##### 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, 2008
 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
    
    93-0962605Incorporation or Organization)
    
    (I.R.S. Employer Identification No.)
 411 First Avenue South, Suite 600Seattle, Washington
    
    98104-2860(Address of Principal Executive Office)
    
    (Zip Code)
 Registrants Telephone Number, Including Area Code:
(206) 701-2000
 þ o
  Large accelerated filer  o
    
    Accelerated filer  þ
    
    Non-accelerated filer  o
    
    Smaller reporting company  o(Do not check if a smaller reporting company)
 o þ




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##### 



CRAY INC.
 TABLE OF CONTENTS
  
 Page No.PART I. FINANCIAL INFORMATION
    
    
    3Item 1. Unaudited Condensed Consolidated Financial Statements:
    
    
    3Balance Sheets as of September 30, 2008 and December 31, 2007
    
    
    3Statements of Operations for the Three Months and Nine Months Ended September 30,
2008 and 2007
    
    
    4Statements of Cash Flows for the Nine Months Ended September 30, 2008 and 2007
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    14Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    26Item 4. Controls and Procedures
    
    
    27Item 4T. Controls and Procedures
    
    
    27PART II. OTHER INFORMATION
    
    
    28Item1A. Risk Factors
    
    
    28Item 6. Exhibits
    
    
    37SIGNATURES
    
    
    38EX-31.1EX-31.2EX-32.1
  Available Information
  h
 2




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1. Unaudited Condensed Consolidated Financial Statements
  
 
 September 30,
    
    
    December 31,2008
    
    
    2007ASSETSCurrent assets:Cash and cash equivalents
    
    $
    89,458
    
    
    $
    120,539Restricted cash
    
    
    1,398
    
    
    
    10,000Short-term investments, available-for-sale
    
    
    12,698
    
    
    
    48,582Accounts receivable, net
    
    
    49,086
    
    
    
    23,635Inventory
    
    
    152,596
    
    
    
    55,608Prepaid expenses and other current assets
    
    
    9,063
    
    
    
    4,120Prepaid research and development services
    
    
    4,633
    
    
    
    Total current assets
    
    
    318,932
    
    
    
    262,484Property and equipment, net
    
    
    15,065
    
    
    
    17,044Service inventory, net
    
    
    2,161
    
    
    
    2,986Goodwill
    
    
    62,518
    
    
    
    65,411Deferred tax asset
    
    
    863
    
    
    
    512Other non-current assets
    
    
    6,547
    
    
    
    7,465TOTAL ASSETS
    
    $
    406,086
    
    
    $
    355,902LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    33,399
    
    
    $
    14,148Accrued payroll and related expenses
    
    
    12,088
    
    
    
    12,023Advance research and development payments
    
    
    1,517
    
    
    
    29,669Short-term
convertible notes
    
    
    40,200Other accrued liabilities
    
    
    6,623
    
    
    
    7,488Deferred revenue
    
    
    94,599
    
    
    
    48,317Total current liabilities
    
    
    188,426
    
    
    
    111,645Long-term deferred revenue
    
    
    31,794
    
    
    
    11,745Other non-current liabilities
    
    
    4,391
    
    
    
    4,310Convertible notes
    
    
    39,800
    
    
    
    80,000TOTAL LIABILITIES
    
    
    264,411
    
    
    
    207,700Commitments 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
33,422,892 and 32,638,415 shares,
respectively
    
    
    517,474
    
    
    
    513,196Accumulated other comprehensive income
    
    
    13,411
    
    
    
    13,562Accumulated deficit
    
    
    (389,210
    )
    
    
    (378,556
    )TOTAL SHAREHOLDERS EQUITY
    
    
    141,675
    
    
    
    148,202TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    406,086
    
    
    $
    355,902
 See accompanying notes
 3




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##### Table of Contents



Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Revenue:Product
    
    $
    38,065
    
    
    $
    42,742
    
    
    $
    81,606
    
    
    $
    90,191Service
    
    
    16,528
    
    
    
    12,247
    
    
    
    45,848
    
    
    
    38,532Total revenue
    
    
    54,593
    
    
    
    54,989
    
    
    
    127,454
    
    
    
    128,723Cost of revenue:Cost of product revenue
    
    
    17,266
    
    
    
    25,618
    
    
    
    45,681
    
    
    
    57,422Cost of service revenue
    
    
    9,362
    
    
    
    7,222
    
    
    
    26,962
    
    
    
    22,880Total cost of revenue
    
    
    26,628
    
    
    
    32,840
    
    
    
    72,643
    
    
    
    80,302Gross margin
    
    
    27,965
    
    
    
    22,149
    
    
    
    54,811
    
    
    
    48,421Operating expenses:Research and development, net
    
    
    12,364
    
    
    
    9,067
    
    
    
    37,973
    
    
    
    25,806Sales and marketing
    
    
    6,135
    
    
    
    5,423
    
    
    
    17,365
    
    
    
    15,814General and administrative
    
    
    3,775
    
    
    
    3,340
    
    
    
    10,936
    
    
    
    11,442Restructuring and severance
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10Total operating expenses
    
    
    22,274
    
    
    
    17,830
    
    
    
    66,274
    
    
    
    53,072Income (loss) from operations
    
    
    5,691
    
    
    
    4,319
    
    
    
    (11,463
    )
    
    
    (4,651
    )Other income (expense), net
    
    
    (432
    )
    
    
    294
    
    
    
    361
    
    
    
    765Interest income (expense), net
    
    
    (341
    )
    
    
    716
    
    
    
    750
    
    
    
    2,715Income (loss) before income taxes
    
    
    4,918
    
    
    
    5,329
    
    
    
    (10,352
    )
    
    
    (1,171
    )Income tax benefit (expense)
    
    
    87
    
    
    
    (228
    )
    
    
    (302
    )
    
    
    (953
    )Net income (loss)
    
    $
    5,005
    
    
    $
    5,101
    
    
    $
    (10,654
    )
    
    $
    (2,124
    )Basic and diluted net income (loss) per common share
    
    $
    0.15
    
    
    $
    0.16
    
    
    $
    (0.33
    )
    
    $
    (0.07
    )Basic weighted average shares outstanding
    
    
    32,628
    
    
    
    32,191
    
    
    
    32,507
    
    
    
    31,744Diluted weighted average shares outstanding
    
    
    32,661
    
    
    
    32,346
    
    
    
    32,507
    
    
    
    31,744
 See accompanying notes
 4




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##### Table of Contents



Nine Months EndedSeptember 30,2008
    
    
    2007Operating activities:Net loss
    
    $
    (10,654
    )
    
    $
    (2,124
    )Adjustments to reconcile net loss to net cash used in operating
activities:Depreciation and amortization
    
    
    8,058
    
    
    
    9,542Share-based compensation cost
    
    
    2,443
    
    
    
    2,574Inventory write-down
    
    
    730
    
    
    
    422Amortization of issuance costs on convertible notes payable
    
    
    520
    
    
    
    516Deferred income taxes
    
    
    (351
    )
    
    
    (72
    )Changes in operating assets and liabilities:Accounts receivable
    
    
    (25,772
    )
    
    
    (4,935
    )Inventory
    
    
    (100,000
    )
    
    
    (17,625
    )Prepaid expenses and other current assets
    
    
    (7,280
    )
    
    
    (2,238
    )Other non-current assets
    
    
    255
    
    
    
    (166
    )Accounts payable
    
    
    19,128
    
    
    
    8,435Accrued payroll and related expenses and other accrued
liabilities
    
    
    2,448
    
    
    
    80Advance research and development payments
    
    
    (28,152
    )
    
    
    (9,117
    )Other non-current liabilities
    
    
    81
    
    
    
    (257
    )Deferred revenue
    
    
    65,906
    
    
    
    13,783Net cash used in operating activities
    
    
    (72,640
    )
    
    
    (1,182
    )Investing activities:Sales/maturities of short-term investments
    
    
    37,601
    
    
    
    27,894Purchases of short-term investments
    
    
    (1,673
    )
    
    
    (68,113
    )Decrease in restricted cash
    
    
    8,602
    
    
    
    Purchases of property and equipment
    
    
    (2,797
    )
    
    
    (2,068
    )Net cash provided by (used in) investing activities
    
    
    41,733
    
    
    
    (42,287
    )Financing activities:Proceeds from issuance of common stock through employee stock
purchase plan
    
    
    354
    
    
    
    358Proceeds from exercise of options
    
    
    51
    
    
    
    1,271Principal payments on capital leases
    
    
    
    
    
    
    (31
    )Net cash provided by financing activities
    
    
    405
    
    
    
    1,598Effect of foreign exchange rate changes on cash and cash
equivalents
    
    
    (579
    )
    
    
    366Net decrease in cash and cash equivalents
    
    
    (31,081
    )
    
    
    (41,505
    )Cash and cash equivalentsBeginning of period
    
    
    120,539
    
    
    
    115,328End of period
    
    $
    89,458
    
    
    $
    73,823Supplemental disclosure of cash flow information:Cash paid for interest
    
    $
    1,202
    
    
    $
    1,207Non-cash investing and financing activities:Inventory transfers to fixed assets and service inventory
    
    $
    2,282
    
    
    $
    3,663Stock issued for 401(k) match
    
    $
    1,430
    
    
    $
    712
 See accompanying notes
 5




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##### Table of Contents



Note 1  Basis of Presentation
     Principles of Consolidation
  Reclassifications
  6




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##### Table of Contents



Use of Estimates
  Note 2  Summary of New Accounting Policies
 Prepaid Research and Development Services
 Accounting for Nonrefundable Advance Payments for Goods or Services to be Used in Future Research
and Development Activities
 Note 3  New Accounting Pronouncements
 The Fair Value Option for Financial Assets and
Financial Liabilities
 Disclosures about Derivative Instruments and
Hedging Activities Accounting for Derivative Instruments and Hedging Activities,
 Accounting for Convertible
Debt Instruments That May be Settled in Cash upon Conversion (Including Partial Cash Settlement)
 7




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##### Table of Contents



Note 4  Earnings Per Share (EPS)
   Note 5  Comprehensive Income (Loss)
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Net income (loss)
    
    $
    5,005
    
    
    $
    5,101
    
    
    $
    (10,654
    )
    
    $
    (2,124
    )Unrealized gain (loss) on available-for-sale
investments
    
    
    (106
    )
    
    
    39
    
    
    
    (113
    )
    
    
    (8
    )Cash flow hedges:Unrealized gain (loss) on cash flow hedges
    
    
    3,480
    
    
    
    (2,197
    )
    
    
    3,357
    
    
    
    (3,967
    )Reclassification adjustment to revenue
    
    
    319
    
    
    
    1,029
    
    
    
    819
    
    
    
    1,0293,799
    
    
    
    (1,168
    )
    
    
    4,176
    
    
    
    (2,938
    )Foreign currency translation adjustment
    
    
    (1,374
    )
    
    
    3,301
    
    
    
    (4,214
    )
    
    
    7,654Comprehensive income (loss)
    
    $
    7,324
    
    
    $
    7,273
    
    
    $
    (10,805
    )
    
    $
    2,584
 Note 6  Fair Value Measurements
 Fair Value Measurements Effective Date of
FASB Statement No. 157
 8




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##### Table of Contents



Quoted
    
    
    SignificantPrices in
    
    
    OtherFair Value
    
    
    Active
    
    
    Observableat September 30,
    
    
    Markets
    
    
    InputsDescription
    
    2008
    
    
    (Level 1)
    
    
    (Level 2)Assets:Cash, cash equivalents and restricted cash
    
    $
    90,856
    
    
    $
    90,856
    
    
    $
    Short-term investments, available-for-sale
    
    
    12,698
    
    
    
    12,698
    
    
    
    Foreign exchange forward contracts(1)
    
    
    2,342
    
    
    
    
    
    
    
    2,342Assets measured at fair value at
September 30, 2008
    
    $
    105,896
    
    
    $
    103,554
    
    
    $
    2,342
 
 (1)
    
    Included in Prepaid expenses and other current assets on the Companys Condensed
Consolidated Balance Sheets.  Short-term Investments
  Amortized
    
    
    Gross
    
    
    GrossCost
    
    
    Unrealized
    
    
    UnrealizedBasis
    
    
    Gains
    
    
    Losses
    
    
    Fair ValueCorporate notes and bonds
    
    $
    9,757
    
    
    $
    3
    
    
    $
    (62
    )
    
    $
    9,698Asset-backed securities
    
    
    2,999
    
    
    
    1
    
    
    
    
    
    
    
    3,000Total short-term investments
    
    $
    12,756
    
    
    $
    4
    
    
    $
    (62
    )
    
    $
    12,698
   2008
    
    $
    7,3992009
    
    
    5,299$
    12,698
 9




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##### Table of Contents



Foreign Currency Derivatives
   Note 7  Accounts Receivable
  September 30,
    
    
    December 31,2008
    
    
    2007Trade accounts receivable
    
    $
    40,566
    
    
    $
    11,569Unbilled receivables
    
    
    1,867
    
    
    
    5,627Advance billings
    
    
    6,752
    
    
    
    6,53849,185
    
    
    
    23,734Allowance for doubtful accounts
    
    
    (99
    )
    
    
    (99
    )Accounts receivable, net
    
    $
    49,086
    
    
    $
    23,635
   Note 8  Inventory
  September 30,
    
    
    December 31,2008
    
    
    2007Components and subassemblies
    
    $
    29,326
    
    
    $
    20,814Work in process
    
    
    7,306
    
    
    
    15,839Finished goods
    
    
    115,964
    
    
    
    18,955Total
    
    $
    152,596
    
    
    $
    55,608
  h
 10




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##### Table of Contents



Note 9  Deferred Revenue
  September 30,
    
    
    December 31,2008
    
    
    2007Deferred product revenue
    
    $
    89,840
    
    
    $
    28,592Deferred service revenue
    
    
    36,553
    
    
    
    31,470Total deferred revenue
    
    
    126,393
    
    
    
    60,062Less long-term deferred revenue
    
    
    (31,794
    )
    
    
    (11,745
    )Deferred revenue in current liabilities
    
    $
    94,599
    
    
    $
    48,317
  Note 10  Commitments and Contingencies
  Operating
    
    
    DevelopmentLeases
    
    
    Agreements2008 (fourth quarter)
    
    $
    912
    
    
    $
    20,2412009
    
    
    2,380
    
    
    
    17,1002010
    
    
    2,337
    
    
    
    5,2262011
    
    
    2,295
    
    
    
    15,0002012
    
    
    2,079
    
    
    
    15,000Thereafter
    
    
    9,991
    
    
    
    Minimum contractual commitments
    
    $
    19,994
    
    
    $
    72,567
  Note 11  Share-Based Compensation
 Share-Based Payment
   Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Risk-free interest rate
    
    
    
    
    
    
    4.4
    %
    
    
    2.9
    %
    
    
    4.5
    %Expected dividend yield
    
    
    
    
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %Volatility
    
    
    
    
    
    
    72
    %
    
    
    69
    %
    
    
    73
    %Expected life
    
    
    
    
    
    4.0 years
    
    
    4.0 years
    
    
    4.0 yearsWeighted average Black-Scholes value of options granted
    
    
    
    
    
    $
    4.13
    
    
    $
    3.52
    
    
    $
    5.42
 11




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##### Table of Contents



Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Cost of product revenue
    
    $
    32
    
    
    $
    14
    
    
    $
    69
    
    
    $
    69Cost of service revenue
    
    
    68
    
    
    
    22
    
    
    
    137
    
    
    
    109Research and
development, net
    
    
    401
    
    
    
    185
    
    
    
    918
    
    
    
    829Sales and marketing
    
    
    167
    
    
    
    87
    
    
    
    376
    
    
    
    360General and
administrative
    
    
    397
    
    
    
    294
    
    
    
    943
    
    
    
    1,207Total
    
    $
    1,065
    
    
    $
    602
    
    
    $
    2,443
    
    
    $
    2,574
  WeightedWeighted
    
    
    AverageAverage
    
    
    Remaining
    
    
    AggregateExercise
    
    
    Contractual
    
    
    IntrinsicOptions
    
    
    Price
    
    
    Term
    
    
    ValueOutstanding at December 31, 2007
    
    
    3,328,798
    
    
    $
    14.68Grants
    
    
    881,350
    
    
    
    6.54Exercises
    
    
    (8,697
    )
    
    
    5.82Cancellations
    
    
    (248,497
    )
    
    
    20.54Outstanding at September 30, 2008
    
    
    3,952,954
    
    
    $
    12.52
    
    
    6.5 years
    
    $
    125,000Exercisable at September 30, 2008
    
    
    2,684,291
    
    
    $
    14.79
    
    
    5.2 years
    
    $
    124,000Available for grant at September
30, 2008
    
    
    1,460,314
 12




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##### Table of Contents



WeightedAverageGrant dateShares
    
    Fair ValueOutstanding at January 1, 2008
    
    
    376,206
    
    
    $
    9.82Granted
    
    
    451,135
    
    
    
    6.38Forfeited
    
    
    (6,400
    )
    
    
    10.56Vested
    
    
    (59,906
    )
    
    
    7.96Outstanding at September 30, 2008
    
    
    761,035
    
    
    $
    7.92
   Note 12  Taxes
    Note 13  Geographic Segment Information
 Disclosure about Segments of an Enterprise and Related Information
 13




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##### Table of Contents



United States
    
    
    Other Countries
    
    
    Total2008
    
    
    2007
    
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Three months ended September 30,Product revenue
    
    $
    32,712
    
    
    $
    6,086
    
    
    $
    5,353
    
    
    $
    36,656
    
    
    $
    38,065
    
    
    $
    42,742Service revenue
    
    
    10,816
    
    
    
    7,421
    
    
    
    5,712
    
    
    
    4,826
    
    
    
    16,528
    
    
    
    12,247Total revenue
    
    $
    43,528
    
    
    $
    13,507
    
    
    $
    11,065
    
    
    $
    41,482
    
    
    $
    54,593
    
    
    $
    54,989
 United States
    
    
    Other Countries
    
    
    Total2008
    
    
    2007
    
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Nine months ended September 30,Product revenue
    
    $
    64,256
    
    
    $
    40,626
    
    
    $
    17,350
    
    
    $
    49,565
    
    
    $
    81,606
    
    
    $
    90,191Service revenue
    
    
    28,340
    
    
    
    23,849
    
    
    
    17,508
    
    
    
    14,683
    
    
    
    45,848
    
    
    
    38,532Total revenue
    
    $
    92,596
    
    
    $
    64,475
    
    
    $
    34,858
    
    
    $
    64,248
    
    
    $
    127,454
    
    
    $
    128,723
   Note 14  Subsequent Events
  
 Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 Preliminary Note Regarding Forward-Looking Statements
  14




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##### Table of Contents



Overview and Executive Summary
   Summary of First Nine Months of 2008 Results
    Market Overview and Challenges
   15




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##### Table of Contents



h
 Our Goals and Strategy
  Gain Share in Our Core HPC Market.
 Extend Technology Leadership.
 Expand Our Total Addressable Market.
 Maintain Our Focus on Execution and Profitability.
  Key Performance Indicators
  Revenue.
 16




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##### Table of Contents



Gross margins.
 Operating expenses.
 Liquidity and cash flows.
 Critical Accounting Policies and Estimates
 10-K
  17




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##### 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.
 Project Revenue. Accounting for Performance of
Construction-Type and Certain Production-Type Contracts.
 18




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Services.
 Inventory Valuation
   Goodwill
    19




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Accounting for Income Taxes
 Accounting for Income Taxes
  Research and Development Expenses
     Share-based Compensation
  20




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New Accounting Pronouncements
 Fair Value Measurement Effective Date of FASB
Statement No. 157
  Accounting for Derivative Instruments and Hedging Activities,
  Results of Operations
 Revenue and Gross Margins
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Product revenue
    
    $
    38,065
    
    
    $
    42,742
    
    
    $
    81,606
    
    
    $
    90,191Less: Cost of product revenue
    
    
    17,266
    
    
    
    25,618
    
    
    
    45,681
    
    
    
    57,422Product gross margin
    
    $
    20,799
    
    
    $
    17,124
    
    
    $
    35,925
    
    
    $
    32,769Product gross margin percentage
    
    
    55
    %
    
    
    40
    %
    
    
    44
    %
    
    
    36
    %Service revenue
    
    $
    16,528
    
    
    $
    12,247
    
    
    $
    45,848
    
    
    $
    38,532Less: Cost of service revenue
    
    
    9,362
    
    
    
    7,222
    
    
    
    26,962
    
    
    
    22,880Service gross margin
    
    $
    7,166
    
    
    $
    5,025
    
    
    $
    18,886
    
    
    $
    15,652Service gross margin percentage
    
    
    43
    %
    
    
    41
    %
    
    
    41
    %
    
    
    41
    %
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Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Total revenue
    
    $
    54,593
    
    
    $
    54,989
    
    
    $
    127,454
    
    
    $
    128,723Less: Total cost of revenue
    
    
    26,628
    
    
    
    32,840
    
    
    
    72,643
    
    
    
    80,302Total gross margin
    
    $
    27,965
    
    
    $
    22,149
    
    
    $
    54,811
    
    
    $
    48,421Total gross margin percentage
    
    
    51
    %
    
    
    40
    %
    
    
    43
    %
    
    
    38
    %
 Product Revenue
 h
  Service Revenue
   Cost of Product Revenue and Product Gross Margin
 h h
  22




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Cost of Service Revenue and Service Gross Margin
   Research and Development Expenses
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Gross research and development expenses
    
    $
    23,797
    
    
    $
    23,730
    
    
    $
    68,105
    
    
    $
    67,913Less: Amounts included in cost of product revenue
    
    
    
    
    
    
    (176
    )
    
    
    
    
    
    
    (641
    )Less: Reimbursed research and development (excludes amounts
in revenue)
    
    
    (11,433
    )
    
    
    (14,487
    )
    
    
    (30,132
    )
    
    
    (41,466
    )Net research and development expenses
    
    $
    12,364
    
    
    $
    9,067
    
    
    $
    37,973
    
    
    $
    25,806Percentage of total revenue
    
    
    23
    %
    
    
    16
    %
    
    
    30
    %
    
    
    20
    %
  h
 h
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Sales and Marketing and General and Administrative Expenses
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2008
    
    2007
    
    2008
    
    2007Sales and marketing
    
    $
    6,135
    
    
    $
    5,423
    
    
    $
    17,365
    
    
    $
    15,814Percentage of total revenue
    
    
    11
    %
    
    
    10
    %
    
    
    14
    %
    
    
    12
    %General and administrative
    
    $
    3,775
    
    
    $
    3,340
    
    
    $
    10,936
    
    
    $
    11,442Percentage of total revenue
    
    
    7
    %
    
    
    6
    %
    
    
    9
    %
    
    
    9
    %
 Sales and Marketing .
 General and Administrative
 Other Income (Expense), net
  Interest Income (Expense)
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Interest income
    
    $
    479
    
    
    $
    1,520
    
    
    $
    3,145
    
    
    $
    5,118Interest expense
    
    
    (820
    )
    
    
    (804
    )
    
    
    (2,395
    )
    
    
    (2,403
    )Net interest
income (expense)
    
    $
    (341
    )
    
    $
    716
    
    
    $
    750
    
    
    $
    2,715
   24




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Taxes
  Net
Income (Loss)
    Liquidity and Capital Resources
      25




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Amounts Committed by Year2008(FourthContractual Obligations
    
    Total
    
    
    Quarter)
    
    
    2009-2011
    
    
    2012-2013
    
    
    ThereafterDevelopment agreements
    
    $
    72,567
    
    
    $
    20,241
    
    
    $
    37,326
    
    
    $
    15,000
    
    
    $
    Operating leases
    
    
    19,994
    
    
    
    912
    
    
    
    7,012
    
    
    
    4,190
    
    
    
    7,880Unrecognized income tax benefits
    
    
    1,018
    
    
    
    
    
    
    
    758
    
    
    
    260
    
    
    
    Total contractual cash obligations
    
    $
    93,579
    
    
    $
    21,153
    
    
    $
    45,096
    
    
    $
    19,450
    
    
    $
    7,880
     h
 
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
  Interest Rate Risk
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WeightedAverageFair Value
    
    
    Interest RateCorporate notes and bonds
    
    $
    9,698
    
    
    
    5.3
    %Asset-backed securities
    
    
    3,000
    
    
    
    4.1
    %Total short-term investments
    
    $
    12,698
 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
  27




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Part II. OTHER INFORMATION
 
 Item 1A. Risk Factors
  Our operating results may fluctuate significantly and we may not achieve profitability in any
given period.
   
    
    successfully completing development and selling of our Cray XT5 system, including upgrades
and successor systems;
    
    the level of revenue recognized in any given period, which is affected by the 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;
    
    the competitiveness of our products, which may be affected by the competitiveness of key
components from suppliers;
    
    our expense levels, including research and development net of government funding, which are
affected by the level and timing of such funding and the meeting of developmental milestones;
    
    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 capacity of our production facility to assemble, test and ship sufficient completed
systems to meet our revenue forecast;
    
    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;
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
    
    the terms and conditions of sale or lease for our products;
    
    the impact of expensing our share-based compensation under Statement of Financial Accounting
Standards No. 123(R), Share-Based Payment; and
    
    whether we will record an impairment charge with respect to our goodwill.
  
    
    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, which may be adversely affected by the current economic and fiscal
situation;
    
    price fluctuations in the commodity electronics and memory markets;
    
    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.
  Our reliance on third-party suppliers poses significant risks to our operating results,
business and prospects.
 
    
    if a supplier does not provide components that meet our specifications or the suppliers
technology roadmap in sufficient quantities on time, then production and sales of our systems
could be delayed, which would result in decreased revenue and gross margin and adversely
affect cash flow  these risks are accentuated during steep production ramp periods as we
introduce new or successor products, such as our current production ramp for our Cray XT5
system;
    
    if an interruption of supply of our components occurs because a supplier decides to no longer
provide those components, increases the price of those components significantly or imposes
allocations on its customers, it could take us a considerable period of time to identify and
qualify alternative suppliers, to redesign our products as necessary and to begin to
manufacture the redesigned components. In some cases, such as with key integrated circuits and
memory parts, we may not be able to redesign such
 29




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##### Table of Contents



components or find alternate sources that we could use in any realistic time frame. Defective
components may need to be replaced, which may result in increased costs and obsolete inventory;
    
    if a supplier cannot provide a competitive key component, such as microprocessors, our
systems may be less competitive than systems using components with greater capability;
    
    if a supplier provides us with hardware, software or other intellectual property that
contains bugs or other errors or is different from what we expected, our development projects
and production systems may be adversely affected through additional design testing and
verification efforts and respins of integrated circuits and/or development of replacement
components, then production and sales of our systems could be delayed and systems installed at
customer sites could require significant field component replacements, which would result in
decreased revenue and gross margin and adversely affect cash flow;
    
    if a supplier providing us with key research and development and design services or core
technology components with respect to integrated circuit design, network communication
capabilities or software is late, fails to provide us with effective functionality or loses
key internal talent, our development programs may be delayed or prove to be not possible to
complete;
    
    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.
  The achievement of our business plan in 2008 and future periods is highly dependent on
increased product revenue and margins from our Cray XT5 and successor systems.
  
    
    the level of product differentiation in our Cray XT5 and successor systems. We need to
compete successfully against HPC systems from large established companies and low bandwidth
cluster systems.
 30




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
    
    in the past, product margins have been adversely impacted by lower volumes than planned and
higher than anticipated manufacturing variances, including scrap, rework and excess and
obsolete inventory;
    
    in March 2008, we placed a last-time buy for a key component for our Cray XT4, Cray XT5 and
Cray XMT systems, which had to be placed before we could know all the possible sales prospects
for these products. If we estimated our needs too low, we could limit the number of possible
sales of these products and reduce potential revenue, or if we estimated too high, we could
incur inventory obsolescence charges and reduce our margins. Either way, our operating results
could be adversely affected; and
    
    we sometimes do not meet all of the contract requirements for customer acceptance and ongoing
reliability of our systems, which has resulted in contract penalties. Most often these
penalties adversely affect the gross margin through the provision of additional equipment and
services and/or service credits to satisfy delivery delays and performance shortfalls. Such
penalties adversely impacted gross margins in 2007 and the first nine months of 2008, and
there may be additional penalties in the fourth quarter of 2008 and future periods. The risk
of contract penalties is increased when we bid for new business prior to completing
development of new products when we must estimate future system performance.
  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.
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##### Table of Contents



If government support for development of our supercomputer systems is delayed, reduced or
lost, our net research and development expenditures and capital requirements would increase
significantly and our ability to conduct research and development would decrease.
 . h
 If we are unable to compete successfully in the HPC market, our revenue will decline.
 32




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Expansion of new Cray Technical Services could reduce our overall service margins. .
 If we cannot retain, attract and motivate key personnel, we may be unable to effectively
implement our business plan.
 Our stock price is volatile.
 33




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##### Table of Contents



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
will require a significant amount of cash to purchase the Convertible Notes and to fund planned capital
expenditures, research and development efforts and other corporate expenses and may have to seek
additional financing.
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##### Table of Contents



We may infringe or be subject to claims that we infringe the intellectual property rights of
others.
 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.
 U.S. export controls could hinder our ability to make sales to foreign customers and our
future prospects.
 35




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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.
 
    
    33,422,892 shares of common stock;
    
    1,284,852 shares of common stock issuable upon exercise of warrants;
    
    3,592,954 shares of common stock issuable upon exercise of options, of which options to
purchase 2,684,291 shares of common stock were then exercisable; and
    
    Convertible Notes convertible into an aggregate of 4,144,008 shares of common stock at a current
conversion price of approximately $19.31 per share, subject to adjustment, or, under certain
circumstances specified in the indenture governing the Convertible Notes, a maximum of 5,698,006 shares of
common stock (in early October 2008 we repurchased certain Convertible Notes, leaving outstanding Convertible Notes
convertible into 2,061,642 shares, subject to adjustment as above to a maximum of 2,834,757
shares).
   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.
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##### Table of Contents




    
    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 up to 5,000,000 shares of 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
 10.1
    
    Lease dated as of August 11, 2008, between 900 Fourth Avenue Property
LLC and the Company (1)10.2
    
    Third Amendment to Credit Agreement entered into as of August 22,
2008, between Wells Fargo Bank, National Association, and the Company
(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 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
 
 (1)
    
    Incorporated by reference to the Companys Current Report on Form 8-K, as filed with the SEC
on August 29, 2008. Items 1, 2, 3, 4 and 5 of Part II are not applicable and have been omitted.
 37




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SIGNATURES
  CRAY INC.Date: November 7, 2008
    /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 38