##### 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, 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 
Incorporation or Organization)
    
    93-0962605
(I.R.S. Employer
Identification No.)
 411 First Avenue South, Suite 600
Seattle, Washington
(Address of Principal Executive Office)
    
    98104-2860
(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 June 30, 2008 and December 31, 2007
    
    
    3Statements of Operations for the Three Months and Six Months Ended June 30, 2008 and 2007
    
    
    4Statements of Cash Flows for the Six Months Ended June 30, 2008 and 2007
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    13Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    24Item 4.
    
    Controls and Procedures
    
    
    24Item 4T.
    
    Controls and Procedures
    
    
    25PART II. OTHER INFORMATION
    
    
    25Item 1A.
    
    Risk Factors
    
    
    25Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    34Item 6.
    
    Exhibits
    
    
    34SIGNATURES
    
    
    35EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1
  Available Information
  h
 2




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1. Unaudited Condensed Consolidated Financial Statements
  
 
 June 30,
    
    
    December 31,2008
    
    
    2007ASSETSCurrent assets:Cash and cash equivalents
    
    $
    90,110
    
    
    $
    120,539Restricted cash
    
    
    10,000
    
    
    
    10,000Short-term investments, available-for-sale
    
    
    14,901
    
    
    
    48,582Accounts receivable, net
    
    
    32,189
    
    
    
    23,635Inventory
    
    
    114,992
    
    
    
    55,608Prepaid expenses and other current assets
    
    
    7,098
    
    
    
    4,120Prepaid research and development services
    
    
    7,808
    
    
    
    Total current assets
    
    
    277,098
    
    
    
    262,484Property and equipment, net
    
    
    15,953
    
    
    
    17,044Service inventory, net
    
    
    2,389
    
    
    
    2,986Goodwill
    
    
    64,018
    
    
    
    65,411Deferred tax asset
    
    
    601
    
    
    
    512Intangible assets, net
    
    
    1,091
    
    
    
    1,181Other non-current assets
    
    
    5,703
    
    
    
    6,284TOTAL ASSETS
    
    $
    366,853
    
    
    $
    355,902LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    65,593
    
    
    $
    14,148Accrued payroll and related expenses
    
    
    11,901
    
    
    
    12,023Advance research and development payments
    
    
    11,621
    
    
    
    29,669Other accrued liabilities
    
    
    8,439
    
    
    
    7,488Deferred revenue
    
    
    37,197
    
    
    
    48,317Total current liabilities
    
    
    134,751
    
    
    
    111,645Long-term deferred revenue
    
    
    14,599
    
    
    
    11,745Other non-current liabilities
    
    
    4,547
    
    
    
    4,310Convertible notes payable
    
    
    80,000
    
    
    
    80,000TOTAL LIABILITIES
    
    
    233,897
    
    
    
    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
33,364,934 and 32,638,415 shares,
respectively
    
    
    516,079
    
    
    
    513,196Accumulated other comprehensive income
    
    
    11,092
    
    
    
    13,562Accumulated deficit
    
    
    (394,215
    )
    
    
    (378,556
    )TOTAL SHAREHOLDERS EQUITY
    
    
    132,956
    
    
    
    148,202TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    366,853
    
    
    $
    355,902
 See accompanying notes
 3




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##### Table of Contents



Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Revenue:Product
    
    $
    32,851
    
    
    $
    13,789
    
    
    $
    43,541
    
    
    $
    47,449Service
    
    
    13,882
    
    
    
    12,836
    
    
    
    29,320
    
    
    
    26,285Total revenue
    
    
    46,733
    
    
    
    26,625
    
    
    
    72,861
    
    
    
    73,734Cost of revenue:Cost of product revenue
    
    
    22,003
    
    
    
    8,227
    
    
    
    28,415
    
    
    
    31,804Cost of service revenue
    
    
    9,241
    
    
    
    7,660
    
    
    
    17,600
    
    
    
    15,658Total cost of revenue
    
    
    31,244
    
    
    
    15,887
    
    
    
    46,015
    
    
    
    47,462Gross margin
    
    
    15,489
    
    
    
    10,738
    
    
    
    26,846
    
    
    
    26,272Operating expenses:Research and development, net
    
    
    11,890
    
    
    
    8,859
    
    
    
    25,609
    
    
    
    16,739Sales and marketing
    
    
    5,848
    
    
    
    5,123
    
    
    
    11,230
    
    
    
    10,391General and administrative
    
    
    3,465
    
    
    
    3,822
    
    
    
    7,161
    
    
    
    8,102Restructuring and severance
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10Total operating expenses
    
    
    21,203
    
    
    
    17,804
    
    
    
    44,000
    
    
    
    35,242Loss from operations
    
    
    (5,714
    )
    
    
    (7,066
    )
    
    
    (17,154
    )
    
    
    (8,970
    )Other income, net
    
    
    540
    
    
    
    76
    
    
    
    793
    
    
    
    471Interest income, net
    
    
    254
    
    
    
    966
    
    
    
    1,091
    
    
    
    1,999Loss before income taxes
    
    
    (4,920
    )
    
    
    (6,024
    )
    
    
    (15,270
    )
    
    
    (6,500
    )Provision for income taxes
    
    
    (107
    )
    
    
    (360
    )
    
    
    (389
    )
    
    
    (725
    )Net loss
    
    $
    (5,027
    )
    
    $
    (6,384
    )
    
    $
    (15,659
    )
    
    $
    (7,225
    )Basic and diluted loss per common share
    
    $
    (0.15
    )
    
    $
    (0.20
    )
    
    $
    (0.48
    )
    
    $
    (0.23
    )Basic and diluted weighted average shares outstanding
    
    
    32,521
    
    
    
    31,635
    
    
    
    32,446
    
    
    
    31,560
 See accompanying notes
 4




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##### Table of Contents



Six Months EndedJune 30,2008
    
    
    2007Operating activities:Net loss
    
    $
    (15,659
    )
    
    $
    (7,225
    )Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization
    
    
    5,421
    
    
    
    6,383Share-based compensation cost
    
    
    1,378
    
    
    
    1,972Inventory write-down
    
    
    420
    
    
    
    156Amortization of issuance costs on convertible notes payable
    
    
    346
    
    
    
    344Deferred income taxes
    
    
    (89
    )
    
    
    (48
    )Changes in operating assets and liabilities:Accounts receivable
    
    
    (8,893
    )
    
    
    19,147Inventory
    
    
    (61,531
    )
    
    
    (6,677
    )Prepaid expenses and other current assets
    
    
    (10,954
    )
    
    
    (2,561
    )Other non-current assets
    
    
    231
    
    
    
    (34
    )Accounts payable
    
    
    50,642
    
    
    
    (3,889
    )Accrued
payroll and related expenses and other accrued liabilities
    
    
    2,015
    
    
    
    (5,079
    )Advance research and development payments
    
    
    (18,048
    )
    
    
    (12,619
    )Other non-current liabilities
    
    
    234
    
    
    
    (393
    )Deferred revenue
    
    
    (8,395
    )
    
    
    (6,534
    )Net cash used in operating activities
    
    
    (62,882
    )
    
    
    (17,057
    )Investing activities:Sales/maturities of short-term investments
    
    
    35,549
    
    
    
    12,850Purchases of short-term investments
    
    
    (1,673
    )
    
    
    (63,668
    )Purchases of property and equipment
    
    
    (1,871
    )
    
    
    (644
    )Net cash provided by (used in) investing activities
    
    
    32,005
    
    
    
    (51,462
    )Financing activities:Proceeds from issuance of common stock through employee stock purchase plan
    
    
    234
    
    
    
    246Proceeds from exercise of options
    
    
    48
    
    
    
    1,271Principal payments on capital leases
    
    
    
    
    
    
    (31
    )Net cash provided by financing activities
    
    
    282
    
    
    
    1,486Effect of foreign exchange rate changes on cash and cash equivalents
    
    
    166
    
    
    
    40Net decrease in cash and cash equivalents
    
    
    (30,429
    )
    
    
    (66,993
    )Cash and cash equivalentsBeginning of period
    
    
    120,539
    
    
    
    115,328End of period
    
    $
    90,110
    
    
    $
    48,335Supplemental disclosure of cash flow information:Cash paid for interest
    
    $
    1,202
    
    
    $
    1,200Non-cash investing and financing activities:Inventory transfers to fixed assets and service inventory
    
    $
    1,727
    
    
    $
    3,369Stock issued for 401(k) match
    
    $
    1,223
    
    
    $
    527
 See accompanying notes
 5




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##### Table of Contents



Note 1  Basis of Presentation
    Principles of Consolidation
  Reclassifications
  Use of Estimates
  6




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##### Table of Contents



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)
 Note 4  Earnings Per Share (EPS)
   7




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Note 5  Comprehensive Loss
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Net loss
    
    $
    (5,027
    )
    
    $
    (6,384
    )
    
    $
    (15,659
    )
    
    $
    (7,225
    )Unrealized net loss on available-for-sale investments
    
    
    (83
    )
    
    
    (64
    )
    
    
    (7
    )
    
    
    (47
    )Cash flow hedges:Unrealized net loss on cash flow hedges
    
    
    (320
    )
    
    
    (1,482
    )
    
    
    (123
    )
    
    
    (1,770
    )Reclassification adjustment to revenue
    
    
    500
    
    
    
    
    
    
    
    500
    
    
    
    Foreign currency translation adjustment
    
    
    485
    
    
    
    4,025
    
    
    
    (2,840
    )
    
    
    4,353Comprehensive loss
    
    $
    (4,445
    )
    
    $
    (3,905
    )
    
    $
    (18,129
    )
    
    $
    (4,689
    )
 Note 6  Fair Value Measurements
 Fair Value Measurements Effective
Date of FASB Statement No. 157
  Quoted
    
    
    SignificantFair Value
    
    
    Prices in
    
    
    Otherat
    
    
    Active
    
    
    ObservableJune 30,
    
    
    Markets
    
    
    InputsDescription
    
    2008
    
    
    (Level 1)
    
    
    (Level 2)Assets:Cash, cash equivalents and restricted cash
    
    $
    100,110
    
    
    $
    100,110
    
    
    $
    Short-term investments, available-for-sale
    
    
    14,901
    
    
    
    14,901
    
    
    
    Assets measured at fair value at June 30, 2008
    
    $
    115,011
    
    
    $
    115,011
    
    
    $
    Liabilities:Foreign exchange forward contracts(1)
    
    $
    859
    
    
    $
    
    
    
    $
    859Liabilities measured at fair value at June 30, 2008
    
    $
    859
    
    
    $
    
    
    
    $
    859
 
 (1)
    
    Included in Other accrued liabilities on the Companys Condensed Consolidated Balance
Sheets.  8




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##### Table of Contents



Short-term Investments
  Amortized
    
    
    Gross
    
    
    GrossCost
    
    
    Unrealized
    
    
    UnrealizedBasis
    
    
    Gains
    
    
    Losses
    
    
    Fair ValueCorporate notes and bonds
    
    $
    11,859
    
    
    $
    37
    
    
    $
    (4
    )
    
    $
    11,892Asset-backed securities
    
    
    2,994
    
    
    
    15
    
    
    
    
    
    
    
    3,009Total short-term investments
    
    $
    14,853
    
    
    $
    52
    
    
    $
    (4
    )
    
    $
    14,901
   2008
    
    $
    8,0242009
    
    
    6,877$
    14,901
 Foreign Currency Derivatives
   Note 7  Accounts Receivable
  June 30,
    
    
    December 31,2008
    
    
    2007Trade accounts receivable
    
    $
    17,688
    
    
    $
    11,569Unbilled receivables
    
    
    6,521
    
    
    
    5,627Advance billings
    
    
    8,079
    
    
    
    6,53832,288
    
    
    
    23,734Allowance for doubtful accounts
    
    
    (99
    )
    
    
    (99
    )Accounts receivable, net
    
    $
    32,189
    
    
    $
    23,635
  9




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##### Table of Contents



Note 8  Inventory
  June 30,
    
    
    December 31,2008
    
    
    2007Components and subassemblies
    
    $
    72,605
    
    
    $
    20,814Work in process
    
    
    21,398
    
    
    
    15,839Finished goods
    
    
    20,989
    
    
    
    18,955Total
    
    $
    114,992
    
    
    $
    55,608
   Note 9  Deferred Revenue
  June 30,
    
    
    December 31,2008
    
    
    2007Deferred product revenue
    
    $
    20,830
    
    
    $
    28,592Deferred service revenue
    
    
    30,966
    
    
    
    31,470Total deferred revenue
    
    
    51,796
    
    
    
    60,062Less long-term deferred revenue
    
    
    (14,599
    )
    
    
    (11,745
    )Deferred revenue in current liabilities
    
    $
    37,197
    
    
    $
    48,317
  Note 10  Commitments and Contingencies
  Operating
    
    
    DevelopmentLeases
    
    
    Agreements2008 (second
half)
    
    $
    1,825
    
    
    $
    25,0632009
    
    
    1,505
    
    
    
    13,5242010
    
    
    587
    
    
    
    2,0202011
    
    
    493
    
    
    
    15,0002012
    
    
    278
    
    
    
    15,000Thereafter
    
    
    1,191
    
    
    
    Minimum contractual commitments
    
    $
    5,879
    
    
    $
    70,607
 10




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##### Table of Contents



Note 11  Share-Based Compensation
 Share-Based Payment
  Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2008
    
    2007
    
    2008
    
    2007Risk-free interest rate
    
    
    2.9%
    
    
    
    4.7%
    
    
    
    2.8%
    
    
    
    4.7%Expected dividend yield
    
    
    0%
    
    
    
    0%
    
    
    
    0%
    
    
    
    0%Volatility
    
    
    69%
    
    
    
    73%
    
    
    
    69%
    
    
    
    73%Expected life
    
    4.0 years
    

    
    4.0 years
    
    
    4.0 years
    
    
    4.0 yearsWeighted average Black-Scholes value of options granted
    
    $
    3.57
    
    
    $
    4.57
    
    
    $
    3.52
    
    
    $
    6.28
    11




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##### Table of Contents



Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Cost of product revenue
    
    $
    23
    
    
    $
    28
    
    
    $
    37
    
    
    $
    55Cost of service revenue
    
    
    43
    
    
    
    46
    
    
    
    69
    
    
    
    87Research and development, net
    
    
    296
    
    
    
    302
    
    
    
    517
    
    
    
    644Sales and marketing
    
    
    128
    
    
    
    136
    
    
    
    209
    
    
    
    273General and administrative
    
    
    315
    
    
    
    438
    
    
    
    546
    
    
    
    913Total
    
    $
    805
    
    
    $
    950
    
    
    $
    1,378
    
    
    $
    1,972
  WeightedWeighted
    
    AverageAverage
    
    Remaining
    
    AggregateExercise
    
    Contractual
    
    IntrinsicOptions
    
    Price
    
    Term
    
    ValueOutstanding at December 31, 2007
    
    
    3,328,798
    
    
    $
    14.68Grants
    
    
    881,350
    
    
    
    6.54Exercises
    
    
    (8,072
    )
    
    
    5.96Cancellations
    
    
    (180,694
    )
    
    
    19.01Outstanding at June 30, 2008
    
    
    4,021,382
    
    
    $
    12.72
    
    
    6.7 years
    
    $
    98,000Exercisable at June 30, 2008
    
    
    2,680,572
    
    
    $
    15.18
    
    
    5.4 years
    
    $
    98,000Available for grant at June 30, 2008
    
    
    1,435,425
   WeightedAverageShares
    
    Grant date Fair ValueOutstanding at January 1, 2008
    
    
    376,206
    
    
    $
    9.82Granted
    
    
    451,135
    
    
    
    6.41Forfeited
    
    
    (3,200
    )
    
    
    10.56Vested
    
    
    (52,406
    )
    
    
    7.58Outstanding at June 30, 2008
    
    
    771,735
    
    
    $
    12.73
   Note 12  Taxes
   12




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Note 13  Geographic Segment Information
 Disclosure about Segments of an Enterprise and Related Information
  United States
    
    
    Other Countries
    
    
    Total2008
    
    
    2007
    
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Three months ended June 30,Product revenue
    
    $
    21,760
    
    
    $
    9,327
    
    
    $
    11,091
    
    
    $
    4,462
    
    
    $
    32,851
    
    
    $
    13,789Service revenue
    
    
    7,994
    
    
    
    7,824
    
    
    
    5,888
    
    
    
    5,012
    
    
    
    13,882
    
    
    
    12,836Total revenue
    
    $
    29,754
    
    
    $
    17,151
    
    
    $
    16,979
    
    
    $
    9,474
    
    
    $
    46,733
    
    
    $
    26,625
 United States
    
    
    Other Countries
    
    
    Total2008
    
    
    2007
    
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Six months ended June 30,Product revenue
    
    $
    31,544
    
    
    $
    34,540
    
    
    $
    11,997
    
    
    $
    12,909
    
    
    $
    43,541
    
    
    $
    47,449Service revenue
    
    
    17,524
    
    
    
    16,428
    
    
    
    11,796
    
    
    
    9,857
    
    
    
    29,320
    
    
    
    26,285Total revenue
    
    $
    49,068
    
    
    $
    50,968
    
    
    $
    23,793
    
    
    $
    22,766
    
    
    $
    72,861
    
    
    $
    73,734
   
 Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 Preliminary Note Regarding Forward-Looking Statements
  13




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##### Table of Contents



Overview and Executive Summary
   Summary of First Half of 2008 Results
    Market Overview and Challenges
    14




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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.
 Gross margins.
 15




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##### Table of Contents



Operating expenses.
 Liquidity and cash flows.
 Critical Accounting Policies and Estimates
    Revenue Recognition
 Revenue Recognition
in Financial Statements
 Multiple-Element Arrangements. Revenue Arrangements with
Multiple Deliverables
 16




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##### Table of Contents




    
    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.
 Services.
 Inventory Valuation
   17




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Goodwill
   Accounting for Income Taxes
 Accounting for Income Taxes
  Accounting for Loss Contracts
   Research and Development Expenses
   18




---



##### Table of Contents



Share-based Compensation
  New Accounting Pronouncements
 Fair Value Measurement Effective
Date of FASB Statement No. 157
  Accounting for Derivative Instruments and Hedging Activities,
  19




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Results of Operations
 Revenue and Gross Margins
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Product revenue
    
    $
    32,851
    
    
    $
    13,789
    
    
    $
    43,541
    
    
    $
    47,449Less: Cost of product revenue
    
    
    22,003
    
    
    
    8,227
    
    
    
    28,415
    
    
    
    31,804Product gross margin
    
    $
    10,848
    
    
    $
    5,562
    
    
    $
    15,126
    
    
    $
    15,645Product gross margin percentage
    
    
    33%
    
    
    
    40%
    
    
    
    35%
    
    
    
    33%Service revenue
    
    $
    13,882
    
    
    $
    12,836
    
    
    $
    29,320
    
    
    $
    26,285Less: Cost of service revenue
    
    
    9,241
    
    
    
    7,660
    
    
    
    17,600
    
    
    
    15,658Service gross margin
    
    $
    4,641
    
    
    $
    5,176
    
    
    $
    11,720
    
    
    $
    10,627Service gross margin percentage
    
    
    33%
    
    
    
    40%
    
    
    
    40%
    
    
    
    40%Total revenue
    
    $
    46,733
    
    
    $
    26,625
    
    
    $
    72,861
    
    
    $
    73,734Less: Total cost of revenue
    
    
    31,244
    
    
    
    15,887
    
    
    
    46,015
    
    
    
    47,462Total gross margin
    
    $
    15,489
    
    
    $
    10,738
    
    
    $
    26,846
    
    
    $
    26,272Total gross margin percentage
    
    
    33%
    
    
    
    40%
    
    
    
    37%
    
    
    
    36%
 Product Revenue
 h
  Service Revenue
   20




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Product Gross Margin
 h
  Service Gross Margin
   Research and Development Expenses
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Gross research and development expenses
    
    $
    22,215
    
    
    $
    21,652
    
    
    $
    44,307
    
    
    $
    44,183Less: Amounts included in cost of product revenue
    
    
    
    
    
    
    (195
    )
    
    
    
    
    
    
    (465
    )Less: Reimbursed research and development
(excludes amounts in revenue)
    
    
    (10,325
    )
    
    
    (12,598
    )
    
    
    (18,698
    )
    
    
    (26,979
    )Net research and development expenses
    
    $
    11,890
    
    
    $
    8,859
    
    
    $
    25,609
    
    
    $
    16,739Percentage of total revenue
    
    
    25%
    
    
    
    33%
    
    
    
    35%
    
    
    
    23%
  h
  21




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h
 Sales and Marketing and General and Administrative Expenses
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Sales and marketing
    
    $
    5,848
    
    
    $
    5,123
    
    
    $
    11,230
    
    
    $
    10,391Percentage of total revenue
    
    
    13%
    
    
    
    19%
    
    
    
    15%
    
    
    
    14%General and administrative
    
    $
    3,465
    
    
    $
    3,822
    
    
    $
    7,161
    
    
    $
    8,102Percentage of total revenue
    
    
    7%
    
    
    
    14%
    
    
    
    10%
    
    
    
    11%
 Sales and Marketing .
 General and Administrative
 Other Income (Expense), net
  Interest Income (Expense)
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Interest income
    
    $
    1,031
    
    
    $
    1,763
    
    
    $
    2,666
    
    
    $
    3,598Interest expense
    
    
    (777
    )
    
    
    (797
    )
    
    
    (1,575
    )
    
    
    (1,599
    )Net interest income
    
    $
    254
    
    
    $
    966
    
    
    $
    1,091
    
    
    $
    1,999
   Taxes
 22




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Liquidity and Capital Resources
     h
 Amounts Committed by YearContractual Obligations
    
    Total
    
    

2008
    
    

2009-2011
    
    

2012-2013
    
    
    ThereafterDevelopment agreements
    
    $
    70,607
    
    
    $
    25,063
    
    
    $
    30,544
    
    
    $
    15,000
    
    
    $
    Operating leases
    
    
    5,879
    
    
    
    1,825
    
    
    
    2,585
    
    
    
    536
    
    
    
    933Unrecognized income tax benefits
    
    
    990
    
    
    
    
    
    
    
    730
    
    
    
    260
    
    
    
    Total contractual cash obligations
    
    $
    77,476
    
    
    $
    26,888
    
    
    $
    33,859
    
    
    $
    15,796
    
    
    $
    933
  23




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h
 
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
  Interest Rate Risk
 Foreign Currency Risk
 
 Item 4. Controls and Procedures
 Evaluation of disclosure controls and procedures.
 24




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Changes in internal control over financial reporting.
 
 Item 4T. Controls and Procedures
  
 Part II. OTHER INFORMATION
 
 Item 1A. Risk Factors
  Our operating results may fluctuate significantly and we may not achieve profitability in any
given period. h
   
    
    successfully completing development and selling of our Cray XT4, Cray XT5 and Cray XT5h
systems, 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;
    
    our expense levels, including research and development net of government funding, which
are affected by the level and timing of such funding and, in certain circumstances, the
meeting of developmental milestones;
    
    maintaining our product development projects on schedule and within budgetary
limitations;
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##### Table of Contents




    
    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;
    
    the terms and conditions of sale or lease for our products; and
    
    the impact of expensing our share-based compensation under Statement of Financial
Accounting Standards No. 123(R), Share-Based Payment.
  
    
    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;
    
    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 in sufficient
quantities on time, then production and sales of our systems would be delayed or result in
decreased gross margin, adversely affecting revenue and 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 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 to manufacture the
 26




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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;
 
    
    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 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.
  h 
 The achievement of our business plan in 2008 and future periods is highly dependent on
increased product revenue and margins from our Cray XT4, Cray XT5 and
Cray XT5h and successor
systems. h h
  27




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##### Table of Contents




    
    the level of product differentiation in our Cray XT4, Cray XT5 and successor systems. The
market for such products is large but is replete with low bandwidth cluster systems. Our
long-term success may be adversely affected if we are not successful in demonstrating the
value of our balanced high bandwidth systems with the capability of solving challenging
problems quickly to a market beyond our current core of customers, largely certain agencies
of the U.S. and other governments, that require systems with the performance and features we
offer;
    
    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, although there is the risk of
contract defaults and product return. Such penalties adversely impacted gross margins in
2007 and the first half of 2008, and we expect additional penalties in the second half of
2008. 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 obtain the consent of DARPA to the incorporation of Intel technologies into our
Cascade project and other proposed changes could lead to a termination of our DARPA HPCS program,
which would impact our desired strategy and result in a significant increase in our research and
development expenditures and reduced operating results. .
 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. h
 28




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If the U.S. government purchases fewer supercomputers, our revenue would be reduced and our
operating results would be adversely affected.
 We will require a significant amount of cash to purchase the Notes and to fund planned capital
expenditures, research and development efforts and other corporate expenses and may have to seek
additional financing.
 If we are unable to compete successfully in the HPC market, our revenue will decline.
 29




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##### Table of Contents



Expansion of new Cray Technical Services could reduce our overall service margins.
 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.
 If we cannot retain, attract and motivate key personnel, we may be unable to effectively
implement our business plan.
 30




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##### Table of Contents



Our stock price is volatile.
 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.
 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.
 31




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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.
 New environmental rules in Europe and other jurisdictions may adversely affect our operations. h
   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.
 
    
    33,364,934 shares of common stock;
 32




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##### Table of Contents




    
    1,284,852 shares of common stock issuable upon exercise of warrants;
    
    4,021,382 shares of common stock issuable upon exercise of options, of which options to
purchase 2,680,572 shares of common stock were then exercisable; and
    
    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 Notes, a maximum of 5,698,006 shares
of common stock.
   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 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.
  33




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Item 4. Submission of Matters to a Vote of Security Holders
   Name
    
    Votes For
    
    % For
    
    Withheld
    
    % WithheldWilliam C. Blake
    
    
    27,299,009
    
    
    
    97.0
    %
    
    
    845,421
    
    
    
    3.0
    %John B. Jones, Jr.
    
    
    27,470,814
    
    
    
    97.6
    %
    
    
    673,616
    
    
    
    2.4
    %Stephen C. Kiely
    
    
    27,451,887
    
    
    
    97.5
    %
    
    
    692,543
    
    
    
    2.5
    %Frank L. Lederman
    
    
    27,469,936
    
    
    
    97.6
    %
    
    
    674,494
    
    
    
    2.4
    %Sally G. Narodick
    
    
    27,454,479
    
    
    
    97.5
    %
    
    
    689,951
    
    
    
    2.5
    %Daniel C. Regis
    
    
    27,456,727
    
    
    
    97.6
    %
    
    
    687,703
    
    
    
    2.4
    %Stephen C. Richards
    
    
    27,473,649
    
    
    
    97.6
    %
    
    
    670,781
    
    
    
    2.4
    %Peter J. Ungaro
    
    
    27,468,252
    
    
    
    97.6
    %
    
    
    676,178
    
    
    
    2.4
    %
  
 Item 6. Exhibits
 10.1
    
    Cray Cash Incentive Plan, as applicable to senior officers (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 May 14, 2008 Items 1, 2, 3 and 5 of Part II are not applicable and have been omitted.
 34




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SIGNATURES
  CRAY INC.Date: August 4, 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 35