Value Line has initiated coverage of Cray Inc. (CRAY) in its flagship product, The Value Line Investment Survey. Cray designs, manufactures, markets, and services high-performance computing (HPC) systems, sometimes referred to as supercomputers. The company also provides storage solutions and software services to its customers, which include government agencies, academic institutions, and commercial entities. Cray was incorporated in Washington in 1987, initially under the name Tera Computer Company. It is based in Seattle. As of December 31, 2012, Cray had 929 employees.

The company has three segments: HPC Systems, Maintenance and Support, and Storage and Data Management. HPC Systems is the largest, representing 71% of 2012 revenues. This division includes highly advanced systems, including the following primary products: Cray XC30, Cray XE6, Cray XK7, and Cray Cluster Solutions. These goods are used by single users as well as large research centers.

The next biggest segment is Maintenance and Support, which provides ongoing upkeep for Cray’s HPC and Big Data systems in order to help clients achieve their objectives. It represented 35% of 2012 revenues. Finally, the Storage and Data Management group offers the Cray Sonexion 1600, as well as other third-party storage products.

The company focuses its sales and marketing efforts on government computing labs, academic institutions, and commercial entities that purchase HPC and Big Data systems and storage. Cray’s sales force operates in the Unites States, Canada, South America, Europe, and Asia. Over half of its sales force is in North America. It subcontracts the production of the majority of its hardware products, including integrated circuits, printed circuit boards, connectors, and cables. This allows it to avoid the large capital equipment expenditures typically associated with establishing a full-scale manufacturing facility. The strategy also allows it to maintain the flexibility to adopt new technologies without the risk of having its manufacturing facilities become obsolete.

Agencies of the U.S. government, and customers serving the U.S. government, accounted for 68% of 2012 sales. Customers that accounted for more than 10% of revenue last year include the National Center for Supercomputing Applications at the University of Illinois, Oak Ridge National Laboratory, and a commercial customer. International sales represented 18% of 2012 revenues.

The Big Data market, which refers to the storage and analytics of enormous volumes of data, has become an important part of Cray’s business. It is a relatively new target market for the company, but given Cray’s products, which can process vast amounts of data at very high speeds, we believe the segment will continue to grow.

Cray faces stiff competition in its business. The HPC market is particularly fierce, with competitors including IBM (IBM - Free IBM Stock Report), Hewlett-Packard (HPQ), and Hitachi (HTHIY). Most of these firms have significantly more financial resources than Cray. The company also competes with systems builders and resellers of systems that are constructed from commodity components using processors made by the aforementioned firms, along with Dell. 

The company faces several risks, including the fact that its operating results vary significantly from quarter to quarter, as a material portion of product revenue in any given quarter depends on a limited number of customers. As a result, revenues are often concentrated in particular quarters, rather than spread evenly throughout the year. The company is also highly dependent on the U.S. government, and government-affiliated companies, so a decline in purchases from these entities would hurt results. Cray’s reliance on third-party suppliers to produce many of its goods can also cause a decline in business if there are any delays in production. Pricing pressure, due to the continuing commoditization of HPC hardware, is another concern. 

Business prospects at Cray remain firm. While there will likely continue to be volatility in sales and earnings for the foreseeable future, given its dependence on a few large customers (most notably the U.S. government), we still look for solid sales and earnings in the coming quarters. Management is particularly optimistic about its commercial business in 2014, which is expected to grow faster than the underlying market. In addition, the company has a solid balance sheet with no debt.

Subscribers interested in learning more about this high-performance computing manufacturer are advised to consult Value Line’s quarterly reports for Cray, as well as any supplemental reports and relevant articles that may arise as important news comes to light.

At the time of this article’s writing, the author did not have any positions in any of the companies mentioned.