##### 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, 2006o

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: NONE
   Securities Registered Pursuant to Section 12(g) of the
    Exchange Act:
 Common Stock, $.01 par value
  o þ
  o þ
  þ o
  Regulation S-K 10-K Form 10-K þ
  Rule 12b-2
 o þ o
  Rule 12b-2 o þ
      DOCUMENTS
    INCORPORATED BY REFERENCE




---



##### 



CRAY
    INC.
  FORM 10-K
 For Fiscal Year Ended December 31, 2006
  INDEX
  
  PagePART IItem 1.

Business


1Item 1A.

Risk
    Factors


14Item 1B.

Unresolved Staff
    Comments


24Item 2.

Properties


24Item 3.

Legal
    Proceedings


24Item 4.

Submission of
    Matters to a Vote of Security Holders


24Item E.O.

Executive Officers
    of the Company


25PART IIItem 5.

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


27Item 6.

Selected Financial
    Data


30Item 7.

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


31Item 7A.

Quantitative and
    Qualitative Disclosures About Market Risk


44Item 8.

Financial
    Statements and Supplementary Data


46Item 9.

Changes in and
    Disagreements with Accountants on Accounting and Financial
    Disclosure


47Item 9A.

Controls and
    Procedures


47Item 9B.

Other
    Information


49PART IIIItem 10.

Directors,
    Executive Officers and Corporate Governance


50Item 11.

Executive
    Compensation


50Item 12.

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


50Item 13.

Certain
    Relationships and Related Transactions, and Director
    Independence


50Item 14.

Principal
    Accountant Fees and Services


50PART IVItem 15.

Exhibits and
    Financial Statement Schedules


51EXHIBIT 10.11EXHIBIT 10.42EXHIBIT 21.1EXHIBIT 23.1EXHIBIT 23.2EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1          Form 10-K, one-for-four




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##### Table of Contents



Forward-Looking
    Statements
  Form 10-K
  Form 10-K,
   PART I  Item 1.
    Business  General
         1




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##### Table of Contents



98104-2860, (206) 701-2000 Form 10-K
  Our
    History
      Cray
    Research Acquisition
    Post-Acquisition
    Developments
         2




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##### Table of Contents



Industry
    Background
    The
    HPC Market
  Worldwide and U.S. Server
    2006-2010
    Forecast Worldwide Technical Computing Systems
    2006-2010
    Forecast sub-sector
     3




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Increasing
    Demand for Supercomputing Power
      time-to-market,
      Limitations
    of Existing and Emerging Solutions
     4




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Our
    Roadmap
        
    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 proprietary processors and
    interconnect systems;
    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.   5




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##### Table of Contents



Our
    Target Market and Customers
    National Security.
  Scientific Research.
  Earth Sciences.
  Computer-Aided Engineering. time-to-market
    Recent
    Customer Contract Wins
    High End Computing Terascale Resources project,
 6




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The Engineer Research and Development Center
    (ERDC)
  CSC Finland (CSC-F)
  National Energy Research Scientific Computing Center
    (NERSC)
  Oak Ridge National Laboratory (ORNL),
  Current
    Products and Products in Development
  and/or
 7




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##### Table of Contents



FirstCustomer

Processor

Market

RepresentativeShipment

Technology

Segment

ApplicationsCurrent ProductsCray XT4

Q4 2006

AMD Opteron
    Dual and
    Quad-Core

Capability and
    Enterprise

Scientific research; nuclear
    stockpile stewardship; defense; structural engineering;
    computer-aided engineeringCray XT3

Q4 2004

AMD Opteron
    Single and
    Dual-Core

Capability and
    Enterprise

Scientific research; nuclear
    stockpile stewardship; defense; structural engineeringCray X1E

Q4 2004

Custom  
    Vector

Capability

National security; earth science;
    aerospace designCray XD1

Q3 2004

AMD Opteron 
    Single and 
    Dual-Core

Enterprise and 
    lower

Crash testing; computational fluid
    dynamics; image processingIn DevelopmentBlackWidow

Expected
    late 2007

Custom  
    Vector

Capability

National security; earth science;
    computational fluid dynamicsCray XMT

Expected
    late 2007

Custom  
    Multithreaded

Capability and 
    Data Analysis

National security; large,
    unstructured data sets; graph algorithmsBaker

Expected
    2009

AMD Opteron 
    Multi-Core

Capability and 
    Enterprise

Scientific research; nuclear
    stockpile stewardship; defense; structural engineering;
    computer-aided engineering   Current
    Products
  Cray XT4 System. field-upgradeable
  Cray XT3 System.
  Cray X1E System.
 8




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##### Table of Contents



Cray XD1 System.
  Products
    in Development
  BlackWidow.
  Cray XMT.
  Baker. and/or
  Our
    Adaptive Supercomputing Vision and Cascade Program
       9




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Technology
    Architecture
            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.   10




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Software
    
    Operating Systems. For our Cray XT3, Cray XT4 and Cray XD1
    systems, we make use of and enhance commercially available
    versions of the Linux operating system. Additionally, on our
    Cray XT3, Cray XT4 and BlackWidow systems, we developed and
    support a lightweight kernel for the compute resources. On the
    Cray X1E and Cray XMT systems, we utilize and support separate
    UNIX-based operating systems. In the future, we anticipate that
    all of our systems will exploit the Linux operating system for
    all node architectures.
    Hardware Supervisory Systems (HSS). For all of our
    systems, we provide a scalable hardware control infrastructure
    for managing hardware, including power control, monitoring of
    environmental data and hardware diagnostics. In the future, we
    anticipate providing a common HSS infrastructure for all of our
    systems.
    Programming Environment. For our Cray XT3, Cray XT4 and Cray XD1
    systems, we use commercially available compilers, libraries and
    tools. We also provide Cray developed libraries and tools that
    make our systems easier to optimize and more robust. For our
    Cray X1E, BlackWidow and Cray XMT systems, we develop our own
    compilers, libraries and tools.      Services
    two-hour
  project-by-project
  Sales and
    Marketing
     11




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Intellectual
    Property
          Manufacturing
    and Procurement
  build-to-order and/or
   12




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Competition
          Employees
    Available
    Information
  Form 10-K, Form 10-Q, Form 8-K
 13




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##### Table of Contents



Item 1A.
    Risk
    Factors.    Our operating results may fluctuate significantly and we may
    not achieve profitability in any given
    period.
      
    successfully selling the Cray XT4 system, including upgrades and
    successor systems, and new products based on our BlackWidow
    project and Cray XMT system, and the timing and funding of
    government purchases, especially in the United States;
    the level of revenue recognized in any given period,
    particularly with very high average sales prices and limited
    number of system sales in any quarter, the timing of product
    acceptances by customers and contractual provisions affecting
    the timing of revenue recognition;
    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;
    maintaining our product development projects on schedule and
    within budgetary limitations;
    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;
    our expense levels, including research and development net of
    government funding, which may be affected by the level and
    timing of such funding;
    the terms and conditions of sale or lease for our products; and
    the impact of expensing our share-based compensation under
    Financial Accounting Standards Board (FASB)
    Statement No. 123(R), Share-Based Payment(FAS 123R). 14




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##### Table of Contents




    the timely availability of acceptable components in sufficient
    quantities to meet customer delivery schedules;
    the timing and level of government funding for product
    acquisitions and research and development contracts;
    the availability of adequate customer facilities to install and
    operate new Cray systems;
    general economic trends, including changes in levels of customer
    capital spending;
    the introduction or announcement of competitive products;
    currency fluctuations, international conflicts or economic
    crises; and
    the receipt and timing of necessary export licenses.    Failure to sell Cray XT4 systems in planned quantities and at
    expected gross margins could adversely affect revenue and
    operating results in 2007 and future periods.
    Our inability to complete the development of our Cray XMT and
    BlackWidow supercomputer systems would adversely affect our
    revenue and operating results in 2007. and/or
 15




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Our reliance on third-party suppliers poses significant risks
    to our business and prospects.
  
    if a supplier does not provide components that meet our
    specifications in sufficient quantities on time, then production
    and sales of our systems would be delayed, adversely affecting
    revenue and cash flow  these risks are accentuated
    during steep production ramp periods as we introduce new or
    successor products;
    if an interruption of supply of our components occurs, because
    of a significant problem with a supplier providing parts that
    later prove to be defective or because a single-source supplier
    imposes allocations on its customers, decides to no longer
    provide those components to us or increases the price of those
    parts significantly, it could take us a considerable period of
    time to identify and qualify alternative suppliers, to redesign
    our products as necessary and to begin manufacture of the
    redesigned components. In some cases, we may not be able to
    redesign such components. Defective components may need to be
    replaced, which may result in increased costs and obsolete
    inventory. See also the Risk Factor captioned We face
    last-time buy decisions affecting all of our current products,
    which may adversely affect our revenue and operating
    results, below;
    if a supplier cannot provide a competitive key component, our
    systems may be less competitive than systems using components
    with greater capability; and
    some of our key suppliers are small companies with limited
    financial and other resources, and consequently may be more
    likely to experience financial and operational difficulties than
    are larger, well-established companies.      If the U.S. government purchases fewer supercomputers,
    our revenue would be reduced and our operating results would be
    adversely affected.
 16




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If we lose government support for development of our
    supercomputer systems, our net research and development
    expenditures and capital requirements would increase and our
    ability to conduct research and development would
    decrease.
  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. and/or and/or
  The achievement of our business plan is highly dependent on
    increased product revenue and margins.
 17




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We face last-time buy decisions affecting all of our current
    products, which may adversely affect our revenue and operating
    results.
  If we are unable to compete successfully in the HPC market,
    our revenue will decline.
       18




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Phase III of the DARPA HPCS program will affect our
    operations.
  Our stock price is volatile.
  If we cannot retain, attract and motivate key personnel, we
    may be unable to effectively implement our business
    plan.
  Lower than anticipated sales of new supercomputers and the
    termination of maintenance contracts on older
    and/or
    decommissioned systems may reduce our service revenue and
    margins from maintenance service contracts.
  Expansion of our Technical Services efforts could reduce our
    service margins. project-by-project
 19




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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.
  U.S. export controls could hinder our ability to make
    sales to foreign customers and our future
    prospects.
  We incorporate software licensed from third parties into the
    operating systems for our products and any significant
    interruption in the availability of these third-party software
    products or defects in these products could reduce the demand
    for our products.
  and/or
 20




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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. Form 10-K.
    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 in planning for, or reacting to, changes
    in our business, including merger and acquisition opportunities;
    place us at a competitive disadvantage compared to competitors
    that have less indebtedness; and
    limit our ability to borrow additional funds that may be needed
    to operate and expand our business.  We may not have the funds necessary to purchase the Notes
    upon a fundamental change or other purchase date and our ability
    to purchase the Notes in such events may be
    limited.
 21




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We will require a significant amount of cash to repay our
    indebtedness and to fund planned capital expenditures, research
    and development efforts and other corporate
    expenses.
  and/or
    New environmental rules in Europe and other jurisdictions may
    adversely affect our operations.
   22




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We may not be able to protect our proprietary information and
    rights adequately.
  A substantial number of our shares are eligible for future
    sale and may depress the market price of our common stock and
    may hinder our ability to obtain additional
    financing.
  
    32,236,888 shares of common stock;
    1,334,852 shares of common stock issuable upon exercise of
    warrants;
    3,867,415 shares of common stock issuable upon exercise of
    options, of which options to purchase 3,144,887 shares of
    common stock were then exercisable; and
    Notes convertible into an aggregate of 4,144,008 shares of
    common stock or, under certain circumstances specified in the
    indenture governing the Notes, a maximum of
    5,698,006 shares of common stock.  lock-up
    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.
 23




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##### Table of Contents




    removal of a director only in limited circumstances and only
    upon the affirmative vote of not less than two-thirds of the
    shares entitled to vote to elect directors;
    the ability of our board of directors to issue preferred stock,
    without shareholder approval, with rights senior to those of the
    common stock;
    no cumulative voting of shares;
    the right of shareholders to call a special meeting of the
    shareholders only upon demand by the holders of not less than
    30% of the shares entitled to vote at such a meeting;
    the affirmative vote of not less than two-thirds of the
    outstanding shares entitled to vote on an amendment, unless the
    amendment was approved by a majority of our continuing
    directors, who are defined as directors who have either served
    as a director since August 31, 1995, or were nominated to
    be a director by the continuing directors;
    special voting requirements for mergers and other business
    combinations, unless the proposed transaction was approved by a
    majority of continuing directors;
    special procedures to bring matters before our shareholders at
    our annual shareholders meeting; and
    special procedures to nominate members for election to our board
    of directors.    Item 1B.
    Unresolved
    Staff Comments    Item 2.
    Properties    ApproximateLocation of Property

Uses of Facility

Square FootageChippewa Falls, WI

Manufacturing, hardware
    development, central service and warehouse


227,800Seattle, WA

Executive offices, hardware and
    software development, sales and marketing


59,600Mendota Heights, MN

Software development, sales and
    marketing


55,300       Item 3.
    Legal
    Proceedings  Form 10-Q
  Item 4.
    Submission
    of Matters to a Vote of Security Holders   24




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##### Table of Contents



Item E.O.
    Executive
    Officers of the Company    Name

Age

PositionPeter J. Ungaro


38


Chief Executive Officer and
    PresidentBrian C. Henry


50


Executive Vice President and Chief
    Financial OfficerChristopher Jehn


63


Vice PresidentKenneth W. Johnson


64


Senior Vice President, General
    Counsel and Corporate SecretarySteven L. Scott


40


Senior Vice President and Chief
    Technology OfficerJan C. Silverman


56


Senior Vice PresidentMargaret A. Williams


48


Senior Vice President     Peter J. Ungaro
  Brian C. Henry e-markets
  Christopher Jehn
  Kenneth W. Johnson
  Steven L. Scott
 25




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##### Table of Contents



Jan C. Silverman
  Margaret A. Peg Williams
 26




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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,
    2005:First Quarter

$
19.64


$
8.32Second Quarter

$
11.00


$
4.72Third Quarter

$
5.64


$
3.40Fourth Quarter

$
6.92


$
3.56Year Ended December 31,
    2006:First Quarter

$
10.16


$
5.20Second Quarter

$
10.16


$
5.88Third Quarter

$
14.36


$
9.95Fourth Quarter

$
13.45


$
8.36     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)


3,078,389


$
15.78



2,680,895Equity compensation plans not
    approved by shareholders (2)


789,026


$
10.37



112,323Total


3,867,415


$
14.68



2,793,218     (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 vest monthly over the twelve months after
    grant. In 2005, the vesting of all employee stock options with
    per share exercise prices 27




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##### Table of Contents



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, 2006, under
    these option and equity compensation plans approved by
    shareholders under which we may grant stock options, an
    aggregate of 2,207,605 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 1,522,006 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, 2006, we had issued
    a total of 526,710 shares under the 2001 plan and had a
    total of 473,290 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, 2006 and will end on
    March 15, 2007, as neither the number of shares to be
    issued in that offering period nor the offering price are 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, 2006, under the 2000 non-executive employee
    stock plan we had options for 731,342 shares outstanding
    and options for 112,323 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 57,684
    options outstanding as of December 31, 2006.From time to time we have issued warrants as compensation to
    consultants and others for services without shareholder
    approval. As of December 31, 2006, we had no such warrants
    outstanding.  Unregistered
    Sales of Securities
    Issuer
    Repurchases
   28




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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,
    2006
  
  12/31/01


12/31/02


12/31/03


12/31/04


12/30/05


12/29/06Cray Inc.



100.0




410.2




531.0




249.2




71.1




158.8Nasdaq Stock Market (U.S.)



100.0




69.1




103.4




112.5




114.9




126.2Nasdaq Computer Manufacturer Stocks



100.0




66.3




92.2




120.5




123.3




126.3  29




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##### Table of Contents



Item 6.
    Selected
    Financial Data    Year Ended December 31,2002


2003


2004


2005


2006(In thousands, except for per share data)Operating Data:Product revenue

$
76,519


$
175,004


$
95,901


$
152,098


$
162,795Service revenue


78,550



61,958



49,948



48,953



58,222Total revenue


155,069



236,962



145,849



201,051



221,017Cost of product revenue


41,187



97,354



104,196



139,518



124,728Cost of service revenue


42,581



40,780



30,338



29,032



32,466Total cost of revenue


83,768



138,134



134,534



168,550



157,194Gross margin


71,301



98,828



11,315



32,501



63,823Research and development, net


32,861



37,762



53,266



41,711



29,042Sales and marketing


20,332



27,038



34,948



25,808



21,977General and administrative


8,923



10,908



19,451



16,145



18,785Restructuring, severance and
    impairment


1,878



4,019



8,182



9,750



1,251In-process research and
    development charge










43,400







Income (loss) from operations


7,307



19,101



(147,932
)


(60,913
)


(7,232
)Other income (expense), net


3,104



1,496



(699
)


(1,421
)


(2,141
)Interest income (expense), net


(2,832
)


444



365



(3,462
)


(2,095
)Income (loss) before income taxes


7,579



21,041



(148,266
)


(65,796
)


(11,468
)Provision (benefit) for income
    taxes


2,176



(42,207
)


59,092



(1,488
)


602Net income (loss)

$
5,403


$
63,248


$
(207,358
)

$
(64,308
)

$
(12,070
)Net income (loss) per common shareBasic

$
0.45


$
3.77


$
(9.95
)

$
(2.91
)

$
(0.53
)Diluted

$
0.40


$
3.25


$
(9.95
)

$
(2.91
)

$
(0.53
)Weighted average outstanding sharesBasic


11,992



16,775



20,847



22,125



22,849Diluted


13,604



19,465



20,847



22,125



22,849Cash Flow Data:Cash provided by (used in):Operating activities

$
(8,689
)

$
(8,713
)

$
(52,656
)

$
(36,705
)

$
12,608Investing activities


(5,992
)


(41,169
)


(29,908
)


41,731



(27,372
)Financing activities


25,335



65,079



84,153



(137
)


83,909Depreciation and amortization


15,364



15,860



17,179



19,578



16,181Purchases of property and equipment


6,038



6,599



12,518



3,982



2,611 30




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##### Table of Contents



Year Ended December 31,2002


2003


2004


2005


2006(In thousands, except for per share data)Balance Sheet Data:Cash, cash equivalents, restricted
    cash and short-term investments

$
23,916


$
74,343


$
87,422


$
46,026


$
140,328Working capital(a)


27,351



115,815



93,616



52,204



136,324Total assets


145,245



291,589



310,504



273,005



337,503Obligations under capital leases


393



152



823



154



31Total debt


4,144







80,000



80,000



80,000Shareholders equity


58,615



222,633



121,965



65,947



141,374     (a)
    
    Working capital is calculated by subtracting current liabilities
    from current assets.  Item 7.
    Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations  Forward-Looking
    Statements
    Overview
    and Executive Summary
        Summary
    of 2006 Results
   31




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##### Table of Contents



Market
    Overview and Challenges
      Our
    Strategy
    Gain Share in Our Core HPC Market.
  Maintain Focus on Execution and
    Profitability.
  Extend Technology Leadership.
  Expand Total Addressable Market.
 32




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##### 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 3  Summary of Significant Accounting
    Policies
 33




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##### Table of Contents



Revenue
    Recognition
  Revenue Recognition in Financial
    Statements
  Products.
  
    Cray X1/X1E and Cray XT3/XT4 Product Lines.  We
    recognize revenue from product sales upon customer acceptance of
    the system, when we have no significant unfulfilled obligations
    stipulated by the contract that affect the customers final
    acceptance, the price is fixed or determinable and collection is
    reasonably assured. A customer-signed notice of acceptance or
    similar document is required from the customer prior to revenue
    recognition.
    Cray XD1 Product Line.  We recognize revenue
    from product sales of Cray XD1 systems upon shipment to, or
    delivery to, the customer, depending upon contract terms, when
    we have no significant unfulfilled obligations stipulated by the
    contract, the price is fixed or determinable and collection is
    reasonably assured. If there is a contractual requirement for
    customer acceptance, revenue is recognized upon receipt of the
    notice of acceptance and when we have no unfulfilled obligations.  81-1, Accounting for Performance of Construction-Type and Certain
    Production-Type Contracts.
  Services.
 34




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##### Table of Contents



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.    Inventory
    Valuation
      Goodwill
    and Other Intangible Assets
   35




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##### Table of Contents



Accounting
    for Income Taxes
  Accounting for Income Taxes (FAS 109),
      Accounting
    for Loss Contracts
   36




---



##### Table of Contents



Research
    and Development Expenses
          Share-Based
    Compensation
  Accounting
    for Stock Issued to Employees Accounting for Stock-Based Compensation
      Recent
    Accounting Pronouncements
  Accounting for Uncertainty in Income Taxes
 37




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##### Table of Contents



Fair Value Measurements
  Employers Accounting for Defined Benefit Pension and
    Other Postretirement Plans
  The
    Fair Value Option for Financial Assets and Financial
    Liabilities
  Results
    of Operations
  Revenue
    and Gross Margins
    Year Ended December 31,2004


2005


2006Product revenue

$
95,901


$
152,098


$
162,795Less: Cost of product revenue


104,196



139,518



124,728Product gross margin

$
(8,295
)

$
12,580


$
38,067Product gross margin percentage


(9)%



8%



23%Service revenue

$
49,948


$
48,953


$
58,222Less: Cost of service revenue


30,338



29,032



32,466Service gross margin

$
19,610


$
19,921


$
25,756Service gross margin percentage


39%



41%



44%Total revenue

$
145,849


$
201,051


$
221,017Less: Total cost of revenue


134,534



168,550



157,194Total gross margin

$
11,315


$
32,501


$
63,823Total gross margin percentage


8%



16%



29%   Product
    Revenue
   38




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##### Table of Contents



Service
    Revenue
      Product
    Gross Margin
           39




---



##### Table of Contents



Service
    Gross Margin
        Operating
    Expenses
  Research
    and Development
    December 31,2004


2005


2006Gross research and development
    expenses

$
98,843


$
96,257


$
99,061Less: Amounts included in cost of
    product revenue


(22,970
)


(19,724
)


(17,012
)Less: Reimbursed research and
    development (excludes amounts in revenue)


(22,607
)


(34,822
)


(53,007
)Net research and development
    expenses

$
53,266


$
41,711


$
29,042Percentage of total revenue


37%



21%



13%          40




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##### Table of Contents



Other
    Operating Expenses
    Year Ended December 31,2004


2005


2006Sales and marketing

$
34,948


$
25,808


$
21,977Percentage of total revenue


24%



13%



10%General and administrative

$
19,451


$
16,145


$
18,785Percentage of total revenue


13%



8%



8%Restructuring, severance and
    impairment

$
8,182


$
9,750


$
1,251Percentage of total revenue


6%



5%



<1%   Sales and Marketing.
      General and Administrative.
  reduction-in-force,
    Restructuring, Severance and
    Impairment.
      In-Process
    Research and Development Charge
   41




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##### Table of Contents



Other
    Income (Expense), Net
    Interest
    Income (Expense), Net
    Year Ended December 31,2004


2005


2006Interest income

$
666


$
741


$
2,525Interest expense


(301
)


(4,203
)


(4,620
)Net interest income (expense)

$
365


$
(3,462
)

$
(2,095
)       Taxes
          Net
    Income (Loss)
       42




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##### Table of Contents



year-over-year
  Liquidity
    and Capital Resources
           43




---



##### Table of Contents



Amounts Committed by YearLess ThanContractual Obligations

Total


1 Year


1-3 Years


3-5 Years


ThereafterDevelopment agreements

$
12,965


$
12,922


$
43


$



$
Capital lease obligations


32



32











Operating leases


7,016



3,215



3,369



410



22Total contractual cash obligations

$
20,013


$
16,169


$
3,412


$
410


$
22       quarter-to-quarter
    Item 7A.
    Quantitative
    and Qualitative Disclosures About Market Risk    Interest Rate Risk:
 44




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##### Table of Contents



Foreign Currency Risk:
 45




---



##### Table of Contents



Item 8.
    Financial
    Statements and Supplementary Data  INDEX TO
    FINANCIAL STATEMENTS*
  Consolidated
    Balance Sheets at December 31, 2005 and December 31,
    2006


F- 1Consolidated
    Statements of Operations for the years ended December 31,
    2004, 2005 and 2006


F- 2Consolidated
    Statements of Shareholders Equity and Comprehensive Income
    (Loss) for the years ended December 31, 2004, 2005 and
    2006


F- 3Consolidated
    Statements of Cash Flows for the years ended December 31,
    2004, 2005 and 2006


F- 4Notes to
    Consolidated Financial Statements


F- 5Reports of
    Independent Registered Public Accounting Firms


F-29     *
    
    The Financial Statements are located following page 57. 46




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##### Table of Contents



QUARTERLY
    FINANCIAL DATA
    (Unaudited, in thousands, except per share data)
  Quarter-to-quarter
  Form 10-K
  2005


2006For the Quarter Ended

3/31


6/30


9/30


12/31


3/31


6/30


9/30


12/31Revenue

$
37,634


$
53,419


$
44,741


$
65,257


$
48,515


$
38,513


$
32,565


$
101,424Cost of revenue


33,927



48,741



36,551



49,331



34,370



26,000



21,169



75,655Gross margin


3,707



4,678



8,190



15,926



14,145



12,513



11,396



25,769Research and development, net


13,032



13,427



6,472



8,780



7,215



6,371



9,692



5,764Sales and marketing


6,599



7,574



5,778



5,857



4,985



5,682



4,924



6,386General and administrative


4,267



4,607



3,617



3,654



5,594



4,600



4,134



4,457Restructuring, severance and
    impairment


(215
)


1,947



1,201



6,817



738



549



3



(39
)Net income (loss)


(21,035
)


(23,796
)


(10,250
)


(9,227
)


(5,305
)


(7,173
)


(8,324
)


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

$
(0.95
)

$
(1.08
)

$
(0.46
)

$
(0.42
)

$
(0.24
)

$
(0.32
)

$
(0.37
)

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

$
(0.95
)

$
(1.08
)

$
(0.46
)

$
(0.42
)

$
(0.24
)

$
(0.32
)

$
(0.37
)

$
0.33         Item 9.
    Changes
    in and Disagreements with Accountants on Accounting and
    Financial Disclosure    Item 9A.
    Controls
    and Procedures  Disclosure
    Controls and Procedures
   47




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##### Table of Contents



Changes
    in Internal Control over Financial Reporting
  Form 10-K/A, Form 10-Q
  Form 10-K.
    Managements
    Report on Internal Control Over Financial
    Reporting
  Rule 13a-15(f)
          REPORT OF
    INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
     Internal Control 
    Integrated Framework
 48




---



##### Table of Contents



Internal
    Control  Integrated Framework Internal Control  Integrated
    Framework
    Peterson
    Sullivan PLLC
     Item 9B.
    Other
    Information   49




---



##### Table of Contents



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   50




---



##### Table of Contents



PART IV  Item 15.
    Exhibits
    and Financial Statement Schedules  Financial Statements
              Financial Statement Schedules
  Form 10-K.
    Exhibits
  Form 10-K.
 51




---



##### Table of Contents



SIGNATURES
      By
    /s/  Peter
    J. Ungaro   Chief Executive Officer and President
  attorney-in-fact Form 10-K attorneys-in-fact attorneys-in-fact attorney-in-fact
    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 52




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##### 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  53




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##### 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,
    immediate vesting (19)10
.11*

Form of Employee Restricted Stock
    Agreement, current form10
.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) 54




---



##### Table of Contents



ExhibitNumber

Description10
.31

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
.32

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
.33

Sublease Agreement between
    Trillium Digital Systems Canada, Ltd. and OctigaBay Systems
    Corporation, dated as of January 13, 2003, with Consent to
    Subletting by and among 391102 B.C, Ltd. and Dominion
    Construction and Development Inc., Trillium Digital Systems
    Canada, Ltd., OctigaBay Systems Corporation and Intel
    Corporation, dated January 20, 2003, and Lease Agreement
    between Dominion Construction Company Inc. and 391102 B.C. Ltd.,
    Trillium Digital Systems Canada, Ltd. and Intel Corporation,
    dated March 5, 2001 (19)10
.34

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

Arrangement Agreement, dated as of
    February 25, 2004, by and among the Company, 3084317 Nova
    Scotia Limited and OctigaBay Systems Corporation (15)10
.36

Purchase Agreement, dated
    December 1, 2004, by and between the Company and Bear,
    Stearns & Co. Inc. as Initial Purchaser (12)10
.37

Senior Secured Credit Agreement
    among the Company, Cray Federal Inc. and Wells Fargo Foothill,
    Inc., dated May 31, 2005 (20)10
.38

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
.39

Amendment Number Two to Senior
    Secured Credit Agreement, dated as of March 14, 2006, among
    Wells Fargo Foothill, Inc., Cray Inc. and Cray Federal Inc. (28)10
.40

Amendment Number Three to Senior
    Secured Credit Agreement, dated as of July 12, 2006, among
    Wells Fargo Foothill, Inc., Cray Inc. and Cray Federal Inc. (31)10
.41

Credit Agreement, dated as of
    December 29, 2006, between Cray Inc. and Wells Fargo Bank,
    National Association  (29)10
.42

First Amendment, dated
    January 31, 2007, to Credit Agreement between Cray Inc. and
    Wells Fargo Bank, National Association21
.1

Subsidiaries of the Company23
.1

Consent of Peterson Sullivan PLLC,
    Independent Registered Public Accounting Firm23
.2

Consent of Deloitte &
    Touche LLP, Independent Registered Public Accounting Firm23
.3

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. 55




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##### Table of Contents



(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.(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)
    
    Incorporated by reference to the Companys Current Report
    on
    Form 8-K,
    as filed with the Commission on April 2, 2004.(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. 56




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##### Table of Contents



(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.(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.    *
    
    Management contract or compensatory plan or arrangement.  Regulation S-K,
 57




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##### Table of Contents



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


December 31,2005


2006ASSETSCurrent assets:Cash and cash equivalents

$
46,026


$
115,328Restricted cash






25,000Accounts receivable, net


55,064



44,790Inventory


67,712



58,798Prepaid expenses and other current
    assets


2,909



2,156Total current assets


171,711



246,072Property and equipment, net


31,292



21,564Service inventory, net


3,285



4,292Goodwill


56,839



57,138Deferred tax asset


575



722Intangible assets, net


1,113



1,404Other non-current assets


8,190



6,311TOTAL ASSETS

$
273,005


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

$
14,911


$
22,450Accrued payroll and related expenses


12,145



17,411Advance research and development
    payments


1,538



21,518Other accrued liabilities


9,164



5,121Deferred revenue


81,749



43,248Total current liabilities


119,507



109,748Long-term deferred revenue


5,234



2,475Other non-current liabilities


2,317



3,906Convertible notes payable


80,000



80,000TOTAL LIABILITIES


207,058



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, 22,743,377 and
    32,236,888 shares, respectively


422,691



507,356Exchangeable shares, no par
    value  Unlimited shares authorized; 19,710 and no
    shares outstanding, respectively


576



Deferred compensation


(2,811
)


Accumulated other comprehensive
    income


6,258



6,855Accumulated deficit


(360,767
)


(372,837
)TOTAL SHAREHOLDERS EQUITY


65,947



141,374TOTAL LIABILITIES AND
    SHAREHOLDERS EQUITY

$
273,005


$
337,503   See accompanying notes
 F-1




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  CONSOLIDATED
    STATEMENTS OF OPERATIONS
 (In
    thousands, except share data)
  Years Ended December 31,2004


2005


2006Revenue:Product

$
95,901


$
152,098


$
162,795Service


49,948



48,953



58,222Total revenue


145,849



201,051



221,017Operating expenses:Cost of product revenue


104,196



139,518



124,728Cost of service revenue


30,338



29,032



32,466Research and development, net


53,266



41,711



29,042Sales and marketing


34,948



25,808



21,977General and administrative


19,451



16,145



18,785Restructuring, severance and
    impairment


8,182



9,750



1,251In-process research and
    development charge


43,400







Total operating expenses


293,781



261,964



228,249Loss from operations


(147,932
)


(60,913
)


(7,232
)Other expense, net


(699
)


(1,421
)


(2,141
)Interest income (expense), net


365



(3,462
)


(2,095
)Loss before income taxes


(148,266
)


(65,796
)


(11,468
)Income tax expense (benefit)


59,092



(1,488
)


602Net loss

$
(207,358
)

$
(64,308
)

$
(12,070
)Basic and diluted net loss per
    common share

$
(9.95
)

$
(2.91
)

$
(0.53
)Basic and diluted weighted average
    shares outstanding


20,847



22,125



22,849   See accompanying notes
 F-2




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF SHAREHOLDERS
    EQUITY
     AND COMPREHENSIVE INCOME (LOSS)
    (In thousands)
  Common Stock











Accumulatedand Additional


Exchangeable





OtherPaid In Capital


Shares





Comprehensive








ComprehensiveNumber





Number





Deferred


Income


Accumulated





Incomeof Shares


Amount


of Shares


Amount


Compensation


(Loss)


Deficit


Total


(Loss)BALANCE, December 31, 2003


18,203


$
312,646






$



$
(105
)

$
(807
)

$
(89,101
)

$
222,633Common stock issued in acquisition
    of OctigaBay


1,846



56,756























56,756


$
Exchangeable shares issued in
    acquisition of OctigaBay










790



24,207















24,207



Deferred compensation related to
    acquisition of OctigaBay


45



1,190



421



11,185



(14,599
)










(2,224
)


Exchangeable shares converted into
    common shares


1,067



31,219



(1,067
)


(31,219
)


















Acquisition-related stock-based
    compensation expense


















11,134











11,134



Fair value of OctigaBay options
    acquired






2,579























2,579



Issuance of shares under Employee
    Stock Purchase Plan


101



1,796























1,796



Exercise of stock options


219



2,841























2,841



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


23



645























645



Exercise of warrants, less issuance
    costs of $191


320



3,634























3,634



Common stock issued for bonus


13



374























374



Compensation expense on restricted
    stock


















105











105



Compensation expense on
    modification of stock options






196























196



Compensation expense on stock
    options issued to contractors






35























35



Other comprehensive income:Unrealized loss on
    available-for-sale
    investments






















(33
)






(33
)


(33
)Currency translation adjustment


















(755
)


5,400







4,645



5,400Net loss


























(207,358
)


(207,358
)


(207,358
)BALANCE, December 31, 2004


21,837



413,911



144



4,173



(4,220
)


4,560



(296,459
)


121,965


$
(201,991
)Exchangeable 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















Amortization of deferred
    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
)   See accompanying notes
 F-3




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  CONSOLIDATED
    STATEMENTS OF CASH FLOWS
 (In
    thousands)
  Years Ended December 31,2004


2005


2006Operating activities:Net loss

$
(207,358
)

$
(64,308
)

$
(12,070
)Adjustments to reconcile net loss
    to net cash used in operating activities:Depreciation and amortization


17,179



19,578



16,181Share-based compensation expense


11,844



4,106



2,099In-process research and development
    charge


43,400







Inventory write-down


8,513



5,751



1,644Impairment of core technology
    intangible asset






4,912



Amortization of issuance costs,
    convertible notes payable and line of credit






1,008



1,644Deferred income taxes


59,188



(2,260
)


(124
)Other






80



Cash provided by (used in) changes
    in operating assets and liabilities, net of the effects of the
    OctigaBay acquisition:Accounts receivable


15,471



(21,623
)


10,305Inventory


(47,443
)


(10,628
)


2,410Prepaid expenses and other assets


11,555



3,908



337Service inventory


(58
)


141



Accounts payable


9,609



(8,422
)


7,562Accrued payroll and related
    expenses, other accrued liabilities and advance research and
    development payments


1,061



833



23,720Other non-current liabilities






473



36Deferred revenue


24,383



29,746



(41,136
)Net cash provided by (used in)
    operating activities


(52,656
)


(36,705
)


12,608Investing activities:Sales/maturities of short-term
    investments


68,635



44,437



Purchases of short-term investments


(68,318
)


(10,161
)


Acquisition of OctigaBay, net of
    cash acquired


(6,270
)






Proceeds from sale of investment










239(Increase) decrease in restricted
    cash


(11,437
)


11,437



(25,000
)Purchases of property and equipment


(12,518
)


(3,982
)


(2,611
)Net cash provided by (used in)
    investing activities


(29,908
)


41,731



(27,372
)Financing activities:Sale of common stock, net of
    issuance costs










81,250Proceeds from issuance of common
    stock through employee stock purchase plan


1,796



1,211



532Proceeds from exercise of options


2,841



138



2,625Proceeds from exercise of warrants


3,634







Proceeds from issuance of
    convertible notes payable


80,000







Convertible notes payable and line
    of credit issuance costs


(3,376
)


(755
)


(375
)Principal payments on capital leases


(742
)


(731
)


(123
)Net cash provided by (used in)
    financing activities


84,153



(137
)


83,909Effect of foreign exchange rate
    changes on cash and cash equivalents


370



(595
)


157Net increase in cash and cash
    equivalents


1,959



4,294



69,302Cash and cash equivalentsBeginning of period


39,773



41,732



46,026End of period

$
41,732


$
46,026


$
115,328Supplemental disclosure of cash
    flow information:Cash paid for interest

$
153


$
2,972


$
3,329Cash paid for income taxes


590



312



279Non-cash investing and financing
    activities:Inventory transfers to fixed assets
    and service inventory

$
11,281


$
8,703


$
4,860Shares issued in acquisition


83,542







Warrants 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
    REVERSE
    STOCK SPLIT  one-for-four Form 10-K
  NOTE 3
    SUMMARY
    OF SIGNIFICANT ACCOUNTING POLICIES  Accounting
    Principles
    Principles
    of Consolidation
    Reclassifications
    Use of
    Estimates
   F-5




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Cash,
    Cash Equivalents and Restricted Cash
  Note 14  Convertible Notes Payable and
    Lines of Credit.
  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
  Products.
  
    Cray X1/X1E and Cray XT3/XT4 Product
    Lines:  The Company recognizes revenue from
    product sales upon customer acceptance of the system, when there
    are no significant unfulfilled Company obligations stipulated by
    the contract that affect the customers final acceptance,
    the price is fixed or determinable and collection is reasonably
    assured. A customer-signed notice of acceptance or similar
    document is required from the customer prior to revenue
    recognition.
    Cray XD1 Product Line:  The Company recognizes
    revenue from product sales of Cray XD1 systems upon shipment to,
    or delivery to, the customer, depending upon contract terms,
    when there are no significant unfulfilled Company obligations
    stipulated by the contract, the price is fixed or determinable
    and collection is reasonably assured. If there is a contractual
    requirement for customer acceptance, revenue is recognized upon
    receipt of the notice of acceptance and when there are no
    unfulfilled obligations.  SOP 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.
  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, the Companys
    performance with respect to any undelivered element is within
    the Companys control and probable.    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
    (FAS 109).
  Stock-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)
     2004

2005

2006Risk-free interest rate

4.2%

4.1%

4.5%Expected dividend yield

0%

0%

0%Volatility

82%

85%

73%Expected life

6.9 years

4.6 years

4.0 yearsWeighted average Black-Scholes
    value of options granted

$15.00

$5.44

$6.00           F-11




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  2004


2005Net loss, as reported

$
(207,358
)

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


11,844



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


(19,423
)


(30,524
)Pro forma net loss

$
(214,937
)

$
(90,726
)   Note 15  Shareholders
    Equity  Stock Option Plans.
    2004


2005Basic and diluted net loss per
    common share:As reported

$
(9.95
)

$
(2.91
)Pro forma

$
(10.31
)

$
(4.10
)   Shipping
    and Handling Costs
    Advertising
    Costs
    Earnings
    (Loss) Per Share (EPS)
   F-12




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Accumulated
    Other Comprehensive Income
    2004


2005


2006Accumulated unrealized loss on
    available-for-sale
    investments

$
(24
)

$



$
Accumulated currency translation
    adjustment


4,584



6,258



6,855Accumulated other comprehensive
    income

$
4,560


$
6,258


$
6,855   Recent
    Accounting Pronouncements
  Accounting for Uncertainty in Income Taxes
  Fair Value Measurements
  Employers Accounting for Defined Benefit Pension and
    Other Postretirement Plans
  The
    Fair Value Option for Financial Assets and Financial
    Liabilities
 F-13




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   NOTE 4
    ACCOUNTS
    RECEIVABLE, NET    2005


2006Trade accounts receivable

$
23,023


$
39,766Unbilled receivables


12,340



4,045Advance billings


19,894



1,07855,257



44,889Allowance for doubtful accounts


(193
)


(99
)Accounts receivable, net

$
55,064


$
44,790       NOTE 5
    INVENTORY    December 31,2005


2006Components and subassemblies

$
10,706


$
22,536Work in process


8,314



15,310Finished goods


48,692



20,952$
67,712


$
58,798      F-14




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   NOTE 6
    PROPERTY
    AND EQUIPMENT, NET    December 31,2005


2006Land

$
131


$
131Buildings


9,638



9,965Furniture and equipment


14,161



14,753Computer equipment


70,704



73,825Leasehold improvements


3,046



3,06097,680



101,734Accumulated depreciation and
    amortization


(66,388
)


(80,170
)Property and equipment, net

$
31,292


$
21,564     NOTE 7
    SERVICE
    INVENTORY, NET    December 31,2005


2006Service inventory

$
26,201


$
28,797Accumulated depreciation


(22,916
)


(24,505
)Service inventory, net

$
3,285


$
4,292   NOTE 8
    GOODWILL
    AND INTANGIBLE ASSETS    2005


2006Goodwill, at January 1

$
55,644


$
56,839Foreign currency translation
    adjustments and other


1,195



299Goodwill, at December 31

$
56,839


$
57,138        F-15




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   NOTE 9
    DEFERRED
    REVENUE    December 31,2005


2006Deferred product revenue

$
58,593


$
26,993Deferred service revenue


28,390



18,730Total deferred revenue


86,983



45,723Less long-term deferred revenue


(5,234
)


(2,475
)Deferred revenue in current
    liabilities

$
81,749


$
43,248     NOTE 10
    RESTRUCTURING
    AND SEVERANCE CHARGES          2004


2005


2006Balance, January 1

$
3,069


$
4,690


$
3,582Additional restructuring charge


8,077



5,092



1,284Payments


(6,420
)


(5,724
)


(3,849
)Adjustments to previously accrued
    amounts


(91
)


(255
)


(33
)Foreign currency translation
    adjustment


55



(221
)


79Total restructuring and severance
    liability, December 31


4,690



3,582



1,063Less long-term restructuring and
    severance liability






(362
)


Current restructuring and
    severance liability

$
4,690


$
3,220


$
1,063  F-16




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  NOTE 11
    FOREIGN
    CURRENCY DERIVATIVE      NOTE 12
    COMMITMENTS
    AND CONTINGENCIES      Convertible Notes Payable and Lines of Credit.
  Capital


Operating


DevelopmentLeases


Leases


Agreements2007

$
32


$
3,215


$
12,9222008






2,576



432009






793



2010






205



2011






205



Thereafter






22



Minimum contractual commitments


32


$
7,016


$
12,965Less amount representing interest


(1
)Recorded capital lease obligations

$
31      F-17




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Litigation
          Other
    NOTE 13
    INCOME
    TAXES  Accounting for Income Taxes
    Year Ended December 31,2004


2005


2006United States

$
(92,654
)

$
(63,304
)

$
(10,550
)International


(55,612
)


(2,492
)


(918
)Total

$
(148,266
)

$
(65,796
)

$
(11,468
)  F-18




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Year Ended December 31,2004


2005


2006Current provision:Federal

$



$



$
State






128



109Foreign


581



644



617Total current provision


581



772



726Deferred provision (benefit):Federal


61,906







State


(3,466
)






Foreign


71



(2,260
)


(124
)Total deferred provision (benefit)


58,511



(2,260
)


(124
)Total provision (benefit) for
    income taxes

$
59,092


$
(1,488
)

$
602     2004


2005


2006Federal statutory income tax rate


(35.0
)%


(35.0
)%


(35.0
)%State taxes, net of federal effect


(2.4
)


(3.1
)


(3.6
)Foreign income taxes at other than
    U.S. rates


(0.3
)


1.0



5.0In-process research and
    development write-off


10.6







Permanent differences


3.9



1.5



8.2Foreign tax credit


(0.3
)






Research and development tax credit


(1.0
)


(2.1
)


(7.6
)Other


(0.1
)


(0.4
)


(4.5
)Effect of change in valuation
    allowance on deferred tax assets


64.5



35.8



42.7Effective income tax rate


39.9
%


(2.3
)%


5.2
%  F-19




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    December 31,2005


2006AssetsCurrent:Inventory

$
2,840


$
2,610Accrued compensation


1,876



4,292Deferred service revenue


684



815Gross current deferred tax assets


5,400



7,717Valuation allowance


(5,377
)


(7,717
)Net current deferred tax assets


23



0Long-Term:Property and equipment


709



455Research and experimentation


12,447



12,587Net operating loss carryforwards


115,110



117,454Accrued restructuring charge


764



240Other


576



518Gross long-term deferred tax assets


129,606



131,254Valuation allowance


(129,031
)


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


575



722Total net deferred tax assets

$
598


$
722         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
   F-21




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      NOTE 15
    SHAREHOLDERS
    EQUITY  Preferred Stock:
  Common Stock:
    Exchangeable Shares:
  Shareholder Warrants:
  Shares of


Exercise Price


ExpirationCommon Stock


per Share


Date of Warrants50,000


$
6.60


June 3, 20091,284,852


$
10.12


June 21, 20091,334,852     Restricted Stock: 18-month
 F-22




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Stock Option Plans:
  Accounting for Certain Transactions Involving Stock
    Compensation
  ,
   F-23




---



##### Table of Contents



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


Remaining


AggregateExercise


Contractual


IntrinsicOptions


Price


Term


ValueOutstanding at January 1, 2004


3,035,033


$
20.92Granted


1,004,958



18.36Exercised


(218,964
)


12.92Canceled


(249,929
)


21.64Outstanding at December 31,
    2004


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



14.68



7.0 years


$
7.2 millionExercisable at December 31,
    2006


3,144,887



15.64



6.4 years


$
6.2 millionAvailable for grant at
    December 31, 2006


2,319,928     (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.  in-the-money
    WeightedAverageGrant DateShares


Fair ValueOutstanding at December 31,
    2004





$
Granted during 2005


491,250



5.87Outstanding at December 31,
    2005


491,250



5.87Granted during 2006


354,993



10.08Outstanding at December 31,
    2006


846,243



7.63  F-24




---



##### Table of Contents



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


87,111



8.6


$
3.77



87,111


$
3.77$ 4.01  $ 8.00


789,160



6.9


$
6.25



780,863


$
6.24$ 8.01  $10.00


292,921



7.1


$
9.32



270,046


$
9.38$10.01   $12.00


1,092,908



8.5


$
10.67



403,008


$
10.87$12.01   $14.00


208,181



7.7


$
13.70



208,181


$
13.70$14.01   $16.00


534,145



6.6


$
15.15



534,145


$
15.15$16.01   $32.00


542,743



4.8


$
24.99



541,337


$
24.98$32.01   $54.75


320,246



5.9


$
39.37



320,196


$
39.37$0.00   $54.75


3,867,415



7.0


$
14.68



3,144,887


$
15.64     2004


2005


2006Cost of product revenue

$



$



$
60Cost of service revenue










101Research and development


5,068



3,444



386Sales and marketing


2,837



579



334General and administrative


3,229



13



1,218Total share-based compensation
    expense

$
11,134


$
4,036


$
2,099   Employee Stock Purchase Plan:
  NOTE 16  BENEFIT
    PLANS
  401(k)
    Plan
   F-25




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Pension
    Plan
    NOTE 17  SEGMENT
    INFORMATION
  Disclosure about Segments of an
    Enterprise and Related Information
    AllUnited


OtherStates


Countries


TotalFor the year ended
    December 31, 2004:Product revenue

$
86,067


$
9,834


$
95,901Service revenue

$
34,800


$
15,148


$
49,948For 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


$
100,719For 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


$
90,709    F-26




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      NOTE 18  RESEARCH
    AND DEVELOPMENT
    December 31,2004


2005


2006Gross research and development
    expenses

$
98,843


$
96,257


$
99,061Less: Amounts reimbursed or
    included in cost of product revenue


(45,577
)


(54,546
)


(70,019
)Net research and development
    expenses

$
53,266


$
41,711


$
29,042   NOTE 19  INTEREST
    INCOME (EXPENSE)
    2004


2005


2006Interest income

$
666


$
741


$
2,525Interest expense


(301
)


(4,203
)


(4,620
)Net interest income (expense)

$
365


$
(3,462
)

$
(2,095
)     Note 14  Convertible Notes Payable
    and Lines of Credit.
  NOTE 20  RESTATEMENT
    OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS
   F-27




---



##### Table of Contents



CRAY INC.
    AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     Consolidated Statement of OperationsAs PreviouslyReported


As Restated


ChangeYear Ended December 31, 2004:Product revenue

$
99,236


$
95,901


$
(3,335
)Total revenue

$
149,184


$
145,849


$
(3,335
)Cost of product revenue

$
107,264


$
104,196


$
(3,068
)Research and development (a)

$
50,198


$
53,266


$
3,068Net loss

$
(204,023
)

$
(207,358
)

$
(3,335
)Basic and diluted net loss per
    common share

$
(9.79
)

$
(9.95
)

$
(0.16
)       (a)
    
    Previously reported amount was increased by $5,068 to conform to
    2005 financial statement presentation. Amount was reclassified
    from Acquisition-related Compensation Expense. F-28




---



##### Table of Contents



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




---



##### Table of Contents



REPORT OF
    INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
             
     F-30




---



##### Table of Contents



Schedule II 
    Valuation and Qualifying Accounts
    December 31, 2006
  Balance at








Balance atBeginning


Charge/(Benefit)





End ofDescription

of Period


to Expense


Deductions


PeriodYear ended December 31,
    2004:Allowance for doubtful accounts

$
1,125


$
373


$
(59
)(1)

$
1,439Warranty accrual

$
655


$



$
(655
)

$
Year 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

$



$



$



$
     (1)
    
    Represents uncollectible accounts written off, net of recoveries. F-31