##### 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 September 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 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 September 30, 2007 and December 31, 2006
    
    
    2Statements of Operations for the Three Months and Nine Months Ended September 30, 2007
and 2006
    
    
    3Statements of Cash Flows for the Nine Months Ended September 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 INFORMATIONItem 1A. Risk Factors
23Item 6. Exhibits
33SIGNATURES
    
    
    
    
    34EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1
  Available Information




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1.
    
    Unaudited Condensed Consolidated Financial Statements
  
 
 September 30,
    
    
    December 31,2007
    
    
    2006ASSETSCurrent assets:Cash and cash equivalents
    
    $
    73,823
    
    
    $
    115,328Restricted cash
    
    
    25,000
    
    
    
    25,000Short-term investments, available-for-sale
    
    
    40,836
    
    
    
    Accounts receivable, net
    
    
    48,733
    
    
    
    44,790Inventory
    
    
    72,338
    
    
    
    58,798Prepaid expenses and other current assets
    
    
    4,228
    
    
    
    2,156Total current assets
    
    
    264,958
    
    
    
    246,072Property and equipment, net
    
    
    18,769
    
    
    
    21,564Service inventory, net
    
    
    3,281
    
    
    
    4,292Goodwill
    
    
    64,821
    
    
    
    57,138Deferred tax asset
    
    
    794
    
    
    
    722Intangible assets, net
    
    
    1,241
    
    
    
    1,404Other non-current assets
    
    
    5,949
    
    
    
    6,311TOTAL ASSETS
    
    $
    359,813
    
    
    $
    337,503LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    31,621
    
    
    $
    22,450Accrued payroll and related expenses
    
    
    10,878
    
    
    
    17,411Advance research and development payments
    
    
    12,401
    
    
    
    21,518Other accrued liabilities
    
    
    11,663
    
    
    
    5,121Deferred revenue
    
    
    49,592
    
    
    
    43,248Total current liabilities
    
    
    116,155
    
    
    
    109,748Long-term deferred revenue
    
    
    11,117
    
    
    
    2,475Other non-current liabilities
    
    
    3,668
    
    
    
    3,906Convertible notes payable
    
    
    80,000
    
    
    
    80,000TOTAL LIABILITIES
    
    
    210,940
    
    
    
    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,
32,589,844 and 32,236,888 shares,
respectively
    
    
    512,271
    
    
    
    507,356Accumulated other comprehensive income
    
    
    11,563
    
    
    
    6,855Accumulated deficit
    
    
    (374,961
    )
    
    
    (372,837
    )TOTAL SHAREHOLDERS EQUITY
    
    
    148,873
    
    
    
    141,374TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    359,813
    
    
    $
    337,503
 See accompanying notes
 2




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Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Revenue:Product
    
    $
    42,742
    
    
    $
    19,074
    
    
    $
    90,191
    
    
    $
    77,990Service
    
    
    12,247
    
    
    
    13,491
    
    
    
    38,532
    
    
    
    41,603Total revenue
    
    
    54,989
    
    
    
    32,565
    
    
    
    128,723
    
    
    
    119,593Cost of revenue:Cost of product revenue
    
    
    25,618
    
    
    
    13,927
    
    
    
    57,422
    
    
    
    58,703Cost of service revenue
    
    
    7,222
    
    
    
    7,242
    
    
    
    22,880
    
    
    
    22,836Total cost of revenue
    
    
    32,840
    
    
    
    21,169
    
    
    
    80,302
    
    
    
    81,539Gross margin
    
    
    22,149
    
    
    
    11,396
    
    
    
    48,421
    
    
    
    38,054Operating expenses:Research and development, net
    
    
    9,067
    
    
    
    9,692
    
    
    
    25,806
    
    
    
    23,278Sales and marketing
    
    
    5,423
    
    
    
    4,924
    
    
    
    15,814
    
    
    
    15,591General and administrative
    
    
    3,340
    
    
    
    4,134
    
    
    
    11,442
    
    
    
    14,328Restructuring and severance
    
    
    
    
    
    
    3
    
    
    
    10
    
    
    
    1,290Total operating expenses
    
    
    17,830
    
    
    
    18,753
    
    
    
    53,072
    
    
    
    54,487Income (loss) from operations
    
    
    4,319
    
    
    
    (7,357
    )
    
    
    (4,651
    )
    
    
    (16,433
    )Other income (expense), net
    
    
    294
    
    
    
    (92
    )
    
    
    765
    
    
    
    (1,964
    )Interest income (expense), net
    
    
    716
    
    
    
    (608
    )
    
    
    2,715
    
    
    
    (1,657
    )Income (loss) before income taxes
    
    
    5,329
    
    
    
    (8,057
    )
    
    
    (1,171
    )
    
    
    (20,054
    )Provision for income taxes
    
    
    228
    
    
    
    267
    
    
    
    953
    
    
    
    748Net income (loss)
    
    $
    5,101
    
    
    $
    (8,324
    )
    
    $
    (2,124
    )
    
    $
    (20,802
    )Earnings (loss) per share:Basic
    
    $
    0.16
    
    
    $
    (0.37
    )
    
    $
    (0.07
    )
    
    $
    (0.93
    )Diluted
    
    $
    0.16
    
    
    $
    (0.37
    )
    
    $
    (0.07
    )
    
    $
    (0.93
    )Weighted average shares outstanding:Basic
    
    
    32,191
    
    
    
    22,634
    
    
    
    31,774
    
    
    
    22,475Diluted
    
    
    32,346
    
    
    
    22,634
    
    
    
    31,774
    
    
    
    22,475
 See accompanying notes
 3




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##### Table of Contents



Nine Months EndedSeptember 30,2007
    
    
    2006Operating activities:Net loss
    
    $
    (2,124
    )
    
    $
    (20,802
    )Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization
    
    
    9,542
    
    
    
    12,615Share-based compensation cost
    
    
    2,574
    
    
    
    1,539Inventory write-down
    
    
    422
    
    
    
    806Amortization of issuance costs, convertible notes payable and line of credit
    
    
    516
    
    
    
    1,017Deferred income taxes
    
    
    (72
    )
    
    
    (121
    )Changes in operating assets and liabilities:Accounts receivable
    
    
    (4,935
    )
    
    
    9,074Inventory
    
    
    (17,625
    )
    
    
    (25,309
    )Prepaid expenses and other current assets
    
    
    (2,238
    )
    
    
    (981
    )Other non-current assets
    
    
    (166
    )
    
    
    (555
    )Accounts payable
    
    
    8,435
    
    
    
    4,163Accrued payroll and related expenses and other accrued liabilities
    
    
    80
    
    
    
    834Advance research and development payments
    
    
    (9,117
    )
    
    
    2,283Other non-current liabilities
    
    
    (257
    )
    
    
    34Deferred revenue
    
    
    13,783
    
    
    
    13,202Net cash used in operating activities
    
    
    (1,182
    )
    
    
    (2,201
    )Investing activities:Sales/maturities of short-term investments
    
    
    27,894
    
    
    
    Purchases of short-term investments
    
    
    (68,113
    )
    
    
    Proceeds from sale of investment
    
    
    
    
    
    
    239Purchases of property and equipment
    
    
    (2,068
    )
    
    
    (2,301
    )Net cash used in investing activities
    
    
    (42,287
    )
    
    
    (2,062
    )Financing activities:Proceeds from issuance of common stock through employee stock purchase plan
    
    
    358
    
    
    
    424Proceeds from exercise of options
    
    
    1,271
    
    
    
    2,381Line of credit issuance costs
    
    
    
    
    
    
    (375
    )Principal payments on capital leases
    
    
    (31
    )
    
    
    (91
    )Net cash provided by financing activities
    
    
    1,598
    
    
    
    2,339Effect of foreign exchange rate changes on cash and cash equivalents
    
    
    366
    
    
    
    62Net decrease in cash and cash equivalents
    
    
    (41,505
    )
    
    
    (1,862
    )Cash and cash equivalentsBeginning of period
    
    
    115,328
    
    
    
    46,026End of period
    
    $
    73,823
    
    
    $
    44,164Supplemental disclosure of cash flow information:Cash paid for interest
    
    $
    1,207
    
    
    $
    1,977Non-cash investing and financing activities:Inventory transfers to fixed assets and service inventory
    
    $
    3,663
    
    
    $
    2,990Stock issued for 401(k) match
    
    $
    712
    
    
    $
    396
 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
 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 Income (Loss)
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    

September
30,2007
    
    
    2006
    
    
    2007
    
    
    2006Net income (loss)
    
    $
    5,101
    
    
    $
    (8,324
    )
    
    $
    (2,124
    )
    
    $
    (20,802
    )Unrealized gain (loss) on available-for-sale investments
    
    
    39
    
    
    
    
    
    
    
    (8
    )
    
    
    Cash flow hedges:Net derivative gains (losses)
    
    
    (2,197
    )
    
    
    105
    
    
    
    (3,967
    )
    
    
    105Reclassification adjustment to revenue
    
    
    1,029
    
    
    
    
    
    
    
    1,029
    
    
    
    (1,168
    )
    
    
    105
    
    
    
    (2,938
    )
    
    
    105Foreign currency translation adjustment
    
    
    3,301
    
    
    
    430
    
    
    
    7,654
    
    
    
    2,590Comprehensive income (loss)
    
    $
    7,273
    
    
    $
    (7,789
    )
    
    $
    2,584
    
    
    $
    (18,107
    )
 6




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##### Table of Contents



Note 6  Accounts Receivable
  September 30,
    
    
    December 31,2007
    
    
    2006Trade accounts receivable
    
    $
    24,262
    
    
    $
    39,417Unbilled receivables
    
    
    4,138
    
    
    
    4,045Other receivables
    
    
    4,709
    
    
    
    349Advance billings
    
    
    15,957
    
    
    
    1,07849,066
    
    
    
    44,889Allowance for doubtful accounts
    
    
    (333
    )
    
    
    (99
    )Accounts receivable, net
    
    $
    48,733
    
    
    $
    44,790
   Note 7  Inventory
  September 30,
    
    
    December 31,2007
    
    
    2006Components and subassemblies
    
    $
    24,646
    
    
    $
    22,536Work in process
    
    
    17,314
    
    
    
    15,310Finished goods
    
    
    30,378
    
    
    
    20,952Total
    
    $
    72,338
    
    
    $
    58,798
   Note 8  Deferred Revenue
  September 30,
    
    
    December 31,2007
    
    
    2006Deferred product revenue
    
    $
    32,349
    
    
    $
    26,993Deferred service revenue
    
    
    28,360
    
    
    
    18,730Total deferred revenue
    
    
    60,709
    
    
    
    45,723Less long-term deferred revenue
    
    
    (11,117
    )
    
    
    (2,475
    )Deferred revenue in current liabilities
    
    $
    49,592
    
    
    $
    43,248
 7




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Note 9  Restructuring and Severance Charges
   Nine Months EndedSeptember 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
    
    
    
    2,795Payments
    
    
    (161
    )
    
    
    (1,496
    )Adjustments to previously accrued amounts
    
    
    
    
    
    
    (99
    )Current period charges
    
    
    
    
    
    
    102Foreign currency translation adjustment
    
    
    5
    
    
    
    11Total liability balance, September 30
    
    
    519
    
    
    
    1,313Less long-term restructuring and severance liability
    
    
    
    
    
    
    (91
    )Current restructuring and severance liability
    
    $
    519
    
    
    $
    1,222
 Note 10  Share-Based Compensation
 Share-Based Payment
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2007
    
    2006
    
    2007
    
    2006Risk-free interest rate
    
    
    4.4
    %
    
    
    
    
    
    
    4.5
    %
    
    
    4.6
    %Expected dividend yield
    
    
    0
    %
    
    
    
    
    
    
    0
    %
    
    
    0
    %Volatility
    
    
    72
    %
    
    
    
    
    
    
    73
    %
    
    
    64
    %Expected life
    
    4.0 years
    
    
    
    
    
    4.0 years
    
    4.3 yearsWeighted averageBlack-Scholes value of options granted
    
    $
    4.13
    
    
    
    
    
    
    $
    5.42
    
    
    $
    4.43
  8




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Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Cost of product revenue
    
    $
    14
    
    
    $
    15
    
    
    $
    69
    
    
    $
    44Cost of service revenue
    
    
    22
    
    
    
    
    
    
    
    109
    
    
    
    Research and development, net
    
    
    185
    
    
    
    101
    
    
    
    829
    
    
    
    287Sales and marketing
    
    
    87
    
    
    
    106
    
    
    
    360
    
    
    
    317General and administrative
    
    
    294
    
    
    
    318
    
    
    
    1,207
    
    
    
    891Total
    
    $
    602
    
    
    $
    540
    
    
    $
    2,574
    
    
    $
    1,539
  WeightedWeighted
    
    AverageAverage
    
    Remaining
    
    AggregateExercise
    
    Contractual
    
    IntrinsicOptions
    
    Price
    
    Term
    
    ValueOutstanding at December 31, 2006
    
    
    3,867,415
    
    
    $
    14.68Grants
    
    
    40,000
    
    
    
    9.25Exercises
    
    
    (162,814
    )
    
    
    7.81Cancellations
    
    
    (187,869
    )
    
    
    20.05Outstanding at September 30, 2007
    
    
    3,556,732
    
    
    $
    14.65
    
    
    6.1 years
    
    $
    1,031,000Exercisable at September 30, 2007
    
    
    2,829,152
    
    
    $
    15.74
    
    
    5.3 years
    
    $
    1,025,000Available for grant at September 30, 2007
    
    
    2,406,000
    9




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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
    
    
    Total2007
    
    
    2006
    
    
    2007
    
    
    2006
    
    
    2007
    
    
    2006Three months ended September 30,Product revenue
    
    $
    6,086
    
    
    $
    13,735
    
    
    $
    36,656
    
    
    $
    5,339
    
    
    $
    42,742
    
    
    $
    19,074Service revenue
    
    
    7,421
    
    
    
    9,411
    
    
    
    4,826
    
    
    
    4,080
    
    
    
    12,247
    
    
    
    13,491Total revenue
    
    $
    13,507
    
    
    $
    23,146
    
    
    $
    41,482
    
    
    $
    9,419
    
    
    $
    54,989
    
    
    $
    32,565
 2007
    
    
    2006
    
    
    2007
    
    
    2006
    
    
    2007
    
    
    2006Nine months ended September 30,Product revenue
    
    $
    40,626
    
    
    $
    59,008
    
    
    $
    49,565
    
    
    $
    18,982
    
    
    $
    90,191
    
    
    $
    77,990Service revenue
    
    
    23,849
    
    
    
    29,846
    
    
    
    14,683
    
    
    
    11,757
    
    
    
    38,532
    
    
    
    41,603Total revenue
    
    $
    64,475
    
    
    $
    88,854
    
    
    $
    64,248
    
    
    $
    30,739
    
    
    $
    128,723
    
    
    $
    119,593
 10




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Note 13  Foreign Currency Derivatives
   Note 14  Red Storm Project Loss Accrual
  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
   Summary of First Nine Months of 2007 Results
    12




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




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




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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.
 DARPA Phase II and Red Storm Project Revenue
 15




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Accounting for Performance of Construction-Type and Certain Production-Type Contracts.
 Services.
 Inventory Valuation
   16




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




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Share-based Compensation
  Results of Operations
 Revenue and Gross Margins
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Product revenue
    
    $
    42,742
    
    
    $
    19,074
    
    
    $
    90,191
    
    
    $
    77,990Less: Cost of product revenue
    
    
    25,618
    
    
    
    13,927
    
    
    
    57,422
    
    
    
    58,703Product gross margin
    
    $
    17,124
    
    
    $
    5,147
    
    
    $
    32,769
    
    
    $
    19,287Product gross margin percentage
    
    
    40
    %
    
    
    27
    %
    
    
    36
    %
    
    
    25
    %Service revenue
    
    $
    12,247
    
    
    $
    13,491
    
    
    $
    38,532
    
    
    $
    41,603Less: Cost of service revenue
    
    
    7,222
    
    
    
    7,242
    
    
    
    22,880
    
    
    
    22,836Service gross margin
    
    $
    5,025
    
    
    $
    6,249
    
    
    $
    15,652
    
    
    $
    18,767Service gross margin percentage
    
    
    41
    %
    
    
    46
    %
    
    
    41
    %
    
    
    45
    %Total revenue
    
    $
    54,989
    
    
    $
    32,565
    
    
    $
    128,723
    
    
    $
    119,593Less: Total cost of revenue
    
    
    32,840
    
    
    
    21,169
    
    
    
    80,302
    
    
    
    81,539Total gross margin
    
    $
    22,149
    
    
    $
    11,396
    
    
    $
    48,421
    
    
    $
    38,054Total gross margin percentage
    
    
    40
    %
    
    
    35
    %
    
    
    38
    %
    
    
    32
    %
  18




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##### Table of Contents



Service Revenue
   Product Gross Margin
   Service Gross Margin
  Research and Development Expenses
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Gross research and development expenses
    
    $
    23,730
    
    
    $
    24,095
    
    
    $
    67,913
    
    
    $
    76,303Less: Amounts included in cost of product revenue
    
    
    (176
    )
    
    
    (1,546
    )
    
    
    (641
    )
    
    
    (16,658
    )Less: Reimbursed research and development
(excludes amounts in revenue)
    
    
    (14,487
    )
    
    
    (12,857
    )
    
    
    (41,466
    )
    
    
    (36,367
    )Net research and development expenses
    
    $
    9,067
    
    
    $
    9,692
    
    
    $
    25,806
    
    
    $
    23,278Percentage of total revenue
    
    
    16
    %
    
    
    30
    %
    
    
    20
    %
    
    
    19
    %
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##### Table of Contents



Other Operating Expenses
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2007
    
    2006
    
    2007
    
    2006Sales and marketing
    
    $
    5,423
    
    
    $
    4,924
    
    
    $
    15,814
    
    
    $
    15,591Percentage of total revenue
    
    
    10
    %
    
    
    15
    %
    
    
    12
    %
    
    
    13
    %General and administrative
    
    $
    3,340
    
    
    $
    4,134
    
    
    $
    11,442
    
    
    $
    14,328Percentage of total revenue
    
    
    6
    %
    
    
    13
    %
    
    
    9
    %
    
    
    12
    %Restructuring and severance
    
    $
    
    
    
    $
    3
    
    
    $
    10
    
    
    $
    1,290Percentage of total revenue
    
    
    
    
    
    
    <1
    %
    
    
    <1
    %
    
    
    1
    %
 Sales and Marketing .
 General and Administrative
 Restructuring and Severance .
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##### Table of Contents



Other Income (Expense), net
  Interest Income (Expense)
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Interest income
    
    $
    1,520
    
    
    $
    460
    
    
    $
    5,118
    
    
    $
    1,574Interest expense
    
    
    (804
    )
    
    
    (1,068
    )
    
    
    (2,403
    )
    
    
    (3,231
    )Net interest income (expense)
    
    $
    716
    
    
    $
    (608
    )
    
    $
    2,715
    
    
    $
    (1,657
    )
   Taxes
  Liquidity and Capital Resources
    21




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##### Table of Contents



Item 3. Quantitative and Qualitative Disclosures About Market Risk
  22




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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
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##### 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;
    
    the introduction or announcement of competitive products;
    
    currency fluctuations, international conflicts or economic crises; and
    
    the receipt and timing of necessary export licenses.
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Our reliance on third-party suppliers poses significant risks to our business and prospects.
 
    
    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 key 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 government support for development of our supercomputer systems is reduced or lost, our net
research and development expenditures and capital requirements would increase and our ability to
conduct research and development would decrease.
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##### 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.
 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.
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##### Table of Contents



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.
 If the U.S. government purchases fewer supercomputers, our revenue would be reduced and our
operating results would be adversely affected.
 If we cannot retain, attract and motivate key personnel, we may be unable to effectively
implement our business plan.
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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.
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##### Table of Contents



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.
 We may infringe or be subject to claims that we infringe the intellectual property rights of
others.
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##### Table of Contents



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.
  Our indebtedness may adversely affect our financial strength.
 
    
    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 investing in significant research and development projects with
long paybacks, as well as 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.
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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.
 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.
 New environmental rules in Europe and other jurisdictions may adversely affect our operations.
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##### Table of Contents



U.S. export controls could hinder our ability to make sales to foreign customers and our
future prospects.
 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.
 
    
    32,589,844 shares of common stock;
    
    1,284,852 shares of common stock issuable upon exercise of warrants;
    
    3,556,732 shares of common stock issuable upon exercise of options, of which options to
purchase 2,829,152 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.
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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 6. Exhibits
 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 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, 4 and 5 of Part II are not applicable and have been omitted.
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SIGNATURES
  CRAY INC.November 7, 2007
    /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 34