Cray Demonstrates One Customer May Not Be Enough

Cray (CRAY) the supercomputer manufacturer surprised Wall Street yesterday morning by announcing that a planned cut back by the Defense Advanced Research Projects Agency (DARPA) would be reducing a planned contract for a new system being built by Cray. This decision would remove $60 million from future revenues.

Unfortunately for Cray the market for their products is extremely limited and they have relied extensively on Government contracts and funding to support their operations. The reduced contract was the third part of a series of contracts with Cray, IBM and Sun to build High Productivity Computing Systems. Cray has already received substantial revenue from the first two phases of the program.

Details of what has changed have yet to be released but it looks like the Government has scaled back some of the goals of the program which will lead to a new contract with changes in delivery items and schedule. DARPA and Cray are still discussing the changes to the scope of the contract but it was made clear that the value will be reduced by up to $60 million.

Cray now expects earnings to be close to $280 million and there is a chance that they will break even or perhaps have a small loss. The company is saying that 2010 will be better with revenue growth and a return to profitability. The company lost over $30 million in 2008. Somewhat ominously they are saying due to the structure of their product sales and availability much of their revenue won't be recognized until the fourth quarter of this year.

Cray like quite a few smaller companies have a limited market outside the Government and defense. This means that the cancellation or restructuring of one or two contracts can greatly affect their revenue and earnings. Many defense contractors remain private until they can build up a base of several contracts allowing a more diversified and stable cash flow. It can only take a funding cut or single decision to move into a different direction to end a small defense program which also ends the majority of funding for a company.

Cray is basically saying that the 20% of their 2009 revenue will be eliminated by the decision at DARPA. This may have been caused by a funding reduction not yet publicly acknowledged, if at all, or a desire to fund another completely different program that is considered by the Government to have a higher need or benefit. In Cray's case it will severely limit some of their future revenue and profit but for other companies a change like this could have been deadly.