2016-02), that replaces existing lease guidance. The new standard is intended to provide enhanced transparency and comparability by requiring lessees to record right-of-use assets and corresponding lease liabilities on the balance sheet. Under the new guidance, leases will continue to be classified as either finance or operating, with classification affecting the pattern of expense recognition in the Consolidated Statements of Operations. Lessor accounting is largely unchanged under ASU 2016-02. Adoption of ASU 2016-02 is required for fiscal reporting periods beginning after December 15, 2018, including interim reporting periods within those fiscal years with early adoption being permitted. The new standard requires application with a modified retrospective approach to each prior reporting period presented with various optional practical expedients. While we expect adoption to lead to a material increase in the assets and liabilities recorded on our Consolidated Balance Sheet, we are still evaluating the overall impact on our consolidated financial statements.
In August 2016, FASB issued Accounting Standards Update No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (ASU 2016-15). The updated guidance clarifies how companies present and classify certain cash receipts and cash payments in the statement of cash flows. We adopted ASU 2016-15 at the beginning of the first quarter of 2018. Adoption of ASU 2016-15 did not have a material impact on our consolidated financial statements.
In November 2016, FASB issued Accounting Standards Update No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (ASU 2016-18), which amends ASC 230 to add or clarify guidance on the classification and presentation of restricted cash in the statement of cash flows. The amended guidance requires that amounts that are deemed to be restricted cash and restricted cash equivalents be included in the cash and cash-equivalent balances in the statement of cash flows. A reconciliation between the consolidated balance sheet and the statement of cash flows must be disclosed when the consolidated balance sheet includes more than one line item for cash, cash equivalents, restricted cash, and restricted cash equivalents. The guidance also requires that changes in restricted cash and restricted cash equivalents that result from transfers between cash, cash equivalents, and restricted cash and restricted cash equivalents should not be presented as cash flow activities in the statement of cash flows. An entity with a material balance of amounts generally described as restricted cash and restricted cash equivalents must disclose information about the nature of the restrictions. We adopted ASU 2016-18 at the beginning of the first quarter of 2018. Restricted cash amounts have been combined with the cash and cash equivalent balances in the Condensed Consolidated Statement of Cash Flows for each period presented. Adoption of ASU 2016-18 did not have a material impact on our consolidated financial statements.
In August 2017, FASB issued Accounting Standards Update No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities (ASU 2017-12). The new standard simplifies and expands the eligible hedging strategies for financial and nonfinancial risks. It also enhances the transparency of how hedging results are presented and disclosed. Further, the new standard provides partial relief on the timing of certain aspects of hedge documentation and eliminates the requirement to recognize hedge ineffectiveness separately in earnings. Adoption of ASU 2017-12 is required for fiscal reporting periods beginning after December 15, 2018, including interim reporting periods within those fiscal years with early adoption being permitted. We are currently evaluating the potential impact of the pending adoption of ASU 2017-12 on our consolidated financial statements.
In February 2018, FASB issued Accounting Standards Update No. 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (ASU 2018-02). The new standard amends ASC 220 to allow a reclassification from accumulated other comprehensive income to retained earnings
for stranded tax effects resulting from the “Tax Cuts and Jobs Act” and requires entities to provide certain disclosures regarding stranded tax effects. Adoption of ASU 2018-02 is required for fiscal reporting periods beginning after December 15, 2018, including interim reporting periods within those fiscal years with early adoption being permitted. We do not expect the adoption of ASU 2018-02 to have a material impact on our consolidated financial statements.
Liquidity and Capital Resources
We generate cash from operations predominantly from the sale of supercomputing systems and related services. We typically have a small number of significant contracts that make up the majority of total revenue. We have also entered into a sales-type lease agreement with a customer, under which we will receive quarterly payments over the term of the lease, which expires in September 2020. Material changes in certain of our balance sheet accounts were due to the level and timing of: product deliveries and customer acceptances, contractually determined billings, cash collections of receivables, inventory purchased for future deliveries, and incentive compensation. Working capital requirements, including inventory purchases and normal capital expenditures, are generally funded with cash from operations.
Cash, cash equivalents and restricted cash
increase
d by
$4.2 million
, from
$140.3 million
at
December 31, 2017
to
$144.5 million
at
June 30, 2018
. As of
June 30, 2018
, we had working capital of
$324.7 million
compared to
$354.3 million
as of
December 31, 2017
.
Cash flow information included the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended
June 30,
|
|
|
2018
|
|
2017
|
Cash provided by (used in):
|
|
|
|
|
Operating Activities
|
|
$
|
(180
|
)
|
|
$
|
41,658
|
|
Investing Activities
|
|
$
|
5,309
|
|
|
$
|
(93,490
|
)
|
Financing Activities
|
|
$
|
(777
|
)
|
|
$
|
(1,059
|
)
|
Operating Activities.
Net cash
used in
operating activities was
$0.2 million
for the first
six
months of
2018
compared to net cash
provided by
operating activities of
$41.7 million
for the first
six
months of
2017
. Net cash
used in
operating activities in the first
six
months of
2018
was primarily driven by the net loss, adjusted for non-cash expenses, of
$21.9 million
, a decrease in our accounts payable balance of
$40.3 million
due to the timing of payments to vendors, largely in connection with inventory purchases in the fourth quarter of 2017, and a decrease in customer contract liabilities of
$27.0 million
. These amounts were largely offset by collections from customers that resulted in a decrease of
$46.5 million
in accounts and other receivables and a decrease of
$32.8 million
in inventory due to customer acceptances of systems during the first
six
months of
2018
.
Net cash provided by operating activities in the first six months of 2017 was primarily driven by collections from customers that resulted in a decrease of $124.5 million in accounts and other receivables, partially offset by an increase of $68.5 million in inventory as a result of system builds for future deliveries and our net loss, adjusted for non-cash items, of $27.3 million.
Investing Activities
. Net cash
provided by
investing activities was
$5.3 million
for the
six months ended June 30, 2018
, compared to
$93.5 million
net cash
used in
investing activities for the same period in
2017
. Net cash
provided by
investing activities for the
six months ended June 30, 2018
was primarily due to sales and maturities of debt securities of
$7.0 million
. Net cash used in investing activities for the six months ended June 30, 2017 was primarily due to purchases of debt securities of $94.9 million and purchases of property and equipment of $13.6 million, mostly related to leasehold improvements for our new facilities in Bloomington, Minnesota. These amounts were partially offset by sales and maturities of debt securities of $15.0 million.
Financing Activities.
Net cash
used in
financing activities for the
six months ended June 30, 2018
was
$0.8 million
compared to
$1.1 million
for the same period in
2017
. Net cash flows from financing activities for both periods resulted primarily from statutory tax withholding amounts made in exchange for the forfeiture of common stock by holders of vesting restricted stock awards, offset by cash received from the issuance of common stock from the exercise of options. Net cash
used in
financing activities for the
six months ended June 30, 2017
was also impacted by the issuance of stock through our employee stock purchase plan.
In addition, we lease certain equipment and facilities used in our operations under operating leases in the normal course of business and have contractual commitments under certain development arrangements. The following table summarizes our contractual obligations as of
June 30, 2018
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amounts Committed by Year
|
Contractual Obligations
|
Total
|
|
2018
(Less than
1 Year)
|
|
2019-2020
|
|
2021-2022
|
|
Thereafter
|
Development agreements
|
$
|
18,764
|
|
|
$
|
13,429
|
|
|
$
|
5,335
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Operating leases
|
50,167
|
|
|
3,676
|
|
|
13,174
|
|
|
12,608
|
|
|
20,709
|
|
Total contractual cash obligations
|
$
|
68,931
|
|
|
$
|
17,105
|
|
|
$
|
18,509
|
|
|
$
|
12,608
|
|
|
$
|
20,709
|
|
On April 20, 2018 we amended our Credit Facility with Wells Fargo. Pursuant to the amendment, the Credit Facility was reduced from $50.0 million to $15.0 million. The Credit Facility is designed to be used for general corporate purposes, including working capital requirements and to support the issuance of letters of credit. The Credit Facility is secured by a first priority lien on up to $15.0 million of the Company’s investments account held with Wells Fargo Bank. The amended Credit Facility expires on March 1, 2020.
We made no draws and had no outstanding cash borrowings on the line of credit as of
June 30, 2018
.
As of
June 30, 2018
, we had $13.7 million in USD equivalent value in outstanding letters of credit and $2.3 million in restricted cash, primarily associated with certain letters of credit to secure customer prepayments and other customer related obligations.
In our normal course of operations, we have development arrangements under which we engage third-party engineering resources to work on our research and development projects. For the
six months ended June 30, 2018
, we incurred
$10.4 million
for such arrangements.
At any particular time, our cash position is affected by the timing of cash receipts for product sales, maintenance contracts, government co-funding for research and development activities and our payments for inventory, resulting in significant fluctuations in our cash balance from quarter-to-quarter and within a quarter. Our principal sources of liquidity are our cash and cash equivalents, short-term investments and cash from operations. We expect our cash resources to be adequate for at least the next twelve months.
Critical Accounting Policies and Estimates
This discussion, as well as disclosures included elsewhere in this quarterly report on Form 10-Q, are based upon our Condensed Consolidated Financial Statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingencies. In preparing our financial statements in accordance with GAAP, there are certain accounting policies that are particularly important. These include revenue recognition, inventory valuation, accounting for income taxes, research and development expenses and share-based compensation. Our significant accounting policies are set forth in Note 2 to the Consolidated Financial Statements included in our annual report on Form 10-K for the year ended
December 31, 2017
and should be reviewed in conjunction with the accompanying Condensed Consolidated Financial Statements and notes thereto as of
June 30, 2018
in this quarterly report on Form 10-Q, as they are integral to understanding our results of operations and financial condition in this interim period. In some cases, these policies represent required accounting. In other cases, they may represent a choice among acceptable accounting methods or may require substantial judgment or estimation.
Additionally, we consider certain judgments and estimates to be significant, including those relating to the allocation of transaction price to each performance obligation in revenue recognition, progress towards completion for satisfied over time performance obligations, collectibility of receivables, determination of inventory at the lower of cost or net realizable value, the value of used equipment returned or to be returned associated with customer contracts, useful lives for depreciation and amortization, determination of future cash flows associated with impairment testing of long-lived assets, including goodwill and other intangibles, determination of the implicit interest rate used in the sales-type lease calculation, estimated warranty liabilities, determination of the fair value of stock options and other assessments of fair value, evaluation of the probability of vesting of performance-based restricted stock and restricted stock units, calculation of deferred income tax assets, including estimates of future financial performance in the determination of the likely recovery of deferred income tax assets, our ability to utilize such assets, potential income tax assessments, the outcome of any legal proceedings and other contingencies. We base our estimates on historical experience, current conditions and on other assumptions that we believe to be reasonable under the circumstances. Actual results may differ materially from these estimates and assumptions.
Our management has discussed the selection of significant accounting policies and the effect of judgments and estimates with the Audit Committee of our Board of Directors.
Revenue Recognition
On January 1, 2018, we adopted the new accounting standard ASC 606, Revenue from Contracts with Customers, which superseded nearly all existing revenue recognition guidance under GAAP, to all contracts using the modified retrospective method. The comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods. Adoption of the new standard did not have a material impact on our net
loss
during the first
six
months of 2018. We expect the impact of the adoption of the new standard to be immaterial to our net income on an ongoing basis.
Our performance obligations are satisfied over time as work is performed or at a point in time. The majority of our revenue is recognized at a point in time when products are accepted, installed or delivered. Most of our revenue is derived from long-term contracts that can span several years. Revenue is recognized when performance obligations under the terms of a contract with the customer are satisfied; generally, this occurs with the transfer of control of our systems or services. In general, this does not occur until the products have been shipped or services provided to the customer, risk of loss has transferred to the customer, and, where applicable, a customer acceptance has been obtained. Revenue is measured as the amount of consideration we expect to receive in exchange for transferring goods or providing services. Sales, value add, and other taxes that we collect concurrent with revenue-producing activities are excluded from revenue. Incidental items that are immaterial in the context of the contract are recognized as expense.
To determine the proper revenue recognition method for contracts, we evaluate whether two or more contracts should be combined and accounted for as one single contract and whether the combined or single contract should be accounted for as more than one performance obligation. Contracts are often modified to account for changes in contract specifications and requirements. To determine the proper revenue recognition method for contract modifications, we evaluate whether the contract modification should be accounted for as a separate contract, part of an existing contract, or termination of an existing contract and the creation of a new contract. This evaluation requires significant judgment and the decision to combine a group of contracts or separate the combined or single contract into multiple performance obligations could change the amount of revenue and profit recorded in a given period. For contracts with multiple performance obligations, we allocate the contract’s transaction price to each performance obligation using our estimate of the standalone selling price of each distinct good or service in the contract.
We determine the transaction price by reviewing the established contractual terms and other relevant information. Contracts can include penalty clauses and contracts with government customers may not be fully funded, both of which represent variable consideration. Generally, we include both the funded and unfunded portions of a contract with a government customer in the transaction price, as most often it is deemed the contract will become fully funded. We also assess the likelihood of certain penalties that would result in contract price reductions and, if deemed probable, the transaction price is adjusted.
The majority of our contracts include multiple promised goods and services, which are assessed at contract inception. Each distinct good or service is identified as a performance obligation, which may be an individual good or service or a bundle of goods or services. In order to determine whether the promises are distinct, we assesses the use of our products and services by customers to determine whether the customer can benefit from the good or service on its own or from other readily available resources, and whether the promised transfer of goods or services is separately identifiable from other promises in the contract.
The majority of our revenues are from product solutions which include supercomputers, storage, and data analytics systems, each of which are usually separate performance obligations. Revenue is recognized when obligations under the terms of a contract with a customer are satisfied. Product revenue is typically recognized upon customer acceptance, or upon installation or delivery if formal acceptance is not required. Service revenue is typically recognized over time and consists mainly of system maintenance, analyst services, and engineering services, each of which are usually separate performance obligations. System maintenance commences upon customer acceptance or installation, depending on the contract terms, and revenue is recognized ratably over the remaining term of the maintenance contract. On-site analysts provide specialized services to customers, the revenue for which is recognized ratably over the contract period. Service revenue is recognized on a straight-line basis over the service period as the services are available continuously to the customer. Revenue from engineering services can be recognized as services are performed or as milestones are achieved, depending on the terms of the contract and nature of services performed. If, in a contract, the customer has an option to acquire additional goods or services, that option gives rise to a performance obligation if the option provides a material right to the customer that it would not receive without entering into that contract. Revenue from purchase options can be recognized as those future goods or services are transferred or when the option expires.
Generally, billing occurs subsequent to product revenue recognition and payment is expected within 30 days, resulting in contract assets. However, we sometimes receive advances or deposits from customers before revenue is recognized, resulting in customer contract liabilities (formerly deferred revenue). These assets and liabilities are reported on the Condensed Consolidated Balance Sheet on a contract-by-contract basis at the end of each reporting period. Our payment terms vary from contract to contract. Contracts may require payment before, at or after our performance obligations have been satisfied.
We perform an assessment to determine whether a significant financing component is present in a contract. If a contract is determined to include a significant financing component, the interest rate used in the calculation is based on the prevailing interest rates at contract inception and the entity’s creditworthiness. When the period between providing a good or service to the customer
is expected to be less than one year from payment, we apply the practical expedient and do not adjust the consideration for the effects of a significant financing component.
Occasionally, our contracts include noncash consideration. This typically consists of returned parts when a system is upgraded or de-installed. Noncash consideration is measured at contract inception at estimated fair value.
The total transaction price is allocated to each performance obligation identified in the contract based on its relative standalone selling price. We do not have directly observable standalone selling prices for the majority of our performance obligations due to a relatively small number of customer contracts that differ in system size and contract terms which can be due to infrequently selling each performance obligation separately, not pricing products within a narrow range, or only having a limited sales history, such as in the case of certain advanced and emerging technologies. When a directly observable standalone selling price is not available, we estimate the standalone selling price. In determining the estimated standalone selling price, we use the cost to provide the product or service plus a margin, or considers other factors. When using cost plus a margin, we consider the total cost of the product or service, including customer-specific and geographic factors as appropriate. We also consider the historical margins of the product or service on previous contracts and several other factors including any changes to pricing methodologies, competitiveness of products and services, and cost drivers that would cause future margins to differ from historical margins.
We occasionally offer discounts to our customers. As these discounts are offered on bundles of goods and services, the discounts are applied to all performance obligations in the contract on a pro-rata basis.
Our incremental direct costs of obtaining a contract come primarily from sales commissions, a portion of which are paid upon contract signing. These commissions are generally capitalized upon payment and expensed at the time of revenue recognition. These deferred commissions are included in prepaid expenses in the Condensed Consolidated Balance Sheet. As of
June 30, 2018
and
December 31, 2017
, we had
$2.0 million
and
$1.3 million
, respectively, of deferred commissions. For the
three and six months ended June 30, 2018
, we recognized
$1.5 million
and
$2.6 million
, respectively, in commissions expense. For the
three and six months ended June 30, 2017
, we recognized
$1.2 million
and
$1.7 million
, respectively, in commissions expense.
Our remaining performance obligations reflect the deliverables within contracts with customers that will have revenue recognized in a future period (this may also be referred to as backlog). Due to the nature of our business and the size of individual transactions, forecasting the timing and total amount of revenue recognition is subject to significant uncertainties. As of
June 30, 2018
, we had an aggregate of
$465 million
in remaining performance obligations stemming from a mixture of system contracts with their related service obligations and other service obligations. Included in this balance are
$0.5 million
in gains resulting from hedged foreign currency transactions, which offset the related increase in revenue from currency fluctuations. These gains will be reclassified from accumulated other comprehensive income to revenue in the period the related transactions are recognized as revenue. These obligations are anticipated to be recognized as revenue over approximately the next
six years
. We estimate that about
80%
of these obligations are expected to be recognized as revenue in the next
18 months
, with the remainder thereafter.
Inventory Valuation
We record our inventory at the lower of cost or net realizable value, with cost computed on a first-in, first-out basis (FIFO). We regularly evaluate the technological usefulness and anticipated future demand for our inventory components. Due to rapid changes in technology and the increasing demands of our customers, we are continually developing new products. Additionally, during periods of product or inventory component upgrades or transitions, we may acquire significant quantities of inventory to support estimated current and future production and service requirements. As a result, it is possible that older inventory items we have purchased may become obsolete, be sold below cost or be deemed in excess of quantities required for production or service requirements. When we determine it is not likely we will recover the cost of inventory items through future sales, we write-down the related inventory to our estimate of its net realizable value.
Because the products we sell have high average sales prices and because a high number of our prospective customers receive funding from U.S. or foreign governments, it is difficult to estimate future sales of our products and the timing of such sales. It also is difficult to determine whether the cost of our inventories will ultimately be recovered through future sales. While we believe our inventory is stated at the lower of cost or net realizable value and that our estimates and assumptions to determine any adjustments to the cost of our inventories are reasonable, our estimates may prove to be inaccurate. We have sold inventory previously reduced in part or in whole to zero, and we may have future sales of previously written-down inventory. We also may incur additional expenses to write-down inventory to its estimated net realizable value. Adjustments to these estimates in the future may materially impact our operating results.
Accounting for Income Taxes
Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and operating loss and tax credit carryforwards and are measured using the enacted tax rates and laws that will be in effect when the differences and carryforwards are expected to be recovered or settled.
A valuation allowance for deferred tax assets is provided when we estimate that it is more likely than not that all or a portion of the deferred tax assets will not be realized through future operations. This assessment is based upon consideration of all available positive and negative evidence, which includes, among other things, our recent results of operations, forecasted domestic and international earnings over a number of years, all known business risks and industry trends, and applicable tax planning strategies that should, if implemented, enable us to utilize our deferred tax assets before they expire. We consider our actual historical results over several years to have stronger weight than other more subjective indicators, including forecasts, when considering whether to establish or reduce a valuation allowance on deferred tax assets. We have significant difficulty projecting future results due to the nature of the business and the industry in which we operate.
As of
June 30, 2018
, we continued to provide a full valuation allowance against our U.S. federal deferred tax assets and against the majority of our state and foreign deferred tax assets as the realization of such assets is not considered to be more likely than not at this time. In a future period our assessment of the realizability of our deferred tax assets and therefore the appropriateness of the valuation allowance could change based on an assessment of all available evidence, both positive and negative in that future period. If our conclusion about the realizability of our deferred tax assets and therefore the appropriateness of the valuation allowance changes in a future period we could record a substantial tax benefit in our Condensed Consolidated Statement of Operations when that occurs. We recognize the income tax benefit from a tax position only if it is more likely than not that the tax position will be sustained on examination by the applicable taxing authorities, based on the technical merits of our position. The tax benefit recognized in the financial statements from such a position is measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement.
As of
June 30, 2018
, we had approximately $91.6 million of net deferred tax assets before application of a valuation allowance. As of
June 30, 2018
, net deferred tax assets after reduction by the valuation allowance of $90.4 million were $1.2 million.
Estimated interest and penalties are recorded as a component of interest expense and other expense, respectively.
Research and Development Expenses
Research and development expenses include costs incurred in the development and production of our hardware and software, costs incurred to enhance and support existing product features, costs incurred to support and improve our development processes, and costs related to future product development. Research and development costs are expensed as incurred, and may be offset by co-funding from third parties. We may also enter into arrangements whereby we make advance, non-refundable payments to a vendor to perform certain research and development services. These payments are deferred and recognized over the vendor’s estimated performance period.
Amounts to be received under co-funding arrangements with the U.S. government or other customers are based on either contractual milestones or costs incurred. These co-funding milestone payments are recognized in operations as performance is estimated to be completed and are measured as milestone achievements occur or as costs are incurred. These estimates are reviewed on a periodic basis and are subject to change, including in the near term. If an estimate is changed, net research and development expense could be impacted significantly.
We do not record a receivable from the U.S. government prior to completing the requirements necessary to bill for a milestone or cost reimbursement. Funding from the U.S. government is subject to certain budget restrictions and milestones may be subject to completion risk, and as a result, 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. Accordingly, there can be substantial variability in the amount of net research and development expenses from quarter to quarter and year to year.
We classify amounts to be received from funded research and development projects as either revenue or a reduction to research and development expense based on the specific facts and circumstances of the contractual arrangement, considering total costs expected to be incurred compared to total expected funding and the nature of the research and development contractual arrangement. In the event that a particular arrangement is determined to represent revenue, the corresponding costs are classified as cost of revenue.
Share-based Compensation
We measure compensation cost for share-based payment awards at fair value and recognize it as compensation expense over the service period for awards expected to vest. We recognize share-based compensation expense for all share-based payment awards, net of an estimated forfeiture rate. We recognize compensation cost for only those shares expected to vest on a straight-line basis over the requisite service period of the award.
Determining the appropriate fair value model and calculating the fair value of share-based payment awards requires subjective assumptions, including the expected life of the share-based payment awards and stock price volatility. We utilize the Black-Scholes
options pricing model to value the stock options granted under our options plans. In this model, we utilize assumptions related to stock price volatility, stock option term and forfeiture rates that are based upon both historical factors as well as management’s judgment.
The fair value of restricted stock and restricted stock units is determined based on the number of shares or units granted and the quoted price of our common stock at the date of grant.
We have granted performance vesting restricted stock units to executives as one of the ways to align compensation with shareholder interests. Vesting of these awards is contingent upon achievement of certain performance conditions. Compensation expense for these awards is only recognized when vesting is deemed to be “probable”. Awards are evaluated for probability of vesting during each reporting period. We do not currently believe that any of our performance vesting restricted stock units are “probable” of vesting.