##### Table of Contents





SECURITIES AND EXCHANGE
    COMMISSIONWashington, D.C.
    20549
       FORM 10-K
      þ

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934For the Fiscal Year Ended
    December 31, 2007o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
    THE SECURITIES EXCHANGE ACT OF 1934For 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
    Incorporation or Organization)

(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
  Securities Registered Pursuant to Section 12(b) of the
    Exchange Act:
  Title of Each
    Class

Name of Each Exchange on
    Which RegisteredCommon Stock, $.01 par value

Nasdaq Stock Market LLC   Securities
    Registered Pursuant to Section 12(g) of the Exchange
    Act: NONE
  o þ
  o þ
  þ o
  Regulation S-K Form 10-K Form 10-K þ
  Rule 12b-2
  Large accelerated
    filer  o

Accelerated
    filer  þ

Non-accelerated
    filer  o

Smaller reporting
    company  o(Do not check if a smaller
    reporting company)   Rule 12b-2 o þ
      DOCUMENTS
    INCORPORATED BY REFERENCE




---



##### 





CRAY
    INC.
  FORM 10-K
 For Fiscal Year Ended December 31, 2007
  INDEX
  
  PagePART IItem 1.

Business


1Item 1A.

Risk Factors


11Item 1B.

Unresolved Staff Comments


21Item 2.

Properties


21Item 3.

Legal Proceedings


21Item 4.

Submission of Matters to a Vote of Security
    Holders


21Item E.O.

Executive Officers of the Company


22PART IIItem 5.

Market for the Companys Common Equity,
    Related Shareholder Matters and Issuer Repurchases of Equity
    Securities


24Item 6.

Selected Financial Data


27Item 7.

Managements Discussion and Analysis of
    Financial Condition and Results of Operations


28Item 7A.

Quantitative and Qualitative Disclosures About
    Market Risk


41Item 8.

Financial Statements and Supplementary Data


42Item 9.

Changes in and Disagreements with Accountants on
    Accounting and Financial Disclosure


43Item 9A.

Controls and Procedures


43Item 9A(T).

Controls and Procedures


45Item 9B.

Other Information


45PART IIIItem 10.

Directors, Executive Officers and Corporate
    Governance


45Item 11.

Executive Compensation


45Item 12.

Security Ownership of Certain Beneficial Owners
    and Management and Related Shareholder Matters


45Item 13.

Certain Relationships and Related Transactions,
    and Director Independence


45Item 14.

Principal Accountant Fees and Services


45PART IVItem 15.

Exhibits and Financial Statement Schedules


46EXHIBIT 21.1EXHIBIT 23.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1      h
    Form 10-K,




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Forward-Looking
    Statements
  Form 10-K
  Form 10-K,
    PART I  Item 1.
    Business  General
        98104-2860, (206) 701-2000 Form 10-K
 1




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##### Table of Contents



Our
    History
          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.
 2




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Industry
    Background
    The
    HPC Market
  Worldwide Technical Server Taxonomy, 2007: Updating the
    Comparison of Technical Servers with the Overall Server Market
    in Revenue IDC 2007 Worldwide HPC Market Revenue Results Show
    Continued Strong Growth
      Increasing
    Demand for Supercomputing Power
       3




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Limitations
    of Existing and Emerging Solutions
           4




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Our
    Solutions
        
    upgrade paths that allow customers to leverage their investments
    over longer periods of time and provide enhanced total costs of
    ownership;
    custom hardware design of interconnect systems and, in certain
    systems, proprietary processors;
    flexibility of processor type, memory and network configuration
    and software tools developed towards implementation of our
    Adaptive Supercomputing vision; and
    the Cray brand name, synonymous with supercomputing, that brings
    with it a proven research and development team and a global
    sales and service organization dedicated to the needs of HPC
    users.    Our
    Current Products and Products in Development
  and/or
  Current
    Products
  Cray XT5 System.
 5




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and/or and/or
  Cray
    XT5h
    Hybrid Supercomputer. h h
  Cray XT4 System. tm
  Products
    in Development
  Cray XMT System.
  Baker. and/or
  Our
    Adaptive Supercomputing Vision and Cascade Program
   6




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Our
    Target Markets
    National Security.
  Scientific Research.
  Earth Sciences.
  Computer-Aided Engineering.
      10-K.
 7




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Our
    Technology
    Architecture
    h
      h
  Hardware
    
    Integrated circuit design. We have experience in designing
    custom and standard cell integrated circuits, including vector
    and multithreaded processors. Our processors and other
    integrated circuits have special features that let them use high
    available memory bandwidth efficiently.
    High speed interconnect systems. We design high speed and high
    bandwidth interconnect systems using a combination of custom I/O
    circuits, high density connectors, carefully chosen transmission
    media and highly optimized logic.
    Packaging and cooling. We use very dense packaging in order to
    produce systems with high processing capabilities and
    complementary bandwidth. This packaging generates more heat per
    unit volume. We use specialized cooling techniques to address
    this issue, including liquid cooling and high volume air cooling.    Software
   8




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Services
    two-hour
    Sales and
    Marketing
         9




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Manufacturing
    and Procurement
  and/or
  h
  Competition
       10




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Intellectual
    Property
          Employees
    Available
    Information
  Form 10-K, Form 10-Q, Form 8-K
  Item 1A.
    Risk
    Factors.    Our operating results may fluctuate significantly and we may
    not achieve profitability in any given
    period.
 11




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##### Table of Contents



h
      
    successfully selling 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;
    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
    Statement of Financial Accounting Standards No. 123(R),
    Share-Based Payment (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;
    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; 12




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
    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;
    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
    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 tm
 13




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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
    XT5h,
    Cray XT5 and successor systems. field-upgrades
    
    We need increased product differentiation in our Cray XT4, Cray
    XT5 and successor systems, including our Baker system. 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; and
    We sometimes do not meet all of the contract requirements for
    customer acceptance of our systems, which have resulted in
    contract penalties. Most often these penalties adversely affect
    the gross margin on a sale through the provision of additional
    equipment and services 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 we expect additional penalties in
    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.    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.
 14




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h
    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 and/or and/or
  If the U.S. government purchases fewer supercomputers,
    our revenue would be reduced and our operating results would be
    adversely affected.
 15




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If we are unable to compete successfully in the HPC market,
    our revenue will decline.
      If we cannot retain, attract and motivate key personnel, we
    may be unable to effectively implement our business
    plan.
  Lower than anticipated sales of new supercomputers and the
    termination of maintenance contracts on older
    and/or
    decommissioned systems may reduce our service revenue and
    margins from maintenance service contracts.
 16




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Expansion of new Technical Services could reduce our overall
    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.
  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.
  and/or
 17




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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 on
    December 1, 2009, upon a fundamental change or other
    purchase date, and our ability to purchase the Notes in such
    events may be limited.
  We will require a significant amount of cash to repay our
    indebtedness and to fund planned capital expenditures, research
    and development efforts and other corporate
    expenses. and/or
 18




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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. 10-K.
  New environmental rules in Europe and other jurisdictions may
    adversely affect our operations. h
      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.
 19




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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.
  
    32,638,415 shares of common stock;
    1,284,852 shares of common stock issuable upon exercise of
    warrants;
    3,328,798 shares of common stock issuable upon exercise of
    options, of which options to purchase 2,767,801 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; 20




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##### Table of Contents




    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 1B.
    Unresolved
    Staff Comments    Item 2.
    Properties    ApproximateLocation of Property

Uses of Facility

Square FootageChippewa Falls, WI

Manufacturing, hardware development,


227,800central service and warehouseSeattle, WA

Executive offices, hardware and software


59,600development, sales and marketingMendota Heights, MN

Software development, sales and marketing


55,300       Item 3.
    Legal
    Proceedings    Item 4.
    Submission
    of Matters to a Vote of Security Holders   21




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##### Table of Contents



Item E.O.
    Executive
    Officers of the Company    Name

Age

PositionPeter J. Ungaro


39


Chief Executive Officer and PresidentBrian C. Henry


51


Executive Vice President and Chief Financial OfficerKenneth W. Johnson


65


Senior Vice President, General Counsel and Corporate SecretaryIan W. Miller


50


Senior Vice PresidentSteven L. Scott


41


Senior Vice President and Chief Technology OfficerMargaret A. Williams


49


Senior Vice President     Peter J. Ungaro
  Brian C. Henry e-markets
  Kenneth W. Johnson
  Ian W. Miller
  Steven L. Scott
 22




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##### Table of Contents



Margaret A. Peg Williams
 23




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##### Table of Contents



PART II  Item 5.
    Market
    for the Companys Common Equity, Related Shareholder
    Matters and Issuer Repurchases of Equity
    Securities  Price
    Range of Common Stock and Dividend Policy
      High


LowYear Ended December 31, 2006:First Quarter

$
10.16


$
5.20Second Quarter

$
10.16


$
5.88Third Quarter

$
14.36


$
9.95Fourth Quarter

$
13.45


$
8.36Year Ended December 31, 2007:First Quarter

$
14.40


$
11.32Second Quarter

$
14.33


$
6.50Third Quarter

$
8.30


$
6.02Fourth Quarter

$
7.38


$
5.52     Equity
    Compensation Plan Information
    Number of Shares ofNumber of Shares of





Common Stock AvailableCommon Stock to be


Weighted-Average


for Future Issuance UnderIssued Upon Exercise of


Exercise Price of


Equity CompensationOutstanding Options,


Outstanding Options,


Plans (excluding sharesPlan Category

Warrants and Rights


Warrants and Rights


reflected in 1st column)Equity compensation plans approved by shareholders (1)


2,674,934


$
15.67



2,869,538Equity compensation plans not approved by shareholders (2)


653,864


$
10.61



143,666Total


3,328,798


$
14.68



3,013,204     (1)
    
    The shareholders approved our 1988, 1995 Independent Director,
    1995, 1999 and 2003 stock option plans, our 2004 long-term
    equity compensation plan, our 2006 long-term equity compensation
    plan and our 2001 employee stock purchase plan; the 1988,
    the 1995 Independent Director and the 1995 stock option plans
    have been terminated and no more options may be granted under
    those plans. Pursuant to these stock option plans, incentive and
    nonqualified options may be granted to employees, officers,
    directors, agents and consultants with exercise prices at least
    equal to the fair market value of the underlying common stock at
    the time of grant. While the Board may grant options with
    varying vesting periods under these plans, most options granted
    to employees vest over four years, with 25% of the options
    vesting after one year and the remaining options vesting monthly
    over the next three years, and most option grants to
    non-employee directors vesting monthly over the twelve months
    after grant. In 2005, the vesting of all employee stock options
    with per share 24




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exercise prices of $5.88 or higher was accelerated; the vesting
    of stock options granted to non-employee directors and
    contractors was not accelerated. Most options granted in 2005
    vested in full on or before December 31, 2005. Under the
    2004 and 2006 long-term equity compensation plans, the Board may
    grant restricted and performance stock grants in addition to
    incentive and nonqualified stock options. As of
    December 31, 2007, under the option and equity compensation
    plans approved by shareholders under which we may grant stock
    options, an aggregate of 2,456,840 shares remained
    available for grant as options and, under the option and equity
    compensation plans approved by shareholders under which we may
    grant restricted and bonus awards, an aggregate of
    1,556,439 shares were available for such awards.Under the 2001 employee stock purchase plan, all employees
    are eligible to participate. Effective December 16, 2005,
    the formula for determining the purchase price of shares under
    this plan was changed to 95% of the fair market value of our
    common stock on the fourth business day after the end of each
    offering period. The 2001 employee stock purchase plan
    covers a total of 1,000,000 shares; at December 31,
    2007, we had issued a total of 587,302 shares under the
    2001 plan and had a total of 412,698 shares available for
    future issuance. The first two columns do not include the shares
    to be issued under the 2001 employee stock purchase plan
    for the offering period that began on December 16, 2007 and
    will end on March 15, 2008, as neither the number of shares
    to be issued in that offering period nor the offering price is
    now determinable.(2)
    
    The shareholders did not approve the 2000 non-executive employee
    stock option plan. Under the 2000 non-executive employee stock
    option plan approved by the Board of Directors on March 30,
    2000, an aggregate of 1,500,000 shares pursuant to
    non-qualified options could be issued to employees, agents and
    consultants but not to officers or directors. Otherwise, the
    2000 non-executive employee stock option plan is similar to the
    stock option plans described in footnote (1) above. At
    December 31, 2007, under the 2000 non-executive employee
    stock plan we had options for 603,309 shares outstanding
    and options for 896,691 shares available for future grant.On April 1, 2004, in connection with the acquisition of
    OctigaBay, subsequently renamed Cray Canada Inc., we assumed
    that companys key employee stock option plan, including
    existing options. Options could be granted to Cray Canada
    employees, directors and consultants. Otherwise the Cray Canada
    key employee stock option plan is similar to the stock option
    plans described in footnote (1) above. On March 8,
    2006, the Cray Canada plan was terminated, which ended future
    grants but did not affect then outstanding options. Under the
    Cray Canada key employee stock option plan, we had 50,555
    options outstanding as of December 31, 2007.From time to time we have issued warrants as compensation to
    consultants and others for services without shareholder
    approval. As of December 31, 2007, we had no such warrants
    outstanding.  Unregistered
    Sales of Securities
    Issuer
    Repurchases
   25




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STOCK
    PERFORMANCE GRAPH
      COMPARISON
    OF CUMULATIVE TOTAL RETURN AMONG OUR COMMON STOCK,
    THE NASDAQ STOCK MARKET (U.S. COMPANIES) INDEX AND THE NASDAQ
    COMPUTER MANUFACTURER STOCKS INDEX THROUGH DECEMBER 31,
    2007
  
  12/31/02


12/31/03


12/31/04


12/30/05


12/29/06


12/31/07Cray Inc.



100.0




129.5




60.8




17.3




38.7




19.5Nasdaq Stock Market (U.S.)



100.0




149.5




162.7




166.2




182.6




198.0Nasdaq Computer Manufacturer Stocks



100.0




138.9




181.1




185.1




189.1




276.6  26




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##### Table of Contents



Item 6.
    Selected
    Financial Data    Year Ended December 31,2007


2006


2005


2004


2003(In thousands, except for per share data)Operating Data:Product revenue

$
133,455


$
162,795


$
152,098


$
95,901


$
175,004Service revenue


52,698



58,222



48,953



49,948



61,958Total revenue


186,153



221,017



201,051



145,849



236,962Cost of product revenue


89,475



124,728



139,518



104,196



97,354Cost of service revenue


31,247



32,466



29,032



30,338



40,780Total cost of revenue


120,722



157,194



168,550



134,534



138,134Gross margin


65,431



63,823



32,501



11,315



98,828Research and development, net


37,883



29,042



41,711



53,266



37,762Sales and marketing


22,137



21,977



25,808



34,948



27,038General and administrative


14,956



18,785



16,145



19,451



10,908Restructuring, severance and impairment


(48
)


1,251



9,750



8,182



4,019In-process research and development charge














43,400



Operating expenses


74,928



71,055



93,414



159,247



79,727Income (loss) from operations


(9,497
)


(7,232
)


(60,913
)


(147,932
)


19,101Other income (expense), net


1,112



(2,141
)


(1,421
)


(699
)


1,496Interest income (expense), net


3,840



(2,095
)


(3,462
)


365



444Income (loss) before income taxes


(4,545
)


(11,468
)


(65,796
)


(148,266
)


21,041(Provision) benefit for income taxes


(1,174
)


(602
)


1,488



(59,092
)


42,207Net income (loss)

$
(5,719
)

$
(12,070
)

$
(64,308
)

$
(207,358
)

$
63,248Net income (loss) per common shareBasic

$
(0.18
)

$
(0.53
)

$
(2.91
)

$
(9.95
)

$
3.77Diluted

$
(0.18
)

$
(0.53
)

$
(2.91
)

$
(9.95
)

$
3.25Weighted average outstanding sharesBasic


31,892



22,849



22,125



20,847



16,775Diluted


31,892



22,849



22,125



20,847



19,465Cash Flow Data:Cash provided by (used in):Operating activities

$
38,650


$
12,608


$
(36,705
)

$
(52,656
)

$
(8,713
)Investing activities


(35,426
)


(27,372
)


41,731



(29,908
)


(41,169
)Financing activities


1,695



83,909



(137
)


84,153



65,079Depreciation and amortization


13,359



16,181



19,578



17,179



15,860Purchases of property and equipment


2,768



2,611



3,982



12,518



6,599 27




---



##### Table of Contents



Year Ended December 31,2007


2006


2005


2004


2003(In thousands, except for per share data)Balance Sheet Data:Cash, cash equivalents, restricted cash and short-term
    investments

$
179,121


$
140,328


$
46,026


$
87,422


$
74,343Working capital


150,839



136,324



52,204



93,616



115,815Total assets


355,902



337,503



273,005



310,504



291,589Obligations under capital leases






31



154



823



152Long-term debt


80,000



80,000



80,000



80,000



Shareholders equity


148,202



141,374



65,947



121,965



222,633   Item 7.
    Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations  Forward-Looking
    Statements
    Overview
    and Executive Summary
       28




---



##### Table of Contents



Summary
    of 2007 Results
        Market
    Overview and Challenges
        h
 29




---



##### Table of Contents



Key
    Performance Indicators
    Revenue. Form 10-K,
  Gross margins.
  Operating expenses.
  Liquidity and cash flows.
  Critical
    Accounting Policies and Estimates
  Form 10-K Note 2 
    Summary of Significant Accounting Policies
   30




---



##### Table of Contents



Revenue
    Recognition
  Revenue Recognition in Financial
    Statements
  Multiple-Element Arrangements. No. 00-21, 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. 81-1, Accounting for Performance of Construction-Type and Certain
    Production-Type Contracts.
 31




---



##### Table of Contents



Services.
  Inventory
    Valuation
      Goodwill
    and Other Intangible Assets
       32




---



##### Table of Contents



Accounting
    for Income Taxes
  Accounting for Income Taxes
    Accounting for Uncertainty in
    Income Taxes  an interpretation of FASB Statement 109
  Accounting
    for Loss Contracts
      Research
    and Development Expenses
       33




---



##### Table of Contents



Share-Based
    Compensation
    Recent
    Accounting Pronouncements
  Fair Value Measurements
  The
    Fair Value Option for Financial Assets and Financial Liabilities
  No. 07-3, Accounting for Nonrefundable Advance Payments for Goods or
    Services to be Used in Future Research and Development
    Activities (EITF 07-3), EITF 07-3 EITF 07-3
  No. 07-1, Accounting for Collaborative Arrangements (EITF 07-1), EITF 07-1 EITF 07-1
  Noncontrolling Interests in Consolidated Financial
    Statements an amendment of Accounting
    Research Bulletin No. 51
  Business Combinations ,
 34




---



##### Table of Contents



Results
    of Operations
  Revenue
    and Gross Margins
    Year Ended December 31,2007


2006


2005Product revenue

$
133,455


$
162,795


$
152,098Less: Cost of product revenue


89,475



124,728



139,518Product gross margin

$
43,980


$
38,067


$
12,580Product gross margin percentage


33%



23%



8%Service revenue

$
52,698


$
58,222


$
48,953Less: Cost of service revenue


31,247



32,466



29,032Service gross margin

$
21,451


$
25,756


$
19,921Service gross margin percentage


41%



44%



41%Total revenue

$
186,153


$
221,017


$
201,051Less: Total cost of revenue


120,722



157,194



168,550Total gross margin

$
65,431


$
63,823


$
32,501Total gross margin percentage


35%



29%



16%   Product
    Revenue
  h
    h
  Service
    Revenue
     35




---



##### Table of Contents



Product
    Gross Margin
  and/or
          Service
    Gross Margin
      Operating
    Expenses
  Research
    and Development
    December 31,2007


2006


2005Gross research and development expenses

$
90,090


$
99,061


$
96,257Less: Amounts included in cost of product revenue


(793
)


(17,012
)


(19,724
)Less: Reimbursed research and development (excludes amounts in
    revenue)


(51,414
)


(53,007
)


(34,822
)Net research and development expenses

$
37,883


$
29,042


$
41,711Percentage of total revenue


20%



13%



21%  36




---



##### Table of Contents



h h
    h
  Other
    Operating Expenses
    Year Ended December 31,2007


2006


2005Sales and marketing

$
22,137


$
21,977


$
25,808Percentage of total revenue


12%



10%



13%General and administrative

$
14,956


$
18,785


$
16,145Percentage of total revenue


8%



8%



8%Restructuring, severance and impairment

$
(48
)

$
1,251


$
9,750Percentage of total revenue


<1%



<1%



5%   Sales and Marketing.
     37




---



##### Table of Contents



General and Administrative.
      Restructuring, Severance and
    Impairment.
    Other
    Income (Expense), Net
    Interest
    Income (Expense), Net
    Year Ended December 31,2007


2006


2005Interest income

$
7,046


$
2,525


$
741Interest expense


(3,206
)


(4,620
)


(4,203
)Net interest income (expense)

$
3,840


$
(2,095
)

$
(3,462
)        38




---



##### Table of Contents



Taxes
        Net
    Income (Loss)
                Liquidity
    and Capital Resources
     39




---



##### Table of Contents



h
  Amounts Committed by YearLess thanContractual Obligations

Total


1 Year


1-3 Years


3-5 Years


ThereafterDevelopment agreements

$
29,040


$
22,793


$
6,247


$



$
Operating leases


6,250



2,798



1,625



674



1,153Unrecognized income tax benefits


990







730



260



Total contractual cash obligations

$
36,280


$
25,591


$
8,602


$
934


$
1,153        40




---



##### Table of Contents



h
  Item 7A.
    Quantitative
    and Qualitative Disclosures About Market Risk    Interest Rate Risk:
  Foreign Currency Risk:
 41




---



##### 



Item 8.
    Financial
    Statements and Supplementary Data  INDEX TO
    FINANCIAL STATEMENTS*
   
 Consolidated Balance Sheets at December 31,
    2007 and December 31, 2006


F-1Consolidated Statements of Operations for the
    years ended December 31, 2007, 2006 and 2005


F-2Consolidated Statements of Shareholders
    Equity and Comprehensive Income (Loss) for the years ended
    December 31, 2007, 2006 and 2005


F-3Consolidated Statements of Cash Flows for the
    years ended December 31, 2007, 2006 and 2005


F-4Notes to Consolidated Financial Statements


F-5Report of Independent Registered Public
    Accounting Firm


F-29      *
    
    The Financial Statements are located following page 52.   42




---



##### Table of Contents



Item 9.
    Changes
    in and Disagreements with Accountants on Accounting and
    Financial Disclosure    Item 9A.
    Controls
    and Procedures  Disclosure
    Controls and Procedures
    Changes
    in Internal Control over Financial Reporting
    Managements
    Report on Internal Control Over Financial
    Reporting
  13a-15(f)
         43




---



##### Table of Contents



REPORT OF
    INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
             Internal Control  Integrated Framework
    Peterson
    Sullivan PLLC
    44




---



##### Table of Contents



Item 9A(T).
    Controls
    and Procedures    Item 9B.
    Other
    Information   PART III    Item 10.
    Directors,
    Executive Officers and Corporate Governance      Item 11.
    Executive
    Compensation    Item 12.
    Security
    Ownership of Certain Beneficial Owners and Management and
    Related Shareholder Matters      Item 13.
    Certain
    Relationships and Related Transactions, and Director
    Independence    Item 14.
    Principal
    Accountant Fees and Services   45




---



##### Table of Contents



PART IV  Item 15.
    Exhibits
    and Financial Statement Schedules  Financial Statements
              Financial Statement Schedules
  Form 10-K.
    Exhibits
  Form 10-K.
 46




---



##### Table of Contents



SIGNATURES
      By
    /s/  Peter
    J. Ungaro   Chief Executive Officer and President
  Form 10-K
    Signature

TitleBy /s/  Peter
    J. UngaroPeter
    J. Ungaro

Chief Executive Officer, President and DirectorBy /s/  Brian
    C. HenryBrian
    C. Henry

Principal Financial OfficerBy /s/  Kenneth
    D. RoselliKenneth
    D. Roselli

Principal Accounting OfficerBy /s/  William
    C. BlakeWilliam
    C. Blake

DirectorBy /s/  John
    B. Jones, Jr.John
    B. Jones, Jr.

DirectorBy /s/  Stephen
    C. KielyStephen
    C. Kiely

DirectorBy /s/  Frank
    L. LedermanFrank
    L. Lederman

Director 47




---



##### Table of Contents



Signature

TitleBy /s/  Sally
    G. NarodickSally
    G. Narodick

DirectorBy /s/  Daniel
    C. RegisDaniel
    C. Regis

DirectorBy /s/  Stephen
    C. RichardsStephen
    C. Richards

Director  48




---



##### Table of Contents



EXHIBIT INDEX
  ExhibitNumber

Description3
.1

Restated Articles of Incorporation (1)3
.2

Amended and Restated Bylaws (8)4
.1

Form of Common Stock Purchase Warrants due June 21,
    2009 (14)4
.2

Indenture dated as of December 6, 2004, by and between the
    Company and The Bank of New York Trust Company, N.A. as
    Trustee (and Form of 3.0% Convertible Senior Subordinated
    Note included as Exhibit A to the Indenture) (12)10
.0*

1999 Stock Option Plan (32)10
.1*

2000 Non-Executive Employee Stock Option Plan (5)10
.2*

2001 Employee Stock Purchase Plan (11)10
.3*

2003 Stock Option Plan (2)10
.4*

2004 Long-Term Equity Compensation Plan (13)10
.5*

Cray Canada Inc. Amended and Restated Key Employee Stock Option
    Plan (18)10
.6*

2006 Long-Term Equity Compensation Plan (30)10
.7*

Form of Officer Non-Qualified Stock Option Agreement (19)10
.8*

Form of Officer Incentive Stock Option Agreement (19)10
.9*

Form of Director Stock Option Agreement (19)10
.10*

Form of Director Stock Option Agreement, immediate
    vesting (19)10
.11*

Form of Employee Restricted Stock Agreement, current
    form (35)10
.12*

Form of Director Restricted Stock Agreement (1)10
.13*

2005 Executive Bonus Plan (17)10
.14*

Cray 2006 Bonus Plan (9)10
.15*

Cray 2007 Cash Incentive Plan (8)10
.16*

Letter Agreement between the Company and Peter J. Ungaro,
    effective March 7, 2005 (16)10
.17*

Offer Letter between the Company and Margaret A. Williams, dated
    April 14, 2005 (23)10
.18*

Offer Letter between the Company and Brian C. Henry, dated
    May 16, 2005 (24)10
.19*

Form of Management Continuation Agreement between the Company
    and its Executive Officers and certain other Employees (10)10
.20*

Executive Severance Policy, as amended (21)10
.21*

Retention Agreement between the Company and Peter J. Ungaro,
    dated December 20, 2005 (26)10
.22*

Retention Agreement between the Company and Brian C. Henry,
    dated December 20, 2005 (26)10
.23*

Retention Agreement between the Company and Margaret A.
    Williams, dated December 20, 2005 (26)10
.24*

Summary sheet setting forth amended compensation arrangements
    for non-employee Directors (27)10
.25

Lease Agreement between Merrill Place, LLC and the Company,
    dated November 21, 1997 (6)10
.26

Fourth Amendment to the Lease between Merrill Place LLC and the
    Company, dated as of October 31, 2005 (22)10
.27

FAB I Building Lease Agreement between Union Semiconductor
    Technology Corporation and the Company, dated June 30,
    2000 (7)10
.28

Amendment No. 1 to the FAB Building Lease Agreement between
    Union Semiconductor Technology Corporation and the Company,
    dated as of August 19, 2002 (3)10
.29

Conference Center Lease Agreement between Union Semiconductor
    Technology Corporation and the Company, dated June 30,
    2000 (7)10
.30

Amendment No. 1 to the Conference Center Lease Agreement
    between Union Semiconductor Technology Corporation and the
    Company, dated as of August 19, 2002 (3) 49




---



##### Table of Contents



ExhibitNumber

Description10
.31

Development Building and Conference Center Lease Agreement
    between Northern Lights Semiconductor Corporation and the
    Company, dated as of February 1, 2008 (33)10
.32

Mendota Heights Office Lease Agreement between the
    Teachers Retirement System of the State of Illinois and
    the Company, dated as of August 10, 2000 (7)10
.33

First Amendment to the Mendota Heights Office Lease Agreement
    between the Teachers Retirement System of the State of
    Illinois and the Company, dated as of January 17,
    2003 (3)10
.34

Technology Agreement between Silicon Graphics, Inc. and the
    Company, effective as of March 31, 2000 (4)10
.35

Amendment No. 2, dated as of March, 30, 2007, to the
    Technology Agreement between Silicon Graphics, Inc. and the
    Company, effective as of March 31, 2000 (34)10
.36

Senior Secured Credit Agreement among the Company, Cray Federal
    Inc. and Wells Fargo Foothill, Inc., dated May 31,
    2005 (20)10
.37

Amendment No. One to the Senior Secured Credit Agreement
    among the Company, Cray Federal Inc. and Wells Fargo Foothill,
    Inc., dated November 9, 2005 (25)10
.38

Amendment Number Two to Senior Secured Credit Agreement, dated
    as of March 14, 2006, among Wells Fargo Foothill, Inc., the
    Company and Cray Federal Inc. (28)10
.39

Amendment Number Three to Senior Secured Credit Agreement, dated
    as of July 12, 2006, among Wells Fargo Foothill, Inc., the
    Company. and Cray Federal Inc. (31)10
.40

Credit Agreement, dated as of December 29, 2006, between
    Wells Fargo Bank, National Association and the Company (29)10
.41

First Amendment, dated January 31, 2007, to Credit
    Agreement between Wells Fargo Bank, National Association and the
    Company (35)10
.42

Second Amendment, effective December 31, 2007, to Credit
    Agreement between Wells Fargo Bank, National Association, and
    the Company (36)21
.1

Subsidiaries of the Company23
.1

Consent of Peterson Sullivan PLLC, Independent Registered Public
    Accounting Firm24
.1

Power of Attorney for directors and officers (included on the
    signature page of this report)31
.1

Rule 13a-14(a)/15d-14(a)
    Certification of Mr. Ungaro, Chief Executive Officer31
.2

Rule 13a-14(a)/15d-14(a)
    Certification of Mr. Henry, Chief Financial Officer32
.1

Certification pursuant to 18 U.S.C. Section 1350 by
    the Chief Executive Officer and the Chief Financial Officer     (1)
    
    Incorporated by reference to the Companys Current Report
    on
    Form 8-K,
    as filed with the Commission on June 8, 2006.(2)
    
    Incorporated by reference to the Companys definitive Proxy
    Statement for the 2003 Annual Meeting, as filed with the
    Commission on March 31, 2003.(3)
    
    Incorporated by reference to the Companys Annual Report on
    Form 10-K,
    as filed with the Commission for the fiscal year ended
    December 31, 2002.(4)
    
    Incorporated by reference to the Companys Quarterly Report
    on
    Form 10-Q,
    as filed with the Commission on May 15, 2000.(5)
    
    Incorporated by reference to the Companys Registration
    Statement on
    Form S-8
    (SEC
    No. 333-57970),
    as filed with the Commission on March 30, 2001.(6)
    
    Incorporated by reference to the Companys Annual Report on
    Form 10-K,
    as filed with the Commission for the fiscal year ended
    December 31, 1997.(7)
    
    Incorporated by reference to the Companys Annual Report on
    Form 10-K,
    as filed with the Commission for the fiscal year ended
    December 31, 2000. 50




---



##### Table of Contents



(8)
    
    Incorporated by reference to the Companys Current Report
    on
    Form 8-K,
    as filed with the Commission on February 12, 2007.(9)
    
    Incorporated by reference to the Companys Current Report
    on
    Form 8-K,
    as filed with the Commission on May 4, 2006.(10)
    
    Incorporated by reference to the Companys Quarterly Report
    on
    Form 10-Q,
    as filed with the Commission on May 17, 1999.(11)
    
    Incorporated by reference to the Companys Registration
    Statement on
    Form S-8
    (SEC
    No. 333-70238),
    filed on September 26, 2001.(12)
    
    Incorporated by reference to the Companys Current Report
    on
    Form 8-K,
    as filed with the Commission on December 7, 2004.(13)
    
    Incorporated by reference to the Companys definitive Proxy
    Statement for the 2004 Annual Meeting, as filed with the
    Commission on March 24, 2004.(14)
    
    Incorporated by reference to the Registration Statement, as
    filed with the Commission on March 30, 2001.(15)
    
    [Reserved](16)
    
    Incorporated by reference to the Companys Current Report
    on
    Form 8-K,
    as filed with the Commission on March 8, 2005.(17)
    
    Incorporated by reference to the Companys Current Report
    on
    Form 8-K,
    as filed with the Commission on March 25, 2005.(18)
    
    Incorporated by reference to the Companys Registration
    Statement on
    Form S-8
    (SEC
    No. 333-114243),
    filed on April 6, 2004.(19)
    
    Incorporated by reference to the Companys Annual Report on
    Form 10-K,
    as filed with the Commission for the fiscal year ended
    December 31, 2004.(20)
    
    Incorporated by reference to the Companys Current Report
    on
    Form 8-K,
    as filed with the Commission on June 1, 2005.(21)
    
    Incorporated by reference to the Companys Current Report
    on
    Form 8-K,
    as filed with the Commission on August 10, 2005.(22)
    
    Incorporated by reference to the Companys Current Report
    on
    Form 8-K,
    as filed with the Commission on November 15, 2005.(23)
    
    Incorporated by reference to the Companys Current Report
    on
    Form 8-K,
    as filed with the Commission on May 9, 2005.(24)
    
    Incorporated by reference to the Companys Quarterly Report
    on
    Form 10-Q,
    as filed with the Commission on November 9, 2005.(25)
    
    Incorporated by reference to the Companys Current Report
    on
    Form 8-K,
    as filed with the Commission on November 16, 2005.(26)
    
    Incorporated by reference to the Companys Current Report
    on
    Form 8-K,
    as filed with the Commission on December 22, 2005.(27)
    
    Incorporated by reference to the Companys Current Report
    on
    Form 8-K,
    as filed with the Commission on February 21, 2006.(28)
    
    Incorporated by reference to the Companys Current Report
    on
    Form 8-K,
    as filed with the Commission on March 17, 2006.(29)
    
    Incorporated by reference to the Companys Current Report
    on
    Form 8-K,
    as filed with the Commission on January 4, 2007.(30)
    
    Incorporated by reference to the Companys definitive Proxy
    Statement for the 2006 Annual Meeting, as filed with the
    Commission on April 28, 2006.(31)
    
    Incorporated by reference to the Companys Quarterly Report
    on
    Form 10-Q,
    as filed with the Commission on August 9, 2006. 51




---



##### Table of Contents



(32)
    
    Incorporated by reference to the Companys Registration
    Statement on
    Form S-8,
    Registration
    No. 333-57970,
    as filed with the Commission on March 30, 2001.(33)
    
    Incorporated by reference to the Companys Current Report
    on
    Form 8-K,
    as filed with the Commission on February 1, 2008.(34)
    
    Incorporated by reference to the Companys Quarterly Report
    on
    Form 10-Q,
    as filed with the Commission on August 7, 2007.(35)
    
    Incorporated by reference to the Companys Annual Report on
    Form 10-K,
    as filed with the Commission for the fiscal year ended
    December 31, 2006 on March 9, 2007.(36)
    
    Incorporated by reference to the Companys Current Report
    on
    Form 8-K,
    as filed with the Commission on January 4, 2008.    *
    
    Management contract or compensatory plan or arrangement.  Regulation S-K,
 52




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  CONSOLIDATED
    BALANCE SHEETS
 (In
    thousands, except share data)
  December 31,


December 31,2007


2006ASSETSCurrent assets:Cash and cash equivalents

$
120,539


$
115,328Restricted cash


10,000



25,000Short-term investments, available for sale


48,582



Accounts receivable, net


23,635



44,790Inventory


55,608



58,798Prepaid expenses and other current assets


4,120



2,156Total current assets


262,484



246,072Property and equipment, net


17,044



21,564Service inventory, net


2,986



4,292Goodwill


65,411



57,138Deferred tax asset


512



722Intangible assets, net


1,181



1,404Other non-current assets


6,284



6,311TOTAL ASSETS

$
355,902


$
337,503LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable

$
14,148


$
22,450Accrued payroll and related expenses


12,023



17,411Advance research and development payments


29,669



21,518Other accrued liabilities


7,488



5,121Deferred revenue


48,317



43,248Total current liabilities


111,645



109,748Long-term deferred revenue


11,745



2,475Other non-current liabilities


4,310



3,906Convertible notes payable


80,000



80,000TOTAL LIABILITIES


207,700



196,129Commitments and Contingencies (Note 12)Shareholders equity:Preferred stock  Authorized and undesignated,
    5,000,000 shares; no shares issued or outstanding






Common stock and additional paid-in capital, par value $.01 per
    share  Authorized, 75,000,000 shares; issued and
    outstanding 32,638,415 and 32,236,888 shares, respectively


513,196



507,356Accumulated other comprehensive income


13,562



6,855Accumulated deficit


(378,556
)


(372,837
)TOTAL SHAREHOLDERS EQUITY


148,202



141,374TOTAL LIABILITIES AND SHAREHOLDERS EQUITY

$
355,902


$
337,503   See accompanying notes
 F-1




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  CONSOLIDATED
    STATEMENTS OF OPERATIONS
 (In
    thousands, except per share data)
  Years Ended December 31,2007


2006


2005Revenue:Product

$
133,455


$
162,795


$
152,098Service


52,698



58,222



48,953Total revenue


186,153



221,017



201,051Cost of revenue:Cost of product revenue


89,475



124,728



139,518Cost of service revenue


31,247



32,466



29,032Total cost of revenue


120,722



157,194



168,550Gross margin


65,431



63,823



32,501Operating expenses:Research and development, net


37,883



29,042



41,711Sales and marketing


22,137



21,977



25,808General and administrative


14,956



18,785



16,145Restructuring, severance and impairment


(48
)


1,251



9,750Total operating expenses


74,928



71,055



93,414Loss from operations


(9,497
)


(7,232
)


(60,913
)Other income (expense), net


1,112



(2,141
)


(1,421
)Interest income (expense), net


3,840



(2,095
)


(3,462
)Loss before income taxes


(4,545
)


(11,468
)


(65,796
)Income tax benefit (expense)


(1,174
)


(602
)


1,488Net loss

$
(5,719
)

$
(12,070
)

$
(64,308
)Basic and diluted net loss per common share

$
(0.18
)

$
(0.53
)

$
(2.91
)Basic and diluted weighted average shares outstanding


31,892



22,849



22,125   See accompanying notes
 F-2




---



##### Table of Contents





CRAY INC.
    AND SUBSIDIARIES



CONSOLIDATED
    STATEMENTS OF SHAREHOLDERS EQUITY

AND COMPREHENSIVE INCOME (LOSS)

(In thousands)  Common Stockand Additional


Exchangeable





AccumulatedPaid In Capital


Shares





OtherNumber





Number





Deferred


Comprehensive


Accumulated





Comprehensiveof Shares


Amount


of Shares


Amount


Compensation


Income


Deficit


Total


Income (Loss)BALANCE, December 31, 2004


21,837


$
413,911



144


$
4,173


$
(4,220
)

$
4,560


$
(296,459
)

$
121,965Exchangeable shares converted into common shares


124



3,597



(124
)


(3,597
)


















Issuance of shares under Employee Stock Purchase Plan


200



1,211























1,211



Exercise of stock options


22



138























138



Issuance of shares under Company 401(k) Plan match


52



770























770



Warrants issued in connection with financing






219























219



Restricted shares issued for compensation


491



2,881











(2,881
)














Amortization of deferred compensation


















4,106











4,106



Reversal of deferred compensation for stock options due to
    employee terminations






(116
)










116















Common shares issued in exchange for lease amendment


17



80























80



Other comprehensive income:Reclassification adjustment for available-for-sale realized
    losses included in net loss






















24







24



24Currency translation adjustment


















68



1,674







1,742



1,674Net loss


























(64,308
)


(64,308
)


(64,308
)BALANCE, December 31, 2005


22,743



422,691



20



576



(2,811
)


6,258



(360,767
)


65,947


$
(62,610
)Common stock offering, less issuance costs


8,625



81,250























81,250



Exchangeable shares converted into common shares


20



576



(20
)


(576
)


















Issuance of shares under Employee Stock Purchase Plan


64



532























532



Exercise of stock options


382



2,625























2,625



Issuance of shares under Company 401(k) Plan match


48



394























394



Restricted shares issued for compensation


355































Reclassification of deferred compensation to additional paid in
    capital upon adoption of FAS 123R






(2,811
)










2,811















Share-based compensation






2,099























2,099



Other comprehensive income:Currency translation adjustment






















597







597



597Net loss


























(12,070
)


(12,070
)


(12,070
)BALANCE, December 31, 2006


32,237



507,356















6,855



(372,837
)


141,374


$
(11,473
)Issuance of shares under Employee Stock Purchase Plan


60



453























453



Exercise of stock options


163



1,273























1,273



Issuance of shares under Company 401(k) Plan match


95



925























925



Restricted shares issued for compensation


58































Exercise of stock warrant


25































Share-based compensation






3,189























3,189



Other comprehensive income:Unrealized gain on available-for-sale securities






















54







54



54Currency translation adjustment






















7,952







7,952



7,952Unrealized loss on cash flow hedges, net of reclassification
    adjustment






















(1,299
)






(1,299
)


(1,299
)Net loss


























(5,719
)


(5,719
)


(5,719
)BALANCE, December 31, 2007


32,638


$
513,196






$



$



$
13,562


$
(378,556
)

$
148,202


$
988   See accompanying notes
 F-3




---



##### Table of Contents





CRAY INC.
    AND SUBSIDIARIES



CONSOLIDATED
    STATEMENTS OF CASH FLOWS

(In
    thousands)  Years Ended December 31,2007


2006


2005Operating activities:Net loss

$
(5,719
)

$
(12,070
)

$
(64,308
)Adjustments to reconcile net loss to net cash provided by (used
    in) operating activities:Depreciation and amortization


13,359



16,181



19,578Share-based compensation expense


3,189



2,099



4,106Inventory write-down


727



1,644



5,751Impairment of core technology intangible asset










4,912Amortization of issuance costs, convertible notes payable and
    line of credit


688



1,644



1,008Deferred income taxes


210



(124
)


(2,260
)Other










80Cash provided by (used in) due to changes in operating assets
    and liabilities:Accounts receivable


19,725



10,305



(21,623
)Inventory


(2,221
)


2,410



(10,628
)Prepaid expenses and other assets


(2,697
)


337



3,908Service inventory










141Accounts payable


(8,531
)


7,562



(8,422
)Accrued payroll and related expenses, other accrued liabilities
    and advance research and development payments


6,642



23,720



833Other non-current liabilities


(665
)


36



473Deferred revenue


13,943



(41,136
)


29,746Net cash provided by (used in) operating activities


38,650



12,608



(36,705
)Investing activities:Sales/maturities of short-term investments


27,894







44,437Purchases of short-term investments


(75,552
)






(10,161
)Proceeds from sale of investment






239



(Increase) decrease in restricted cash


15,000



(25,000
)


11,437Purchases of property and equipment


(2,768
)


(2,611
)


(3,982
)Net cash provided by (used in) investing activities


(35,426
)


(27,372
)


41,731Financing activities:Sale of common stock, net of issuance costs






81,250



Proceeds from issuance of common stock through employee stock
    purchase plan


453



532



1,211Proceeds from exercise of options


1,273



2,625



138Convertible notes payable and line of credit issuance costs






(375
)


(755
)Principal payments on capital leases


(31
)


(123
)


(731
)Net cash provided by (used in) financing activities


1,695



83,909



(137
)Effect of foreign exchange rate changes on cash and cash
    equivalents


292



157



(595
)Net increase in cash and cash equivalents


5,211



69,302



4,294Cash and cash equivalentsBeginning of period


115,328



46,026



41,732End of period

$
120,539


$
115,328


$
46,026Supplemental disclosure of cash flow information:Cash paid for interest

$
2,414


$
3,329


$
2,972Cash paid for income taxes


964



279



312Non-cash investing and financing activities:Inventory transfers to fixed assets and service inventory

$
4,684


$
4,860


$
8,703Shares issued for 401(k) match


925



394



770Warrants issued in connection with line of credit arrangement










219   See accompanying notes
 F-4




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
  NOTE 1
    DESCRIPTION
    OF BUSINESS      NOTE 2
    SUMMARY
    OF SIGNIFICANT ACCOUNTING POLICIES  Accounting
    Principles
    Principles
    of Consolidation
    Reclassifications
    Use of
    Estimates
    Cash,
    Cash Equivalents and Restricted Cash
  Note 14  Convertible Notes
    Payable and Lines of Credit
 F-5




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Short-term
    investments
    Foreign
    Currency Derivatives
    Concentration
    of Credit Risk
  Note 17  Segment Information
  Accounts
    Receivable
    Fair
    Values of Financial Instruments
   F-6




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Inventories
  first-in,
    Property
    and Equipment, net
    98-1, Accounting for the Costs of Computer Software Developed or
    Obtained for Internal Use
  Service
    Inventory
    Goodwill
    and Other Intangible Assets
  Goodwill and Other Intangible
    Assets
   F-7




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Impairment
    of Long-Lived Assets
  Accounting for the
    Impairment or Disposal of Long-Lived Assets
  Revenue
    Recognition
  Revenue Recognition in Financial
    Statements
  Multiple-Element Arrangements. No. 00-21, 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. 81-1, Accounting for Performance of Construction-Type and Certain
    Production-Type Contracts
 F-8




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      Services.
  Foreign
    Currency Translation
    Research
    and Development
       F-9




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      Income
    Taxes
  Accounting for Income Taxes
  Accounting
    for Uncertainty in Income Taxes  an interpretation of
    FASB Statement 109
  Share-Based
    Compensation
  Share-Based Payment Accounting for Stock Issued to
    Employees Accounting for
    Stock-Based Compensation
   F-10




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    2007

2006

2005Risk-free interest rate

4.4%

4.5%

4.1%Expected dividend yield

0%

0%

0%Volatility

72%

73%

85%Expected life

4.0 years

4.0 years

4.6 yearsWeighted average Black-Scholes value of options granted

$5.09

$6.00

$5.44           2005Net loss, as reported

$
(64,308
)Add:Stock-based employee compensation included in reported net loss,
    net of related tax effects


4,106Less:Amortized stock-based employee compensation expense determined
    under fair value based method for all awards, net of related tax
    effects


(30,524
)Pro forma net loss

$
(90,726
)  F-11




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Note 15  Shareholders
    Equity  Stock Option Plans.
    2005Basic and diluted net loss per common share:As reported

$
(2.91
)Pro forma

$
(4.10
)   Shipping
    and Handling Costs
    Advertising
    Costs
    Earnings (Loss) Per Share (EPS)
    Accumulated
    Other Comprehensive Income
    2007


2006


2005Accumulated unrealized net gain on available-for-sale investments

$
54


$



$
Accumulated unrealized net loss on cash flow hedges


(1,299
)






Accumulated currency translation adjustment


14,807



6,855



6,258Accumulated other comprehensive income

$
13,562


$
6,855


$
6,258   Recent
    Accounting Pronouncements
  Fair Value Measurements
 F-12




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    The
    Fair Value Option for Financial Assets and Financial
    Liabilities
  No. 07-3, Accounting for Nonrefundable Advance Payments for Goods or
    Services to be Used in Future Research and Development
    Activities (EITF 07-3), EITF 07-3 EITF 07-3
  No. 07-1, Accounting for Collaborative Arrangements (EITF 07-1), EITF 07-1 EITF 07-1
  Noncontrolling Interests in Consolidated Financial
    Statements  an amendment of Accounting Research
    Bulletin No. 51
  Business Combinations
  NOTE 3
    SHORT-TERM
    INVESTMENTS    Amortized


Gross


GrossCost


Unrealized


UnrealizedBasis


Gains


Losses


Fair ValueCorporate notes and bonds

$
43,364


$
46


$
(5
)

$
43,405Asset-backed securities


5,164



13







5,177Total short-term investments

$
48,528


$
59


$
(5
)

$
48,582  F-13




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      2008

$
39,6842009


3,7222010


2,1842011


2,992$
48,582   NOTE 4
    ACCOUNTS
    RECEIVABLE, NET    2007


2006Trade accounts receivable

$
11,569


$
39,766Unbilled receivables


5,627



4,045Advance billings


6,538



1,07823,734



44,889Allowance for doubtful accounts


(99
)


(99
)Accounts receivable, net

$
23,635


$
44,790       NOTE 5
    INVENTORY    December 31,2007


2006Components and subassemblies

$
20,814


$
22,536Work in process


15,839



15,310Finished goods


18,955



20,952$
55,608


$
58,798    F-14




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      NOTE 6
    PROPERTY
    AND EQUIPMENT, NET    December 31,2007


2006Land

$
131


$
131Buildings


10,022



9,965Furniture and equipment


12,232



14,753Computer equipment


76,634



73,825Leasehold improvements


2,959



3,060101,978



101,734Accumulated depreciation and amortization


(84,934
)


(80,170
)Property and equipment, net

$
17,044


$
21,564     NOTE 7
    SERVICE
    INVENTORY, NET    December 31,2007


2006Service inventory

$
28,890


$
28,797Accumulated depreciation


(25,904
)


(24,505
)Service inventory, net

$
2,986


$
4,292   NOTE 8
    GOODWILL
    AND INTANGIBLE ASSETS    2007


2006Goodwill, at January 1

$
57,138


$
56,839Foreign currency translation adjustments


8,273



299Goodwill, at December 31

$
65,411


$
57,138    F-15




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    NOTE 9
    DEFERRED
    REVENUE    December 31,2007


2006Deferred product revenue

$
28,592


$
26,993Deferred service revenue


31,470



18,730Total deferred revenue


60,062



45,723Less long-term deferred revenue


(11,745
)


(2,475
)Deferred revenue in current liabilities

$
48,317


$
43,248     NOTE 10
    RESTRUCTURING
    AND SEVERANCE CHARGES          2007


2006


2005Balance, January 1

$
1,063


$
3,582


$
4,690Additional restructuring charge






1,284



5,092Payments


(665
)


(3,849
)


(5,724
)Adjustments to previously accrued amounts


(48
)


(33
)


(255
)Foreign currency translation adjustment


11



79



(221
)Total restructuring and severance liability, December 31


361



1,063



3,582Less long-term restructuring and severance liability


(203
)






(362
)Current restructuring and severance liability

$
158


$
1,063


$
3,220    F-16




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  NOTE 11
    FOREIGN
    CURRENCY DERIVATIVES    NOTE 12
    COMMITMENTS
    AND CONTINGENCIES      Operating


DevelopmentLeases


Agreements2008

$
2,798


$
22,7932009


1,106



4,1372010


519



2,1102011


430



2012


244



Thereafter


1,153



Minimum contractual commitments

$
6,250


$
29,040   Convertible Notes Payable and Lines of Credit
    Litigation
    Other
   F-17




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    NOTE 13
    INCOME
    TAXES  Accounting for Income Taxes
    Year Ended December 31,2007


2006


2005United States

$
(7,658
)

$
(10,550
)

$
(63,304
)International


3,113



(918
)


(2,492
)Total

$
(4,545
)

$
(11,468
)

$
(65,796
)     Year Ended December 31,2007


2006


2005Current provision:Federal

$



$



$
State


35



109



128Foreign


929



617



644Total current provision


964



726



772Deferred provision (benefit):Federal










State










Foreign


210



(124
)


(2,260
)Total deferred provision (benefit)


210



(124
)


(2,260
)Total provision (benefit) for income taxes

$
1,174


$
602


$
(1,488
)  F-18




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    2007


2006


2005Federal statutory income tax rate


(35.0
)%


(35.0
)%


(35.0
)%State taxes, net of federal benefit


(6.3
)


(3.6
)


(3.1
)Foreign income taxes


(0.3
)


5.0



1.0Deemed dividends for U.S. income tax purposes


23.7



4.5



0.9Meals and entertainment expense


2.2



1.3



0.2Nondeductible expenses


3.1



2.4



0.4Research and development tax credit


(17.5
)


(7.6
)


(2.1
)Other


0.3



(4.5
)


(0.4
)Effect of change in valuation allowance on deferred tax assets


55.6



42.7



35.8Effective income tax rate


25.8
%


5.2
%


(2.3
)%     December 31,2007


2006Current:Deferred Income Tax AssetsInventory

$
2,421


$
2,610Accrued compensation


2,741



4,292Deferred service revenue


1,369



815Gross current deferred tax assets


6,531



7,717Valuation allowance


(6,531
)


(7,717
)Net current deferred tax assets

$
0


$
0Long-Term:Deferred Income Tax Assets:Property and equipment


2,625



455Research and experimentation credit carryforwards


13,209



12,587Net operating loss carryforwards


118,056



117,454Accrued restructuring charge






240Other


2,853



518Gross long-term deferred tax assets


136,743



131,254Valuation allowance


(134,259
)


(130,532
)Net long-term deferred tax assets


2,484



722Deferred Income Tax Liabilities:Amortization


(637
)


Other


(1,335
)


Net long-term deferred tax liabilities


(1,972
)


Net long-term deferred tax asset

$
512


$
722  F-19




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
          Balance at January 1, 2007

$
480Increase related to current year income tax positions


510Balance at December 31, 2007

$
990     NOTE 14  CONVERTIBLE
    NOTES PAYABLE AND LINES OF CREDIT
         F-20




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
        Lines of
    Credit
    NOTE 15  SHAREHOLDERS
    EQUITY
  Preferred Stock:
  Common Stock:
 F-21




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Form 10-K
  Exchangeable Shares:
  Shareholder Warrants:
    Restricted Stock:
  Stock Option Plans:
  Accounting for Certain
    Transactions Involving Stock Compensation
 F-22




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
        WeightedAverage


Remaining


AggregateExercise


Contractual


IntrinsicOptions


Price


Term


ValueOutstanding at January 1, 2005


3,571,098


$
20.64Granted


1,278,567



8.56Exercised


(22,295
)


6.24Canceled


(327,225
)


16.60Outstanding at December 31, 2005(a)


4,500,145



16.56Granted


725,430



10.44Exercised


(381,890
)


6.87Canceled


(976,270
)


23.25Outstanding at December 31, 2006


3,867,415



14.68Granted


60,500



8.80Exercised


(163,189
)


7.80Canceled


(435,928
)


16.44Outstanding at December 31, 2007


3,328,798



14.68



6.2 years


$
200,000Exercisable at December 31, 2007


2,767,801



15.56



5.6 years


$
200,000Available for grant at December 31, 2007


2,600,506     (a)
    
    The weighted average exercise price of outstanding options at
    December 31, 2005 includes the impact of the 2005 repricing
    of 318,565 options, as described above.   F-23




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      WeightedAverageGrant DateShares


Fair ValueOutstanding at January 1, 2005


0


$
Granted during 2005


491,250



5.96Outstanding at December 31, 2005


491,250



5.96Granted during 2006


354,993



10.08Outstanding at December 31, 2006


846,243



7.69Granted during 2007


65,501



7.51Forfeited during 2007


(7,900
)


10.56Vested during 2007


(527,638
)


6.10Outstanding at December 31, 2007


376,206



9.82         Outstanding Options


Exercisable OptionsWeighted


Weighted





WeightedAverage


Average





AverageRange of Exercise

Number


Remaining


Exercise


Number


ExercisePrices per Share

Outstanding


Life (Years)


Price


Exercisable


Price$ 0.00  $ 4.00


83,779



7.6


$
3.79



83,779


$
3.79$ 4.01  $ 8.00


724,875



6.0


$
6.30



685,634


$
6.25$ 8.01  $10.00


236,146



6.0


$
9.34



223,748


$
9.37$10.01  $12.00


982,292



7.6


$
10.70



477,934


$
10.80$12.01  $14.00


193,206



6.5


$
13.64



188,206


$
13.68$14.01  $16.00


352,725



5.8


$
14.84



352,725


$
14.84$16.01  $32.00


449,599



3.9


$
25.21



449,599


$
25.21$32.01  $54.75


306,176



4.9


$
39.17



306,176


$
39.17$ 0.00  $54.75


3,328,798



6.2


$
14.68



2,767,801


$
15.56  F-24




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    2007


2006


2005Cost of product revenue

$
86


$
60


$
Cost of service revenue


143



101



Research and development


1,085



386



3,444Sales and marketing


422



334



579General and administrative


1,453



1,218



83Total share-based compensation expense

$
3,189


$
2,099


$
4,106   Employee Stock Purchase Plan:
  NOTE 16  BENEFIT
    PLANS
  401(k)
    Plan
  and/or and/or
  Pension
    Plan
  Employers Accounting for Defined Benefit Pension
    and Other Postretirement Plans  an amendment of FASB
    Statements No. 87, 88, 106, and 132(R)
  NOTE 17
    SEGMENT
    INFORMATION   F-25




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      AllUnited


OtherStates


Countries


TotalFor the year ended December 31, 2007:Product revenue

$
83,704


$
49,751


$
133,455Service revenue

$
31,724


$
20,974


$
52,698Long-lived assets

$
35,012


$
57,894


$
92,906For the year ended December 31, 2006:Product revenue

$
76,370


$
86,425


$
162,795Service revenue

$
37,979


$
20,243


$
58,222Long-lived assets

$
41,554


$
49,155


$
90,709For the year ended December 31, 2005:Product revenue

$
104,274


$
47,824


$
152,098Service revenue

$
33,377


$
15,576


$
48,953Long-lived assets

$
50,464


$
50,255


$
100,719      F-26




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  NOTE 18
    RESEARCH
    AND DEVELOPMENT    December 31,2007


2006


2005Gross research and development expenses

$
90,090


$
99,061


$
96,257Less: Amounts reimbursed or included in cost of product revenue


(52,207
)


(70,019
)


(54,546
)Net research and development expenses

$
37,883


$
29,042


$
41,711   NOTE 19
    INTEREST
    INCOME (EXPENSE)    2007


2006


2005Interest income

$
7,046


$
2,525


$
741Interest expense


(3,206
)


(4,620
)


(4,203
)Net interest income (expense)

$
3,840


$
(2,095
)

$
(3,462
)       NOTE 20
    RELATED
    PARTY TRANSACTION    NOTE 21
    QUARTERLY
    DATA (UNAUDITED)     F-27




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##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    2007


2006For the Quarter Ended

3/31


6/30


9/30


12/31


3/31


6/30


9/30


12/31Revenue

$
47,109


$
26,625


$
54,989


$
57,430


$
48,515


$
38,513


$
32,565


$
101,424Cost of revenue


31,575



15,887



32,840



40,420



34,370



26,000



21,169



75,655Gross margin


15,534



10,738



22,149



17,010



14,145



12,513



11,396



25,769Research and development, net


7,880



8,859



9,067



12,077



7,215



6,371



9,692



5,764Sales and marketing


5,268



5,123



5,423



6,323



4,985



5,682



4,924



6,386General and administrative


4,280



3,822



3,340



3,514



5,594



4,600



4,134



4,457Restructuring, severance and impairment


10











(58
)


738



549



3



(39
)Net income (loss)


(841
)


(6,384
)


5,101



(3,595
)


(5,305
)


(7,173
)


(8,324
)


8,732Net income (loss) per common share, basic

$
(0.03
)

$
(0.20
)

$
0.16


$
(0.11
)

$
(0.24
)

$
(0.32
)

$
(0.37
)

$
0.36Net income (loss) per common share, diluted

$
(0.03
)

$
(0.20
)

$
0.16


$
(0.11
)

$
(0.24
)

$
(0.32
)

$
(0.37
)

$
0.33    F-28




---



##### Table of Contents



REPORT OF
    INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM             Internal Control  Integrated
    Framework
   
    F-29




---



##### Table of Contents



Schedule II 
    Valuation and Qualifying Accounts
    December 31, 2007
    (In Thousands)
  Balance at








Balance atBeginning


Charge/(Benefit)





End ofDescription

of Period


to Expense


Deductions


PeriodYear ended December 31, 2005:Allowance for doubtful accounts

$
1,439


$
165


$
(1,411
)(1)

$
193Warranty accrual

$



$



$



$
Year ended December 31, 2006:Allowance for doubtful accounts

$
193


$
(17
)

$
(77
)(1)

$
99Warranty accrual

$



$



$



$
Year ended December 31, 2007:Allowance for doubtful accounts

$
99


$
327


$
(327
)(1)

$
99Warranty accrual

$



$



$



$
     (1)
    
    Represents uncollectible accounts written off, net of recoveries. F-30