##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 Form 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2006
 OR
 o
    
    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
(State or other jurisdiction of
incorporation or organization)
    
    93-0962605
(I.R.S. Employer
Identification No.)
 
 
 þ o
  o Large accelerated filer
    
    þ Accelerated filer
    
    o Non- accelerated
  o þ




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##### 



CRAY INC.
 TABLE OF CONTENTS
 Page No.PART I FINANCIAL INFORMATIONItem 1. Unaudited Condensed Consolidated Financial Statements:Balance Sheets as of December 31, 2005 and March 31, 2006
    
    2Statements of Operations for the Three Months Ended March 31, 2005 and 2006
    
    3Statements of Cash Flows for the Three Months Ended March 31, 2005 and 2006
    
    4Notes to Financial Statements
    
    5Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    12Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    21Item 4. Controls and Procedures
    
    22PART II OTHER INFORMATIONItem 1. Legal Proceedings
    
    22Item 1A. Risk Factors
    
    22Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    31Item 6. Exhibits
    

    31SIGNATURES
    
    33EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1
  Available Information
   1




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##### Table of Contents



Item 1. Unaudited Condensed Consolidated Financial Statements
  
   December 31,
    
    
    March 31,2005
    
    
    2006ASSETSCurrent assets:Cash and cash equivalents
    
    $
    46,026
    
    
    $
    69,893Accounts receivable, net
    
    
    55,064
    
    
    
    30,265Inventory
    
    
    67,712
    
    
    
    60,117Prepaid expenses and other current assets
    
    
    2,909
    
    
    
    3,635Total current assets
    
    
    171,711
    
    
    
    163,910Property and equipment, net
    
    
    31,292
    
    
    
    28,058Service inventory, net
    
    
    3,285
    
    
    
    3,167Goodwill
    
    
    56,839
    
    
    
    56,753Deferred tax asset
    
    
    575
    
    
    
    631Intangible assets, net
    
    
    1,113
    
    
    
    1,174Other non-current assets
    
    
    8,190
    
    
    
    7,580TOTAL ASSETS
    
    $
    273,005
    
    
    $
    261,273LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    14,911
    
    
    $
    19,421Accrued payroll and related expenses
    
    
    12,145
    
    
    
    10,625Other accrued liabilities
    
    
    10,702
    
    
    
    9,946Deferred revenue
    
    
    81,749
    
    
    
    71,157Total current liabilities
    
    
    119,507
    
    
    
    111,149Long-term deferred revenue
    
    
    5,234
    
    
    
    5,035Other non-current liabilities
    
    
    2,317
    
    
    
    2,875Convertible notes payable
    
    
    80,000
    
    
    
    80,000TOTAL LIABILITIES
    
    
    207,058
    
    
    
    199,059Commitments and Contingencies (Note 13)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, 150,000,000
shares; issued and outstanding, 90,973,506 and 91,667,542 shares, respectively
    
    
    422,691
    
    
    
    421,956Exchangeable shares, no par value  Unlimited shares authorized; 78,840 and no shares
outstanding, respectively
    
    
    576
    
    
    
    Deferred compensation
    
    
    (2,811
    )
    
    
    Accumulated other comprehensive income
    
    
    6,258
    
    
    
    6,330Accumulated deficit
    
    
    (360,767
    )
    
    
    (366,072
    )TOTAL SHAREHOLDERS EQUITY
    
    
    65,947
    
    
    
    62,214TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    273,005
    
    
    $
    261,273
 See accompanying notes
 2




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##### Table of Contents



Three Months EndedMarch 31,2005
    
    
    2006Revenue:Product
    
    $
    26,310
    
    
    $
    34,269Service
    
    
    11,324
    
    
    
    14,246Total revenue
    
    
    37,634
    
    
    
    48,515Operating expenses:Cost of product revenue
    
    
    26,352
    
    
    
    26,677Cost of service revenue
    
    
    7,575
    
    
    
    7,693Research and development, net
    
    
    13,032
    
    
    
    7,215Sales and marketing
    
    
    6,599
    
    
    
    4,985General and administrative
    
    
    4,267
    
    
    
    5,594Restructuring and severance
    
    
    (215
    )
    
    
    738Total operating expenses
    
    
    57,610
    
    
    
    52,902Loss from operations
    
    
    (19,976
    )
    
    
    (4,387
    )Other expense, net
    
    
    (502
    )
    
    
    (41
    )Interest expense, net
    
    
    (437
    )
    
    
    (608
    )Loss before income taxes
    
    
    (20,915
    )
    
    
    (5,036
    )Provision for income taxes
    
    
    (120
    )
    
    
    (269
    )Net loss
    
    $
    (21,035
    )
    
    $
    (5,305
    )Basic and diluted net loss per share
    
    $
    (0.24
    )
    
    $
    (0.06
    )Basic and diluted weighted average shares outstanding
    
    
    88,114
    
    
    
    89,351
 See accompanying notes
 3




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Three Months EndedMarch 31,2005
    
    
    2006Operating activities:Net loss
    
    $
    (21,035
    )
    
    $
    (5,305
    )Adjustments to reconcile net loss to net cash provided by (used in) operating activities:Depreciation and amortization
    
    
    4,467
    
    
    
    4,630Share-based compensation cost
    
    
    1,199
    
    
    
    481Inventory write-down
    
    
    1,657
    
    
    
    117Amortization of issuance costs, convertible notes payable and line of credit
    
    
    166
    
    
    
    338Deferred income taxes
    
    
    (29
    )
    
    
    (56
    )Changes in operating assets and liabilities:Accounts receivable
    
    
    (8,489
    )
    
    
    24,846Inventory
    
    
    (38,394
    )
    
    
    7,179Prepaid expenses and other current assets
    
    
    (1,828
    )
    
    
    (725
    )Other non-current assets
    
    
    (1,430
    )
    
    
    33Service inventory
    
    
    (156
    )
    
    
    Accounts payable
    
    
    20,523
    
    
    
    4,519Accrued payroll and related expenses and other accrued liabilities
    
    
    (2,857
    )
    
    
    (1,957
    )Other non-current liabilities
    
    
    1,602
    
    
    
    559Deferred revenue
    
    
    1,224
    
    
    
    (10,771
    )Net cash provided by (used in) operating activities
    
    
    (43,380
    )
    
    
    23,888Investing activities:Sales/maturities of short-term investments
    
    
    16,674
    
    
    
    Purchases of short-term investments
    
    
    (10,161
    )
    
    
    Proceeds from sale of minority investment
    
    
    
    
    
    
    239Decrease in restricted cash
    
    
    3
    
    
    
    Purchases of property and equipment
    
    
    (866
    )
    
    
    (996
    )Net cash provided by (used in) investing activities
    
    
    5,650
    
    
    
    (757
    )Financing activities:Proceeds from issuance of common stock through employee stock purchase plan
    
    
    440
    
    
    
    130Proceeds from exercise of options
    
    
    138
    
    
    
    602Principal payments on capital leases
    
    
    (539
    )
    
    
    (30
    )Net cash provided by financing activities
    
    
    39
    
    
    
    702Effect of foreign exchange rate changes on cash and cash equivalents
    
    
    (102
    )
    
    
    34Net increase (decrease) in cash and cash equivalents
    
    
    (37,793
    )
    
    
    23,867Cash and cash equivalentsBeginning of period
    
    
    41,732
    
    
    
    46,026End of period
    
    $
    3,939
    
    
    $
    69,893Supplemental disclosure of cash flow information:Cash paid for interest
    
    $
    8
    
    
    $
    212Non-cash investing and financing activities:Inventory transfers to fixed assets and service inventory
    
    $
    5,099
    
    
    $
    299
 See accompanying notes
 4




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Note 1  Basis of Presentation
    Principles of Consolidation
  Reclassifications
  Use of Estimates
  5




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Note 2
 Summary of New Accounting Policies
 Foreign Currency Derivatives
 Foreign Currency Derivative
 Note 3  Earnings Per Share (EPS)
   Note 4
 Comprehensive Loss
  Three Months EndedMarch 31,2005
    
    
    2006Net loss
    
    $
    (21,035
    )
    
    $
    (5,305
    )Unrealized loss on available-for-sale investments
    
    
    (63
    )
    
    
    Foreign currency translation adjustment
    
    
    (1,032
    )
    
    
    72Comprehensive loss
    
    $
    (22,130
    )
    
    $
    (5,233
    )
 Note 5  Accounts Receivable
  6




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December 31,
    
    
    March 31,2005
    
    
    2006Trade accounts receivable
    
    $
    14,547
    
    
    $
    11,027Unbilled receivables
    
    
    12,340
    
    
    
    7,306Government funding pass-through
    
    
    8,476
    
    
    
    10,116Advance billings
    
    
    19,894
    
    
    
    1,95055,257
    
    
    
    30,399Allowance for doubtful accounts
    
    
    (193
    )
    
    
    (134
    )Accounts receivable, net
    
    $
    55,064
    
    
    $
    30,265
   Note 6  Inventory
  December 31,
    
    
    March 31,2005
    
    
    2006Components and subassemblies
    
    $
    10,706
    
    
    $
    14,950Work in process
    
    
    8,314
    
    
    
    5,104Finished goods
    
    
    48,692
    
    
    
    40,063Total
    
    $
    67,712
    
    
    $
    60,117
   Note 7  Deferred Revenue
  December 31,
    
    
    March 31,2005
    
    
    2006Deferred product revenue
    
    $
    58,593
    
    
    $
    48,752Deferred service revenue
    
    
    28,390
    
    
    
    27,440Total deferred revenue
    
    
    86,983
    
    
    
    76,192Less long-term deferred revenue
    
    
    (5,234
    )
    
    
    (5,035
    )Deferred revenue in current
liabilities
    
    $
    81,749
    
    
    $
    71,157
 7




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Note 8  Restructuring and Severance Charges
   2005
    
    
    2006Balance, January 1
    
    $
    4,690
    
    
    $
    3,582Payments
    
    
    (2,212
    )
    
    
    (1,429
    )Adjustments to previously accrued amounts
    
    
    (236
    )
    
    
    107Current period charges
    
    
    21
    
    
    
    631Foreign currency translation adjustment
    
    
    (162
    )
    
    
    36Total liability balance, March 31
    
    
    2,101
    
    
    
    2,927Less long-term restructuring and severance liability
    
    
    
    
    
    
    (272
    )Current restructuring and severance liability
    
    $
    2,101
    
    
    $
    2,655
 Note 9  Share-Based Compensation
 Share-Based Payment Accounting for Stock
Issued to Employees Accounting for Stock-Based Compensation
    Three Months EndedMarch 31,2005
    
    2006Risk-free interest rate
    
    
    4.2
    %
    
    
    4.5
    %Expected dividend yield
    
    
    0
    %
    
    
    0
    %Volatility
    
    
    90
    %
    
    
    60
    %Expected life
    
    8.7 years
    
    4.5 years
 8




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Three MonthsEndedMarch 31, 2006Cost of product revenue
    
    $
    15Research and development, net
    
    
    93Sales and marketing
    
    
    105General and administrative
    
    
    268Total
    
    $
    481
  WeightedWeighted
    
    
    AverageAverage
    
    
    Remaining
    
    
    AggregateExercise
    
    
    Contractual
    
    
    IntrinsicOptions
    
    
    Price
    
    
    Term
    
    
    ValueOutstanding at December 31, 2005
    
    
    18,000,580
    
    
    $
    4.14Grants
    
    
    107,120
    
    
    
    2.11Exercises
    
    
    (398,171
    )
    
    
    1.51Cancellations
    
    
    (2,596,244
    )
    
    
    6.22Outstanding at March 31, 2006
    
    
    15,113,285
    
    
    $
    3.84
    
    
    6.2 years
    
    $1,447,454Exercisable at March 31, 2006
    
    
    14,988,934
    
    
    $
    3.85
    
    
    6.2 years
    
    $1,445,181Available for grant at March 31, 2006
    
    
    1,919,365
    9




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##### Table of Contents



Three MonthsEndedMarch 31, 2005Net loss, as reported
    
    $
    (21,035
    )Add:Stock-based compensation included in reported net loss
    
    
    1,199Total stock-based compensation expense determined under fair value-based method for all awards
    
    
    (19,083
    )Pro forma net loss
    
    $
    (38,919
    )Basic and diluted net loss per share:As reported
    
    $
    (0.24
    )Pro forma
    
    $
    (0.44
    )
 Note 10  Taxes
  Note 11  Geographic Segment Information
 Disclosure about Segments of an Enterprise and Related Information
  United States
    
    
    Other Countries
    
    
    TotalThree months ended March 31,
    
    2005
    
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005
    
    
    2006Product revenue
    
    $
    15,561
    
    
    $
    31,428
    
    
    $
    10,749
    
    
    $
    2,841
    
    
    $
    26,310
    
    
    $
    34,269Service revenue
    
    
    7,824
    
    
    
    10,464
    
    
    
    3,500
    
    
    
    3,782
    
    
    
    11,324
    
    
    
    14,246Total revenue
    
    $
    23,385
    
    
    $
    41,892
    
    
    $
    14,249
    
    
    $
    6,623
    
    
    $
    37,634
    
    
    $
    48,515
   10




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Note 12  Foreign Currency Derivative
  Note 13  Litigation
     11




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations
 Preliminary Note Regarding Forward-Looking Statements
  Overview and Executive Summary
   Strategic Focus
   Summary of 1 st Quarter 2006 Results
  12




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Critical Accounting Policies and Estimates
    Revenue Recognition
  Products:
 
    
    Cray X1/X1E and Cray XT3 Product Lines:We recognize revenue from product sales
upon customer acceptance of the system, when we have no significant unfulfilled
obligations stipulated by the contract that affect the customers final acceptance, the
price is determinable and collection is reasonably assured. A customer-signed notice of
acceptance or similar document is required from the customer prior to revenue
recognition.
 
    
    Cray XD1 Product Line:We recognize revenue from product sales of Cray XD1
systems upon shipment to, or delivery to, the customer, depending upon contract terms,
when we have no significant unfulfilled obligations
 13




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stipulated by the contract, the price is determinable and collection is reasonably
assured. If there is a contractual requirement for customer acceptance, revenue is
recognized upon receipt of the notice of acceptance and when we have no unfulfilled
obligations.
 Accounting for Performance of Construction-Type and Certain
Production-Type Contracts
 Services:
 Multiple-Element Arrangements. Revenue
Arrangements with Multiple Deliverables
 
    
    The element could be sold separately;
    
    The fair value of the undelivered element is established; and
    
    In cases with any general right of return, our performance with respect to any
undelivered element is within our control and probable.
  Inventory Valuation
   14




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Goodwill
   Accounting for Income Taxes
 Accounting for
Income Taxes,
 Accounting for Loss Contracts
  15




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Share-based Compensation
 Share-Based Payment Accounting for Stock Issued to Employees Accounting for
Stock-Based Compensation
    Results of Operations
 Revenue
  Three Months EndedMarch 31,2005
    
    
    2006Product Revenue
    
    $
    26,310
    
    
    $
    34,269Percentage of total revenue
    
    
    70%
    
    
    
    71%Service Revenue
    
    $
    11,324
    
    
    $
    14,246Percentage of total revenue
    
    
    30%
    
    
    
    29%Total Revenue
    
    $
    37,634
    
    
    $
    48,515
 Product Revenue
   16




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Service Revenue
   Operating Expenses
 Cost of Revenue
  Three Months EndedMarch 31,2005
    
    2006Cost of Product Revenue
    
    $
    26,352
    
    
    $
    26,677Percentage of product revenue
    
    
    100%
    
    
    
    78%Cost of Service Revenue
    
    $
    7,575
    
    
    $
    7,693Percentage of service revenue
    
    
    67%
    
    
    
    54%
 Cost of Product Revenue
  17




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Cost of Service Revenue
  Research and Development (in thousands):
  Three MonthsEnded March 31,2005
    
    
    2006Gross research and development expenses
    
    $
    22,289
    
    
    $
    26,073Less: Amounts included in cost of product revenue
    
    
    (4,390
    )
    
    
    (6,378
    )Less: Reimbursed research and development (excludes amounts in revenue)
    
    
    (4,867
    )
    
    
    (12,480
    )Net research and development expenses
    
    $
    13,032
    
    
    $
    7,215Percentage of total revenue
    
    
    35%
    
    
    
    15%
     Other Operating Expenses
  18




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Three MonthsEnded March 31,2005
    
    2006Sales and marketing
    
    $
    6,599
    
    
    $
    4,985Percentage
of total revenue
    
    
    18%
    
    
    
    10%General and administrative
    
    $
    4,267
    
    
    $
    5,594Percentage
of total revenue
    
    
    11%
    
    
    
    12%Restructuring and severance
    
    $
    (215
    )
    
    $
    738Percentage
of total revenue
    
    
    <(1%)
    
    
    
    2%
 Sales and Marketing .
 General and Administrative
 Restructuring and Severance .
 Other Expense, net
  Interest Income (Expense)
  Three MonthsEnded March 31,2005
    
    
    2006Interest income
    
    $
    338
    
    
    $
    485Interest expense
    
    
    (775
    )
    
    
    (1,093
    )Net interest income (expense)
    
    $
    (437
    )
    
    $
    (608
    )
   Taxes
  19




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Liquidity and Capital Resources
      Amounts Committed by YearLess than
    
    
    1-3
    
    
    4-5Contractual Obligations
    
    Total
    
    
    1 year
    
    
    years
    
    
    years
    
    
    ThereafterDevelopment agreements
    
    $
    12,866
    
    
    $
    10,796
    
    
    $
    2,070
    
    
    $
    
    
    
    $
    Capital lease obligations
    
    
    124
    
    
    
    93
    
    
    
    31
    
    
    
    
    
    
    
    Operating leases
    
    
    8,828
    
    
    
    2,643
    
    
    
    5,981
    
    
    
    181
    
    
    
    23Total contractual cash obligations
    
    $
    21,818
    
    
    $
    13,532
    
    
    $
    8,082
    
    
    $
    181
    
    
    $
    23
   20




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Item 3. Quantitative and Qualitative Disclosures About Market Risk
  Interest Rate Risk
 Foreign Currency Risk
 21




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Item 4. Controls and Procedures
 Evaluation of disclosure controls and procedures.
 Changes in internal control over financial reporting.
 
 Part II. Other Information
 
 Item 1. Legal Proceedings
     
 Item 1A. Risk Factors
  22




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Risk Factors Pertaining to Our Business and Operations
 Our operating results may fluctuate significantly.
  
    
    successfully selling the Cray XT3, Cray X1E and Cray XD1 systems, including upgrades and
successor systems, new products, and the timing and funding of government purchases,
especially in the United States;
 
    
    the level of product margin contribution in any given period;
 
    
    maintaining our other product development projects on schedule and within budgetary limitations;
 
    
    the level of revenue recognized in any given period, particularly for the high average
sales prices and limited number of sales of our larger systems in any quarter, including
the shipment of products to Europe in compliance with new environmental regulations and
the timing of product acceptances by customers and contractual provisions affecting
revenue recognition;
 
    
    revenue delays or losses due to customers postponing purchases to await future upgraded
or new systems, delays in delivery of upgraded or new systems and longer than expected
customer acceptance cycles;
 
    
    our expense levels, including research and development net of government funding, which
may be affected by the timing of such funding;
 
    
    the terms and conditions of sale or lease for our products;
 
    
    whether we conclude that all or some part of our recorded goodwill has been impaired,
which may be due to changes in our business plans and strategy and/or a decrease in our
fair value (i.e., the market value of our outstanding shares of common stock); and
 
    
    the impact of expensing our share-based compensation under
FAS 123R.
  
    
    the timely availability of acceptable components in sufficient quantities to meet
customer delivery schedules;
 
    
    timing and level of government funding for products and research and development contracts;
 
    
    changes in levels of customer capital spending;
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
 
 
  Failure to sell Cray XT3 and upgrade systems in planned quantities and margins would
adversely affect 2006 revenue and earnings.
 Improved future performance is highly dependent on increased product revenue and
margins
  Our inability to overcome the technical challenges of completing the development of our
supercomputer systems would adversely affect our revenue and earnings in 2006 and beyond.
 If we lose government support for development of our supercomputer systems, our
research and development expenses and capital requirements would increase and our ability to
conduct research and development would decrease.
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Phase 3 of the DARPA HPCS Program will affect our operations.
 New European environmental rules may adversely affect our operations.
  Our reliance on third-party suppliers poses significant risks to our business and
prospects.
 
    
    if a supplier did not provide components that met our specifications in
sufficient quantities, then production and sale of our systems would be delayed;
 25




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##### Table of Contents




    
    if a reduction or an interruption of supply of our components occurred,
either because of a significant problem with a supplier not providing parts on time
or providing parts that later prove to be defective or a single-source supplier
deciding to no longer provide those components to us, it could take us a considerable
period of time to identify and qualify alternative suppliers to redesign our products
as necessary and to begin manufacture of the redesigned components or we may not be
able to so redesign such components; see also We face last-time buy decisions
affecting all of our products, which may adversely affect our earnings and
prospects, below;
    
    if we were unable to locate a supplier for a key component, we would be
unable to complete and deliver our products;
    
    one or more suppliers could make strategic changes in their product
offerings, which might delay, suspend manufacture or increase the cost of our
components or systems; and
    
    some of our key suppliers are small companies with limited financial and
other resources, and consequently may be more likely to experience financial and
operational difficulties than larger, well-established companies.
    We face increased liquidity risk if we do not receive cash flow from operating
activities as planned.
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We face last-time buy decisions affecting all of our products, which may adversely
affect our revenue and earnings.
 To be successful we need to establish the value of our high-bandwidth sustained
performance systems, increase differentiation of our massively parallel commodity
processor-products and reduce doubts about our long-term viability.
 Lower than anticipated sales of new supercomputers and the termination of maintenance
contracts on older and/or decommissioned systems would further reduce our service revenue
and margins from maintenance service contracts.
 We may not meet the covenants imposed by our current credit agreement.
 We were not successful in completing the Red Storm project on time and on budget, which
adversely affected our 2004 and 2005 earnings and could adversely affect our future earnings
and financial condition.
 If the U.S. government purchases fewer supercomputers, our revenue would be reduced and
our earnings would be adversely affected.
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If we are unable to compete successfully in the high performance computer market, our
revenue will decline.
 If we cannot retain, attract and motivate key personnel, we may be unable to
effectively implement our business plan.
 Federal class action and derivative lawsuits were recently dismissed subject to filing
amended complaints, a state court derivative action continues and additional lawsuits may
be filed
 The adoption of FAS 123R will lower our earnings and may adversely affect the market
price of our common stock.
 U.S. export controls could hinder our ability to make sales to foreign customers and
our future prospects.
 We incorporate software licensed from third parties into the operating systems for our
products and any significant interruption in the availability of these third-party software
products or defects in these products could reduce the demand for our products.
 We have recently formed a new senior management team that must work together
effectively for us to be successful
 While we determined that we have adequate internal control over financial reporting as
of December 31, 2005, as of the end of each subsequent fiscal year we are required to
evaluate our internal control over
financial reporting under Section 404 of the Sarbanes-Oxley Act of 2002 and any adverse
results from such future evaluations could result in a loss of investor confidence in our
financial reports and have an adverse effect on our stock price.
 We may infringe or be subject to claims that we infringe the intellectual property
rights of others.
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We may not be able to protect our proprietary information and rights adequately.
 Risk Factors Pertaining to our Notes and Our Common Stock
 Our indebtedness may adversely affect our financial strength.
 
 
 
 
 
 
 Our existing and any future credit facilities may adversely affect our ability to make
payments under the Notes.
 We will require a significant amount of cash to service our indebtedness and to fund
planned capital expenditures, research and development efforts and other corporate expenses.
 There are no covenants in the indenture for the Notes restricting our ability or the
ability of our subsidiaries to incur future indebtedness or restricting the terms of any
such indebtedness.
 The Notes are subordinated in right of payment to our existing and future senior
indebtedness.
 The Notes are effectively subordinated to our secured indebtedness and are structurally
subordinated to all indebtedness and other liabilities of our current and future
subsidiaries.
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In certain circumstances, holders of senior debt can require us to suspend or defer
cash payments due in respect of the Notes.
 Unless a condition to conversion is met prior to the maturity of the Notes, the Notes
will not be convertible at any time.
 Upon conversion of the Notes, we may pay cash or a combination of cash and shares of
our common stock in lieu of issuing shares of our common stock. Therefore, Note holders may
receive no shares of our common stock or fewer shares than the number into which their Notes
are convertible.
 If a principal conversion settlement election is made, we may not have sufficient funds
to pay the cash settlement upon conversion.
 The conversion rate of the Notes may not be adjusted for all dilutive events, including
third-party tender or exchange offers, that may adversely affect the trading price of the
Notes or our common stock issuable upon conversion of the Notes.
 If we pay cash dividends on our common stock, Note holders may be deemed to have
received a taxable dividend without the receipt of cash.
 If we elect to settle upon conversion in cash or a combination of cash and shares of
common stock, there will be a delay in settlement.
 Some significant corporate transactions may not constitute a fundamental change, in
which case we would not be obligated to offer to repurchase the Notes.
 Our Notes may not be rated or may receive a lower rating than investors anticipate,
which could cause a decline in the trading volume and market price of the Notes and our
common stock.
 We may not have the funds necessary to purchase the Notes upon a fundamental change or
other purchase date and our ability to purchase the Notes in such events may be limited.
 The make whole premium payable on Notes that are converted in connection with certain
fundamental changes may not adequately compensate Note holders for the lost option time
value of the Notes as a result of that fundamental change.
 There are restrictions on the Note holders ability to transfer or resell the Notes
without registration under applicable securities laws, and if we fail to fulfill our
obligations to keep effective the registration statement covering the resale of the Notes,
we will be required to pay additional interest on the Notes affected by that failure and to
issue additional shares of common stock on Notes converted during such failure and satisfied
by us in common stock.
 There is no active market for the Notes and if an active trading market does not
develop for these Notes, the holders of the Notes may be unable to resell them.
 Our stock price is volatile.
 A substantial number of our shares are eligible for future sale and may depress the
market price of our common stock and may hinder our ability to obtain additional financing.
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
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  Provisions of our Articles of Incorporation and Bylaws could make a proposed
acquisition that is not approved by our Board of Directors more difficult.
 We do not anticipate declaring any cash dividends on our common stock.
 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
   
 Item 6. Exhibits
 3.2
    
    Amended and Restated Bylaws of Cray Inc., as amended through February 15, 2006 (1)10.1
    
    Amendment Number Two to Senior Secured Credit Agreement, dated as of March 14,
2006, between Wells Fargo Foothill, Inc., Cray Inc. and Cray Federal Inc. (2)10.2
    
    Summary sheet setting forth amended compensation arrangements for non-employee
Directors (1)31.1
    
    Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) of the
Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
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31.2
    
    Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) of the
Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 200232.1
    
    Certificate pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
 
 (1)
    
    Incorporated by reference to the Companys Current Report on Form 8-K, as filed
with the Commission February 21, 2006(2)
    
    Incorporated by reference to the Companys Current Report on Form 8-K, as filed
with the Commission March 17, 2006 Items 3, 4 and 5 of Part II are not applicable and have been omitted.
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SIGNATURES
  CRAY INC.May 8, 2006
    
    /s/ PETER J. UNGAROPeter J. UngaroChief Executive Officer and President/s/ BRIAN C. HENRYBrian C. HenryChief Financial Officer/s/ KENNETH D. ROSELLIKenneth D. RoselliChief Accounting Officer
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