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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________________________ 
FORM 10-Q
 ______________________________________________
 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: March 31, 2019
Or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from:              to             
Commission File Number: 0-26820
 
______________________________________________ 
CRAY INC.
(Exact name of registrant as specified in its charter)
______________________________________________ 
 
Washington
 
93-0962605
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
 
 
901 Fifth Avenue, Suite 1000
Seattle, Washington
 
98164
(Address of Principal Executive Office)
 
(Zip Code)
(206) 701-2000
(Registrant’s telephone number, including area code)
 ______________________________________________ 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
ý
Accelerated filer
¨
 
 
 
 
Non-accelerated filer
¨
Smaller reporting company
¨
 
 
Emerging growth company
¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act ¨




Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
Securities registered pursuant to Section 12(b) of the Act
Title of each class
Trading Symbol
Name of each exchange on which registered
Common Stock
CRAY
NASDAQ
As of May 3, 2019, there were 41,127,714 shares of Common Stock issued and outstanding.




CRAY INC.
TABLE OF CONTENTS
 
 
Page No.
 
 
Condensed Consolidated Balance Sheets as of March 31, 2019 and December 31, 2018
Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2019 and March 31, 2018
Condensed Consolidated Statements of Comprehensive Loss for the Three Months Ended March 31, 2019 and March 31, 2018
Condensed Consolidated Statements of Shareholders’ Equity for the Three Months Ended March 31, 2019 and March 31, 2018
Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2019 and March 31, 2018

CRAY, ClusterStor, DataWarp, and Sonexion are registered trademarks of Cray Inc. in the United States and other countries. The CS and XC families of supercomputers, Shasta, and other Cray technologies are all trademarks of Cray Inc. Other trademarks used in this report are the property of their respective owners.
Available Information
Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, amendments to those reports and proxy statements filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge at our website at www.cray.com as soon as reasonably practicable after we electronically file such reports with the U.S. Securities and Exchange Commission.


3



PART I. FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements
CRAY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited and in thousands, except share data)
 
March 31,
2019
 
December 31,
2018
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
205,121

 
$
228,434

Restricted cash
1,281

 
1,300

Accounts and other receivables, net
65,986

 
87,819

Inventory
80,516

 
80,360

Prepaid expenses and other current assets
22,778

 
22,331

Total current assets
375,682

 
420,244

 
 
 
 
Long-term restricted cash
16,030

 
16,030

Property and equipment, net
36,373

 
35,737

Operating lease right-of-use assets
33,649

 

Goodwill
14,182

 
14,182

Intangible assets other than goodwill, net
2,897

 
3,178

Other non-current assets
21,623

 
27,761

TOTAL ASSETS
$
500,436

 
$
517,132

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
25,035

 
$
32,847

Accrued payroll and related expenses
10,743

 
23,703

Accrued and other liabilities
12,915

 
10,805

Customer contract liabilities
64,021

 
61,983

Total current liabilities
112,714

 
129,338

 
 
 
 
Long-term customer contract liabilities
26,615

 
32,021

Long-term operating lease liabilities
40,871

 

Other non-current liabilities
2,564

 
12,394

TOTAL LIABILITIES
182,764

 
173,753

Commitments and contingencies (Note 10)
 
 
 
 
 
 
 
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 41,096,605 and 40,893,807 shares, respectively
651,441

 
647,045

Accumulated other comprehensive income
2,355

 
3,208

Accumulated deficit
(336,124
)
 
(306,874
)
TOTAL SHAREHOLDERS’ EQUITY
317,672

 
343,379

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
500,436

 
$
517,132

The accompanying notes are an integral part of these condensed consolidated financial statements

4



CRAY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited and in thousands, except per share data)
 
 
 
Three Months Ended
March 31,
 
 
2019
 
2018
Revenue:
 
 
 
 
Product
 
$
34,158

 
$
44,454

Service
 
37,388

 
35,140

Total revenue
 
71,546

 
79,594

Cost of revenue:
 
 
 
 
Cost of product revenue
 
26,102

 
34,045

Cost of service revenue
 
19,420

 
18,597

Total cost of revenue
 
45,522

 
52,642

Gross profit
 
26,024

 
26,952

Operating expenses:
 
 
 
 
Research and development, net
 
35,786

 
29,892

Sales and marketing
 
14,275

 
15,665

General and administrative
 
5,942

 
5,779

Restructuring
 

 
476

Total operating expenses
 
56,003

 
51,812

Loss from operations
 
(29,979
)
 
(24,860
)
 
 
 
 
 
Other expense, net
 
(247
)
 
(382
)
Interest income, net
 
925

 
713

Loss before income taxes
 
(29,301
)
 
(24,529
)
Income tax expense
 
(119
)
 
(479
)
Net loss
 
$
(29,420
)
 
$
(25,008
)
 
 
 
 
 
Basic net loss per common share
 
$
(0.72
)
 
$
(0.62
)
Diluted net loss per common share
 
$
(0.72
)
 
$
(0.62
)
 
 
 
 
 
Basic weighted average shares outstanding
 
40,945

 
40,436

Diluted weighted average shares outstanding
 
40,945

 
40,436

The accompanying notes are an integral part of these condensed consolidated financial statements

5



CRAY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited and in thousands)
 
 
 
Three Months Ended
March 31,
 
 
2019
 
2018
Net loss
 
$
(29,420
)
 
$
(25,008
)
Other comprehensive loss, net of tax:
 
 
 
 
Unrealized loss on available-for-sale investments
 

 
(2
)
Foreign currency translation adjustments
 
208

 
26

Unrealized loss on cash flow hedges
 
(849
)
 
(1,232
)
Reclassification adjustments on cash flow hedges included in net loss
 

 
476

Other comprehensive loss
 
(641
)
 
(732
)
Comprehensive loss
 
$
(30,061
)
 
$
(25,740
)
The accompanying notes are an integral part of these condensed consolidated financial statements

6



CRAY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(Unaudited and in thousands)

 
 
Three Months Ended
March 31,
 
 
2019
 
2018
Total shareholders’ equity, beginning balance
 
$
343,379

 
$
400,297

 
 
 
 
 
Common stock and additional paid-in capital:
 
 
 
 
Beginning balance
 
647,045

 
633,408

Exercise of stock options
 
829

 
1,538

Restricted shares issued for compensation, net of forfeitures and taxes
 
(99
)
 
(105
)
Share-based compensation
 
3,666

 
2,942

Ending balance
 
651,441

 
637,783

 
 
 
 
 
Accumulated other comprehensive income:
 
 
 
 
Beginning balance
 
3,208

 
915

Other comprehensive loss
 
(641
)
 
(732
)
Reclassification of stranded tax effects resulting from adoption of ASU 2018-02
 
(212
)
 

Ending balance
 
2,355

 
183

 
 
 
 
 
Accumulated deficit:
 
 
 
 
Beginning balance
 
(306,874
)
 
(234,026
)
Net loss
 
(29,420
)
 
(25,008
)
Restricted shares issued for compensation, net of forfeitures and taxes
 
(42
)
 
(54
)
Reclassification of stranded tax effects resulting from adoption of ASU 2018-02
 
212

 

Ending balance
 
(336,124
)
 
(259,088
)
 
 
 
 
 
Total shareholders’ equity, ending balance
 
$
317,672

 
$
378,878

The accompanying notes are an integral part of these condensed consolidated financial statements

7



CRAY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited and in thousands)
 
Three Months Ended
March 31,
 
2019
 
2018
Operating activities:
 
 
 
Net loss
$
(29,420
)
 
$
(25,008
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Depreciation and amortization
3,893

 
4,278

Share-based compensation expense
3,666

 
2,942

Other
3,105

 
(255
)
Cash provided (used) due to changes in operating assets and liabilities:
 
 
 
Accounts and other receivables
22,113

 
65,323

Inventory
(3,750
)
 
4,056

Prepaid expenses and other assets
5,428

 
4,771

Accounts payable
(7,775
)
 
(36,299
)
Accrued payroll and related expenses and other liabilities
(14,440
)
 
(2,501
)
Customer contract liabilities
(3,402
)
 
(18,322
)
Net cash used in operating activities
(20,582
)
 
(1,015
)
Investing activities:
 
 
 
Cash received in strategic transaction

 
1,584

Purchases of property and equipment
(3,659
)
 
(2,188
)
Net cash used in investing activities
(3,659
)
 
(604
)
Financing activities:
 
 
 
Purchase of employee restricted shares to fund related statutory tax withholding

(141
)
 
(158
)
Proceeds from exercises of stock options
829

 
1,538

Net cash provided by financing activities
688

 
1,380

Effect of foreign exchange rate changes on cash, cash equivalents and restricted cash
221

 
166

Net decrease in cash, cash equivalents and restricted cash
(23,332
)
 
(73
)
Cash, cash equivalents and restricted cash:
 
 
 
Beginning of period
245,764

 
140,320

End of period
$
222,432

 
$
140,247

 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
Cash paid (refunded) for income taxes
$
(292
)
 
$
301

Non-cash investing and financing activities:
 
 
 
Inventory transfers to fixed assets and service spares
$
404

 
$
1,613

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:
 
March 31,
2019
 
December 31,
2018
Cash and cash equivalents
$
205,121

 
$
228,434

Restricted cash (1)
1,281

 
1,300

Long-term restricted cash (1)
16,030

 
16,030

Total cash, cash equivalents and restricted cash
$
222,432

 
$
245,764

(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

8



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, Statements of Shareholders’ Equity 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, 2018.
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.
New Accounting Pronouncements
In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2016-02, Leases: Topic 842 (ASU 2016-02), which replaces existing lease guidance. The new standard is intended to provide enhanced transparency and comparability by requiring lessees to record right-of-use (ROU) assets and corresponding lease liabilities on the balance sheet. The new standard initially required application with a modified retrospective approach to each prior reporting period presented with various optional practical expedients. In July 2018, this requirement was amended with the issuance of Accounting Standards Update No. 2018-11, Leases: Topic 842: Targeted Improvements (ASU 2018-11), which permits an additional (and optional) transition method to adopt the new leases standard.
The Company adopted ASU 2016-02 and related ASUs, collectively ASC 842, on January 1, 2019 using the optional transition method. Consequently, periods before January 1, 2019 will continue to be reported in accordance with the prior accounting guidance, ASC 840, Leases.
The Company elected the package of practical expedients, which permits the Company to retain prior conclusions about lease identification, lease classification and initial direct costs for leases that commenced before January 1, 2019. The new standard also provides practical expedients for an entity’s ongoing accounting. The Company elected the short-term lease recognition exemption for all leases that qualify. The Company also elected the practical expedient to combine lease and non-lease components for all of its leases other than net lease real estate leases.
Adoption of ASC 842 resulted in the recording of ROU assets and lease liabilities of $34.4 million and $46.6 million, respectively, as of January 1, 2019. The difference between ROU assets and lease liabilities relates to liabilities of $12.2 million for deferred rent and lease incentives liabilities that were included on the Company’s Condensed Consolidated Balance Sheets prior to adoption of ASC 842. These amounts were eliminated at the time of adoption and are included in the lease liabilities number above. Adoption of ASC 842 did not have a material impact on the Company’s consolidated net earnings and had no impact on cash flows.

9



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. The Company adopted ASU 2017-12 on January 1, 2019. Adoption of ASU 2017-12 did not have a material impact on the Company’s consolidated financial statements. Upon adoption of ASU 2017-12, the Company revised its accounting policy for foreign currency derivatives from the policy included in the Notes to Consolidated Financial Statements in its annual report on Form 10-K for year ended December 31, 2018. The revised accounting policy for foreign currency derivatives is included below.
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. The Company adopted ASU 2018-02 on January 1, 2019. At the time of adoption, the Company reclassified $0.2 million of stranded tax effects resulting from the Tax Cuts and Jobs Act from accumulated other comprehensive income to accumulated deficit. Adoption of ASU 2018-02 did not have a material impact on the Company’s consolidated financial statements.
In August 2018, FASB issued Accounting Standards Update No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement (ASU 2018-13). The new standard makes various modifications to the disclosure requirements on fair value measurement in Topic 820. The Company adopted ASU 2018-13 on January 1, 2019. Adoption of ASU 2018-13 did not have a material impact on the Company’s consolidated financial statements.
Revised Accounting Policies
Foreign Currency Derivatives
The Company uses foreign currency exchange contracts to manage certain foreign currency exposures. Foreign currency exchange contracts are cash flow hedges of the Company’s foreign currency exposures on certain revenue contracts and are recorded at the contract’s fair value. Most of the Company’s foreign currency exchange contracts are designated as cash flow hedges for the purposes of hedge accounting treatment and any gains or losses on the foreign currency exchange contract is initially reported in “Accumulated other comprehensive income,” a component of shareholders’ equity, with a corresponding asset or liability recorded based on the fair value of the foreign currency exchange contract. When the hedged transaction is recognized, any unrecognized gains or losses on the hedged transaction are reclassified into results of operations in the same period and presented in the same income statement line item as the earnings effect of the hedged item. The Company excludes the changes in fair value of the contract related to forward points from the assessment of hedge effectiveness and the gains and losses associated with the excluded component are presented in the same line of the income statement for the hedged item. For hedging relationships executed before the date of adoption of ASU 2017-12, the gains and losses associated with the excluded components are recognized currently in earnings. The amortization approach is used for hedging relationships executed after the date of adoption of ASU 2017-02. Cash flows from foreign currency exchange contracts accounted for as cash flow hedges are classified in the same category as the cash flows from the items being hedged. The Company typically dedesignates its cash flow hedges for the purposes of hedge accounting treatment when the receivable related to the hedged cash flow is recorded. Unrealized gains or losses related to foreign currency exchange contracts that are not designated as cash flow hedges for the purposes of hedge accounting treatment are recorded in other income (expense) in the Condensed Consolidated Statements of Operations and are generally offset by foreign currency adjustments on related receivables. The Company does not use derivative financial instruments for speculative purposes.
Note 2— Revenue Recognition
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

10



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.

11



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:
 
 
March 31,
2019
 
December 31, 2018
 
Change
Contract receivables
 
$
61,854

 
$
78,634

 
$
(16,780
)
Contract assets
 
6,441

 
6,404

 
37

Contract liabilities
 
90,636

 
94,004

 
(3,368
)

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. Generally, billing occurs subsequent to product revenue recognition and payment is expected within 30 days. 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 increase in the Company's contract asset balance for the three months ended March 31, 2019 is primarily due to the addition of new contract assets, partially offset by the transfer from contract assets to contract receivables that were included in the contract asset balance at the beginning of the period.
For the three month period ended March 31, 2019, the Company recognized $20.4 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 March 31, 2019 and December 31, 2018, the Company had $1.7 million and $2.0 million, respectively, of deferred commissions. For the three months ended March 31, 2019 and 2018, the Company recognized $1.0 million and $1.1 million, respectively, in commissions expense.
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 March 31, 2019, the Company has an aggregate of $589 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 $0.8 million in gains resulting from hedged foreign currency transactions, which offset the related decrease 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 55% of these obligations are expected to be recognized as revenue in the next 18 months, with the remainder thereafter.
The Company’s revenue is presented on a disaggregated basis in “Note 13-Segment Information” in the Notes to Condensed Consolidated Financial Statements in this quarterly report on Form 10-Q.

12



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 that have been measured at fair value as of March 31, 2019, 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
March 31,
2019
 
Quoted
Prices in
Active
Markets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
Assets:
 
 
 
 
 
 
Cash, cash equivalents and restricted cash
 
$
222,432

 
$
222,432

 
$

Foreign currency exchange contracts (1)
 
2,976

 

 
2,976

Assets measured at fair value at March 31, 2019
 
$
225,408

 
$
222,432

 
$
2,976


(1)
Included in “Prepaid expenses and other current assets” and “Other non-current assets” 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 March 31, 2019 and December 31, 2018, 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):
 
 
March 31,
2019
 
December 31, 2018
Canadian Dollars (CAD)
 
54.4

 
54.4


The Company had hedged foreign currency exposure related to these designated cash flow hedges of approximately $41.6 million as of March 31, 2019 and December 31, 2018.
As of March 31, 2019 and December 31, 2018, 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):
 
March 31,
2019
 
December 31, 2018
British Pounds (GBP)
15.6

 
24.8

Korean Won (KRW)

 
4,446.5

Singapore Dollars (SGD)

 
2.0


The foreign currency exposure related to these contracts was approximately $22.9 million as of March 31, 2019 and $40.6 million as of December 31, 2018. Unrealized gains or losses related to these dedesignated contracts are recorded in other expense 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.

13



Cash receipts associated with the foreign currency exchange contracts are expected to be received from 2019 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
March 31,
2019
 
Fair Value
as of
December 31,
2018
Prepaid expenses and other current assets
 
$
609

 
$
1,296

Other non-current assets
 
32

 
137

Total fair value of derivative instruments designated as cash flow hedges
 
$
641

 
$
1,433

Fair values of derivative instruments not designated as cash flow hedges (in thousands):
Balance Sheet Location
 
Fair Value
as of
March 31,
2019
 
Fair Value
as of
December 31,
2018
Prepaid expenses and other current assets
 
$
1,616

 
$
1,894

Other non-current assets
 
719

 
1,242

Accrued and other liabilities
 

 
(63
)
Total fair value of derivative instruments not designated as cash flow hedges
 
$
2,335

 
$
3,073


The following table shows the impact on product revenue of foreign currency exchange contracts that were designated as cash flow hedges (in thousands):
 
 
Three Months Ended
March 31,
 
 
2019
 
2018
Total amounts of product revenue presented in the condensed consolidated statement of operations in which the effects of cash flow hedges are recorded
 
$
34,158

 
44,454

 
 
 
 
 
Amount of loss reclassified from accumulated other comprehensive income to product revenue
 

 
(476
)
Amount excluded from effectiveness testing recognized as an increase in product revenue based on changes in fair value
 
56

 


The following table shows the impact on other expense of losses on foreign currency exchange contracts that were not designated as cash flow hedges. These amounts increased other expense for both periods presented (in thousands):
 
 
Three Months Ended
March 31,
 
 
2019
 
2018
Other expense, net
 
$
(427
)
 
$
(1,911
)


14



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 months ended March 31, 2019 and 2018 (in thousands). The reclassification adjustments decreased product revenue for the three months ended March 31, 2018.
 
 
Three Months Ended
March 31,
 
 
2019
 
2018
 
 
 
 
 
Gross of tax reclassifications
 
$

 
$
(476
)
Net of tax reclassifications
 
$

 
$
(476
)

The following tables show the changes in accumulated other comprehensive income by component for the three months ended March 31, 2019 and 2018 (in thousands):
Three Months Ended March 31, 2019
 
 
Foreign Currency Translation Adjustments
 
Unrealized Gain on Cash Flow Hedges
 
Accumulated Other Comprehensive Income
Beginning balance
 
$
606

 
$
2,602

 
$
3,208

Current-period change, net of tax
 
208

 
(849
)
 
(641
)
Reclassification of stranded tax effects resulting from adoption of ASU 2018-02
 
210

 
(422
)
 
(212
)
Ending balance
 
$
1,024

 
$
1,331

 
$
2,355

 
 
 
 
 
 
 
Income tax expense (benefit) associated with current-period change
 
$

 
$

 
$

Three Months Ended March 31, 2018
 
 
Unrealized Loss on Investments
 
Foreign Currency Translation Adjustments
 
Unrealized Loss on Cash Flow Hedges
 
Accumulated Other Comprehensive Income
Beginning balance
 
$
(7
)
 
$
1,611

 
$
(689
)
 
$
915

Current-period change, net of tax
 
(2
)
 
26

 
(756
)
 
(732
)
Ending balance
 
$
(9
)
 
$
1,637

 
$
(1,445
)
 
$
183

 
 
 
 
 
 
 
 
 
Income tax expense (benefit) associated with current-period change
 
$

 
$

 
$

 
$


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 months ended March 31, 2019 and 2018, 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 diluted EPS. For each of the three months ended March 31, 2019 and 2018, potential gross common shares of 2.9 million were antidilutive and not included in computing diluted EPS. An additional 0.5 million performance vesting restricted stock and performance vesting restricted stock units were excluded from the computation of potential common shares for each of the three months ended March 31, 2019 and 2018, because the conditions for vesting had not been met as of the balance sheet date.

15



Note 6— Accounts and Other Receivables, Net
Net accounts and other receivables consisted of the following (in thousands):
 
 
March 31,
2019
 
December 31, 2018
Trade accounts receivable
 
$
35,759

 
$
63,414

Current contract assets
 
4,539

 
4,391

Advance billings
 
6,900

 
1,832

Short-term investment in sales-type lease
 
12,805

 
12,462

Other receivables
 
6,001

 
6,708

 
 
66,004

 
88,807

Allowance for doubtful accounts
 
(18
)
 
(988
)
Accounts and other receivables, net
 
$
65,986

 
$
87,819


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 March 31, 2019 and December 31, 2018, accounts receivable included $15.5 million and $25.6 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, $0.2 million and $1.5 million were unbilled and included in contract assets as of March 31, 2019 and December 31, 2018, respectively, based upon contractual billing arrangements with these customers. As of March 31, 2019, one non-U.S. Government customer accounted for 19% of total accounts and other receivables. As of December 31, 2018, two non-U.S. Government customers accounted for 28% of total accounts and other receivables.
Note 7— Leases
The Company leases certain equipment and facilities used in operations under operating leases in its normal course of business. The Company’s leases have remaining lease terms of 1 to 11 years, some of which include options to extend the leases for up to 5 years, and some of which include options to terminate the leases within 1 to 5 years. The exercise of these options is at the Company’s sole discretion. The Company has not included these options to extend or terminate in its calculation of right-of-use assets or lease liabilities as it is not reasonably certain to exercise these options.
The Company’s lease agreements do not contain any residual value guarantees, material restrictions or covenants.
Operating lease cost for the three months ended March 31, 2019 was $1.9 million.
The Company has elected the practical expedient for short-term leases. Operating lease cost for the Company’s short-term leases for the three months ended March 31, 2019 was immaterial.
Supplemental cash flow information related to operating leases for the three months ended March 31, 2019 was as follows (in thousands):
 
 
Three Months Ended
March 31,
 
 
2019
Cash paid for amounts included in the measurement of operating lease liabilities:
 
$
2,038

Operating right-of-use assets obtained in exchange for lease obligations:
 
$
348



16



Supplemental balance sheet information related to operating leases as of March 31, 2019 was as follows (in thousands, except lease term and discount rate):
 
 
March 31,
2019
Operating lease right-of-use assets
 
$
33,649

 
 
 
Current portion of operating lease liabilities, included in accrued and other liabilities
 
$
4,838

Long-term operating lease liabilities
 
40,871

Total operating lease liabilities
 
$
45,709

 
 
 
Weighted average remaining lease term (in years):
 
8.9

Weighted average discount rate (1):
 
6.84
%
(1)
Where the Company could not determine the rate inherent in the lease, its incremental borrowing rate was calculated using LIBOR plus a spread for similar companies.
As of March 31, 2019, maturities of operating lease liabilities were as follows (in thousands):
2019 (less than 1 year)
 
$
6,220

2020
 
8,065

2021
 
7,857

2022
 
7,520

2023
 
6,535

Thereafter
 
29,513

Total lease payments
 
65,710

Less: interest
 
(20,001
)
Present value of lease liabilities
 
$
45,709


Sales-type Lease
The Company has a sales-type lease with one non-U.S. Government customer, under which it receives 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.
Interest income for the sales-type lease for the three months ended March 31, 2019 was $0.1 million.
The following table shows the components of the net investment in the sales-type lease as of March 31, 2019 and December 31, 2018 (in thousands):
 
 
March 31,
2019
 
December 31, 2018
Total minimum lease payments to be received
 
$
22,321

 
$
25,543

Less: executory costs
 
(2,608
)
 
(2,985
)
Net minimum lease payments receivable
 
19,713

 
22,558

Less: unearned income
 
(372
)
 
(510
)
Net investment in sales-type lease
 
19,341

 
22,048

Less: long-term investment in sales-type lease included in other non-current assets
 
(6,536
)
 
(9,586
)
Investment in sales-type lease included in accounts and other receivables
 
$
12,805

 
$
12,462



17



As of March 31, 2019, minimum lease payments related to our sales-type lease for each of the succeeding two fiscal years are as follows (in thousands):
2019 (less than 1 year)
 
$
11,168

2020
 
11,153

Total minimum lease payments to be received
 
$
22,321


Note 8— Inventory
Inventory consisted of the following (in thousands):
 
 
March 31,
2019
 
December 31, 2018
Components and subassemblies
 
$
37,093

 
$
42,390

Work in process
 
22,415

 
17,429

Finished goods
 
21,008

 
20,541

Total
 
$
80,516

 
$
80,360


Finished goods inventory of $19.6 million and $16.0 million was located at customer sites pending acceptance as of March 31, 2019 and December 31, 2018, respectively. At March 31, 2019, the U.S. Government accounted for $5.0 million of finished goods inventory and two non-U.S. Government customers accounted for $13.9 million of finished goods inventory. At December 31, 2018, the U.S. Government accounted for $13.9 million of finished goods inventory.
The Company wrote off $3.2 million of excess and obsolete inventory during the three months ended March 31, 2019. The Company did not write off any inventory during the three months ended March 31, 2018.
Note 9— Customer Contract Liabilities
Liabilities from contracts with customers consisted of the following (in thousands):
 
 
March 31,
2019
 
December 31, 2018
Contract liability - product
 
$
9,447

 
$
5,667

Contract liability - service
 
81,189

 
88,337

Total contract liabilities
 
90,636

 
94,004

Less: long-term contract liabilities
 
(26,615
)
 
(32,021
)
Current contract liabilities
 
$
64,021

 
$
61,983


As of March 31, 2019 and December 31, 2018, the U.S. Government accounted for $30.8 million and $29.8 million, respectively, of total customer contract liabilities. As of March 31, 2019, one non-U.S. Government customer accounted for 10% of total customer contract liabilities. As of December 31, 2018, no non-U.S. government customers accounted for more than 10% of total customer contract liabilities.
Note 10— Contingencies
The Company is subject to patent lawsuits brought by Raytheon Company (“Raytheon”). A 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 (“First Action”). 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 (“Second Action”. In the Second Action, 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. 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. The Wisconsin court, upon joint motion of the parties, 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 Texas court, upon joint motion of the parties, 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

18



California court has stayed the Second Action pending resolution of the First Action. In the First Action, the Wisconsin court held a summary judgment hearing on January 10, 2019. Respecting Cray’s contentions that Raytheon’s claims of infringement of the Software Patents fail as a matter of law, on April 15, 1019, the Wisconsin court, by opinion and order, granted Cray’s motion for summary judgment and directed judgment in favor of Cray regarding Raytheon’s claims of infringement of the Software Patents.  Cray intends to seek attorneys fees under 35 U.S.C. § 285 which provides that the Court in “exceptional cases may award reasonable attorney fees to the prevailing party.” The Company will continue to vigorously defending these actions including any appeal of the favorable decision by the Wisconsin court in the First Action. The probable outcome of the described litigation cannot be determined, nor can the Company estimate a range of potential loss (or gain from a potential recovery of attorney’s fees). Based on its review of the matters to date, the Company notes that its defenses have to date prevailed in the First  Action, and the Company believes that it has valid defenses in the Second  Action. As a result, the Company considers the likelihood of a material loss related to these matters to be remote.
Note 11— 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 month period ended March 31, 2019. There were no stock option grants during the three month period ended March 31, 2018:
 
 
Three Months Ended
March 31,
 
 
2019
Risk-free interest rate
 
2.47%
Expected dividend yield
 
%
Volatility
 
48.04%
Expected life
 
4.0 years
Weighted average Black-Scholes value of options granted
 
$9.05

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 months ended March 31, 2019 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.

19



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 (Years)
Outstanding at December 31, 2018
 
1,877,602

 
$
18.81

 
 
Grants
 
20,000

 
$
22.62

 
 
Exercises
 
(194,900
)
 
$
4.25

 
 
Canceled and forfeited
 
(2,002
)
 
$
27.54

 
 
Outstanding at March 31, 2019
 
1,700,700

 
$
20.51

 
5.7
Exercisable at March 31, 2019
 
1,310,996

 
$
19.45

 
4.8
Available for grant at March 31, 2019 (1)
 
2,221,195

 
 
 
 

(1)
Using the plan’s fungible ratio of 1.55:1 for full-value awards, 1,433,029 shares were available for restricted stock awards, stock bonus awards, restricted stock units, performance shares or performance units.
As of March 31, 2019, there was $11.4 million of aggregate intrinsic value of outstanding stock options, including $10.2 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 first quarter of 2019 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 March 31, 2019. During the three months ended March 31, 2019, stock options covering 194,900 shares of common stock with a total intrinsic value of $3.6 million were exercised. During the three months ended March 31, 2018, stock options covering 172,115 shares of common stock with a total intrinsic value of $2.4 million 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 three months ended March 31, 2019 is as follows:
 
 
Service Vesting Restricted Shares
 
 
Shares
 
Weighted
Average
Grant Date
Fair Value
Outstanding at December 31, 2018
 
34,269

 
$
27.64

Granted
 

 
$

Forfeited
 

 
$

Vested
 
(1,000
)
 
$
29.14

Outstanding at March 31, 2019
 
33,269

 
$
27.59


There were no restricted stock grants during the three months ended March 31, 2019 and 2018. The aggregate fair value of restricted stock vested during the three months ended March 31, 2019 and 2018, was $29.0 thousand and $0.1 million, respectively.

20



A summary of the Company’s unvested restricted stock unit grants and changes during the three months ended March 31, 2019 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, 2018
 
1,166,308

 
$
23.07

 
482,485

 
$
30.13

 
1,648,793

 
$
25.14

Granted
 
76,200

 
$
24.84

 

 
$

 
76,200

 
$
24.84

Forfeited
 
(14,526
)
 
$
21.29

 

 
$

 
(14,526
)
 
$
21.29

Vested
 
(14,125
)
 
$
24.95

 

 
$

 
(14,125
)
 
$
24.95

Outstanding at March 31, 2019
 
1,213,857

 
$
23.18

 
482,485

 
$
30.13

 
1,696,342

 
$
25.16


The estimated forfeiture rate applied to the Company’s service vesting restricted stock unit grants during the three months ended March 31, 2019 and 2018, was 8.0%. The aggregate fair value of restricted stock units vested during each of the three months ended March 31, 2019 and 2018, was $0.4 million. 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 period for which the performance measures of the performance vesting restricted stock units can be satisfied ends at the end of 2019.
Including performance-based equity awards, the Company had $32.4 million of total unrecognized compensation cost related to unvested stock options, unvested restricted stock and unvested restricted stock units as of March 31, 2019. 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 $17.9 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 2.8 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 months ended March 31, 2019 and 2018 (in thousands):
 
 
Three Months Ended
March 31,
 
 
2019
 
2018
Cost of product revenue
 
$
125

 
$
106

Cost of service revenue
 
108

 
97

Research and development, net
 
1,169

 
860

Sales and marketing
 
789

 
734

General and administrative
 
1,475

 
1,145

Total
 
$
3,666

 
$
2,942


Note 12— Taxes
The Company’s effective tax rates for the three months ended March 31, 2019 and 2018 were as follows:
 
 
Three Months Ended
March 31,
 
 
2019
 
2018
Effective tax rates
 
(0.4)%
 
(2)%

The difference between the expected statutory tax rate of 21% and the actual tax rates of (0.4)% and (2)% for the three months ended March 31, 2019 and 2018, respectively, was attributable to the Company’s decision to continue to provide a full valuation allowance against its U.S. federal deferred tax assets offset, in part, by foreign taxes.
As of March 31, 2019, 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

21



is not considered to be more likely than not at this time. The Company’s conclusion about the realizability of its deferred tax assets, and therefore the appropriateness of the valuation allowance, is reviewed quarterly and could change in future periods depending on the Company’s future assessment of all available evidence in support of the likelihood of realization of its deferred tax assets. If the Company’s conclusion about the realizability of its deferred tax assets and therefore the appropriateness of its valuation allowance changes in a future period, it could record a substantial tax benefit in its Condensed Consolidated Statements of Operations when that occurs.
Note 13— 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
Engineering Services and Other includes analytics and artificial intelligence and Custom Engineering.


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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 $0.5 million for the three months ended March 31, 2018 related to hedging gains and losses which do not represent revenues recognized from contracts with customers.
 
 
Americas
 
EMEA
 
Asia Pacific & Japan
 
Total
Three Months Ended March 31, 2019
 
 
 
 
 
 
 
 
Supercomputing
 
$
35,682

 
$
4,982

 
$
9,643

 
$
50,307

Storage and Data Management
 
13,058

 
2,140

 
1,888

 
17,086

Maintenance and Support
 
21,354

 
7,060

 
6,913

 
35,327

Engineering Services and Other
 
3,614

 
281

 
258

 
4,153

Elimination of inter-segment revenue
 
(21,354
)
 
(7,060
)
 
(6,913
)
 
(35,327
)
Total revenue
 
$
52,354

 
$
7,403

 
$
11,789

 
$
71,546

 
 
 
 
 
 
 
 
 
 
 
Americas
 
EMEA
 
Asia Pacific & Japan
 
Total
Three Months Ended March 31, 2018
 
 
 
 
 
 
 
 
Supercomputing
 
$
20,609

 
$
8,658

 
$
26,599

 
$
55,866

Storage and Data Management
 
8,038

 
4,176

 
8,539

 
20,753

Maintenance and Support
 
20,545

 
7,490

 
4,799

 
32,834

Engineering Services and Other
 
2,721

 
60

 
194

 
2,975

Elimination of inter-segment revenue
 
(20,545
)
 
(7,490
)
 
(4,799
)
 
(32,834
)
Total revenue
 
$
31,368

 
$
12,894

 
$
35,332

 
$
79,594


The following table presents gross profit for the Company’s operating segments for the three months ended March 31, 2019 and 2018 (in thousands):
 
 
Three Months Ended
March 31,
 
 
2019
 
2018
Gross Profit:
 
 
 
 
Supercomputing
 
$
16,545

 
$
18,121

Storage and Data Management
 
7,179

 
7,033

Maintenance and Support
 
16,673

 
15,075

Engineering Services and Other
 
2,300

 
1,798

Elimination of inter-segment gross profit
 
(16,673
)
 
(15,075
)
Total gross profit
 
$
26,024

 
$
26,952


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.
Sales to the U.S. Government totaled approximately $36.0 million for the three months ended March 31, 2019 compared to approximately $19.7 million for the three months ended March 31, 2018. For the three months ended March 31, 2019, no non-U.S. Government customer or foreign country accounted for more than 10% of total revenue. For the three months ended March 31, 2018, two non-U.S. Government customers in Japan and New Zealand accounted for 35% of total revenue.

23



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”, “likely”, “forecast” 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 or our ability to sell into any market or to any customer; any statements regarding the timing of recognizing revenue for sales of our products or service; any statements regarding the 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
Our focus is on the design, development, manufacture, marketing, and servicing of computing products that magnify and enhance human capital, foster discovery and innovation, and create scientific break-throughs, as well as competitive advantages. That means our products are aimed primarily at the high end of the high-performance computing (HPC), data analytics, and artificial intelligence (AI) markets—the segments populated by the pioneers, executives, and entrepreneurs leading their industries in both the public and private sectors. These products include compute systems commonly known as supercomputers, as well as high-performance 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 needs. 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 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 graph analysis, 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, as well as expanding our addressable market in areas where we can leverage our experience and technology, such as in AI applications and data analytics. Underpinning this strategy is our focus on understanding our customers’ needs and building products that continually extend their capabilities.
Summary of First Three Months of 2019 Results
Total revenue decreased by $8.0 million for the first three months of 2019 compared to the first three months of 2018, from $79.6 million to $71.5 million, due to lower product revenue. Product revenue was $10.3 million lower in the first three months of 2019 compared to the first three months of 2018, primarily driven by two large sales to international customers during the first three months of 2018.
Net loss for the first three months of 2019 was $29.4 million compared to net loss of $25.0 million for the same period in 2018. The increase in net loss was primarily driven by an increase of $5.9 million in research and development expenses for the first three months of 2019 compared to the first three months of 2018.
Net cash used in operating activities was $20.6 million for the first three months of 2019 compared to $1.0 million for the first three months of 2018. Net cash used in operating activities for the first three months of 2019 was primarily driven by the net loss, adjusted for non-cash expenses, of $18.8 million, and a decrease of $14.4 million in accrued payroll and related expenses and other liabilities, largely resulting from payment of 2018 accrued incentive compensation. These amounts were partially offset by collections from customers that resulted in a decrease of $22.1 million in accounts and other receivables.

24



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 GPUs), as the rate of increases in per-core performance slows;
data I/O and storage capacity needs growing as fast as computational needs;
the rise of AI, machine learning, and deep learning algorithms that utilize HPC technologies for performance and scale;
technology innovations in memory and storage allowing for faster data access such as high bandwidth memory, non-volatile memory and storage, solid state and flash devices;
the increasing commoditization of HPC hardware;
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 in both the HPC and big data markets;
increased adoption of cloud computing as a solution for loosely-coupled HPC applications;
significant price volatility for memory in recent years; and
significant variability in market demand for high-end 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. This has increased the breadth of competition. 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, which is an order of magnitude more processing power than the current top systems). In addition, we are industry leaders in developing an integrated supercomputing software stack with 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

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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 use both Cray developed and open source software, 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 data; other open source libraries like Keras to enable the quick development of neural networks and commercial application; and Python and R, distributed Dask, BigDL, TensorFlow and TensorBoard for advanced AI solutions, as well as many others.
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.