##### 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 June 30, 2007
 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
    
    93-0962605(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)
 
 
 
 þ o
  o þ o
  o þ




---



##### 

\

CRAY INC.
 TABLE OF CONTENTS
 Page No.PART I FINANCIAL INFORMATIONItem 1. Unaudited Condensed Consolidated Financial Statements:Balance Sheets as of June 30, 2007 and December 31, 2006
    
    2Statements of Operations for the Three Months and Six Months Ended June 30, 2007 and 2006
    
    3Statements of Cash Flows for the Six Months Ended June 30, 2007 and 2006
    
    4Notes to Condensed Consolidated 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
    
    22Item 4. Controls and Procedures
    
    23Item 4T. Controls and Procedures
    
    23PART II OTHER INFORMATION
    
    23Item 1A. Risk Factors
    
    23Item 4. Submission of Matters to a Vote of Security Holders
    
    33Item 6. Exhibits
    
    34SIGNATURES
    
    35EXHIBIT 10.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1
  Available Information
   1




---



##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1. Unaudited Condensed Consolidated Financial Statements
  
   June 30,
    
    
    December 31,2007
    
    
    2006ASSETSCurrent assets:Cash and cash equivalents
    
    $
    48,335
    
    
    $
    115,328Restricted cash
    
    
    25,000
    
    
    
    25,000Short-term investments, available-for-sale
    
    
    51,163
    
    
    
    Accounts receivable, net
    
    
    24,599
    
    
    
    44,790Inventory
    
    
    61,950
    
    
    
    58,798Prepaid expenses and other current assets
    
    
    4,635
    
    
    
    2,156Total current assets
    
    
    215,682
    
    
    
    246,072Property and equipment, net
    
    
    19,697
    
    
    
    21,564Service inventory, net
    
    
    3,707
    
    
    
    4,292Goodwill
    
    
    61,503
    
    
    
    57,138Deferred tax asset
    
    
    770
    
    
    
    722Intangible assets, net
    
    
    1,309
    
    
    
    1,404Other non-current assets
    
    
    6,000
    
    
    
    6,311TOTAL ASSETS
    
    $
    308,668
    
    
    $
    337,503LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    18,686
    
    
    $
    22,450Accrued payroll and related expenses
    
    
    11,944
    
    
    
    17,411Advance research and development payments
    
    
    8,899
    
    
    
    21,518Other accrued liabilities
    
    
    5,515
    
    
    
    5,121Deferred revenue
    
    
    37,808
    
    
    
    43,248Total current liabilities
    
    
    82,852
    
    
    
    109,748Long-term deferred revenue
    
    
    1,589
    
    
    
    2,475Other non-current liabilities
    
    
    3,526
    
    
    
    3,906Convertible notes payable
    
    
    80,000
    
    
    
    80,000TOTAL LIABILITIES
    
    
    167,967
    
    
    
    196,129Commitments and ContingenciesShareholders 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, 32,547,950 and
32,236,888 shares, respectively
    
    
    511,372
    
    
    
    507,356Accumulated other comprehensive income
    
    
    9,391
    
    
    
    6,855Accumulated deficit
    
    
    (380,062
    )
    
    
    (372,837
    )TOTAL SHAREHOLDERS EQUITY
    
    
    140,701
    
    
    
    141,374TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    308,668
    
    
    $
    337,503
 See accompanying notes
 2




---



##### Table of Contents



Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Revenue:Product
    
    $
    13,789
    
    
    $
    24,647
    
    
    $
    47,449
    
    
    $
    58,916Service
    
    
    12,836
    
    
    
    13,866
    
    
    
    26,285
    
    
    
    28,112Total revenue
    
    
    26,625
    
    
    
    38,513
    
    
    
    73,734
    
    
    
    87,028Cost of revenue:Cost of product revenue
    
    
    8,227
    
    
    
    18,099
    
    
    
    31,804
    
    
    
    44,776Cost of service revenue
    
    
    7,660
    
    
    
    7,901
    
    
    
    15,658
    
    
    
    15,594Total cost of revenue
    
    
    15,887
    
    
    
    26,000
    
    
    
    47,462
    
    
    
    60,370Gross margin
    
    
    10,738
    
    
    
    12,513
    
    
    
    26,272
    
    
    
    26,658Operating expenses:Research and development, net
    
    
    8,859
    
    
    
    6,371
    
    
    
    16,739
    
    
    
    13,586Sales and marketing
    
    
    5,123
    
    
    
    5,682
    
    
    
    10,391
    
    
    
    10,667General and administrative
    
    
    3,822
    
    
    
    4,600
    
    
    
    8,102
    
    
    
    10,194Restructuring and severance
    
    
    
    
    
    
    549
    
    
    
    10
    
    
    
    1,287Total operating expenses
    
    
    17,804
    
    
    
    17,202
    
    
    
    35,242
    
    
    
    35,734Loss from operations
    
    
    (7,066
    )
    
    
    (4,689
    )
    
    
    (8,970
    )
    
    
    (9,076
    )Other income (expense), net
    
    
    76
    
    
    
    (1,831
    )
    
    
    471
    
    
    
    (1,872
    )Interest income (expense), net
    
    
    966
    
    
    
    (441
    )
    
    
    1,999
    
    
    
    (1,049
    )Loss before income taxes
    
    
    (6,024
    )
    
    
    (6,961
    )
    
    
    (6,500
    )
    
    
    (11,997
    )Provision for income taxes
    
    
    360
    
    
    
    212
    
    
    
    725
    
    
    
    481Net loss
    
    $
    (6,384
    )
    
    $
    (7,173
    )
    
    $
    (7,225
    )
    
    $
    (12,478
    )Basic and diluted net loss per share
    
    $
    (0.20
    )
    
    $
    (0.32
    )
    
    $
    (0.23
    )
    
    $
    (0.56
    )Basic and diluted weighted average shares outstanding
    
    
    31,635
    
    
    
    22,451
    
    
    
    31,560
    
    
    
    22,395
 See accompanying notes
 3




---



##### Table of Contents



Six Months EndedJune 30,2007
    
    
    2006Operating activities:Net loss
    
    $
    (7,225
    )
    
    $
    (12,478
    )Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization
    
    
    6,383
    
    
    
    8,751Share-based compensation cost
    
    
    1,972
    
    
    
    999Inventory write-down
    
    
    156
    
    
    
    383Amortization of issuance costs, convertible notes payable and line of credit
    
    
    344
    
    
    
    676Deferred income taxes
    
    
    (48
    )
    
    
    (27
    )Changes in operating assets and liabilities:Accounts receivable
    
    
    19,147
    
    
    
    12,836Inventory
    
    
    (6,677
    )
    
    
    (13,589
    )Prepaid expenses and other current assets
    
    
    (2,561
    )
    
    
    (944
    )Other non-current assets
    
    
    (34
    )
    
    
    (173
    )Service inventory
    
    
    
    
    
    
    22Accounts payable
    
    
    (3,889
    )
    
    
    7,745Accrued payroll and related expenses and other accrued liabilities
    
    
    (5,079
    )
    
    
    (634
    )Advance research and development payments
    
    
    (12,619
    )
    
    
    Other non-current liabilities
    
    
    (393
    )
    
    
    (8
    )Deferred revenue
    
    
    (6,534
    )
    
    
    (5,773
    )Net cash used in operating activities
    
    
    (17,057
    )
    
    
    (2,214
    )Investing activities:Sales/maturities of short-term investments
    
    
    12,850
    
    
    
    Purchases of short-term investments
    
    
    (63,668
    )
    
    
    Proceeds from sale of investment
    
    
    
    
    
    
    239Purchases of property and equipment
    
    
    (644
    )
    
    
    (1,475
    )Net cash used in investing activities
    
    
    (51,462
    )
    
    
    (1,236
    )Financing activities:Proceeds from issuance of common stock through employee stock purchase plan
    
    
    246
    
    
    
    288Proceeds from exercise of options
    
    
    1,271
    
    
    
    880Line of credit issuance costs
    
    
    
    
    
    
    (375
    )Principal payments on capital leases
    
    
    (31
    )
    
    
    (59
    )Net cash provided by financing activities
    
    
    1,486
    
    
    
    734Effect of foreign exchange rate changes on cash and cash equivalents
    
    
    40
    
    
    
    62Net decrease in cash and cash equivalents
    
    
    (66,993
    )
    
    
    (2,654
    )Cash and cash equivalentsBeginning of period
    
    
    115,328
    
    
    
    46,026End of period
    
    $
    48,335
    
    
    $
    43,372Supplemental disclosure of cash flow information:Cash paid for interest
    
    $
    1,200
    
    
    $
    1,880Non-cash investing and financing activities:Inventory transfers to fixed assets and service inventory
    
    $
    3,369
    
    
    $
    2,275Stock issued for 401(k) match
    
    $
    527
    
    
    $
    394
 See accompanying notes
 4




---



##### Table of Contents



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




---



##### Table of Contents



Note 2  Summary of New Accounting Policies
 Short-term investments
 Accounting
for Certain Investments in Debt and Equity Securities
 Note 3  Recent Accounting Developments
 Accounting for Nonrefundable Advance Payments for Goods or Services to be Used in Future
Research and Development Activities
 Note 4  Earnings Per Share (EPS)
   Note 5  Comprehensive Loss
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Net loss
    
    $
    (6,384
    )
    
    $
    (7,173
    )
    
    $
    (7,225
    )
    
    $
    (12,478
    )Unrealized loss on available-for-sale investments
    
    
    (64
    )
    
    
    
    
    
    
    (47
    )
    
    
    Unrealized losses on hedged transactions
    
    
    (1,482
    )
    
    
    
    
    
    
    (1,770
    )
    
    
    Foreign currency translation adjustment
    
    
    4,025
    
    
    
    2,088
    
    
    
    4,353
    
    
    
    2,160Comprehensive loss
    
    $
    (3,905
    )
    
    $
    (5,085
    )
    
    $
    (4,689
    )
    
    $
    (10,318
    )
 6




---



##### Table of Contents



Note 6  Accounts Receivable
  June 30,
    
    
    December 31,2007
    
    
    2006Trade accounts receivable
    
    $
    13,129
    
    
    $
    39,417Unbilled receivables
    
    
    5,625
    
    
    
    4,045Other receivables
    
    
    4,931
    
    
    
    349Advance billings
    
    
    1,247
    
    
    
    1,07824,932
    
    
    
    44,889Allowance for doubtful accounts
    
    
    (333
    )
    
    
    (99
    )Accounts receivable, net.
    
    $
    24,599
    
    
    $
    44,790
   Note 7  Inventory
  June 30,
    
    
    December 31,2007
    
    
    2006Components and subassemblies
    
    $
    22,117
    
    
    $
    22,536Work in process
    
    
    12,817
    
    
    
    15,310Finished goods
    
    
    27,016
    
    
    
    20,952Total
    
    $
    61,950
    
    
    $
    58,798
   Note 8  Deferred Revenue
  June 30,
    
    
    December 31,2007
    
    
    2006Deferred product revenue
    
    $
    24,988
    
    
    $
    26,993Deferred service revenue
    
    
    14,409
    
    
    
    18,730Total deferred revenue
    
    
    39,397
    
    
    
    45,723Less long-term deferred revenue
    
    
    (1,589
    )
    
    
    (2,475
    )Deferred revenue in current liabilities
    
    $
    37,808
    
    
    $
    43,248
 7




---



##### Table of Contents



Note 9  Restructuring and Severance Charges
   Six Months EndedJune 30,2007
    
    
    2006Balance, January 1
    
    $
    1,063
    
    
    $
    3,582Payments
    
    
    (285
    )
    
    
    (1,429
    )Adjustments to previously accrued amounts
    
    
    10
    
    
    
    107Current period charges
    
    
    
    
    
    
    631Foreign currency translation adjustment
    
    
    2
    
    
    
    36Total liability balance, March 31
    
    
    790
    
    
    
    2,927Payments
    
    
    (116
    )
    
    
    (723
    )Adjustments to previously accrued amounts
    
    
    
    
    
    
    (3
    )Current period charges
    
    
    
    
    
    
    552Foreign currency translation adjustment
    
    
    1
    
    
    
    42Total liability balance, June 30
    
    
    675
    
    
    
    2,795Less long-term restructuring and severance liability
    
    
    
    
    
    
    (181
    )Current restructuring and severance liability
    
    $
    675
    
    
    $
    2,614
 Note 10  Share-Based Compensation
 Share-Based Payment
  Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2007
    
    2006
    
    2007
    
    2006Risk-free interest rate
    
    
    4.7
    %
    
    
    4.8
    %
    
    
    4.7
    %
    
    
    4.6
    %Expected dividend yield
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %Volatility
    
    
    73
    %
    
    
    76
    %
    
    
    73
    %
    
    
    64
    %Expected life
    
    4.0 years
    
    4.0 years
    
    4.0 years
    
    4.3 yearsWeighted
average Black-Scholes value of
options granted
    
    $
    4.57
    
    
    $
    4.39
    
    
    $
    6.28
    
    
    $
    4.43
  8




---



##### Table of Contents



Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Cost of product revenue
    
    $
    28
    
    
    $
    14
    
    
    $
    55
    
    
    $
    29Cost of service revenue
    
    
    46
    
    
    
    
    
    
    
    87
    
    
    
    Research and development, net
    
    
    302
    
    
    
    93
    
    
    
    644
    
    
    
    186Sales and marketing
    
    
    136
    
    
    
    106
    
    
    
    273
    
    
    
    211General and administrative
    
    
    438
    
    
    
    305
    
    
    
    913
    
    
    
    573Total
    
    $
    950
    
    
    $
    518
    
    
    $
    1,972
    
    
    $
    999
  WeightedWeighted
    
    AverageAverage
    
    Remaining
    
    AggregateExercise
    
    Contractual
    
    IntrinsicOptions
    
    Price
    
    Term
    
    ValueOutstanding at December 31, 2006
    
    
    3,867,415
    
    
    $
    14.68Grants
    
    
    22,000
    
    
    
    10.88Exercises
    
    
    (162,783
    )
    
    
    7.81Cancellations
    
    
    (121,786
    )
    
    
    19.93Outstanding at June 30, 2007
    
    
    3,604,846
    
    
    $
    14.79
    
    
    6.3 years
    
    $
    1,304,000Exercisable at June 30, 2007
    
    
    2,884,535
    
    
    $
    15.85
    
    
    5.5 years
    
    $
    1,301,000Available for grant at June 30, 2007
    
    
    2,358,516
    9




---



##### Table of Contents



Note 11  Taxes
  Accounting for Uncertainty in
Income Taxes  an interpretation of FASB Statement 109
  Note 12  Geographic Segment Information
 Disclosure about Segments of an Enterprise and Related Information
  United States
    
    
    Other Countries
    
    
    TotalThree months ended June 30,
    
    2007
    
    
    2006
    
    
    2007
    
    
    2006
    
    
    2007
    
    
    2006Product revenue
    
    $
    9,327
    
    
    $
    13,845
    
    
    $
    4,462
    
    
    $
    10,802
    
    
    $
    13,789
    
    
    $
    24,647Service revenue
    
    
    7,824
    
    
    
    9,971
    
    
    
    5,012
    
    
    
    3,895
    
    
    
    12,836
    
    
    
    13,866Total revenue
    
    $
    17,151
    
    
    $
    23,816
    
    
    $
    9,474
    
    
    $
    14,697
    
    
    $
    26,625
    
    
    $
    38,513Six months ended June 30,
    
    
    2007
    
    
    
    2006
    
    
    
    2007
    
    
    
    2006
    
    
    
    2007
    
    
    
    2006Product revenue
    
    $
    34,540
    
    
    $
    45,273
    
    
    $
    12,909
    
    
    $
    13,643
    
    
    $
    47,449
    
    
    $
    58,916Service revenue
    
    
    16,428
    
    
    
    20,435
    
    
    
    9,857
    
    
    
    7,677
    
    
    
    26,285
    
    
    
    28,112Total revenue
    
    $
    50,968
    
    
    $
    65,708
    
    
    $
    22,766
    
    
    $
    21,320
    
    
    $
    73,734
    
    
    $
    87,028
  10




---



##### Table of Contents



Note 13  Foreign Currency Derivative
  
 Note 14  Subsequent Events
  11




---



##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations
 Preliminary Note Regarding Forward-Looking Statements
  Overview and Executive Summary
    Summary of 1 st Half of 2007 Results
    12




---



##### Table of Contents



Market Overview and Challenges
     Our Strategy
  Gain Share in Our Core HPC Market.
 Maintain Focus on Execution and Profitability.
 Extend Technology Leadership.
 13




---



##### Table of Contents



Expand Total Addressable Market.
 Key Performance Indicators
  Revenue.
 Gross margins.
 Operating expenses.
 Liquidity and cash flows.
 Critical Accounting Policies and Estimates
  14




---



##### Table of Contents



Revenue Recognition
 Revenue
Recognition in Financial Statements
 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.
  Products.
 15




---



##### Table of Contents



DARPA Phase II and Red Storm Project Revenue Accounting for Performance of Construction-Type and
Certain Production-Type Contracts.
 Services.
 Inventory Valuation
   16




---



##### Table of Contents



Goodwill
   Accounting for Income Taxes
 Accounting for
Income Taxes,
  Accounting for Loss Contracts
  Research and Development Expenses
   17




---



##### Table of Contents



Share-based Compensation
  Results of Operations
 Revenue and Gross Margins
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Product revenue
    
    $
    13,789
    
    
    $
    24,647
    
    
    $
    47,449
    
    
    $
    58,916Less: Cost of product revenue
    
    
    8,227
    
    
    
    18,099
    
    
    
    31,804
    
    
    
    44,776Product gross margin
    
    $
    5,562
    
    
    $
    6,548
    
    
    $
    15,645
    
    
    $
    14,140Product gross margin percentage
    
    
    40
    %
    
    
    27
    %
    
    
    33
    %
    
    
    24
    %Service revenue
    
    $
    12,836
    
    
    $
    13,866
    
    
    $
    26,285
    
    
    $
    28,112Less: Cost of service revenue
    
    
    7,660
    
    
    
    7,901
    
    
    
    15,658
    
    
    
    15,594Service gross margin
    
    $
    5,176
    
    
    $
    5,965
    
    
    $
    10,627
    
    
    $
    12,518Service gross margin percentage
    
    
    40
    %
    
    
    43
    %
    
    
    40
    %
    
    
    45
    %Total revenue
    
    $
    26,625
    
    
    $
    38,513
    
    
    $
    73,734
    
    
    $
    87,028Less: Total cost of revenue
    
    
    15,887
    
    
    
    26,000
    
    
    
    47,462
    
    
    
    60,370Total gross margin
    
    $
    10,738
    
    
    $
    12,513
    
    
    $
    26,272
    
    
    $
    26,658Total gross margin percentage
    
    
    40
    %
    
    
    33
    %
    
    
    36
    %
    
    
    31
    %
 18




---



##### Table of Contents



Service Revenue
   Product Gross Margin
   Service Gross Margin
  Research and Development Expenses
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Gross research and development expenses
    
    $
    21,652
    
    
    $
    26,135
    
    
    $
    44,183
    
    
    $
    52,208Less: Amounts included in cost of product revenue
    
    
    (195
    )
    
    
    (8,734
    )
    
    
    (465
    )
    
    
    (15,112
    )Less: Reimbursed research and development
(excludes amounts in revenue)
    
    
    (12,598
    )
    
    
    (11,030
    )
    
    
    (26,979
    )
    
    
    (23,510
    )Net research and development expenses
    
    $
    8,859
    
    
    $
    6,371
    
    
    $
    16,739
    
    
    $
    13,586Percentage of total revenue
    
    
    33
    %
    
    
    17
    %
    
    
    23
    %
    
    
    16
    %
 19




---



##### Table of Contents



Other Operating Expenses
  Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2007
    
    2006
    
    2007
    
    2006Sales and marketing
    
    $
    5,123
    
    
    $
    5,682
    
    
    $
    10,391
    
    
    $
    10,667Percentage of total revenue
    
    
    19
    %
    
    
    15
    %
    
    
    14
    %
    
    
    12
    %General and administrative
    
    $
    3,822
    
    
    $
    4,600
    
    
    $
    8,102
    
    
    $
    10,194Percentage of total revenue
    
    
    14
    %
    
    
    12
    %
    
    
    11
    %
    
    
    12
    %Restructuring and severance
    
    $
    
    
    
    $
    549
    
    
    $
    10
    
    
    $
    1,287Percentage of total revenue
    
    
    
    
    
    
    1
    %
    
    
    <1
    %
    
    
    1
    %
 Sales and Marketing .
 General and Administrative
 Restructuring and Severance .
 20




---



##### Table of Contents



Other Income (Expense), net
  Interest Income (Expense)
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Interest income
    
    $
    1,763
    
    
    $
    629
    
    
    $
    3,598
    
    
    $
    1,114Interest expense
    
    
    (797
    )
    
    
    (1,070
    )
    
    
    (1,599
    )
    
    
    (2,163
    )Net interest income (expense)
    
    $
    966
    
    
    $
    (441
    )
    
    $
    1,999
    
    
    $
    (1,049
    )
   Taxes
  Liquidity and Capital Resources
    21




---



##### Table of Contents



Item 3. Quantitative and Qualitative Disclosures About Market Risk
  22




---



##### Table of Contents



Interest Rate Risk
 Foreign Currency Risk 
 
 Item 4. Controls and Procedures
 Evaluation of disclosure controls and procedures.
 Changes in internal control over financial reporting.
 
 Item 4T. Controls and Procedures
  
 PART II. OTHER INFORMATION
 
 Item 1A. Risk Factors
  23




---



##### Table of Contents



Our operating results may fluctuate significantly and we may not achieve profitability
in any given period.
   
    
    successfully selling the Cray XT4 system, including upgrades and
successor systems, and new products based on our BlackWidow project and Cray
XMT system, and the timing and funding of government purchases, especially
in the United States;
    
    the level of revenue recognized in any given period, particularly with
very high average sales prices and limited number of system sales in any
quarter, the timing of product acceptances by customers and contractual
provisions affecting the timing and amount of revenue recognition;
    
    our expense levels, including research and development net of government
funding, which is affected by the level and timing of such funding;
    
    maintaining our product development projects on schedule and within
budgetary limitations;
    
    the level of product margin contribution in any given period due to
product mix, strategic transactions, product life cycle and component costs;
    
    the level and timing of maintenance contract renewals with existing
customers;
    
    revenue delays or losses due to customers postponing purchases to wait
for future upgraded or new systems, delays in delivery of upgraded or new
systems and longer than expected customer acceptance cycles;
    
    the terms and conditions of sale or lease for our products; 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;
    
    the timing and level of government funding for product acquisitions and
research and development contracts;
    
    the availability of adequate customer facilities to install and operate new Cray systems;
    
    general economic trends, including changes in levels of customer capital spending;
 24




---



##### Table of Contents




    
    the introduction or announcement of competitive products;
    
    currency fluctuations, international conflicts or economic crises; and
    
    the receipt and timing of necessary export licenses.
  Failure to sell Cray XT4 systems in planned quantities and at expected gross margins
could adversely affect revenue and operating results in 2007 and future periods.
  Our inability to complete the development of our BlackWidow and Cray XMT supercomputer
systems has adversely affected our revenue and operating results in 2007 and may affect our
operating results in future periods.
 Our reliance on third-party suppliers poses significant risks to our business and
prospects.
 25




---



##### Table of Contents




    
    if a supplier does not provide components that meet our specifications in
sufficient quantities on time, then production and sales of our systems
would be delayed, adversely affecting revenue and cash flow  these risks
are accentuated during steep production ramp periods as we introduce new or
successor products;
    
    if an interruption of supply of our components occurs, because of a
significant problem with a supplier providing parts that later prove to be
defective or because a single-source supplier imposes allocations on its
customers, decides to no longer provide those components to us or increases
the price of those parts significantly, 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. In some cases, we may not be able to redesign such components.
Defective components may need to be replaced, which may result in increased
costs and obsolete inventory. See also the Risk Factor captioned, Last-time
buy decisions affecting our products may adversely affect our revenue and
operating results, below;
    
    if a supplier provides us with software or other intellectual property
that contains bugs or other errors or is different from what we expected,
our development projects may be adversely affected through additional design
testing and verification efforts and respins of integrated circuits;
    
    if a supplier providing us with key research and development services
with respect to integrated circuit design, network communication
capabilities or internal software is late, fails to provide us with
effective designs or products or loses key internal talent, our development
programs may be delayed or prove to be not possible to complete;
    
    if a supplier cannot provide a competitive key component, our systems may
be less competitive than systems using components with greater capability;
    
    some of our key component and service 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; and
    
    if a supplier is acquired or has a significant business change,
production and sales of our systems may be delayed or our development
programs may be delayed or may not be possible to complete.
   If we lose government support for development of our supercomputer systems, our net
research and development expenditures and capital requirements would increase and our
ability to conduct research and development would decrease.
 26




---



##### Table of Contents



Failure to overcome the technical challenges of completing the development of our
supercomputer systems on our product roadmap would adversely affect our revenue and
operating results in subsequent years.
 If the U.S. government purchases fewer supercomputers, our revenue would be reduced and
our operating results would be adversely affected.
 27




---



##### Table of Contents



The achievement of our business plan is highly dependent on increased product revenue
and margins.
 Last-time buy decisions affecting our products may adversely affect our revenue and
operating results.
 If we are unable to compete successfully in the HPC market, our revenue will decline.
  28




---



##### Table of Contents



If we cannot retain, attract and motivate key personnel, we may be unable to
effectively implement our business plan.
 Lower than anticipated sales of new supercomputers and the termination of maintenance
contracts on older and/or decommissioned systems may reduce our service revenue and margins
from maintenance service contracts.
 Expansion of our Technical Services efforts could reduce our service margins.
 Our stock price is volatile.
 The adoption of FAS 123R has and will continue to adversely affect our operating
results and may adversely affect the market price of our common stock.
 29




---



##### Table of Contents



We may infringe or be subject to claims that we infringe the intellectual property
rights of others.
 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 are required to evaluate our internal control over financial reporting under Section
404 of the Sarbanes-Oxley Act of 2002 at the end of each fiscal year, 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.
 Our indebtedness may adversely affect our financial strength.
 30




---



##### Table of Contents




    
    increase our vulnerability to general economic and industry conditions,
including recessions;
    
    require us to use cash from operations to service our indebtedness,
thereby reducing our ability to fund working capital, capital expenditures,
research and development efforts and other expenses;
    
    limit our flexibility in planning for, or reacting to, changes in our
business, including merger and acquisition opportunities;
    
    place us at a competitive disadvantage compared to competitors that have
less indebtedness; and
    
    limit our ability to borrow additional funds that may be needed to
operate and expand our business.
 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.
 We will require a significant amount of cash to repay our indebtedness and to fund
planned capital expenditures, research and development efforts and other corporate expenses.
 New environmental rules in Europe and other jurisdictions may adversely affect our
operations.
 31




---



##### Table of Contents



We may not be able to protect our proprietary information and rights adequately.
 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.
 
    
    32,547,950 shares of common stock;
    
    1,284,852 shares of common stock issuable upon exercise of warrants;
    
    3,604,846 shares of common stock issuable upon exercise of options, of
which options to purchase 2,884,535 shares of common stock were then
exercisable; and
    
    Notes convertible into an aggregate of 4,144,008 shares of common stock
or, under certain circumstances specified in the indenture governing the
Notes, a maximum of 5,698,006 shares of common stock.
  32




---



##### Table of Contents



Provisions of our Restated Articles of Incorporation and Bylaws could make a proposed
acquisition that is not approved by our Board of Directors more difficult.
 
    
    removal of a director only in limited circumstances and only upon the
affirmative vote of not less than two-thirds of the shares entitled to vote
to elect directors;
    
    the ability of our board of directors to issue preferred stock, without
shareholder approval, with rights senior to those of the common stock;
    
    no cumulative voting of shares;
    
    the right of shareholders to call a special meeting of the shareholders
only upon demand by the holders of not less than 30% of the shares entitled
to vote at such a meeting;
    
    the affirmative vote of not less than two-thirds of the outstanding
            shares entitled to vote on an amendment, unless the amendment was approved
by a majority of our continuing directors, who are defined as directors who
have either served as a director since August 31, 1995, or were nominated to
be a director by the continuing directors;
    
    special voting requirements for mergers and other business combinations,
unless the proposed transaction was approved by a majority of continuing
directors;
    
    special procedures to bring matters before our shareholders at our annual
shareholders meeting; and
    
    special procedures to nominate members for election to our board of
directors.
  
 Item 4. Submission of Matters to a Vote of Security Holders
  Name
    
    Votes For
    
    % For
    
    Withheld
    
    % WithheldWilliam C. Blake
    
    
    29,743,386
    
    
    
    98.51
    %
    
    
    448,680
    
    
    
    1.49
    %John B. Jones, Jr.
    
    
    29,452,404
    
    
    
    97.55
    %
    
    
    739,662
    
    
    
    2.45
    %Stephen C. Kiely
    
    
    29,450,280
    
    
    
    97.54
    %
    
    
    741,786
    
    
    
    2.46
    %Frank L. Lederman
    
    
    29,196,509
    
    
    
    96.70
    %
    
    
    995,557
    
    
    
    3.30
    %Sally G. Narodick
    
    
    28,476,917
    
    
    
    94.32
    %
    
    
    1,715,149
    
    
    
    5.68
    %Daniel C. Regis
    
    
    28,736,982
    
    
    
    95.18
    %
    
    
    1,455,084
    
    
    
    4.82
    %Stephen C. Richards
    
    
    28,795,658
    
    
    
    95.37
    %
    
    
    1,396,408
    
    
    
    4.63
    %Peter J. Ungaro
    
    
    29,730,679
    
    
    
    98.47
    %
    
    
    461,387
    
    
    
    1.53
    %
 33




---



##### Table of Contents



Item 6. Exhibits
 10.1
    
    Amendment No. 2, dated as of March 30, 2007, to the Technology Agreement, dated
March 31, 2000 between Silicon Graphics, Inc. and the Company31.1
    
    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 200231.2
    
    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
 
 Items 1, 2, 3 and 5 of Part II are not applicable and have been omitted.
 34




---



##### Table of Contents



SIGNATURES
  CRAY INC.August 7, 2007
    
    /s/ PETER J. UNGARO

Peter J. UngaroChief Executive Officer and President/s/ BRIAN C. HENRYBrian C. HenryChief Financial Officer/s/ KENNETH D. ROSELLIKenneth D. RoselliChief Accounting Officer
 35